17/7/2013: Sunday Times, July 14: The New Normal for Ireland

This is an unedited version of my Sunday Times article from July 14, 2013.



The release of the Irish quarterly national accounts for Q1 2013 two weeks ago should have been a watershed moment for Ireland. Aside from confirming the fact that Irish economy is back in a recession, the new figures reinforce the case for the New Normal – a longer-term slowdown in trend growth and continued volatility of economic performance along this trend. The former revelation warrants a change in the short-term policies direction. The latter requires a more structural policies shift.


Months ago, based on the preliminary data for the last quarter of 2012, it was painfully clear that Irish economy has entered another period of economic recession. This point was made on these very pages back in early March although it was, at the time, vigorously denied by the official Ireland.

Irish economy is currently in its fourth recession in GDP terms since 2007. Q1 2013 marked the third consecutive quarter in the latest recessionary episode. Since the onset of the crisis, Ireland had 17 quarters of negative growth in private and public domestic investment and expenditure, and counting.

For the Government that spent a good part of the last 2 years telling everyone willing to listen about our returning fortunes, things are looking pretty grim. Since settling into the office by the end of H1 2011, through the first quarter 2013, Coalition-steered economy has contracted by EUR1.52 billion or 3.75%.

The fabled exports-led recovery, first declared in Q1 2010, is not translating into real economic expansion. Neither do scores of strategic policies documents launched with promises of tens of thousands of new jobs.

With the national accounts officially in the red, the bubble of claimed policies successes is bursting. What is emerging from behind this bubble is the New Normal. Whether we like it or not, in years to come we will continue facing high risks to growth and a lower long-term growth trend. Traditional Keynesianism and Parish Pump Gombeenism - the two, largely complementary policy options normally promoted in Ireland - cannot sustain us in the future.

Prior to the crisis, Irish economy experienced three periods of economic growth, all driven by different internal and external forces, none of which are likely to materialize once again any time soon.

The first period of 1991-1997 witnessed rapid convergence in physical and financial capital, as well as in human capital utilization to the standards, observed in other small open economies of the EU.

From 1998 through 2003, Irish economy experienced a combination of rising share of economic activity generated in the domestic economy and rapid expansion of the financial services. This period is characterised by two short-lived, but significant booms and busts: the dot.com expansion and the subsequent dramatic acceleration in public spending.

From the late 1990s, Ireland also experienced accelerating property boom, which culminated in an unsustainable investment bubble. All three periods of economic expansion in recent past were underpinned by favourable external demand for MNCs exports out of Ireland, low or falling cost of capital and accommodative tax environments, in which tax competition was an accepted norm.

These drivers are now history.

Since the onset of the second stage of the domestic economy’s recession in H2 2010, Ireland has entered an entirely new period of development that will shape our long-term growth performance.

Externally, our capacity to extract rents and growth out of tax arbitrage is coming under severe pressures, best highlighted by the recent G8 decisions, the CCCTB proposals tabled in Europe and by accelerated tax policies gains in countries capable of serving big growth regions outside the EU. The financial repression that commonly follows credit busts is also denting our tax-driven growth engine by raising competition for tax revenues, and lowering our real cost competitiveness vis-à-vis Europe and North America.

Internally, since 2002, MNCs-led manufacturing in Ireland has suffered what appears to be an irreversible decline. Goods exports are down from EUR90.4bn in 2002 to EUR78.7bn in 2012 before we take account for inflation. Meanwhile, exports of services are up from EUR32.2bn to EUR93.3bn. Problem is: over the same time, services exports net contribution to the economy has expanded by only EUR18 billion. More worryingly, services exports growth is now falling precipitously.

Data from the Purchasing Managers Indices confirms the long-term nature of our economic slowdown. Average rates of growth in GDP are now closer to 1.5% per annum based on Services sectors contribution and closer to 1.0% for Manufacturing. Prior to the crisis these were 7.0% and 2.6%, respectively. In 1990-2007, all sectors included, Ireland experienced average annual growth of 6.6%. Now, we are looking at ca 1.5-1.7% average growth rates through 2020.

Lower growth rates for Ireland will be further reinforced by the lack of access to credit flows previously abundantly available from the global funding markets. This will impact our banks lending, direct debt issuance by companies, and securitised or asset-backed credit.

The retrenchment of the global financial flows away from the euro area, coupled with regulatory changes in European banking suggest that investment in the New Normal will become inseparably linked to the internal economy and significantly more expensive than the decade preceding the 2008 crisis. Much of this change will be driven by the same financial repression that will act to reduce our tax regime advantages.

This means that at the times of adverse shocks - such as, for example, a fall in revenues from exports or an increase in foreign companies extraction of profits from Ireland – our economy will be experiencing more severe credit and income contractions. This will put more pressure on investment and lower the velocity of money in the economy. Longer-term capital financing will become more difficult as domestic investors will face more uncertain returns and higher liquidity risk. A bust and severely restricted in competitiveness banking sector - legacy of the misguided post-2008 reforms - will not be helpful.

Thus, in the future, switch to services exports away from manufacturing and domestic investment, and reduced access to credit will mean higher volatility in growth, and lower predictability of our economic environment.

The New Normal requires more agile, more responsive and better-diversified economic systems, alongside a more conservative risk management in fiscal policies and less centralisation and harmonisation of policies at super-national level. It also calls for more aggressive incentivising of domestic investment and savings.

In terms of the fiscal policy stance, this means adopting a more cautious approach advocated, in part, by the ESRI this week. Irish Government should aim to continue reducing public spending, but do so in a structural way, not in a simplified framework of pursuing slash-and-burn targets. In addition, the Government needs to re-focus on identifying lines of expenditure that can be re-directed toward more productive use. In the short run, this can take the form of switching some of the current expenditure into capital investment programmes.

Reforms of social welfare, public education, health and state pensions systems will have to make these lines of spending more effective in helping people in real need, while slimmer in terms of total spend allocations. This can be achieved by direct means-testing and capping some of the benefits. But majority of these changes will have to wait until after the immediate unemployment and growth crises have passed.

In the longer run, going beyond the ESRI proposals, the Government should permanently reallocate some of the spending (such as, for example, overseas aid or poorly performing enterprise supports) to areas where it can increase value-added in public services (e.g. water supply or public transport) and create new exports platforms (e.g. e-health and higher quality internationally marketable education). Additionally, new revenues should be raised from severely undertaxed sectors and assets, such as agriculture and land, to be used to lower tax burden on both, ordinary and highly skilled workers.

Beyond a short-term stimulus, rather than directing tax- and debt-funded new investment, public sector should help generate new opportunities for more intensive growth. Increasing value added in existent activities, not simply scaling these activities up in terms of quantity of services deployed or employment levels involved should become the priority for future public sector growth.

Adding further to the ESRI analysis, the objective of using fiscal policy to drive enterprise creation requires simultaneously freeing more resources in the private sector to invest in new technologies acquisition and adoption, and development of indigenous R&D. We need to increase, not shrink, disposable incomes of the middle- and upper-middle classes and improve incentives for these segments of the population to invest. IBEC's suggestion this week that the Government should abandon any future tax increases makes sense in this context. The key, however, is that direct and indirect income tax increases of recent years must be reversed.

We need to recognise, support and scale up clustering initiatives in the tech and R&D sectors that deliver partnerships between the existent MNCs and larger domestic enterprises and start ups. To do this, we should create direct links between the existent clusters, such as for example IT@Cork initiative and public procurement systems. To re-orient public procurement toward supporting younger enterprises, larger procurement tenders should explicitly target new opportunities for partnerships between MNCs and SMEs or start-ups.

To address structural decline in debt financing available in the economy, we should exempt from taxation capital gains accruing to any real investment in Irish enterprises, including the IPOs and new rights issues, where such investments are held for at least 5 years. To qualify for this scheme, an enterprise should have at least a quarter of its worldwide employees based in Ireland.

The New Normal of lower trend growth and higher uncertainty about the economic environment is here. Addressing the challenges it presents requires robust policy reforms. The least painful and the most productive way of implementing these would be to start as early as possible.

Box-out:

Recent report from CBRE on office market in Dublin for Q2 2013 provides an interesting insight into the commercial real estate markets dynamics in Ireland. Despite the cheerful headlines and some marginally encouraging news, the market remains in deep slump and so far, hard data shows no signs of a major revival. Good news: vacancy rate in Dublin office space has declined by 4% on Q1 2013, to 17.2% in Q2 2013. The vacancy rate was 19.32% in Q2 2012. Bad news: at this rate, it will take us good part of 10 years to catch up with the EU-average rates. More bad news: office investment spend fell from EUR79.6mln in Q2 2012 to EUR72.6mln in Q2 2013. Adding an insult to the injury, prime yields fell from 7.0% to 6.25% in the year through June 2013. The office market in Dublin is firmly reflective of what is happening in the economy. Only 37% of offices take ups in Q2 2013 were by Irish companies. Massive 65-66% of the city and suburban office space was taken up by the ICT and Financial services providers in a clear sign that outside these sectors, economic activity remains largely stagnant. Overall, on a quarterly basis, offices take up in Dublin has fallen for the second quarter in a row while there was the first annual decline since Q3 2012.

27/4/2013: Village Magazine, April 2013

The third of three posts covering my recent articles.

This is an unedited version of my regular column in The Village magazine, April 2014.




As the events of the last few weeks clearly show, Irish trade union movement is suffering from a number of acute crises, ranging from systemically existential to psychological.

First up, the crisis of identity, best symptomised by the conclusion of the Croke Park 2.0 deal in which the Unions once again traded the interests of their future members – the younger public sector workers – to preserve the privileges of their current and past members. This is hardly surprising. During the last decade-and-a-half, the Unions and their leadership have became firmly embedded in the corporatist structure of the Irish State. Self-serving, focused on the immediate membership concentrated in the least productive sectors of the economy, the unions have opted to be paid over being relevant to the changing economy and society.

Second, the crisis of the short-term memory amnesia. In recent weeks, the Irish Trade Unions have managed to produce much bluster on the topic of the centenary anniversary of the 1913 Lockout. Throughout the crisis, the very same unions have been vocal on the topics of social fairness, austerity, protection of the frontline services etc. Yet, all along, the Liberty Hall has attempted to sweep under the rug its principal role in helping the Irish State to polarize and pillage both the society and the economy during the Celtic Tiger era, in part aiding the very processes that led to our national insolvency. Promoting the narrow interests of the state and associated domestic private sectors’ elites, the Social Partnership (including the two Croke Park agreements) assured boards representations, funds and other pathways to decision-making for unions. This power was deployed consistently to reduce accountability in the public sector for decisions and actions of its foot soldiers and bosses alike. By corollary of the cooperative approach to policy formation, the Partnership also protected domestic sectors, especially those dominated by the semi-state companies.  As the money rolled into the unionized sectors of the economy, the Unions had no problem with rampant costs inflation in health insurance and services, energy, transport, and education. The interests of the own members were always well ahead of the interests of the society at large.  Thus, today, in the environment of reduced incomes and high unemployment, with hundreds of thousands households in sever financial distress, Liberty Hall sees no problem with state-generated inflation in state-controlled Unionized sectors.

All in, the irony has it, Irish Trade Unions movement has been traveling along the same road previously mapped out by the Anglo Irish Bank: reducing their scope of competencies, their reach across various social. demographic and economic groups, and focusing on a singular, medium-term unsustainable objective. Where Anglo, post-2001, became a monoline bank for funding speculative property plays, Irish Trade Unions today are a monoline agency for preserving the status quo of the incumbent public vs private sector divisions in the economy.

The failure of the Trade Unions movement model in Ireland is best exemplified by the years of the current crisis.

Since the onset of the present economic recession Irish Government policy, directly and indirectly supported by the majority of the Unions’ leaders was to consistently shift the burden of the economic adjustment to younger workers in both private and public sectors, indebted Irish households, and consumers. Liberty Hall’s clear objective underpinning their position toward these groups of people was to retain, at all possible costs, the pay and working conditions protection granted to the incumbent full-time employees in the public and semi-state sector. Grumbling about the ‘low-paid public sector workers’ aside, the Unions have consented to the creation of a two-tier public sector employment with incumbent workers collecting the benefits of jobs security and higher pay, and the new incoming workers paying the price of these benefits with lower pay and virtually no promotion opportunities. The very same unions are now acting to preserve, at huge costs to the economy, unsustainably high levels of employment in our zombified banking sector.

Even on the surface, based on the headline figures, the Unions act to protect the pay and working conditions of the incumbent public sector employees. Average weekly earnings in Ireland have fallen 2.7% between 2008 and 2012 in the private sectors, while in the broader public sector these were down only 1.1%. Over the same period of time, the pay gap between public and private sector has risen from 46.1% in favour of public sector employees to 48.5%.

But the reality is much worse than that.  Between 2008 and 2012, numbers in employment in private sectors have fallen 14.7% while in the public sector the decline was less than 8.9%.  Within the public sector, largest losses in employment took place in Defence (-20% on 2008), Regional bodies (-15.4% on 2008), Semi-State bodies (-10.1%). No layoffs or compulsory redundancies took place, with natural attrition and cuts to contract and temporary staff taking on all of the adjustments.

In simple terms, the Machiavelian Croke Park deals have meant that the Irish public sector ‘reforms’ were neither structural, nor progressive in their nature. These ‘reforms’ do not support long-term process of realigning Irish economy to more sustainable growth path away from the bubbles-prone path of the last fifteen years.

Lack of layoffs and across-the-board shedding of temporary and contract staff have meant that the public sector in Ireland has lost any ability to link pay and promotions to real productivity differentials that exist between individual employees, work groups and organizations. This effect was further compounded by the Croke Park 2.0 agreement. The shinier the pants, the higher the pay principle of rewards has now been legally enshrined, relabeled as a ‘reform’ and fully protected at the expense of younger, better educated and potentially more innovative employees.


Such a system of pay and promotions engenders severe and irreversible selection bias, whereby the quality of applicants for jobs in the public sector is likely to decline over time, with more ambitious and more employable candidates opting out of pursuing careers in the state sector. Deterred by limited promotions opportunities and lower pay for the same, and in some cases heavier workloads, younger applicants are likely to seek work in private sector and outside the country. This selection bias will only gain in strength as economy starts to add private jobs in the future recovery.

The status quo of non-meritocratic employment in the public sector will also mean continued emigration of the younger workers with internationally marketable skills.

Meanwhile, per EU-wide KLEMS database, back at the peak of the public sector activities in 2007, labour productivity in Ireland’s public sectors was already running at below 1995 levels. In Public Administration and Defence, Compulsory Social Security sector, labour productivity stood at below 86% of 1995 levels, in Education at 80% and in Health and Social Work at 95%. In contrast, in Industry, labour productivity in 2007 was running at 153% of 1995 levels.  The same holds for the technological innovation intensities of the specific sectors. Three core public sectors of public administration, education and health all posted declines in productivity associated with new technologies compared to 1995 of 17-30% against an increase of 8% in Industry and a 20% rise in Manufacturing.

If Irish public services productivity was falling in the times of massive spending uplifts and big-ticket capital investment programmes, what can we expect in the present environment of drastically reduced investment? Unfortunately, we do not have data beyond 2007 to provide such an insight.  But the most probable answer is that stripping away superficial productivity gains recorded due to higher current spend on social welfare supports being managed by fewer overall state employees, plus the productivity growth arising from reductions in employment levels, there is little or no real same-employee productivity gains in the public sector.

One has to simply consider the ‘cost reduction’ measures enacted through the Budgets 2010-2012 to realize that during the crisis, Irish public sector was shedding, not adding responsibilities. Much of these reductions in services was picked up by the private sector payees and providers. This too implies that the actual productivity in the public sector in Ireland has probably declined during the years of the crisis.

Marking the centenary anniversary of the 1913 Lockout, Irish Trade Unions movement needs serious and deep rethink of both its raison d’etre and its modus operandi. Otherwise the movement is risking being locked out of the society itself as the irrelevant and atavistic remnant of the Celtic Tiger and Social Partnership.

The Liberty Hall must shake off the ethos of corrupting proximity to the State power and re-discover its grass roots. It will also need to purge completely the legacy of the Social Partnership and embrace new base within the workforce and the society at large in order to assure its ability to last beyond the rapidly advancing retirement age of its members. Lastly, the Unions should think hard about their overall role in the society to better balance the interests of their members against the needs of the country and the reality of the new economy.

Irish society needs a strong and ethically underpinned Unions as the guarantors of the rights of association and supporters of the policy dialogues and debates. What Ireland does not need is another layer of quasi-state bureaucracy insulating protected elites and sectors from pressures of demographically young, technologically modernizing and global competitiveness-focused small open economy.

27/4/2013: Sunday Times : April 7, 2013

Second post of three catching up with some of my recent articles.

This is an unedited version of Sunday Times article from April 7, 2013.


Just when the EU leaders were ready to relax after the tough couple of weeks spent dismantling the economy of Cyprus, the news flow has turned once again and, predictably, not in their favour.

Over the last week, euro area Purchasing Managers Indices for manufacturing have showed that the economic activity in the sector has fallen for 19th consecutive month. The downturn in the eurozone manufacturing has accelerated, slipping to 46.8 in March, down from 47.9 in February. In Ireland, manufacturing PMI reading fell to a 14-months low at 48.6.

Meanwhile, Eurostat data showed that seasonally adjusted unemployment in the common currency area reached 19.1 million in February, up on 17.3 million a year ago. In Ireland, seasonally adjusted unemployment rate is stuck at 14.2% since December 2012, while youth unemployment rate rose to 30.8% in February.

Adding insult to an injury, CEPR and Bank of Italy leading growth indicator for the euro area, eurocoin, posted another negative reading in March. This means that the euro area economy has been contracting now for 18 months in a row. The previous crisis of 2008-2009 counted only 13 months of continued sub-zero readings.

In short, over the last 10 days we had a plethora of reminders that the current growth crisis sweeping across the euro area is both deep and structural in nature. Which puts into the context last week’s warning from the IMF to Ireland that the headwinds to our economic growth prospects in the medium term are posing some serious risks to the prospects of our recovery and debt sustainability.


The underlying causes of the crisis we are experiencing since 2008 relate to the structural weakness in our economic system when it comes to identifying, pursuing and delivering organic growth opportunities.

Since around 1997-1998, Irish economy has been growing by one asset bubble displacing another. We started with a sizeable bubble in the ICT sector that inflated out of any proportion with the real economy from 1997 and finally met its end with the dot.com crash of 2000-2001. Alongside this bubble, around 1998, we began to inflate a public spending and investment bubble. Between 1999 and 2005 Irish Government voted spending rose from EUR22.8bn to EUR45.1bn, with 2001-2002 period increases accounting for 43% of the total  rise over 1999-2005. Rampant over-spending in the public sector was coincident with (and co-dependent on) a massive bubble in the property market.

In short, Irish economy has been running on steroids of spending or credit bubbles for some eleven years prior to the crisis of 2008. An entire generation of Irish policymakers, analysts, bankers, investors and businessmen has matured with not a slightest idea as to where the real sustainable economic value added comes from other than the over-inflated egos, valuations and leverage.

As the result, today, we need serious reforms to reduce our reliance for growth on the structurally sick euro area, and to shift our own economy's development engine away from unsustainable reliance on bubbles-inflating activities and re-focus it on growth reliant on high value added activities, entrepreneurship and human capital.

On human capital, OECD's annual Going for Growth report from 2013 shows that Irish economy suffers from structural deficiencies in labour force participation by women. On average, women outside the workforce have higher skills and better work experience than men in similar demographics and work status. However, women participation rates in Ireland are below those in many other advanced economies due to a combination of factors, including high cost of early age education, childcare.

Improving affordability and access to childcare is an imperative for Ireland, given our demographics, but we also require a wholesale re-balancing of our tax system to reduce Exchequer reliance on income tax-related revenues. Current tax system in Ireland penalises skills and higher investment in human capital through excessive taxation at the upper marginal tax rate and exceptionally low threshold for the upper tax band applicability.

Other labour market measures needed include: increasing resources for job-search assistance and workplace training within the existent education systems, and better aligning training programmes with skills needs of the economy. Both of these objectives formed cornerstone of the Fas reforms. However, these reforms were only partial, especially considering that the very same people who were responsible for the past training and up-skilling systems failures are now manning in the reformed entities.

Irish economy must become more knowledge and skills-intensive - a process that requires simultaneous development and rapid expansion of our R&D capacity and output, as well as our human capital base.

On R&D front, the Government pursued policy of retaining and even enhancing R&D tax credits. Alas, recent research shows that lower tax rate on patent income is more effective in improving R&D climate in the economy than R&D tax credits and allowance.

Supporting human capital investment in the economy means strengthening value-for-money delivery in public services, providing higher quality services to skilled workers (an area where Irish system fails completely), reducing tax disincentives relating to human capital and enhancing our education, training and immigration systems to improve inflow of human capital.

Education acts as major driver of human capital formation and innovation in the economy, as well as a viable exporting sector. In a small economy like Ireland we have to think outside the box to deliver greater efficiencies in the higher education sector.

We need to decentralise pricing and decision-making in universities and IT sector by introducing variable, flexible fees reflective of differences in degrees and awarding institutions. To continue increasing access to education a system of merit and need-based grants should be used to offset the cost of tuition. Ireland has three or four internationally competitive universities with potential to compete globally for quality students and staff, including TCD, UCD and UCC. These universities should move toward a model of accepting 2nd and 3rd year undergraduates to deliver full and internationally-competitive 4 year degrees. This can free more resources to focus on post-graduate education. Other Universities can continue with the current model of 3 year degrees and focus on undergraduate education with post-graduate training geared toward more applied fields. IT schools should become feeder-schools for universities, supplying early-stage undergraduate training equivalent to years 1 and 2 of the 4-year degrees, and on professional and applied training.


Both OECD and the IMF focus a lot of attention on increasing competition and efficiencies in our non-manufacturing domestic sectors, including energy, utilities, health insurance, legal and professional services. The recent strengthening of the Competition Authority is helpful, but hardly sufficient, especially in the environment where regulators of the domestic services are captives of the semi-state companies operating in these sectors. The way to break this industry stronghold on the state is to break up and privatise commercial semi-state entities. The Government has committed to such actions, but no privatizations took place to-date and the break ups under the planned privatizations remain inadequate in scope.

The same principles of increasing completion and choice of service providers should apply to the all client-facing public services. Alas, the Government is incapable of even starting a debate about such a change in the status quo.


Another major reform of domestic economy we need to undertake that is not covered by the Government strategies is the change in the way we fund our business creation and growth. Globally, as the fall-out from the financial crisis settles, advanced economies are shifting more and more corporate and SMEs funding away from debt, toward business equity. In Ireland, such a change is being held back by a number of small policy bottlenecks.

One is the unequal treatment of debt and equity in taxation. Last month, IMF published a research paper looking at the effects of preferential treatment that debt financing receives over equity in the majority of the advanced economies. The paper concluded that such asymmetry in taxation increases likelihood and severity of the financial crises. IMF study shows that providing for a tax on business equity returns, in line with the treatment of bonds returns, is the most effective measure to improve systemic stability of the economy.

The second, and somewhat related bottleneck is the punitive treatment of employee share ownership in Ireland. Issuance of business equity to key and long-term employees is both an efficient means for raising capital for the firms and for incentivising key employees. However, in Ireland, such a move triggers income tax liability on equity granted for the employees, which is completely divorced from any actual returns accruing to the employee. The solution to this problem is simple enough: the state should apply capital gains tax to employees shares, with an added incentive for shares issued to long-term key employees.

Another major problem with out tax regime is the application of taxes to proceeds from the sale of business. Many new ventures are launched by entrepreneurs on the basis of funding obtained from the sale of pervious business. Allowing a 2-3 year tax-deferral for any reinvestment of such proceeds can stimulate flow of funding into the Irish economy, reduce incentives for entrepreneurs to domicile outside Ireland prior to the sale of business and net exchequer more tax revenues over the medium term than the current regime allows.

Reaching well beyond the confines of the existent Troika and Government-own programmes for reforms, the above measures can help shift Ireland’s growth model away from unsustainable reliance on tax arbitrage activities of the MNCs and bubbles-prone domestic investment.

Box-out:

Recent data from CSO’s Residential Property Price Index and the GeoView/DKM survey of commercial property vacancy rates shows that contrary to the Government claims of turnaround in the Irish property markets, our real estate sector continues to suffer from the ongoing crisis. Per GeoView/DKM survey, 23,432 commercial premises remained vacant in Ireland in January 2013, up 6.7 percent on previous survey results from August 2012. In Dublin, some 13% of all commercial premises are empty, up on 12% in August 2012. Meanwhile, prices of residential properties have fallen 1.53% in February 2012, compared to January, marking the steepest decline in 12 months and the decline is accelerating over the last 3 months period compared to previous 3 months through November 2012. In other words, the green shoots in our domestic investment, claimed by the Government and property sector analysts over 2012 so far appear to be an illusion. Irish property market remains stagnant, with occasional volatility pushing prices up a few percentage points only to see subsequent reversion to the zero growth trend established since January 2012.

31/3/2013: German Hartz IV reforms - evidence

Another interesting paper, worth a read: Krebs, Tom and Scheffel, Martin, "Macroeconomic Evaluation of Labor Market Reform in Germany" (February 2013). IMF Working Paper No. 13/42.

Back in 2005 Germany undertook a massive reform of social welfare systems, known as Hartz IV reform. This "amounted to a complete overhaul of the German unemployment insurance system and resulted in a significant reduction in unemployment benefits for the long-term unemployed".

The IMF paper used "an incomplete-market model with search unemployment to evaluate the macroeconomic and welfare effects of the Hartz IV reform". The model was calibrated to German data before the reform followed by simulation of the calibrated model to identify the effects of Hartz IV.

"In our baseline calibration, we find that the reform has reduced the long-run (non-cyclical) unemployment rate in Germany by 1.4 percentage points. We also find that the welfare of employed households increases, but the welfare of unemployed households decreases even with moderate degree of risk aversion."

For all the debate about the merits of such reforms, it is pretty darn clear that Hartz IV-styled reforms - currently being advocated by the IMF and the EU for the peripheral states - cannot take place in the environment of protracted and structural Euro area-wide and national recessions and especially in the presence of other exacerbating factors, such as debt overhangs,  insolvency regime breaks, dysfunctional banking sector, monetary policy mismatch, etc.

Put simply, in 2005, German economy was into its second year of (anaemic at 0.7% in 2004 and 0.84% in 2005) growth with unemployment at an uncomfortable 11.2% still leagues below the current rates in the peripheral state. German government deficit in 2005 was at relatively benign 3.42% compared to the deficits in the peripheral states, with structural deficit at even lighter load of -2.6% of p-GDP and primary deficit at 1.0%. German debt/GDP ratio on Government side was at 68.5% of GDP. All of these parameters clearly indicate that Germany was in a much better starting position for consolidating social insurance systems than the peripheral states find themselves today.

5/12/2011: Sunday Times, December 4, 2011

For those of you who missed it - here is an unedited version of my article for Sunday Times, December 4, 2011.


Comes Monday and Tuesday, the Government will announce yet another one of the series of its austerity budgets. Loaded with direct and indirect taxation measures and cuts to middle class benefits, Budget 2012 is unlikely to deliver the reforms required to restore Irish public finances to a sustainable path. Nor will Budget 2012 usher a new area of improved Irish economic competitiveness. Instead, the new Budget is simply going to be a continuation of the failed hit-and-run policies of the past, with no real structural reforms in sight.

Structural reforms, however, are a must, if Ireland were to achieve sustainable growth and stabilize, if not reverse, our massive insolvency problem. And these reforms must be launched through the budgetary process that puts forward an agenda for leadership.

Firstly, Budgetary arithmetic must be based on realistic economic growth assumptions, not the make-believe numbers plucked out of the thin air by the Department for Finance. Secondly, budgetary strategy should aim for hard targets for institutional and systemic improvements in Irish economic competitiveness, not the artificial targets for debt/deficit dynamics.

Let’s take a look at the macroeconomic parameters framing the Budget. The latest ESRI projections for growth – released this week – envision GDP growth of 0.9% and GNP decline of -0.3% in 2012. Exports growth is projected at 4.7% in 2012, consumption to fall 1.5% and investment by 2.3%. Domestic drivers of the economy are forecast to fall much less in 2012 than in 2011 due to unknown supportive forces. This is despite the fact that the ESRI projects deepening contraction in government expenditure from -3% in 2011 to -4% in 2012. ESRI numbers are virtually identical to those from the latest OECD forecasts, which show GDP growing by 1.0% in 2012, but exports of goods and services expanding by 3.3%. OECD is rather less pessimistic on domestic consumption, projecting 2012 decline of just 0.5%, but more pessimistic on investment, predicting gross fixed capital formation to shrink 2.7%.

In my view, both forecasts are erring on optimistic side. Looking at the trends in external demand, my expectation is for exports growing at 2.9-3.2% in 2012, and imports expanding at the same rate. The reason for this is that I expect significant slowdown in public sector purchasing across Europe, impacting adversely ICT, capital goods, and pharmaceutical and medical devices sectors. On consumption and investment side, declines of -1.5-1.75% and -4-4.5% are more likely. Households hit by twin forces of declining disposable incomes, rising VAT and better retail margins North of the border are likely to cut back even more on buying larger ticket items in the Republic. All in, my forecast in the more stressed scenario is for GDP to contract at ca 0.6% and GNP to fall by 1.7% in 2012. Even under most benign forecast assumptions, GDP is unlikely to grow by more that 0.3% next year, with GNP contracting by 0.5%.

Under the four-year plan Troika agreement, the projected average rate of growth for GDP between 2012 and 2015 was assumed to be 3.1% per annum. Under the latest pre-Budget Department of Finance projections, the same rate of growth is assumed to average 2.5% per annum. My forecasts suggest closer to 1.5% annual average growth rate – the same forecast I suggested for the period of 2010-2015 in these same pages back in May 2010.

Using my most benign scenario, 2015 general government deficit is likely to come in at just above 4.0%, assuming the Government sticks to its spending and taxation targets. Meanwhile, General Government Debt to GDP ratio will rise to closer to 120% of GDP in 2015 and including NAMA liabilities still expected to be outstanding at the time, to ca 130% of GDP.

In brief, even short-term forecast changes have a dramatic effect on sustainability of our fiscal path.

Yes, the Irish economy is deteriorating in all short-term growth indicators. The latest retail figures for October, released this week show that relative to pre-crisis peak, core retail sales are now down 16% in volume terms and 21% in value terms. In the first half 2011, nominal gross fixed capital formation in the Irish economy fell 15% on H1 2010 levels and is now down 38% on pre-crisis peak in H1 2007. And exports, though still growing, are slowing down relative to imports. Ireland’s trade balance expanded 5% in H1 2011 on H1 2010, less than one fifth of the rate of growth achieved a year before. More ominously, using data through August this year, Ireland’s exports growth was outpaced by that of Greece and Spain. Ireland’s exporting performance is not as much of a miracle as the EU Commissioners and our own Government paint it to be.

However, longer-term budgetary sustainability rests upon just one thing – a long-term future growth based on comparative advantages in skills, institutions and specialization, as well as entrepreneurship and accumulation of human and physical capital. Sadly, the years of economic policy of hit-and-run budgetary measures are taking their toll when it comes to our institutional competitiveness.

This year, Ireland sunk to a 25^th place in Economic Freedom of the World rankings, down from the average 5-7^th place rankings achieved in 1995-2007. In particular, Ireland ranks poorly in terms of the size of Government in overall economy, and the quality of our legal systems, property rights and regulatory environments. The index is widely used by multinational companies and institutional investors in determining which countries can be the best hosts for FDI and equity investments.

In World Bank Ease of Doing Business rankings, we score on par with African countries in getting access to electricity (90^th place in the world), registering property (81^st in the world), and enforcing contracts (62^nd in the world). We rank 27^th in dealing with construction permits and 21^st ease of trading across borders. Even in the area of entrepreneurship, Ireland is ranked 13^th in the world, down from 9^th last year. This ranking is still the highest in the euro area, but, according to the World Bank data, it takes on average 13 times longer in Ireland to register a functional business than in New Zealand. The cost of registering business here amounts to ca 0.4% of income per capita; in Denmark it is zero. In the majority of the categories surveyed in the World Bank rankings, Ireland shows no institutional quality improvements since 2008, despite the fact that many such improvements can reduce costs to the state.

I wrote on numerous occasions before that despite all the talk about fiscal austerity, Irish Exchequer voted current expenditure continues to rise year on year. Given that this segment of public spending, unlike capital expenditure, exerts a negative drag on future growth potential in the economy, it is clear that Government’s propensity to preserve current expenditure allocations is a strategy that bleeds our economy’s future to pay for short-term benefits and public sector wages and pensions.

Similarly, the new tax policy approach – enacted since the Budget 2009 – amounts to a wholesale destruction of any comparative advantage Ireland had before the crisis in terms of attracting, retaining and incentivising domestic investment in human capital. Continuously rising income taxes on middle class and higher earners, along with escalating cost of living, especially in the areas where the Irish State has control over prices, and a host of complicated charges and levies are now actively contributing to the erosion of our competitiveness. Improvements in labour costs competitiveness are now running into the brick wall of tax-induced deterioration in the households’ ability to pay for basic mortgages and costs of living in Ireland. Year on year, average hourly earnings are now up in Financial, Insurance and Real Estate services (+3.1%) primarily due to IFSC skills crunch, unchanged in Industry, and Information and Communications, and down just 2.6% in Professional, Scientific and Technical categories. In some areas, such as software engineering and development, and biotechnology and high-tech research and consulting, unfilled positions remain open or being filled by foreign workers as skills shortages continue.

By all indications to-date Budget 2012 will be another failed opportunity to start addressing the rapidly widening policy reforms gap. Institutional capital and physical investment neglect is likely to continue for another year, absent serious reforms. In the light of some five years of the Governments sitting on their hands when it comes to improving Ireland’s institutional environments for competitiveness, it is the Coalition set serious targets for 2012-2013 to achieve gains in Ireland’s international rankings in areas relating to entrepreneurship, economic freedom and quality of business regulation.

Box-out:

Amidst the calls for the ECB to become a lender of last resort for the imploding euro zone, it is worth taking some stock as to what ECB balance sheet currently looks like on the assets side. As of this week, ECB’s Securities Market Programme under which the Central Bank buys sovereign bonds in the primary and secondary markets holds some €200 billion worth of sovereign debt from across the euro area. Banks lending is running at €265 billion under the Main Refinancing Operations and €397 billion under the Long-Term Refinancing Operations facilities. Covered Bonds Purchasing Programmes 1 and 2 are now ramped up to €60 billion and climbing. All in, the ECB holds some €922 billion worth of assets – the level of lending into the euro area economy that, combined with EFSF and IMF lending to peripheral states takes emergency funding to the euro system well in excess of €1.5 trillion. Clearly, this level of intervention has not been enough to stop euro monetary system from crumbling. This puts into perspective the task at hand. Based on recently announced emergency IMF lending programmes aimed at euro area member states, IMF capacity to lend to the euro area periphery is capped at around €210 billion. The EFSF agreement, assuming the fund is able to raise cash in the current markets, is likely to see additional €400-450 billion in firepower made available to the governments. That means the last four months of robust haggling over the crisis resolutions measures between all euro zone partners has produced an uplift on the common currency block ‘firepower’ that is less than a half of what already has been deployed by the ECB and IMF. Somewhere, somehow, someone will have to default big time to make the latest numbers work as an effective crisis resolution tool.