Economics 29/12/2009: Looking back at 2009

For those of you who missed my article in the Sunday Times last weekend (December 27, 2009) here is, per usual, an unedited version of the text.

By all possible measures 2009 will go down as yet another annus horribilis in the history of Ireland. Some 29 months since the inception of the crisis there is hardly any sight of the end of our depression – the worst on the record that any Euro area state has endured in modern history.

In 2008-2009 Irish economy has lost a compound 9.6% of GDP and a whooping 13.2% of our GNP. Over the same period of time, Eurozone economy has contracted by the total of 3.3%.

Based on Department of Finance latest projections, by the end of 2010, our gross domestic output will fall 10.8% and GNP will have declined by 14.7%, against the European Commission forecast for the Euro area income contracting by 2.65% on 2007 levels.

Put into perspective, assuming the current crisis runs its course as projected by analysts, the US will regain the 2007 levels of real annual income in late 2010. For Euro area, this moment will arrive in 2012-2013. Ireland is going to return to the 2007 level of prosperity in 2015 in terms of GDP and 2016-2017 in terms of GNP. And this is under optimistic assumptions of relatively robust growth post-2011.

These figures only begin to describe the extent of our economy’s collapse in 2009. It is now a common realization amongst the economic forecasters that whatever growth we might achieve in the next few years, unemployment will remain at extremely elevated levels.

In Q3 2009 official employment fell 40,200 on Q2 2009. This means that in 12 months to the end of September 2009, Irish economy shed some 183,400 jobs - the highest rate of jobs destruction on the record. In the course of this recession, we have now lost some 236,300 jobs.

Back in December 2007, the live register stood at 173,200. A year later, it rose to 293,000, up 119,800 or 69.2% in 12 months period. This December, live register is lingering at 423,400 – an increase of 44.5% on 2008 levels. Sounds like an improvement? Not really. Such is the nature of statistical optics that an 8.8% rise in the number of people on unemployment benefits looks like an improvement in the rate of unemployment growth.

If in the mid 2008 Irish economy had 17^th highest unemployment rate in the EU27, by the middle of this year it was the 5^th highest.

Do the math: the above jobs losses imply that in 2009 some €13.5 billion was lost in employment-related economic activity in Ireland. This translates into an additional €4-5 billion in lost private consumption while our welfare bill rose by some €3.5 billion.

All of these jobs losses (save for ca 5,900 jobs eliminated through natural attrition in the public sector excluding health services between the end of 2007 and the end of 2009) came out of the private sector. In terms of the drain on Exchequer revenue these losses simply cannot be offset through wage bill cuts imposed by Budget 2010 onto public sector.

Even more problematic is the trend of falling labour force participation rate which has contracted from 64.2% to 62.5% in a year to Q3 2009. This change is extremely hard to reverse within a given generation. Much of the fall in 2009 has been driven by rising long-term unemployment, pushing people into permanent welfare traps, and net emigration.

In 2009, some 45,000 non-Irish nationals left the country. I would estimate that at least 20,000 Irish natives did the same. On the net, CSO data shows that while unemployment climbed by roughly 120,000 over the last 12 months, the actual fall in employment was 185,000.

These people have left their productive employment in this state and moved on to work elsewhere. Many worked in the construction and domestic services sector and had skills beyond their jobs. Many worked in industry – where their skills and future productivity were being enhanced by on-the-job training and through experience. In Q3 2009, industry displaced construction as the leasing source of new unemployment. Quarter on quarter, industry lost 12,200 jobs in Q3 2009 relative to Q2 2009, while construction sector lost 8,700.

But scores of those who are now emigrating out of Ireland worked in traded services and here the losses to our productive potential are even greater. 2,300 jobs were lost in professional, scientific and technical activities in Q3 alone. The future of Irish economy is in traded services – the elusive 'knowledge' economy we've been pursuing. This economy requires more people with cultural, linguistic and skills sets that are distinct from our 'national' averages. Given that we cannot hope to retrain lower skilled workers to take up jobs in professional services exports, the loss of junior non-national staff in finance, professional services and ICT is doing irreparable damage to our international competitiveness.

The good news, of course, is that we are now starting to see some re-hiring in financial services (600 net jobs created in Q3 2009 relative to Q2 2009) and MNCs-supported employment remains strong. The bad news is that serious layoffs are yet to materialize in the state-supported banking.

Lastly, 2009 was another year of banking sector disasters. Irish banks began 2009 teetering on the verge of full blow bankruptcy – with our third largest bank falling into the hands of the state and two largest banks seeing their shareholders’ capital virtually wiped out. The crisis of the early months of 2009 was temporarily resolved by the introduction of Nama, leading to a robust, but short-lived rally in banks shares. The real problems – weak balance sheets, pressured deposits, precipitously collapsing asset valuations, rapidly deteriorating loans performance and dwindling capital reserves – remain unaddressed.

Thus, as was predicted by this column in May 2009, the Nama solution turned out to be nothing more than an expensive means for delaying the inevitable. It is by now an accepted consensus that nationalization of the main Irish banks is an inevitable denouement to the saga of misguided banks rescue measures that began with the regulatory Green-Jerseying of the banking sector against the short-sellers in the late 2007, progressing to the wholesale banks guarantee scheme in September 2008, and via nationalization of the Anglo Irish Bank, on to Nama passage in 2009.

All along, Irish Government and banking sector have made all efforts to evade and silence critical independent analysis of the causes of the current crisis: inept regulation and enforcement, reckless risk-taking in lending and funding, and wrong-footed solutions advanced by the State. The Irish taxpayers are now facing a bill of tens of billions of Euros, as well as the decade-long prospect of zombie banking, development and property markets and construction sectors – courtesy of Nama.

Just as in the end of 2008, only the stock markets are now capable of reflecting the extent of the expected Nama damages back to the economy. AIB shares are now trading some 36% down on their January 2, 2009 levels and 67% down from their 12-months peak. Bank of Ireland shares, having gained 32% on January prices are still down 66% on the 12-months peak.

As Winston Churchill said once: “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” One can only wish our policymakers discover the second half of this dictum in the New Year.

Box-out:

Per latest CSO data, average weekly earnings in the Public Sector (ex Health) rose by 2.5% in 12 months to September 2009, reaching €969.11 per week. While the lower rate of increase is a welcome sign of some moderation in public sector pay, the numbers reveal a farcical nature of the Government’s efforts to date to control its own expenditure.

Weekly earnings for the Regional Bodies rose by 4.6% (from €815.58 to €852.71), the Education Sector by 3.0%, from €944.49 to €973.10. An Garda Síochána weekly earnings excluding overtime decreased slightly by 0.1% from €1,077.55 to €1,076.22 for the same period. Now, compare this record with the rates of increases between September 2005 and September 2009 when average weekly earnings in the Public Sector (excluding Health) rose by 14.2% from €848.94 to €969.11 per week.

The same lack of progress on reducing public expenditure is manifested in the numbers employed in the sector. Natural attrition with recruitment bans has produced a decline in Public Sector employment from 369,100 in September 2008 to 360,900 in September 2009. Just 8,200 or 2.22% fewer people worked in the Public Sector in this country despite the nearly total collapse in the Exchequer revenue. In the four years to September 2009, employment in the Public Sector rose by 17,300 to 360,900.

If Ireland’s public sector employment pay and numbers were to be benchmarked against the UK levels, it would take some 15-20 years before these rates of ‘moderation’ bear the fruit of reaching parity with our next door neighbors.

Economics 16/12/2009: Budget 2010 Analysis

As promised - here is my more in-depth view of the Budget 2010. This is an un-edited version of the Sunday Times (13/12/2009 issue) article.

After weeks of leaks, speculations and over-dramatized Partnership talks, this week Brian Lenihan has delivered the final move in the Government v Economy chess game. Lisbon, Nama and the Budget 2010, we were promised, were all that the Cabinet had to do in 2009 in order to manage the nation through the worst economic storm in its history.

In its last stance of 2009 the Government has reluctantly and belatedly recognised the reality of the crisis we face. Thus, the Budget has done just about enough to delay our descent into the nightmarish company of Greece. For this Brian Lenihan deserves praise.

A Chance at Reforms - Missed

But the net outcome of the Budget 2010 is that we are now entering the third year of recession with virtually no reforms that can support future growth.

There is no real stimulus to the rapidly contracting private sector. Cost efficient and much needed export credits are not in and neither are foreign exchange risk supports – the two cornerstone policies for sustaining exports, especially for indigenous companies.

Taxes remain regressively skewed toward ‘soaking the rich’, by which the Government means the middle class. As in 2009, the burden of taxation in 2010 will be borne squarely by those in the most productive employment with above average skills and aptitude. If a combination of consumption and income taxes accounted for under 68.9% of total tax revenues in 2009, by the end of the next year these taxes will account for 70.3% of total tax take.

Today, some 40% of Irish households deliver 90% of non-corporate dosh for the Exchequer. By the end of 2010, given current trends in unemployment and wages, this ‘honor’ will befall just 37% of households. This is hardly a sign of resilience in the economy.

In 2009, 4% of top earners – many of whom are wealth and jobs creating entrepreneurs and business owners – pay 50% of total income tax. Next year, we are risking to hike this share to 55%. This is hardly a sign of the economy promoting jobs growth.

Should Ireland-based multinationals reduce their transfer pricing activities in 2010 – a prospect consistent with a possibility of a restart of new investment cycle in Asia and the US – an even greater share of the burden of paying for public sector expenditure will be falling onto the shoulders of rapidly thinning minority who still have higher value-adding jobs.

Cuts to unemployment benefits in excess of reductions to social welfare imply that Budget 2010 only strengthened the incentives to transfer from unemployment benefits roster onto social welfare for anyone in long-term unemployment. This will lead a decline in labour force participation rates throughout 2010. Paradoxically this will result in lower official unemployment but a higher cost to the taxpayers.

Uncompetitive Costs Base - Remains Intact

The Budget has done nothing to address the issue of uncompetitive costs imposed onto businesses by our state-owned utilities and suppliers of services. It also did nothing to address excessively high local authorities’ charges and rates.

A net positive of the Budget was honorable mentioning of the internationally trading financial services. However, it remains to be seen what exactly will be done on this front.

Brian Lenihan missed another chance of reforming our business-crippling quangoes. In doing so, the Budget failed to recognize the real damages state and local authorities’ costs inflation poses to the survival of both domestic and exporting companies. If anything, the Budget further expanded the Fas empire – an unchecked state behemoth that yields dubious benefits and wastes hard cash in truckloads. The policy, it seems, is to shove more unemployed into perpetual training programmes with little hope of gainful employment in the foreseeable future.

A failure to introduce university fees means that our education system will spend another year mired in funding uncertainty. It will also mean that many graduating students will desperately cling to education for another 1-2 years. For some, this is a productive opportunity to invest further into their future skills. For many, however, it is an unnecessary extension of studies that will not lead to any meaningful skills augmentation but will consume precious resources. Classroom sizes will rise, international rankings will be threatened, but we will increase output of devalued in quality degrees, certificates and diplomas.

Retaining prohibitively high rates on PRSI, health and income will undoubtedly keep jobs growth on ice. Other, so-called soft labour costs, could have been tackled through simple measures, such as for example abolishing risk equalization scheme in health insurance to lower the costs of employees benefits. These opportunities were missed.

Banking Sector Costs - Unpriced

There are no provisions whatsoever for the banking sector in the Budget. Yet, two future developments with respect to the sector are now virtually assured for 2010.

First, we are likely to see significant demands from the banks for new capital. My estimates suggest that our six banking institutions will need €9.7-12.4 billion in capital post-Nama. If even a half of this falls in 2010, Budget deficit risks reaching 14.5% of GDP. The only way to avoid such a debacle will be to use Nama as a vehicle for issuing even more State-guaranteed bonds. This will make Ireland even more dependent on ECB’s good will.

Second, the Minister has introduced a set of new conceptual frameworks for using Nama to apply pressure on lenders to increase funding for SMEs and distressed households. All are ambivalent, although well-meaning, and all are regressive when it comes to securing stable future for our banking system. None will actually expand real lending.

Structural Deficit - Unaddressed

The Budget has failed to significantly tackle our structural deficit. The pre-Budget projections suggested that Brian Lenihan was facing €14-16 billion worth of structural deficit. The Budget promises to reduce this number to €10-12 billion. Even if this comes to pass the Government is now facing two stark choices. One – hope for a spectacular recovery from the crisis with an average rate of growth in the economy of over 5% per annum over the next 5 years. In this case, the Government will need to cut some €4-6 billion more in 2011 and 2012. Two – take the medicine and cut at least €8 billion in 2011. We have clearly opted for the first option to the detriment of the future growth.

Carbon Tax - More of the Same

Carbon tax introduction is a purely revenue raising and economically distortionary measure. In theory, carbon tax should alter environmentally harmful behavior of consumers and producers, pushing them to adopt cleaner technologies and habits, thus gradually reducing carbon tax revenue. Alas, in the case of Ireland, years of poor planning and zoning, successions of absurd spatial development plans and politically motivated capital investment programmes have resulted in a situation where many Irish consumers and producers have no room for altering their choices. Living and working in the Greater Dublin area often means no alternative but to use a car to commute to work, or even to visit grocery stores. The same can be said about all other parts of the country. Our family structures – with high fertility and dispersed households – mean that many of us have no choice but to do school runs in a car, to undertake international air travel and to deal with employment patterns that do not favor efficient time management that can be conducive to reducing emissions. Ireland’s shambolic (in quality and scope) public transport system simply compounds the lack of choices.

Hence, despite its ‘Green Policy’ label, carbon tax is nothing more than an extension of an income tax with all the associated disincentives when it comes to higher value-added jobs creation in Ireland. Irony has it, transforming this economy into more human capital intensive and thus environmentally cleaner ‘knowledge’-based one is an objective poorly served by the carbon tax introduction.


On the net, Budget 2010 turned out to be more a whimper than a bang. Whether or not it will pave the way for economically more constructive policies in 2010 remains to be seen. But the task left unfinished is daunting – Ireland will need to cut some €10-12 billion more off the Exchequer annual bill in 2011 through 2012. So far, we’ve only made a first step in a longer journey.


Box out:
In light of this week’s events, it worth quickly revisiting one aspect of our budgetary trends – their frightening stickiness to historic targets that runs contrary to any change in the underlying economic realities. Looking at Budget 2007 estimates, one gets a sense of history playing a cruel trick on Department of Finance forecasting section. Back then, the Department projected a steady rise in spending from ca €45.5 billion to ca €58 billion in 2009. In line with this, the revenue was expected to rise from ca €47 billion in 2006 to roughly €58 billion in 2009. What actually happened between then and now is that the expenditure has shot up, settling at above €60 billion in 2009, while revenue has fallen to below €35 billion. Thus, Department for Finance forecasters were almost 97% right on the expenditure forecast side, but some 60% wrong on their revenue predictions. This implies an error swing of some160 points for the Department of Finance. A random error would be consistent with a 50-point range between two calls. In household economics such accuracy of forecasting could earn one a trip to a debt court. In public sector it guarantees the job for life and a nice tidy pension at the end of an errors-prone journey. Accountability is not really a strong point of Ireland Inc.