21/5/2105: The Darker Side of Transparency?

World Bank paper published earlier this month and titled "The Dark Side of Disclosure: Evidence of Government Expropriation from Worldwide Firms" raises some very interesting questions about the relationship between corporate transparency and government incentives.

The paper by Liu, Tingting and Ullah, Barkat and Wei, Zuobao and Xu, Lixin Colin (May 4, 2015, World Bank Policy Research Working Paper No. 7254: http://ssrn.com/abstract=2602586)  looks at "the effects of voluntary accounting information disclosure through auditing on firm access to finance, exposure to corruption, and sales growth." The authors use data for more than 70,000 firms in 121 countries.

The authors find that "…disclosure can be a double-edged sword" with overall effect depending on institutional capital present in a specific country.

"On the one hand, audited firms exhibit a slightly lower level of financial constraints than unaudited firms." This is in line with traditional theory whereby voluntary transparency increases information quality about the firm, but also signals self-selection of better-governed and better-performing firms to the markets.

"On the other hand, audited firms face a significantly higher level of corruption obstacles." Which is really surprising, until you understand the underlying logic.

"The net effects of voluntary information disclosure on firm growth are negative, which can largely be explained by the fact that most of the countries in the sample are developing countries where institutions are weak. The beneficial effect of disclosure increases as a country's property rights protection improves. The qualitative results are robust to considerations of the endogeneity of auditing and to alternative measures of corruption and financial constraints. The findings reveal the dark side of voluntary information disclosure: exposing firms to government expropriation where institutions are weak."

In other words, in more institutionally-advanced economies, voluntary disclosure is a positive factor for the firms, even she we control for self-selection bias. But in countries where institutional capital is weak, the effect is the opposite: in presence of corrupt and accountable governments, disclosing corporate information to the markets can trigger greater effort by the government to expropriate from the reporting firm.

There are serious ramifications for policy and development economics from this study. Traditionally, we tend to push more transparency and more disclosure for the firms operating in institutionally-weak emerging markets. In doing so, we may be aiding the predatory governments who, thus, gain greater ability to corruptly capture firm assets and/or profits over and above legally required taxation. This, in turn, strengthens the corrupt state institutions and government, instead of pushing them toward adopting more rule of law-styled reforms.

Beyond this, the study results suggest that at least in some setting, less transparency and greater ability for the corporates to operate within private information markets can actually be a good thing.

What is interesting is that in public domain, very little attention is paid to this issue. The results of this study, however, are broadly supportive of Acemoglu and Johnson ("Unbundling Institutions", Journal of Political Economy 113(5), 949–92005, 2005) work on the overwhelming importance of constraining government expropriation in facilitating economic development, ex ante other reforms.

On the other hand, transparency is value-additive in the advanced economies setting, where institutions are sufficiently high quality to preempt (or at the very least, diffuse significantly) the emergence of actionable incentives for state expropriation and information-led corruption.

20/11/2013: Irish pensions: a crisis of policy, institutions and savings - Sunday Times November 17

This is an unedited version of my Sunday Times article from November 17, 2013.


Back in the early 2011, with the new Government coming into the office, fresh ideas were filling the airy halls of the Department of Finance. Armed with the knowledge that Irish pensions industry was the last vault in the country that still had money in it, Minister Noonan focused his sights. Hitting private pensions was a preferred alternative to raiding banks deposits or imposing cuts to public sector pensions. It suited the pseudo-fairness agenda of the Labor. Better yet, setting a levy on private pensions funds would, in PR-speak, allowed Fine Gael to avoid 'increasing taxes'. The fat cats (private pensions investors) were to share the burden of the fiscal adjustment while the Government was riding a high horse of delivering a rhetorical victory for the little man. The real logic of the move was exactly in line with the reasoning used in continuously raiding health insurance policies: go after the money.

Economics of the measure swept aside, the Government got busy expropriating private property and weakening the system of future pensions provisions. A temporary pensions levy was born out of this. With it, the country was firmly put on the road to a comprehensive dismantling of the already dysfunctional system.

Set at 0.6 percent per annum for 2011-2014 the original levy was dressed up in 2011 as a measure to free unproductive savings to fund jobs creation in the economy. Budgets 2012 and 2013 followed up with a raft of other measures, all designed to take more cash out of savings. Budget 2014 not only failed to curtail this onslaught but created a new levy of 0.15 percent that will run over 2014-2015 period and, according to a large number of analysts, is expected to continue beyond the 2015.

Yet, as the documents recently released by the Department of Finance show, back in 2011, the Department briefed the Minister as to the fallacy of his thinking. At the time, the pensions deficits accumulated in the Irish system totaled EUR10-15 billion. These deficits, according to the briefing, were in excess of what the nation's employers and employees could shoulder even before the Government moved on the funds. Between 75 and 80 percent of all Defined Benefit funds in the country were technically insolvent, accounting for two thirds of all pensions.

The Minister also had to be aware that a tax on capitalised value of the funds amounted to expropriation of private property. And that it cuts across the serious warnings concerning our pensions sustainability coming from the Troika and the OECD.

The problems with this approach to pensions systems are manifold and are setting us up for a long-term crisis. They include: exacerbating catastrophic pensions shortfalls, reducing future credibility of the system and undermining public confidence in the security of our financial system. Increasing future pressures on the Exchequer finances stemming from demographic changes and the legacy of the current crisis is the direct corollary of the short-termist position adopted by the Government.


Irish pensions system is fundamentally insolvent today and this insolvency is only made worse by our policies.

Top figures speak for themselves: at the end of 2012, there were 232,939 Defined Contribution schemes members, 527,681 Defined Benefit schemes signees and 206,936 PRSAs. Inclusive of PRSAs, total capitalisation of the system was around EUR78-79 billion. Defined Benefit schemes made virtually no contributions to the capital pool backing pensions system in the country. Excluding PRSAs, almost 7 out of 10 Irish pensions were funded by the IOUs on future taxpayers and company employees. The cumulated potential obligations in the pensions provisions of the Defined Benefits schemes amounted to some EUR 165 billion or around 100 percent of Ireland's GDP. These are growing, fuelled by early retirement schemes in the public sector and exits of private sector Defined Contributions savers.

Private pensions in Ireland remain not only underfunded, but also insufficient in cover. Currently, Ireland ranks the lowest in the OECD in terms of net pensions wealth held for those earning at or above average wages. Things are somewhat better for those on lower incomes. Still, we rank below OECD mean in terms of pensions cover for workers earning less than the average wage. An Irish family with two earners and combined annual earnings of around EUR90,000 can expect a pension cover of 40% of the pre-retirement earnings for 10.5 years. Budget 2014 has reduced this number by at least 0.5 years. OECD average for such coverage is closer to 28 years. OECD estimates show that at the end of 2009 only 41.3 percent of our public and private sectors’ workers were enrolled in a funded pension plan.

Since the beginning of the century, the systematic policy approach adopted by the Irish Governments to dealing with the pensions crisis has been to rely on Defined Contribution schemes to plug the vast deficit in the Defined Benefit schemes. The former are dominant in the private sector, the latter are the cornerstone of the public sector. Since the onset of the crisis, Irish state has acted to level huge burden of fiscal adjustment on future retirees, with levies and tax adjustments reaching into billions of euros and rising rapidly. The measures hit hard not only the savers at the top of the income distribution, but ordinary middle class investors. For example, according to a recent report on Budget 2014 measures, a young worker setting aside annually some EUR2,500 as a starting pension in 2011 will see a life-time cost of the pensions levies reach EUR32,500. He or she will face a reduction of EUR1,625 per annum in annual retirement benefits thanks solely to levies alone.

All of this is gradually eroding the public credibility in the system and acts to lower future solvency of the private and public schemes. According to the Pensions Board and OECD data, Ireland pensions coverage is declining over time. The numbers of workers covered by both, Defined Benefit and Defined Contribution schemes have fallen steadily since 2006 for the former and 2008 for the latter.

This trend is compounded by the nature of the crisis that hit Ireland since the end of the Celtic Tiger era. Unprecedented collapse in property markets triggered massive destruction of household wealth and catastrophic inflation of the debt crisis for households that are nearing the age when they normally accelerate their pensions savings.

Despite this, the Government continues to reduce tax deferrals available for those retirement savings. Examples of such policies include changes to lump sum payments tax treatments, changes to the Standard Fund Threshold, elimination of the PRSI and health levy/USC relief and so on. In effect, pensions funds became a ground zero of the Irish Government-waged war of financial repression – a brutal and cynical policy aimed at protecting own interests at the expense of the future retirees.


The OECD report on Irish pensions system, presented to the Government earlier this year, before Budget 2014 contained the usual litany of complaints about the system.

These include the fact that Ireland does not have a mandatory earnings-related pensions system to complement the State pension at basic level. According to the OECD, as a result, Ireland "faces the challenge of filling the retirement savings gap to reach adequate levels of pension replacement rates to ward off pensioner poverty." Furthermore, private pension coverage, both in occupational and personal pensions, is uneven and needs to be increased urgently. The latest changes introduced in Budget 2014 clearly exacerbate this, and the Government cannot claim that it was not aware of this problem. The existing tax deferral structure in Ireland, based on marginal tax rates, provides higher incentives to invest in pensions for higher earners, resulting in severe pensions under provision for middle classes. The OECD identified "unequal treatment of public and private sector workers due to the prevalence of defined benefit plans in the public sector and defined contribution plans in the private sector."  The reforms aiming to address this gap by introducing new pensions scheme for public servants are "being phased in only very slowly and [are] unlikely to affect a majority of public sector workers for a long time".

The OECD produced a long list of recommendations for the Government aimed at improving the system design and addressing some of the above bottlenecks. Virtually none of these saw any significant action.

The two options for a structural reform of the State pension scheme recommended by the OECD: a universal basic pension or a means-tested basic pension remain off the drawing board. Explicitly, OECD stated that “to increase adequacy of pensions in Ireland, there is a need to increase coverage in funded pensions. Increasing coverage can be achieved through 1) compulsion, 2) soft-compulsion, automatic enrolment, and/or 3) improving the existing financial incentives.” Instead, the Government continues to treat private pensions savings as funds it can raid to raise quick revenues. This makes it impossible for broad and structural reforms to gain support of the public, undermining in advance any future effort to address the crisis we face.

Note: this information was just released today: http://www.independent.ie/business/personal-finance/pensions/thousands-of-oaps-facing-the-shock-of-cuts-in-their-pensions-29768766.html

Box-out:

In economics terms, it is often impossible to put a hard number on the value of less tangible institutional capital of the nation. Yet, systems and institutions of governance and democratic participation do matter in determining nation’s economic capacity and competitiveness. Sadly, it appears that the Irish Government is giving the idea that open and transparent state systems are a necessary condition for building a sustainable and prosperous economy and society little credit. Instead, the Irish authorities are about to significantly restrict effective access to state information. To do so, the Government is planning to introduce a new, more complex and expensive system of fees that apply to the requests filed under the Freedom of Information Act. Some observers have been arguing that the true objective is to reduce the public disclosure of information. Others have suggested more benign reasons for the proposals. Irrespective of the motives, over time, these changes are likely to lead to greater opacity and lower accountability across the State and private sectors. Such trends usually go hand-in-hand with increases in corruption, mismanagement, poor design of public policies, and increased political and civic apathy. In the long run, the proposed reforms can, among other things, spill over into generating greater economic inefficiencies, less meritocratic distribution of resources, and distort returns to investment. They can also reduce our attractiveness as a destination for domestic and foreign investors, entrepreneurs and workers. The victims of poor governance that can arise on foot of any effort to reduce effective access to information will be both the Irish society and our economy.

27/10/2013: Financial Repression, Economic Suppression & Budget 2014

This is an unedited version of my Sunday Times article for October 20, 2013.


With fanfare of media appearances and fireworks of Dail statements, Budget 2014 was pushed off the dry dock and into the turbulent waters of reality. Full of political sparkle on the outside, overloaded with hidden taxes and charges and yet-to-be-fully-detailed painful cuts on the inside, it sailed off into the future. It will take at least 9-12 months from now to see what adjustments will have to be made in 2015 to compensate for the 'savings' on cuts delivered this week. It will take us longer to find out if the Budget 2014 will have a positive or negative effect on our ability to fund our deficits in the markets.

Yet, one thing is beyond the doubt: Budget 2014 was a significant gamble by the Government that could have done better by avoiding taking any gambles at all. Minister Noonan has decided to buy some political capital in the Budget. This capital came in the form of reduced rate of overall budgetary adjustment, compensated for by the hope-based increases in public sector efficiencies, plus some symbolic handouts to middle class families. Majority, such as the free GP visits for children under the age of 5, were poorly targeted and economically inefficient – extending scarce resources not to where they are needed most (such as, for example, long-term care provision or means-tested provision of health services) but to where political expediency leads. Many fail the core Budget objectives of making our fiscal policies more robust to adverse shocks that may occur in the near-term future.

In the end, Budget 2014 delivered virtually no real departures from the past Budgets. Predictably, there were no 'new' taxes. Instead the Budget put forward a list of new 'revenue raising measures'. The State will claw out of the banks EUR150 million in levies. Given that our banking sector is being reduced to a Three Pillars oligopoly, the levies will come straight from charging customers more for the same services. Pensions funds levy - a form of expropriation of private property - is to raise additional EUR135 million. This is a tax on present income, and in the case of pensions funds levy a tax on current wealth, plus a tax on future incomes foregone due to reduced levels of pensions funds. EUR140 million will be pumped out of the banks’ customers by taxing interest on savings. All in – financial sector will take a hit of EUR425 million on a full year basis, reducing its ability to lend, invest in the economy and to deal with mortgages distress. The measures will also weaken the quality of Irish banks' deposits base by reducing incentives to save. Carmen Reinhart and Kenneth Rogoff aptly termed such measures ‘financial repression’. De facto, we are bailing in ordinary banks customers and savers to pay for the past sins of the banks. Cyprus redux, anyone?

Cuts side of the Budget was also predictable. At the aggregate level, departmental expenditure as the share of GDP continues to run above 1990-2007 average. Instead of real cost reductions in Health we got some EUR250-300 million worth of new charges to be levied on services to insurance holders. And reduced insurance deductibility on the revenues side should do even more to reduce insurance coverage in the market. Net effect will most likely be falling transfers from private patients to public services, and higher demand for public health.

From businesses perspective, whatever the State added on one side of the budgetary equation, the state took out on the other. Thus, for all incentives for construction and building trade, overall capital spending by the Government in 2014 is projected to fall by some EUR100 million. As we stand, in 2013, capital spending by the Government barely covers amortization and depreciation of the total stock of public capital. Next year, things are going to get worse.

Much of the business stimulus schemes are geared toward supports for the property markets, including the incentives for foreign investors to put money into Irish REITs. Aside from the property-related measures, other business stimulus polices are either extensions of the already existent ones or more promise of doing something in the future. One example is the issue of Trade Finance supports. We are now five years into talking about the need to help smaller exporters with the cost of and access to trade insurance and credit.  Still, there is no tangible delivery on this.


However, the real question, left unanswered by Budget 2014 is: what's next for Ireland? The Government is rhetorically focused on our 'exit' from the Troika-led funding programme. This objective is a policy epicycle designed to ease public attention off the realities of bad domestic governance during the crisis. Exit from the bailout, financially, fiscally and economically, means a public recognition that Ireland has run out of funds we can borrow from the IMF and the EU. It also puts forward a commitment that, unlike Greece, we will not be asking for another bailout. Being not Greece does not make us Iceland, however, since Iceland repaid its bailout loans. In contrast, we will be carrying our debts to Troika for years to come.

The Government is promising that once we exit the bailout, we will regain our control over fiscal policies. This is a gross over-exaggeration. Having ratified the Fiscal Compact, Ireland is now subjected to heavy EU oversight as long as our fiscal performance falls short of the targets set in the treaty. It will be long time before we meet all of the conditions.

The scrutiny of our targets will increase, while our performance will remain under serious pressures arising from the crisis. Most recent IMF forecasts assume full EUR5.6 billion adjustments taken over 2014-2015 period, and economic growth averaging over 2.1 percent per annum (almost 6 times the average growth in 2012-2013 period). These forecasts imply that in 2014-2015 Ireland will still face the third highest cumulative deficits in the euro area ‘periphery’. And the debt levels of Irish state are set to continue rising. In 2013, the Department of Finance projects the level of Irish Government debt to be at EUR205.9 billion. By 2018 this is projected to rise to EUR211.6 billion.

And here's another kicker. The Fiscal Compact sets the target for long-term structural deficits (in other words deficits that would prevail were the economy running at its long run sustainable growth potential) at 0.5 percent of GDP. IMF projections out through 2018 put Irish structural deficits declining from 5.1 percent of potential GDP in 2013 to 2.0 percent in 2018. In other words, in 2018 Ireland is expected to be the worst performing 'peripheral' state in terms of structural deficits and operate well outside the criteria set in the Fiscal Compact.

Worse, comes December 15, we will lose a strong supporter of our efforts to restructure legacy banking debts and the only member of the Troika that promotes structurally more important economic and markets reforms.

On foot of our weak fiscal position, the politicisation of the Irish economy is already building up, driven primarily by our European partners and – until December 15 – resisted by the IMF.

The pressure is rising on Ireland's corporate taxation regime. The Government admitted as much by promising to close the loophole that allows some MNCs to nearly completely avoid paying Irish corporate taxes.

The pressure is also growing on blocking Ireland’s chances to restructure legacy banks debts. Germany, the ECB and the Eurogroup are angling to block Ireland's potential access to the European funds set up to deal with the future banking crises.

We are going into 2014 self-funding mode with all the costs of the bailout in place, including the Dvoika (Troika less one) oversight and substantial deficit and debt overhangs. It now appears that there will be no credit line to cover any increases in the cost of borrowing that might arise in the future. There will be no precautionary fund to cushion against any risk to market demand for Irish Government bonds. There will be no system in place to deal with any future banking problems or with the legacy debts should such arise. The ECB, the IMF and our forecasters are all warning us that we still face potentially significant downside risks to growth and banks stability. The IMF has been for months raising the issues of the SMEs insolvencies and poor quality of banks capital.

In other words, we are boxing ourselves into a high-risk game with little to show for this in terms of a positive return from our 'exit' from the bailout.

History suggests that prudence, not pride should be our guide. Back in 2010 we pre-borrowed aggressively in the markets prior to the state finances collapsing under the poorly structured banks bailouts. Now, we are gunning for the 'exit' without having secured any support from our 'partners' once again. The hope is that this time it will be different: the markets will lend us at decreasing costs, while growth lifts the entire domestic economy out of stagnation. This might not be an equivalent of playing Russian roulette, but it is certainly a game of chance with high stakes on the losses side and little tabled on the potential winnings side.

Box-out:
The latest OECD research on basic skills across the advanced economies puts to a serious test our claims to having a highly educated workforce. Ireland ranked eighth in terms of the proportion of younger adults with tertiary education. In terms of problem solving proficiency, both our college graduates and adults with only secondary education rank below their respective OECD averages. In problem solving in a technology-rich environment – a proxy for skills related to internationally-traded services, the sole driver of our economy today – Ireland ranks 18th in the OECD. Our younger workers score below their OECD peers in basic literacy and in numeracy. When it comes to introduction of new processes and technologies in the workplace Ireland is ranked between such premier divisions of the global innovation league as Cyprus and Belgium. Given our poor performance in digital economy-specific skills, exposed in October 2012 report by the OECD and covered in these pages before, it is high time for us to get serious about reforming our education and training systems.

19/10/2013: Debt Bias and Wealth Taxes: Pesky IMF Ideas...

Nasty little bit from the IMF Fiscal Monitor - a box-out on page 49 of the report...

So the IMF basically reminds us that once things get desperate, wealth taxes (err... Irish pensions levy anyone?) or put differently - expropriation of private wealth - can be contemplated...

Reinhart and Rogoff have warned us all about the Financial Repression coming, so no surprise here. What is, however, surprising is the IMF estimate at the end of the box-out. "The tax rates needed to bring public debt to precrisis levels... are sizeable: reducing debt ratios to end-2007 levels would require (for a sample of 15 euro area countries) a tax rate of about 10 percent of households with positive net wealth".

Give it a thought - 10 percent on average for the euro area... for Ireland? 20%? 30%?.. And, of course, what will that do to households' debt?.. oh, wait, that does not matter in Europe...


Oh, and while on the topic of debt. I wrote recently (here) about the issue of 'debt bias' (incentives to hold debt over equity) in tax systems... Here's a chart from the same report (page 45) showing the impact of eliminating 'debt bias' in tax system on systemic stability of the country financial system:

Of course, Irish policymakers are keen to eliminate the bias - not because it can help repair the systemic instability of our financial system, but because eliminating the bias will increase state yields from debt-funded property loans (via closing of the mortgages interest relief).

Once again, the problem is that of legacy - what do such closures of 'debt bias' do to sustainability of mortgages debt already carried in the system? Once again, no one pays any attention to the issue...