12/8/2014: Experience, Earnings & differences Between Economies

In the previous post, I summarised recent research paper on entrepreneurial learning-by-doing (http://trueeconomics.blogspot.it/2014/08/1082014-serial-entrepreneurship.html). Here are some other recent papers on the topic of entrepreneurship and human capital.

First paper is by Lagakos, David and Moll, Benjamin and Porzio, Tommaso and Qian, Nancy, titled "Experience Matters: Human Capital and Development Accounting" (December 2012, CEPR Discussion Paper No. DP9253: http://ssrn.com/abstract=2210223). The authors use micro-level data from 36 countries to look at evolution (over time) of ratios of experience-to-earnings. They find that the ratios profiles are flatter in poor countries than in advanced economies. In other words, experience-linked returns are flatter in poorer economies, or put differently: for each year gained in experience, poor country workers gain less in earnings than their rich countries counterparts.

The paper does not aim to explain the reasons for this empirical regularity, though the authors do say that "…composition differences [of workers (e.g., by schooling attainment or sector of work)] explain very little of the cross-country differences in the steepness of experience-earnings profiles. …Amongst other possible explanations, we note that our main finding that experience-earnings profiles are flatter in poorer countries is consistent with a class of theories in which TFP and experience human capital accumulation are complementary (i.e., low TFP in poor countries depresses the incentives to accumulate human capital)."

What the authors do, however, is look at the role that differences in experience-earnings profiles found between countries can have on levels of development. "When the country-specific returns to experience are interpreted in such a development accounting framework -- and are therefore accounted for as part of human capital -- we find that human and physical capital differences can account for almost two thirds of the variation in cross-country income differences, as compared to less than half in previous studies."

Specifically, on human capital side, "We calculate the part of human capital due to experience and show that this is positively correlated with income, and furthermore that its cross-country dispersion is similar in magnitude to the dispersion of human capital due to schooling."

In the forthcoming article in the Village magazine, I challenge Thomas Piketty's interpretation of income and wealth inequality data, in part, on the grounds of his failure to reflect the role of human capital in generating financial returns. It looks like the above study provides some more support for my arguments.

10/8/2014: Serial Entrepreneurship: Learning by Doing?

We often hear references to the U.S. entrepreneurial climate whereby one's failure at the first venture is commonly rewarded with an encouragement to start again. One of the alleged reasons for this climate emergence, the popular belief asserts, is that an entrepreneur learns from failure or success of the first venture to deploy this knowledge to achieve a greater success in the second entrepreneurial endeavour.

"Serial Entrepreneurship: Learning by Doing?" (NBER Working Paper No. w20312) by FRANCINE LAFONTAINE, and KATHRYN L. SHAW, looks are whether "Among typical entrepreneurs, is the serial entrepreneur more likely to succeed?" and "If so, why?"

The paper uses "a comprehensive and unique data set on all establishments started at any time between 1990 and 2011 to sell taxable goods and services in the state of Texas. An entrepreneur is defined as the owner of a new business. A serial entrepreneur is one who opens repeat businesses. The success of the business is measured by the duration over which the business is in operation."

And the conclusions are:

• "The data show that serial entrepreneurship is relatively uncommon in retail trade. Of the almost 2.3 million retail businesses of small owners of new businesses in our data, only 25 percent are started by owners who have started at least one business before, and only 8 percent are started by an owner who is still operating at least one other business started earlier."
• "However, once one becomes an entrepreneur for a second time, the probability of becoming one a third time, or fourth time, and so on, keeps rising."
• "Moreover, we find that an owner's prior experience at starting a business increases the longevity of the next business opened, and that controlling for person fixed effects, prior experience still matters."
• "Finally, experience at starting retail businesses in other sectors (e.g. a clothing store versus a repair shop) is beneficial as well, though not as much as same sector experience, and not in the restaurant sector."

The authors conclude that "prior experience imparts general skills that are useful in running the new business."

19/7/2014: Global Innovation Index 2014: Ireland vs 'Periphery'

In the previous post I gave detailed breakdown of Ireland's performance in Global Innovation Index 2014. I used small open economies and Switzerland (the world's highest ranked economy) as a reference group.

Here, primarily for the reason of convention, are the comparatives of Ireland's performance relative to the Euro area 'peripheral' states:

Clearly, Ireland is a much stronger performer in Innovation than all other 'peripheral' states. This is neither surprising nor unexpected. Crucially, the gap is wider today than in 2007-2008 and the gap is rather persistent over time. Average ex-Ireland 'peripheral' state rank was 34st in 2014 against Ireland's 11th, this is a very significant gap. This gap increased from 16-19 points on average for 2007-2010 period to 32 points in 2012 and 23 points in 2014.

Furthermore, it appears that even if we are to abstract away from the metrics very heavily influenced by the tax optimising MNCs, Ireland (under such a metric closer to 20th-23rd position in the World rankings) would still post a stronger performance than any other 'peripheral' state (best - Spain at 27th).

19/7/2014: Global Innovation Index 2014: Ireland's Performance

Global Innovation Index is out this week and the 2014 edition focus is on Human Capital (here) a topic close to my heart (see my TEDx talk on this here).

Here are some interesting comparatives taken over the Index history for Ireland and its core peers.

Firstly, in 2014, top 20 ranks are:

Ireland shows good performance, with 11th place in 2014, slightly down on 10th place in 2013 and significantly down on 7th place in 2012 rankings, but still better than historical average of 16th rank.

Here is evolution of Irish rankings over time, compared to other small open economies of Europe that rank in top 25 this year:

Not a bad performance for Ireland, I must say, though we should be aiming for a place in the top-10.

However, over longer time horizon our performance is second best in the group of peer economies:

The above chart highlights top 3 performers in terms of rankings dynamics (green bars) and worst 3 performers (red bars).

It is worth noting that Luxembourg is, in my view, an economy that simply should not be ranked due to massive distortions in its rankings induced by large share of the companies operating in the country only as post-box offices and due to huge proportion of its workforce not being residents of the country. In Ireland, there are some distortions as well, and these are very significant, but of magnitude they are much smaller than those in Luxembourg.

Here are some Ireland vs Switzerland comparatives in specific sub-indices:

Institutions:

The above shows relatively strong performance for Ireland, except for:

• Political Stability and Environment
• Government Effectiveness

Ireland leads Switzerland strongly on

• Business Environment metrics

Human Capital and Research:

Overall, we have a strong lead compared to Switzerland in:

• Education, when it comes to Spending on Education and on School Life Expectancy (so we spend more and our students stay in school longer, on average)
• Tertiary Enrolment (we have more student-age people in tertiary education)

We significantly lag Switzerland in:

• Tertiary Inbound Mobility (ability to attract students into Ireland)
• R&D
• Researchers
• Spending on R&D
• University Rankings (quality of education)

 Infrastructure:

We outperform Switzerland in nothing, save for GDP per unit of energy use, which is of course consistent with the fact that a larger share of our GDP accrues to tax optimisation than in the already low-tax Switzerland.

We lag Switzerland in everything else...

Market Sophistication:

We lead Switzerland in Credit, thanks to allegedly greater ease of getting credit in Ireland (I am not sure what the Index analysts mean by that, given that our credit supply is negative). Despite beating Swiss in 'credit' we lag them in Investment, which, presumably means that while we borrow more and easier, we do not invest what we borrow... may be it is because our businesses are buying BMWs and Mercs instead of machinery and technology? I have no idea...

Business Sophistication:

Remember that Ireland beats Switzerland on Ease of Doing Business. But with all that 'Ease' around, we are really not that far up on Switzerland in actual Business Sophistication... and if we strip out FDI inflows and imports of high tech equipment and inputs (a proxy for how many ICT MNCs we have 'operating' from here), we are probably actually ranked lower than Swiss.

Knowledge & Technology Outputs:

When it comes to actual Knowledge & Tech outputs, all of the above 'advantages' of Ireland over Switzerland vanish. Just as Savings vs Investments, we are good on inputs, but much less good on deriving anything meaningful from them. Control for tax optimisation activities of ICT services MNCs in Ireland and we sink even further below Switzerland.

Creative Outputs:

We are keen on painting Ireland as a Creative Land, while the Swiss are, as we often note, boring and 'Germanic' - aka not creative and too stringent. Right? Not really. Swiss beat us hands down on Creative Output metrics. We only outperform them in terms of Wikipedia edits and YouTube uploads - presumably due to the need to control our reputation by editing out unpleasant references to our social and industry and politics 'stars' from the public domain and down to our 'craic' in pubs and bars that get mistakenly posted on-line... I am, of course, being slightly sarcastic.

So net conclusions (on serious note):

1. We are getting better and are strong performers when it comes to many 'inputs' into Innovation; but
2. We are not that great in deriving 'outputs' from the 'inputs' we commit.
3. Much of the performance upside for Ireland is down to distortionary activities of a handful of MNCs trading from Ireland; and
4. Much of the performance downside for Ireland is down to indigenous activities of the rest of our economy.

29/6/2014: Tech & Science Migrants & Native Workers: US Evidence

Tech specialists and ICT specialists hired from abroad into countries like Ireland are seen, by the policymakers, as a necessary and sufficient evidence of growth in employment and domestic economic well-being. The reason for this is often found the argument that lack of local skills will result in higher labour costs and lower competitiveness of the sector and, thus, lead to outflow of ICT-linked FDI and reduced MNCs activity in the economy.

Part of this rationale is correct. Part is wrong. I recently posited, in my Sunday Times ex-column and in a WSJ op-ed, the thesis that in Ireland's case, tax optimisation by ICT MNCs is equivalent to a resource curse, whereby excessive amounts of financial resources flows into attracting and retaining skilled workers, resulting in underinvestment in other sectors of economy. Beyond this, the Government, grown accustomed to windfall revenues from the tax optimising MNCs has lower incentives to focus on developing indigenous and highly competitive specialisation.

Setting aside these more complex arguments, what is the effect of the skilled ICT and tech and R&D workers immigration on domestic economy?

Peri, Giovanni and Shih, Kevin Yang and Sparber, Chad, in their recent paper titled "Foreign Stem Workers and Native Wages and Employment in U.S. Cities" (May 2014, NBER Working Paper No. w20093) looked at the effects of the Scientists, Technology professionals, Engineers, and Mathematicians (STEM workers) immigration into the US. Per authors, STEM workers "are fundamental inputs in scientific innovation and technological adoption, the main drivers of productivity growth in the U.S."

In their paper, the authors attempt to "identify the effect of STEM worker growth on the wages and employment of college and non-college educated native workers in 219 U.S. cities from 1990 to 2010. In order to identify a supply-driven and heterogeneous increase in STEM workers across U.S. cities, we use the distribution of foreign-born STEM workers in 1980 and exploit the introduction and variation of the H-1B visa program granting entry to foreign-born college educated (mainly STEM) workers."

Key findings:

• "We find that H-1B-driven increases in STEM workers in a city were associated with significant increases in wages paid to college educated natives." In other words, shortages of specialist skills (signified by intensity of inflow of STEM migrants) do bid up wages for similarly-educated (in degree attainment and also in skills similarities) natives. This agrees with my argument that far from driving down labour costs for skilled workers not just in STEM-related sectors, but across all educated workforce, STEM-targeted immigration is associated with higher labour costs. Often, this is seen as being driven by complementarity between STEM skills and related services professionals (legals, accounting, sales, marketing, etc). But is that the case of signalling value of their degrees going up in the market, or is it the case of their skills value going up? One way or the other, more STEM immigrants seems to do nothing to improve labour costs competitiveness.
• "Wage increases for non-college educated natives are smaller but still significant." So wage inflation is not moderated by STEM migration, even if we control for skills. In other words, all sectors of city economy are facing rising costs in the presence of STEM immigration. This, of course, is not an argument of causality, but it is also not the evidence that would be consistent with an argument that STEM immigration induces gains in labour competitiveness.
• "We do not find significant effects on employment." In other words, jobs creation is not what happens when you open up targeted skills-driven migration. And, by converse, it is not impacted by restricting it. Which begs a question: every month Irish ministers present jobs announcements by STEM-intensive ICT services companies as evidence of employment creation. Every time they do so, they omit consideration of what higher cost of skilled and unskilled workers is doing to the rest of the economy. Should they be concerned with the latter at least as much as with the former? The study evidence suggests they should.
• "We also find that STEM workers increased housing rents for college graduates, which eroded part of their wage gains." Ah, can that be a reason why rents are inflating in Dublin, especially in the areas where STEM-equivalent skills are at the highest premium (IFSC and South Docklands corridor)? In summary, therefore, higher employment and immigration of STEM workers seems to be associated with higher costs of living for all workers. Is it correct to posit a question of spillovers or externalities that arise from greater share of new employment going to skilled ICT immigrants onto the long term residents of the country or city? If yes, then the logic suggests that there should be consideration of transfers from the immigrants under STEM programme to at least those natives and long term residents who do not gain in wages enough to compensate them for the rising cost of living.

Overall, authors conclude that "Together, these results imply a significant effect of foreign STEM on total factor productivity growth in the average US city between 1990 and 2010." Which is, of course, good. But it does not tell us if this TFP growth actually spreads across the entire economy or stays within STEM-intensive sectors. We do not know if TFP gains in STEM sectors are not offset by labour competitiveness losses in the rest of the host economy. And, crucially, it does not tell us if the above questions, posited in the bullet point comments, can be answered unambiguously in favour of more STEM-linked immigration.

26/6/2014: Explaining the Gender Gap in Entrepreneurship

A new paper by Caliendo, Marco and Fossen, Frank M. and Kritikos, Alexander and Wetter, Miriam, titled "The Gender Gap in Entrepreneurship: Not Just a Matter of Personality" (May 23, 2014: CESifo Working Paper Series No. 4803 http://ssrn.com/abstract=2457841) tackles a very important and highly sensitive issue of gender gap in entrepreneurship.

The authors ask "Why do entrepreneurship rates differ so markedly by gender?"

The paper uses data from a large, representative German household panel, covering 2000-2009 period, to "investigate to what extent personality traits, human capital, and the employment history influence the start-up decision and can explain the gender gap in entrepreneurship."

"In contrast to previous research the main advantage of our data set is that it contains not only information on the socio-demographic background of the respondents, but also on a broad set of personality constructs that elicit the Big Five traits and several specific personality characteristics."

Note: Big Five Factor Model of personality (McCrae and Costa, 2008) "describes the personality by the factors openness to experience, conscientiousness, extraversion, agreeableness, and neuroticism (or, reversely, emotional stability)."

Per authors, "To the best of our knowledge information on the Big Five approach has not been used to assess the gender gap in entrepreneurship. We are the first to simultaneously analyse the effects of the Big Five factors, risk aversion, locus of control, and the ability to trust others ..., as well as of a variety of variables controlling for human capital, employment status, and other socio-demographic factors on the gender specific decision to enter self-employment."

The findings are very far-reaching and substantially in dispute with commonly held views:

1. "Applying a decomposition analysis, we observe that the higher risk aversion among women explains a large share of the entrepreneurial gender gap."
2. "We also find an education effect contributing to the gender difference." More specifically: "On average, working aged women in Germany are still less educated than men and are, therefore, less inclined to start a business."
3. "Thirdly, the current employment state has a strong effect into the opposite direction: If the share of women in wage employment were as high as the male share, holding everything else constant, their entry rate into self-employment would be much smaller."
4. "…we show that personality traits help explain the gender gap in nuanced ways. While specific characteristics, in particular risk attitudes, are able to explain a substantial amount of the gender gap, the overall influence of the Big Five personality constructs point to the opposite direction. This means that if women were endowed with the same scores in the Big Five as men, the gap would be even larger."

Overall: "the explained gap is therefore negative meaning that if women exhibited in all observable variables the same parameter values as men, the entry rate of women would be even smaller than actually observed."

24/6/2014: US Productivity Slowdown: It's Structural & Nasty

"Productivity and Potential Output Before, During, and After the Great Recession" a new paper by John Fernald (NBER Working Paper No. 20248, June 2014) looks at the U.S. labor and total-factor productivity growth slowdown prior to the Great Recession in the context of the slowdown "located in industries that produce information technology (IT) or that use IT intensively, consistent with a return to normal productivity growth after nearly a decade of exceptional IT-fueled gains". In a sense, the paper reinforces the point of view that I postulated in my TEDx talk last year dealing with the 'end' of the Age of Tech (here: http://trueeconomics.blogspot.ie/2013/11/14112013-human-capital-age-of-change.html).

Fernald opens the paper with a set of two quotes. One brilliantly describes the core question we face:
"When we look back at the 1990s, from the perspective of say 2010,…[w]e may conceivably conclude…that, at the turn of the millennium, the American economy was experiencing a once-in-a-century acceleration of innovation….Alternatively, that 2010 retrospective might well conclude that a good deal of what we are currently experiencing was just one of the many euphoric speculative bubbles that have dotted human history." Federal Reserve Chairman Alan Greenspan (2000)

Fernald argues that "The past two decades have seen the rise and fall of exceptional U.S. productivity growth. This paper argues that labor and total-factor-productivity (TFP) growth slowed prior to the Great Recession. It marked a retreat from the exceptional, but temporary, information-technology (IT)-fueled pace from the mid-1990s to the early 2000s. This retreat implies slower output growth going forward as well as a narrower output gap than recently estimated by the Congressional Budget Office (CBO, 2014a)."

Figure 1 from the paper illustrates how the mid-1990s surge in productivity growth indeed ended prior to the Great Recession. The rise in labor-productivity growth, shown by the height of the bars, came after several decades of slower growth. But, notes Fernald, "in the decade ending in 2013:Q4, growth has returned close to its 1973-95 pace. The figure shows that the slower pace of growth in both labor productivity and TFP was similar in the four years prior to the onset of the Great Recession as in the six years since."

And things have been bad since. Labour productivity growth (slope of liner trend below) is now on par with what we have been witnessing in 1973-1995, and shallower than in 1995-2003. But the trend is still close to actual performance, which signals little potential for any appreciable acceleration:

Beyond labour productivity, things are even messier. Charts below plot the Great Recession against other recessions in terms of productivity, output and labour utilisation:

Notes: For each plot, quarter 0 is the NBER business-cycle peak which, for the Great Recession,
corresponds to 2007:Q4. The shaded regions show the range of previous recessions since 1953. Local
means are removed from all growth rates prior to cumulating, using a biweight kernel with bandwidth of 48 quarters. Source is Fernald (2014).

All of the above show the cyclical disaster that is the current Great Recession, but crucially, they show poor recent performance in Labour Productivity, exceptionally poor performance in Hours of Labour used, disastrous performance in Total Factor Productivity… in other words - historically problematic trends relating to productivity, labour utilisation and tech-related productivity in the current recession compared to all previous recessions.

But more worrying is that, as Fernald notes: "That the slowdown predated the Great Recession rules out causal stories from the recession itself. …The evidence here complements Kahn and Rich’s (2013) finding in a regime-switching model that, by early 2005—i.e., well before the Great Recession—the probability reached nearly unity that the economy was in a low-growth regime."

So what's behind all of this slowing productivity growth? "A natural hypothesis is that the slowdown was the flip side of the mid-1990s speedup. Considerable evidence… links the TFP speedup to the exceptional contribution of IT—computers, communications equipment, software, and the Internet. IT has had a broad-based and pervasive effect through its role as a general purpose technology (GPT) that fosters complementary innovations, such as business reorganization. Industry TFP data provide evidence in favor of the IT hypothesis versus alternatives. Notably, the euphoric, “bubble” sectors of housing, finance, and natural resources do not explain the slowdown. Rather, the slowdown is in the remaining ¾ of the economy, and is concentrated in industries that produce IT or that use IT intensively. IT users saw a sizeable bulge in TFP growth in the early 2000s, even as IT spending itself slowed. That pattern is consistent with the view that benefiting from IT takes substantial intangible organizational investments that, with a lag, raise measured productivity. By the mid-2000s, the low-hanging fruit of IT had been plucked."

This a hugely far-reaching paper with two related implied conclusions:

1. Prepare for structurally slower growth period in the US (and global) economy as the last catalyst for growth - tech - appears to have been exhausted; and
2. The Age of Tech is now in the part of the cycle where returns to innovation and technology are falling, while returns to financial assets overlaying tech sector are still going strong. The classic bubble scenario is being formed once again, as always on foot of disconnection between the real economic returns to the assets and asset valuations. This bubble will have to deflate.

9/6/2014: Reversal of Human Capital Flows

An interesting post on reversals of old patterns in human capital flows: http://www.project-syndicate.org/commentary/mohammed-bin-rashid-al-maktoum-highlights-the-success-of-some-developing-countries-in-reversing-the-outflow-of-their-most-talented-people

that gels well with my speech on same topic here: http://trueeconomics.blogspot.ie/2013/11/14112013-human-capital-age-of-change.html

15/5/2014: Innovation, Employment & Growth: Ireland's Human Capital Dilemma

This is an unedited version of my article for Sunday Times, April 06.


From jobs programmes aiming to boost employment creation to entrepreneurship strategies and to solemn promises to unlock credit supply and investment for indigenous innovation-based enterprises, Irish SMEs have been basked in the public policy sunshine.

Much of this attention is cross-linked to another public policy fad, Ireland’s long-running obsession with innovation and R&D. In 2013, amidst continued borrowing for day-to-day operations from the Troika, Irish State spent EUR773 million on supporting research and development activities in academia and industry. Of this, a good portion was targeted to fund R&D and other innovation activities linked to Irish indigenous SMEs.

There are three basic problems with all this policies activism. One, we have no idea as to what sort of financial returns this public investment generates to the taxpayers. Two, we have virtually no coherent and independently verified evidence that the innovation-focused SMEs are delivering any serious economic returns in terms of real jobs creation and income generation. Three, we have no proof the state-funded innovation is a right model for SMEs growth generation in the first place.


Enterprise innovation is a weak spot for Ireland. Indigenous patent applications reported in July last year by the Patents Office and covering full year 2012 stand at decades low. Monthly data from the New Morning IP – an Irish consultancy dealing with issues of intellectual property – shows that in 2013 indigenous patents applications fell even further, down by almost 3 percent year on year.

Back in 2006, the national strategy for science set 2013 as the target date to deliver a 'world class knowledge economy'. Since then, numbers of indigenous patents filed under the Cooperation Treaty and to the European Patent Office have declined.

And the problem reaches beyond our SMEs. For example, per IDA own figures, only 28 percent of agency clients have spent more than EUR100,000 per annum on R&D. In other words, nearly three out of four MNCs had, de facto, nil research activity here.

The university sector is the cornerstone of Irish Government's vision for delivering an innovation-focused SMEs culture. Sadly, our best universities are barely visible on the radar of international rankings. Ireland’s top university currently ranks only 61st in the QS Top University league table and 129th in the Times Higher Education (THE) rankings. Trinity ranks 55th in Arts & Humanities – an area that receives absolutely zero attention from the likes of IDA and Enterprise Ireland and is firmly placed outside our economic development policy umbrella. TCD ranks 81st in engineering and technology, 83rd in life sciences and medicine and 136th in natural sciences. All of these areas are focal points for R&D spending and feed into state enterprise supports systems. UCD is no better: ranked 139th in the world under QS criteria and 161st by the THE rankings.

By pretty much every possible metric, our innovation engines are not firing.


Meanwhile, enterprise formation, an area that should be a core priority for the Government that is allegedly focusing on entrepreneurship and jobs creation, is lagging. Irish start-ups rates, relative to the economy size, are low today and have been low even in the days prior to the Great Recession.

Based on the OECD statistics, despite years of booming ICT services and substantial growth in the IFSC, Ireland today shows relatively static number of enterprises trading in market services, and declines in the number of enterprises working in manufacturing and industries, excluding the construction sector.

Late last year, OECD published its Economic Survey of Ireland. The document recommended empirically founded approach to enterprise and innovation supports. OECD noted that over-proliferation of funding agencies and programmes is yet to be scaled back. Per OECD, Ireland has over 170 "separate budget lines… and 11 major funding agencies involved in disbursing the Science Budget". Meanwhile, the Government continues to add new ones, seemingly with little regard for their effectiveness. Not surprisingly, there is no evidence on systematic and independent evaluation of these programmes effectiveness. And there are no continuously reported return metrics relating to state investments in enterprise development and innovation.

Instead of real statistics, often misleading and highly aggregate numbers are being put forward as markers of success. Jobs commitments and gross jobs additions are presented as signifiers of major breakthroughs, without independent audits. Companies’ registrations rates are reported as being equivalent to start up rates and no central data reporting is provided for actual enterprise formation. Take for example a jump reported in new companies registrations in Q1 2014 when 10,741 new companies were entered into the register, marking a 6% rise year on year. This number included 3,989 limited companies - the third highest rate of new limited companies registrations for the first quarter over the last 10 years.

Sadly, these headline statistics tell us preciously little about the underlying dynamics of companies formation. For example, how many business restructurings completed in 2012-2013 are now leading to companies re-registrations? How many of the businesses launched in previous years survive? How many of businesses launched are actively trading in the real economy? We simply do not know.

Focus on top-line reporting metrics, such as aggregate numbers of companies registered, VC funds disbursed, R&D budgets spent, obscures the woeful lack of coherent policies supporting indigenous enterprises formation and growth. As the result, beyond the areas of ICT services, biotech and medical devices, we neither foster formation of micro enterprises nor help smaller companies to reach 'medium' size. And, via tax and compliance measures, we actively penalize self-employment – the source of much of the early-stage entrepreneurship.


Promoting real innovation and enterprise cultures requires supporting investment ecosystem and entrepreneurial risk-taking. These goals can only be achieved by lower taxation, especially via lower CGT and income tax, and a benign and highly efficient personal and business insolvency regime. These are not priority areas for the Government.

However, tax policies mix is a necessary, but not a sufficient condition for success. To further promote real enterprise growth, we need to stop fetishising scientific R&D-driven enterprises and ICT and refocus public funding toward more evidence-based enterprise development projects.

International research shows that ordinary and traditional sectors SMEs drive growth in jobs and income. Where traditional sectors are put onto exporting paths, these SMEs can drive exports growth as well. In contrast, high performance start-ups in ICT services, usually focused directly on exports markets, are less employment and income-intensive. ICT does contribute strongly to productivity growth and is a nice niche business to have on offer for investors, but as McKinsey recent research pointed out, tech innovation business is unlikely to fulfill the economy-wide hunger for jobs, especially jobs for the indigenous workforce.

Focusing on active training for entrepreneurship and mentoring of new companies is another necessary addition to the policies mix that is currently being sidelined in favour of populist drive for state investment and R&D funding. One key area where we are lacking in supports is access for entrepreneurs to legal, tax and financial advice. Costs of tax and legal compliance and structuring are unbearably high for younger companies and for smaller enterprises considering growth strategies. These costs crowd out funding available to companies to finance further development, hiring, as well as cap companies growth potential.

On investment side, we have a thriving culture of VCs chasing the 'next Facebook'. Over 90 percent of all VC funding extended in Ireland goes to finance ICT start-ups, with more than two-thirds of this going to ICT services companies, as opposed to physical technologies.  We also have over 75 incubators and accelerators, with the vast majority of these being state-owned and/or state-funded. These too focus almost exclusively on companies working in ICT, biotech and other lab-linked innovation sectors.

But we have no idea as to the effectiveness of this strategy. Numbers employed in core ‘knowledge economy’ sectors have grown by about 4,900 from the onset of the crisis through 2013. All of this growth was down solely to ICT jobs which added 9,125 new employees, while professional, scientific, and technical activities employment, excluding education sector, is down 4,225 on 2008. Adding up jobs creation reported by the MNCs from 2008 through present, it is highly likely that indigenous employment in professional, scientific, technical, and information and communication sectors has probably shrunk.

Looking at the overall landscape of enterprise formation here, we do know that with exception of Ryanair, CRH, Paddy Power and a handful of other flagship companies, no Irish SME has grown beyond the 'medium' level threshold. The magic target of exceeding EUR20 million in annual sales - set in the Enterprise Ireland 2005-2007 strategy plan has vanished, unmet.

Put simply, Irish indigenous companies are not getting smarter with billions of public funds invested in SMEs-targeting R&D activities and ventures over the years. At the same time, Irish SMEs are not growing in size either. Micro enterprises show some progression toward becoming small firms, but small firms show little dynamism upward and medium-sized companies are stuck with no capacity to break into the big firms league. The system is broken and incremental policy adjustments are not holding a promise of a solution. We need to go back to the drawing table on enterprise policy in Ireland.

Box-out: 

Recent research from the US, published by the National Bureau for Economic Research looked into sell-side equity analysts' ability to predict equity prices and the impact their predictions have on market valuations over the period of 1983-2011. Controlling for a wide variety of factors that routinely influence forecast errors, the study has found that at the times of the crises sell-side analysts forecasting accuracy deteriorates by up to 50 percent relative to normal. And just as analysts’ errors explode, their influence rises as well. In particular, forecasts that upgrade outlook for companies amidst the falling market tend to carry the greatest weight of public attention. Optimism pays, even if only for analysts’ employers. Which, of course, creates a powerful incentive for sell-siders to ‘talk up’ equities just around the time of the worst bear market. Lastly, the study found that at the time of financial crises, marketing efforts by sell-side analysts tend to increase, in part due to greater pressure on them to perform, in part due to expanded opportunities for being ‘heard’ by investors.

John Kenneth Galbraith thought that "The conventional view serves to protect us from the painful job of thinking." In the case of sell-side analysts musings on the crises, that might be not a bad alternative.

15/4/2014: Flat Tax for Italy? Ask PIN...

Last week Italy sold EUR3.5 billion in 2016 Bonds today at an average yield 0.93% and with bid cover of 1.41, delivering a record low yield. At these yields, it is easy to think that the Italian fiscal and economic crises are over. Or at least that they are easing substantially enough to allow for the repricing of risks and some breathing space when it comes to markets expectations concerning euro area's third largest economy.

However, despite the positive news, Italy's economy remains a 'sick man' of Europe and it has been such for some time now. More importantly, the problem is unlike to go way unless Italian economy is reformed; dramatically and radically.

Chart below shows very clearly sustained, long-term underperformance of the Italian economy in terms of real growth since 1980. In addition, Italian economy has been a significant laggard in terms of growth during the current crisis. For example, if the Great Recession resulted in the G7 economies regaining their pre-crisis peak real GDP of 2007 by the end of 2011, Italian economy is not expected to regain pre-crisis peak levels of real output (2007) until at least 2020.

Growth weaknesses in the economy, running over the long periods of time, drive persistent structural decline in multi-annual, generational trends. One of particular note is the trend relating to employment ratios and unemployment.

The key takeaway from the above is that Italy is structurally (or in other words long-term, very long-term) sustaining economic development model that is associated with persistently higher unemployment and dependency ratios. Coupled with relatively high emigration, this model is driving generational momentum toward loss of human capital.According to the World Bank data, Italy had one of the highest rates of net emigration of population with at least tertiary education in the 1990s and 2000s - averaging around 10 percent and unemployment rate for those with tertiary education well in excess of the euro area and G7 averages.

This relatively poor performance, when it comes to the country ability to create, attract, retain and enable human capital is a core weakness and challenge for Italian economy that I recently was asked to address by the new political party, PIN: Partito Italia Nuova (https://www.facebook.com/partitoitalianuova) in Milan.

The core argument of my presentation was focused on the thesis that I started developing at IBM (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2001907) and summarised in my TEDx talk last year (https://www.youtube.com/watch?v=y1sueM_jhSk).

In my presentation in Milan, I looked at Irish experience from the 1980s through present in the context of developing a human capital-intensive economy. Here are some slides from the presentation:

From the point of view of Italian policies, post-crisis structural reforms require refocusing Italy's economy toward facilitating:

• Closure of the human capital gap (education, immigration and emigration)
• Stimulation of growth at the SMEs levels (family firms incentives and investment, professionalisation of management, enterprise reforms)
• Reforms of incentives structures in labour markets (increase returns to Human Capital, reduce disincentives to work, increase incentives to take up self-employment and entrepreneurship)
• Closer alignment of tax rates with tax compliance and enforcement
• Conversion of 'black economy' into legally and tax compliant transactions
• Reducing distortions from outflows of savings and investment from private sectors to public debt.

As argued in my analysis of the Irish situation, changes along these lines are required not only to bring domestic economy to pre-crisis levels of competitiveness and growth generation, but also address the pressures arising from international markets and from the transition of the global economy toward greater dependency on Human Capital as the core driver for growth.

The above objectives can be partially addressed via reforms of tax codes that act to simplify tax compliance, reduce tax burden on income from work, and increase transparency of tax systems. Flat tax is one of the best ways to achieve these, but flat tax is just the first step on aligning global realities of Human Capital intensive growth with national institutional and policies frameworks.

10/4/2014: The curse of Long-Term Joblessness

This is an unedited version of my Sunday Times column from March 30, 2014


The unemployment crisis has not passed unnoticed in many households. Ours’ is no exception. Back in 2008, for a brief period of time, both of us found ourselves out of jobs. Thankfully, the spell was very short-lived. Then, in 2011, over a couple of months, I was dusting out my CV for unplanned updates. Just a few days ago, I learned that this year I will not be teaching two of the courses I have taught over the recent years. It's part-time unemployment, again, and this time it is down not to the economic crisis, but to the senile EU 'labour protection' laws.

Yet, spared long-term unemployment spells and able to pick up freelance and contract work, our family is a lucky one. In contrast, many in Ireland today find themselves in an entirely different camp.

Per latest statistics, in February 2014, 180,496 individuals were officially in receipt of Live Register supports for longer than 1 year. Inclusive of those long-term unemployed who were engaged in state-run 'activation programmes' there were around 265,500 people who were seeking employment and not finding one for over a year.

Countless more, discouraged by the zero prospect of securing a new job and not eligible or no longer eligible (having run out of benefits and not qualifying for full social welfare due to total family income) for Live Register supports have dropped out of the workforce and/or emigrated. They simply vanished from the official statistics counts. By latest counts, their numbers can range around 250,000; half of these coming from emigrants who left the country between April 2010 and April 2013.


The numbers above starkly contrast with the boisterous claims by the Government that the economy has created some 61,000 new jobs in 2013. Looking deeper into the new jobs claim, there has been a tangible rise in full-time employment of roughly 27,000 in 2013. Which is still a good news, just not good enough to make a serious dent in the long-term unemployment figures.

Officially, year on year, long-term unemployment fell by 20,900 in Q4 2013. Accounting for those in activation programmes, it was down by around 18,200. Live Register numbers are showing even shallower declines. In 12 months through February 2014, total number of unemployment supports recipients fell 30,807. But factoring in the effect of state training programmes, the decline was only 7,364 amongst those on live register for longer than 1 year. Even more worrisome, since Q1 2011 when the current Government took office, through the first two months of 2014, numbers of the long-term recipients of Live Register support are up by 31,352.

Whichever way you look at the figures, the conclusion is brutally obvious: the problem of long-term unemployment is actually getting worse just as the Government and the media are talking about rapid jobs creation. More ominously, with every month passing, those stuck in long-term joblessness lose skills, aptitude and sustain rising psychological stress.

All of this adds up to what economists identify across a number of studies as a long-term or nearly permanent loss of economic and social wellbeing for workers directly impacted by the long-term unemployment.

However, long-term unemployment also impacts many more individuals than the unemployed themselves.

The lifetime declines in career paths and incomes traceable to the long-term unemployment are also found across the groups related to those without the jobs either via family or via job market connections. Researchers in the US, UK, Germany and Denmark have shown that long-term unemployment for one member of the family leads to a reduction in the lifetime income and pensions cover for the entire household. Studies have also linked long-term unemployment of parents to poorer outcomes in education and jobs market performance for their children.

The adverse effects of long-term unemployment also occur much earlier in the out-of-work spell than our statistics allow for. Whilst we consider the unemployment spells of over 1 year to be the benchmark for long-term unemployment, studies from the US and UK show that the adverse effects kick in as early as six months after the job termination. The US-based Urban Institute found that being out of work for a period in excess of six months is "associated with lower well-being among the long-term unemployed, their families, and their communities. Each week out of work means more lost income. The long-term unemployed also tend to earn less once they find new jobs. They tend to be in poorer health and have children with worse academic performance than similar workers who avoided unemployment. Communities with a higher share of long-term unemployed workers also tend to have higher rates of crime and violence."

This is a far cry from the Irish Government rhetoric on the issue of long term unemployment that paints the picture of relatively isolated, largely personal effects of the problem. Empirical evidence from a number of European countries, as well as the US and Australia shows that these effects are directly attributable to the unemployment spells themselves, rather than being driven by the same causative factors that may contribute to a person becoming unemployed.

Such evidence directly disputes the validity of the Irish Government policies that rely almost entirely on so-called 'activation programmes'. Activation programmes put in place in Ireland during this crisis primarily aim at providing disincentives for the unemployed to stay outside the labour market. Such programmes can be effective in the case where there is significant voluntary unemployment. Instead, in the environment with shortages of jobs and big mismatches between skills and jobs, policy emphasis should be on providing long-term supports to acquire necessary skills and empower unemployed to gradually transition into new professions, enterprises and self-employment.

In part, our state training programmes are falling short of closing the skills gaps that do exist in the labour markets. ICT and ICT support services training, as well as international financial services and professional services skills – including those in sales, marketing, back office operations - are barely covered by the existent programmes.

And where they are present, their quality is wanting. For a good reason: much of our training at best involves instructors who are part-time employed in the sectors of claimed expertise and are too often on the pre-retirement side of their careers, having already fallen behind the curve in terms of what is needed in the markets. In worst cases, training is supplied by those who have no proven track record in the market. Structuring of courses and programmes is done by public sector employees who have little immediate understanding of what is being demanded. We should rely less on the use of training 'specialists' and more on industry-based apprenticeships.

Many practices today substitute applied teaching in a quasi-educational programme with class-based instructions and formal qualification attainment for an hands-on, on-site engagement with actual employers. Evidence collected in Denmark during the 1990s showed that classroom-based training programmes significantly increase individual unemployment rates instead of decreasing them. The reason for this is that attainment of formal or highly specialised qualifications tends to increase individual expectations of wages offers post-programme completion, reducing the range of jobs for which they apply. This evidence in part informed the German reforms of the early 2000s that focused on on-the-job apprenticeship-based skills development. Beyond that, class-based training lacks incentives for self-advancement, such as performance bonuses and commissions.

Self-employment acts as a major springboard to new business formation and can lead to acquisition of skills necessary for full-time employment in the future. Currently, there is little training and support available for people who are considering self-employment. There are, however, strong disincentives to undertake self-employment inherent in our tax systems, access to benefits, and in reduced burden of legal compliance. One possible cross-link between self-employment training and larger enterprises' demand for contractors is not explored in the current training programmes. There are no available shared services platforms that can help self-employed and budding entrepreneurs reduce costs in the areas of accounting, legal and marketing.


Unless we are willing to sustain the indefinitely some 100,000-120,000 in long-term unemployment, we need to rethink of the entire approach to skills development, acquisition and deployment in this country.

Some recent proposals in this area include calls from the private sector employers groups to drop minimum wage. This can help, but in the current environment of constrained jobs supply, it will mean more hardship for families, in return for potentially only marginal gains in employment. Incentivising self-employment and contracting work, by reducing tax penalties will probably have a larger impact. Encouraging, supporting and incentivising real internships and apprenticeships - based on equal pay, commensurable with experience and productivity - will benefit primarily younger workers and workers with proximate skills to those currently in demand. Backing such programmes with deferred tax credits for employers, accessible after, say 3 years of employing new workers, will be a big positive.

In addition we need to review our current system of job-search assistance. For starters, this should be provided by professional placement and search firms, not by State agencies.

Finally, we need to review our current definition of the long-term unemployed to cover all those who are out of the job for longer than 6 months, as well as those who moved into unemployment fro, being self-employed.


This week, former White House economist Alan Krueger identified US long-term unemployment in the US as the "most serious problem" the economy faces right now. He is right. Yet, in the US, long-term unemployed represent roughly one third of all those receiving unemployment assistance. In Ireland, the number currently stands at almost two thirds. The crisis has not gone away. Neither should the drive for reforms.

Box-out: 

With the opening of the first Bitcoin ATMs in Dublin and with growing number of companies taking payments in the world's most popular crypto currency, the crypto-currency became a flavour of the week for financial press in Ireland.

The most hotly debated financial instrument in the markets, it is generating mountains of comments, rumors, as well as serious academic, industry and policy papers. Is it a currency? A commodity, like gold - limited in supply, unlimited in demand? Or a Ponzi scheme?

Few agree as to the true nature of Bitcoin. Bank of Finland denied Bitcoin a status of money, defining it as a commodity of sorts. Norway followed the suit, while Denmark is still deliberating. Sweden classified Bitcoin as 'another asset' proximate to art and antiques, the U.S. Internal Revenue Service - as property.The European Banking Authority is clearly not a fan, having ruled that "when using virtual currency for commercial transactions, consumers are not protected by any refund rights under EU law." In contrast, German authorities recognise Bitcoin as 'a unit of account' as do the French.

Financially, Bitcoin is neither a commodity nor a currency. Bitcoin does not share in any of the main features of commodities. You can't take a physical delivery under an insured contract. You cannot use it to hedge any other asset classes, such as stocks or other currencies. And it is not a currency because it has no issuer who guarantees its value. Nor can it feasibly serve as a unit of accounting and store of value, given extreme levels of price volatility.

Thus, one of the more accurate ways is to think of Bitcoin as a very exciting, interesting (from speculative, academic and practitioner point of view) financial instrument. For now, it shares some properties common to the dot.com stocks of around 1996-1998 and Dutch tulips ca 1620-1630, the periods before the full mania hit, but already showing the signs of some excessive investor confidence. So plant your seed with care.

29/3/2014: WLASze: Soul v Science in a Corporeal Juxtaposition

This is WLASze: Weekend Links on Arts, Sciences and zero economics.


Nothing can be as inspirational as real artistry and craftsmanship. And few examples of both stand head tall over the endless horizon of time than the works of Antonio Stradivari.

This week, Sotheby's announced that it is selling "what is regarded as the finest viola in existence – the "Macdonald" made by Antonio Stradivari in 1719." The 295-years old instrument is expected to go for more than £27m, "a figure that would easily surpass currently standing auction record for an instrument – the Lady Blunt Stradivari, which sold for £9.8m. It would (if achieved) also be higher than any known private sale." Per Sotheby's VC: "The instruments of the Stradivari are in a class of their own among the pinnacles of human craftsmanship and the Macdonald viola stands at the unquestioned summit."

Source: http://www.theguardian.com/uk-news/2014/mar/26/stradivarius-sothebys-macdonald?CMP=twt_fd Announcement: http://www.sothebys.com/content/sothebys/en/news-video/videos/2014/03/the-macdonald-viola-by-stradivari.html and you can read about the sale of Lady Blunt instrument here: http://www.newser.com/story/121578/stradivarius-violin-sells-for-16m.html

There is little doubt Antonio Stradivari (1644-1737) was the greatest maker of violins and violas of all times, having authored at least 1,116 instruments, although only around half still survive today.

There is a host of arguments attempting to capture the Stradivari's unique character. Here is an example:

"A Stradivarius in a good condition emits high-frequency sounds in a range where human hearing is the most sensitive. These frequencies become more audible in larger rooms. That makes the Stradivarius ideal for concerts in spacious concert halls and for performances together with big philharmonic orchestras.

The sound of these sublime instruments is so very characteristic that an observant listener can distinguish their superior tone when hearing the same artist playing on different instruments.

The sound of the old master instruments is not only superior in the vivacity of the tone; it is also insistent and captivatingly beautiful. The lustre and beauty of the instrument’s tone is as close you can come to the immaculate voice of a great opera diva." (Source: http://stradivariinvest.com/instruments/luthiers/)


But the magic, the allure, the raw emotional connection to Stradivari instruments - wether by public, critics or performers - also raises questions. The most pressing and the longest running one is: What makes Stradivari unique? And the less pressing, but probably more important one is: Is Stradivari unique?

Here is a note about one attempt to answer the first questions - a paper using the x-ray imagery to study the instruments: http://www.telegraph.co.uk/news/worldnews/europe/netherlands/2230123/Secret-of-Stradivarius-violins-superiority-uncovered.html

In contrast to physical qualities, some researchers have argued that chemical qualities to the wood used by Stradivari grant his instruments the power of uniqueness. Here is the paper looking into that aspect: http://www.scientificamerican.com/article/secrets-of-the-stradivari/ and http://www.sciencedaily.com/releases/2009/01/090122141228.htm

But there are doubts about both the existence and the source of Stradivari's violins performance compared to other outstanding works by contemporary and later craftsmen.

Here is an example of the scientific work performed by Colin Gough over the years that attempts to identify unique properties of Stradivari sound and fails to find them:
http://www.fritz-reuter.com/articles/physicsorg/Science%20and%20the%20Stradivarius%20(April%202000)%20-%20Physics%20World%20-%20PhysicsWeb.htm

And a more recent, brilliantly structured (albeit small sample and restricted spatial dimension) double-blind test study attempting to assess the ability of top violinists to discern the instrument they play: http://blogs.discovermagazine.com/notrocketscience/2012/01/02/violinists-cant-tell-the-difference-between-stradivarius-violins-and-new-ones/#.UzRD3a1_uzg

But may be the science of all of this is simply missing one core point: an artist is more than just a collection of physical properties - be they of her/his instrument or her/his own making. May be art is an intimate expression or at least a reflection of the soul (let me be old-fashioned here and surmise that soul exists without having to resort to attempting to explain what it might be). If so, then who cares if technically Stradivari's greatest achievement might have been in his instruments ability to trigger a (scientifically) placebo effect. The core result is the effect itself, as far as we are concerned with art. And that effect is undeniable. Virtuoso violinist Anne-Sophie Mutter likened playing her Strad for the first time to meeting her soul mate: "It sounded the way I (had) always been hoping," she said. "It's the oldest part of my body and my soul. The moment I am on stage, we are one, musically."

You might smile and say 'But studies show…' or you might marvel at her music and remember that is some intangible, non-scientific, quasi-religious way, it is a product of the Strad and thus a product of some guy who lived 300 years ago in a town called Cremona and had no computers, no state-granted labs, no complicated supply chains to procure and deliver rare varieties of wood, no precision equipment to mix his glues, lacquers, dyes and so on… and yet was able to give us something that no scientist to-date was able to explain...

Not bad. 300 years old… yet to be surpassed by anyone or anything, short of Stradivari's younger contemporary: Bartolomeo Giuseppe Guarneri del Gesù…  yet to be explained by anything or anyone... yet to be definitively established as anything beyond being sublime...

6/3/2014: Defending Ireland's Tax Regime Requires Reforms

This is an unedited version of my Sunday Times article from February 16, 2014.


Last week, Irish Government delegation to the OECD's Paris-based headquarters was all smiles and photo-ops at the front end, with lunches and joint press conferences at the back. In-between, there were speeches and statements extolling the virtues of our economic recovery and the Government leadership through the crisis.

Only one cloud obscured the otherwise sunny horizon of the trip: our corporate tax regime. Mentioned in the context of Yahoo’s decision to shift all of its European tax affairs from the ‘high tax’ Switzerland to ‘fully transparent’ Ireland, it required a high level intervention. Aptly, the Taoiseach was standing by to point that our effective corporate tax rate (the average tax rate that applies to companies here) is almost 12 percent, higher than France's 8 percent. Ireland 1: Tax Begrudgers  0.

Case closed? Not so fast.

In recent months, Irish corporate tax regime has featured prominently in international debates about European tax reforms, corporate earnings and multinational investment. G20 and G8 mentioned it, as did German, Finnish, Italian, French, the US and the UK leaders. As financial repression sweeps across the OECD member states in the wake of the sovereign debt crises, this debate is far from over.

This week, Professor James Stewart of TCD School of Business produced an insightful and well-researched analysis showing that the effective tax rate for the US MNCs in Ireland was 2.2% back in 2011. Methodologies bickering aside, Professor Stewart study challenges the core research used to support our corporate tax regime – the PWC studies that focus on domestically-trading SMEs.

The problem of course, is that the official discussions of Irish corporate tax regime are nothing more than a tactic of diffusing the issue by deflecting the real debate. Professor Stewart's research hints at this forcefully. The real issue with our corporate tax is not the headline rate, nor its transparency, but a host of loopholes that riddle the system and that allow companies here to dramatically reduce their global tax exposures well below the 12.5 percent rate.

Some of these loopholes, such as the notorious Double Irish scheme, are the subject of the EU Commission and OECD scrutiny as potentially anti-competitive, subsidy-like measures. Contrary to what public exhortations by our Ministers suggest, the threat is so real, the last Budget saw a closure of one of the more notorious features of our tax law that allowed companies to be registered here without having a tax residency anywhere on the face of Earth.

The core focus of the EU analysis, discussed by the Commissioner Almunia this week, centres on an even more worrisome feature: tax base shifting by the ICT Services MNCs. The practice basically permits MNCs to book vast revenues earned elsewhere in Europe into Ireland in order to move these revenues to tax havens. The issue is non-trivial to Ireland: tax-optimising MNCs currently underwrite virtually all growth officially registered in our economy. Not all of their activities are driven by tax optimisation alone, but our tax regime does serve as a major attractor and does generate significant uplift to our economy. Absent their activities, Irish economy would be in a recession, the Exchequer would be in an unenviable position worse than that of Portugal, and our GDP would be at least one fifth lower than it is today.


Instead of the headline rate of corporate taxation, two core questions about the entire tax regime operating in the Irish economy should be at the heart of our public debates. One: Can Irish economy afford the current tax regime in the long run? Two: Is our tax regime sustainable given the direction of European integration in fiscal, monetary and corporate policies development?

Let's deal with these questions in some details.

Current system of taxation in Ireland is directly contradictory to the core growth and development drivers in our economy. Since the collapse of the property lending and public spending bubbles of the 2000s, our sources of growth have rapidly shifted from domestic investment in real estate and infrastructure toward the skills-dependent ICT services, international financial and professional services, and specialist agrifood and manufacturing sectors.

All of these sectors share two fundamental features. They employ large number of highly skilled and internationally mobile specialists. And, they rely on new value creation via innovation. These features are based on investments in human capital, rather than traditional bricks and mortar or physical machinery. And human capital gets its returns either from entrepreneurial returns or wages. The latter dominate the former across the economy.

Faced with an option of having to pay huge direct and indirect tax rates on their labour income, while receiving virtually no services in return for these outlays, the highly skilled workers tend to run out of Ireland within 1-2 years of arriving here. Forced to compete for talent with tax optimizing MNCs, indigenous entrepreneurs are struggling to generate returns on their own investments. And both, innovation-based MNCs and indigenous producers are facing high and rising costs of recruiting key employees.

In 2013, corporation tax receipts totaled EUR4.27 billion, or 11.3 percent of total tax receipts. This compares to 15.3 percent on average in 2000-2004. Over the same period of time, the share of income tax in total tax receipts rose from 31.4 percent to 40.0 percent. VAT receipts share slipped only marginally from 29.3 percent to 28.9 percent.  Thus, the rate of extraction of tax revenues from households’ incomes rose dramatically. Burden of corporate taxation befalling rapidly growing MNCs, meanwhile, declined in relative terms.

Great Recession only partially explains this trend. Instead, the Government policy consciously shifted tax base away from activities with low economic value added, such as property and transfer pricing-driven corporate profits, and onto the shoulders of the households. Given the changes in 2010-2013 in the composition of our exports of goods and services, Ireland-based MNCs are now paying less in taxes per unit of exports than in the 1990s.

With the tax extraction hitting hard the professional and higher skilled workers earnings, our tax regime is damaging our core source of competitiveness. You don't have to troll the depths of datasets to spot this one. Every Budget since 2009 attracted numerous proposals for attempting to address the problem of income tax costs across ICT services, international financial services and R&D intensive activities. These proposals come from both the indigenous sectors and exporters and MNCs, highlighting the breadth of the problem.


In the longer run, Irish economy's reliance on tax arbitrage is similar to the 'curse of oil'. Low effective corporate tax rate accompanied by a very high upper marginal income tax and sky-high indirect levies are driving investment, as well as financial and human capital, away from well-anchored indigenous sectors and toward foot-loose MNCs.

This, in turn, exposes us to cyclical changes in MNCs global production patterns. We have already experienced such events in the late 1990s - early 2000s when ICT manufacturing and dot.com sectors evaporated from this country virtually overnight. And today we are witnessing global re-allocation and re-shaping of pharmaceutical industry. We got lucky in the 2000s when domestic economy bubble replaced deflating MNCs presence. We also got lucky this time around, with pharma patent cliff being compensated for by growing exports of ICT services. With every iteration of these risks, levels of employment in the MNCs per euro of export revenues have been falling. Next time around, things might not turn out to be as easy to manage.

Double-Irish and other loopholes are also costing us in terms of reputational and institutional capital - two major contributors to making Ireland an attractive location for international business and key environmental factors supporting indigenous entrepreneurship. While many MNCs for now have little problem dealing with tax havens, they tend to locate little but shell presence in these jurisdictions. Ireland, not being an official tax haven, offers an attractive alternative for them to both create tax optimising structures and put some real activity on the ground. However, should our reputation continue to suffer from the publicity our tax regime receives around the world as of late, this acceptability of Ireland as a real platform for doing business can change. Reputations, not made overnight, can fall in an instant, and Ireland has plenty competitors in Europe hoping for such an outrun.

Which brings us to the question of whether our tax regime is sustainable in the long run given the current policy climate in the EU and across the Atlantic. The answer to it is a ‘no’.

As this week’s comments by Commissioner Almunia and the numerous previous statements from G20, G8 and the OECD clearly indicate, governments across the advanced economies are moving to curb excessive tax optimisation strategies by the multinationals. In doing so, they are not about to sacrifice their own long-established economic systems. The main driver for this global resurgence of interest in tax avoidance and optimisation is the ongoing process of long-term structural deleveraging of public debts. Another key driver is a long-term restructuring of unfunded pensions and social welfare liabilities accumulated by the advanced economies now staring into the prospect of rapid onset of demographic ageing. Put simply, over the next 16 years, through 2030, advanced economies around the world will be facing a need to fund fiscal and retirement systems gaps of between 9 and 25 percent of current GDP. This funding is unlikely to materialise from growth in GDP alone, and will require significant restructuring of tax revenues.


One way or the other, Irish tax system will have to be reformed. The longer we resist an open and constructive debate about the entire tax system, the more likely that these reforms will be imposed onto us by the EU dictate.  To enhance our reputational and institutional capital, we need to aggressively curb tax optimisation schemes. To develop a domestically-anchored innovation-based economy, we need to shift some burden of income-related tax measures onto corporates. The best way to achieve these objectives is to protect our low corporate tax rate and close the egregious loopholes.

BOX-OUT:

Earlier this month, the EU Commission published a report into public perceptions of corruption across the EU. The findings were described by the EU Home Affairs commissioner Cecilia Malmstroem as exposing a "breathtaking" spread of corruption across the everyday lives of the European citizens. For starters, total annual cost of corruption to the European economy was estimated at EUR120 billion or roughly 10 percent of the EU GDP. According to Ms Malmstroem, the true costs are "probably much higher".

Ireland fared relatively well in the report findings, compared to the worst offenders – the member states of Eastern and Central Europe and the Mediterranean. Still, one third of Irish respondents expressed concern that officials awarding public tenders and building permits are corrupt. More than one fifth of Irish people surveyed thought that various inspectors serving the state are on the take – hardly a solid vote of confidence in our systems.

Spain and the Netherlands were the only two countries where a majority of respondents thought that corruption is widespread among banks and financial institutions, but Ireland was a close third with 48 percent.

The good news is that 13 percent (a relatively high proportion by European standards) of Irish respondents felt that corruption has decreased in the past 3 years. Bad news is that the vast majority believes that there was no improvement at all.