10/12/2016: Austerity: Three Wrongs Meet One Euro

"Is it the 'How' or the 'When' that Matters in Fiscal Adjustments?" asks a recent NBER Working Paper (NBER Working Paper No. w22863). The authors, Alberto Alesina, Gualtiero Azzalini, Carlo A. Favero and Francesco Giavazzi ask a rather interesting and highly non-trivial question.

Much of recent debate about the austerity in the post-GFC world have focused on the timing of fiscal tightening. The argument here goes as follows: the Government should avoid tightening the pursue strings at the time of economic contraction or slowdown. Under this thesis, austerity has been the core cause of the prolonged and deep downturn in the euro area, as compared to to other economies, because austerity in the euro area was brought about during the downturn part of the business cycle.

However, there is an alternative view of the austerity impact. This view looks at the type of austerity policies being deployed. Here, the argument goes that austerity can take two forms: one form - that of reduced Government spending, another form - that of increased taxation.

There is some literature on the analysis of the effects of the two types of austerity compared to each other. But there is no literature, as far as I am aware, that looks at the impact of austerity across different types, while controlling for the timing of austerity policies implementation.

The NBER paper does exactly that. And it uses data from 16 OECD economies covering time period of 1981 through 2014 - allowing for both heterogeneity amongst economic systems and cycles, as well as full accounting of the most recent Great Recession experiences.

The authors "find that the composition of fiscal adjustments is much more important than the state of the cycle in determining their effects on output." So that the 'How' austerity is structured is "much more important" in determining its effects than the 'When' austerity is introduced.

More specifically, "adjustments based upon spending cuts are much less costly than those based upon tax increases regardless of whether they start in a recession or not." This is self explanatory.

But there is an added kicker (emphasis is mine): the overall "results appear not to be systematically explained by different reactions of monetary policy. However, when the domestic central bank can set interest rates -- that is outside of a currency union -- it appears to be able to dampen the recessionary effects of tax-based consolidations implemented during a recession." Now, here is a clear cut evidence of just how disastrous the euro has been for the real economies in Europe during the current crisis. As the authors note, correctly, "European austerity... was mostly tax based and implemented within a currency union". In other words, Europe choose the worst possible type of austerity (tax-based), implemented in the worst possible period (during a recession) and within the worst possible monetary regime (common currency zone).

In allegorical terms, the euro zone was like a food-starved runner starting a marathon by shooting himself in a knee.

11/12/2014: QNA Q3 2014: Real GDP & GNP Growth Dynamics

Here is the second post on QNA detailed analysis, covering sectoral distribution of activity in Q3 2014.

• My post on the top level results for Q3 2014 is here: http://trueeconomics.blogspot.ie/2014/12/11122014-q3-2014-irish-growth-broadly.html
• And the second post covering sectoral performance by broader sectors of economy is here: http://trueeconomics.blogspot.ie/2014/12/11122014-qna-q3-2014-sectoral-activity.html

Now, onto a closer look at the GDP and GNP aggregates.

First, non-seasonally adjusted data, allowing for year-on-year comparatives.

• In Q3 2014, taxes net of subsidies amounted to EUR5.103 billion which is up 4.33% (+EUR212 million) on Q3 2013
• GDP in real terms reached EUR45.972 billion in Q3 2014, which is 3.54% higher than in Q3 2013. This is the slowest rate of GDP growth in y/y terms since Q4 2013 when GDP contracted 1.15%. Overall, GDP growth in Q3 2014 in y/y terms was less than half the rate of growth in Q2 2014.
• In Q3 2014, GNP stood at EUR38.52 billion which represents a growth of 2.49% y/y - the slowest rate of growth since Q2 2013.
• Excluding taxes and subsidies, private sectors GDP (GDP netting out taxes and subsidies) few strongly in Q3 2014 - which is the good news - rising 4.18% y/y. This is slower than Q2 2014 growth of 6.66%, but is better than Q1 growth of 3.55%.

GNP/GDP gap at the end of Q3 2014 stood at 16.21% which is the lowest in 3 quarters. Private sectors GNP/GDP gap also fell - reaching 18.23%, down from 19.18% in Q2.

Now, consider seasonally-adjusted data, allowing for quarter-on-quarter comparatives:

• In Q3 2014, seasonally-adjusted GDP grew at the rate of 0.0793% which marks the slowest rate of q/q growth since Q4 2013 when real GDP contracted q/q. The rate of growth in Q3 was 14 times lower than in Q2 and almost 36 times lower than in Q1 2014. In effect, the economy - measured by real GDP - stood still in Q3 2014.
• Meanwhile, in Q3 2014, real GNP expanded by 0.472% which marks weak, sub-period average growth and the second consecutive quarter of very poor GNP performance: in Q2 2014 GNP expanded by just 0.23% on q/q basis. 
• Last healthy growth in q/q terms for real GNP was back in Q1 2014 when it expanded by 1.86%.

Quarter-on-quarter growth terms signal official recessions (defined as two consecutive quarters of negative growth). Charts below map relative GDP and GNP performance in q/q terms by each quarter, identifying strong expansions, weak expansions and contractions. As charts clearly show, in GDP terms, we are currently in the first quarter of sub-average growth after Q1-Q2 above average growth periods. In GNP terms, we are into third consecutive quarter of sub-average growth.

Once again, broadly-speaking, we are witnessing a slowdown in growth momentum (bad news), but are still managing to stay in non-negative growth territory (good news).

Stay tuned for more Q3 QNA analysis later.

8/3/2014: Democracy and Inequality: A Link of Surprising Direction?

Everything written or co-authored by Daron Acemoglu is worth reading. Everything. And here is an example why. The man does not shy away from big questions in life.

"DEMOCRACY, REDISTRIBUTION AND INEQUALITY" by Daron Acemoglu, Suresh Naidu, Pascual Restrepo and James A. Robinson (Working Paper 13-24, Massachusetts Institute of Technology, Department of Economics, October 30, 2013: http://ssrn.com/abstract=2367088) looks into the relationship between democracy, redistribution and inequality.

"We first explain the theoretical reasons why democracy is expected to increase redistribution and reduce inequality, and why this expectation may fail to be realized when democracy

• is captured by the richer segments of the population; when it caters to the preferences of the middle class; or 
• it opens up disequalizing opportunities to segments of the population previously excluded from such activities, thus exacerbating inequality among a large part of the population."

From theoretical reasons for differences in inequality and redistribution, the paper moves to empirical. The authors "survey the existing empirical literature, which is both voluminous and full of contradictory results. We provide new and systematic reduced-form evidence on the dynamic impact of democracy on various outcomes."

Core empirical findings are:

1. "…there is a significant and robust effect of democracy on tax revenues as a fraction of GDP, but no robust impact on inequality." So while democracy increases taxes, it does not reduce inequality. why? Because "policy outcomes and inequality depend not just on the de jure but also the de facto distribution of power", so "those who see their de jure power eroded by democratization may sufficiently increase their investments in de facto power (e.g., via control of local law enforcement, mobilization of non-state armed actors, lobbying, and other means of capturing the party system) in order to continue to control the political process". Furthermore, "democratization can result in “Inequality-Increasing Market Opportunities”. Nondemocracy may exclude a large fraction of the population from productive occupations (e.g., skilled occupations) and entrepreneurship (including lucrative contracts) as in Apartheid South Africa or the former Soviet block countries. To the extent that there is significant heterogeneity within this population, the freedom to take part in economic activities on a more level playing field with the previous elite may actually increase inequality within the excluded or repressed group and consequently the entire society".
2. "…we find a positive effect of democracy on secondary school enrollment and the extent of structural transformation (e.g., an impact on the nonagricultural share of employment and the nonagricultural share of output)".
3. Very interestingly, "The evidence …points to an inequality-increasing impact of democracy in societies with a high degree of land inequality, which we interpret as evidence of (partial) capture of democratic decision making by landed elites."
4. "We also find that inequality increases following a democratization in relatively nonagricultural societies, and also when the extent of disequalizing economic activities is greater in the global economy as measured by U.S. top income shares (though this effect is less robust)."
5. "We also find that democracy tends to increase inequality and taxation when the middle class are relatively richer compared to the rich and poor. These correlations are consistent with Director’s Law, which suggests that democracy allows the middle class to redistribute from both the rich and the poor to itself."

"All of these are broadly consistent with a view that is different from the traditional median voter model of democratic redistribution: democracy does not lead to a uniform decline in post-tax inequality, but can result in changes in fiscal redistribution and economic structure that have ambiguous effects on inequality."

13/10/2013: On Taxes, Debt & Equity

EU Commission published some interesting research into Tax Reforms across the EU. The paper is available here: http://ec.europa.eu/economy_finance/publications/european_economy/2013/pdf/ee5_en.pdf

One interesting topic covered relates to the substitution away from equity in favour of debt funding in corporate capital investment. A chart to start with:

Now, per above, the disincentives to equity investment and incentives in favour of debt seem to be the lowest (in euro area) in Cyprus and Ireland. Note that these countries are associated with aggressive brass-plating (Luxembourg) are distinct from countries with aggressive tax arbitrage activities (Cyprus and Ireland). And thus, behold the skew in the EU Commission analysis: MNCs investing into these countries do not use debt on-shoring (US MNCs do not borrow in these countries), but use registry of equity there (for example, in Irish case - due to FDI-booked investments, or equity investment by IFSC companies, ditto for old Cypriot banking system vis Russian corporates).

The EU admits almost as much:
"There is also evidence that the tax advantage of debt fuels international profit-shifting activities as
rules on interest deductibility differ between countries and there are mismatches in decisions on which instruments are considered debt financing. Several studies analyse the debt financing of multinationals with either parent companies or subsidiaries in the United States, Germany, Canada and the EU. The results of these studies suggest that firms use intra-group loans to adapt their financial structure and minimise their overall tax burden. By shifting debt to an affiliate located in a high-tax country, corporate groups are able to deduct interest payments against a higher statutory tax rate while the interest received by the lending affiliate is taxed at a lower rate. Taking data from 32 European countries between 1994 and 2003, Huizinga et al. (2008) find that a 10 % increase in the tax rate increases leverage by 1.8 %. The authors also show evidence of debt-shifting as, for multinationals with two equal-size establishments in two countries, a 10 % increase in the tax rate in one country leads to an increase in leverage of the company located in that country by 2.4 % and a decrease in leverage in the affiliated foreign company by 0.6 %."

However, overall the tax rates also play the role in this debt-shifting: "Two recent meta-studies by Feld et al. (2013) and de Mooij (2011a) review the existing empirical studies and find that ... a one percentage point higher CIT rate is associated with a 0.27 percentage point higher debt-asset ratio."

Two more major points raised in the paper:

1. Welfare costs: "The tax bias towards debt financing also creates welfare costs. Weichenrieder and Klautke (2008) estimate this cost at between 0.08 % and 0.23 % of GDP, while Gordon (2010) estimates it at about 0.25 % of GDP. As pointed by de Mooij (2011b), these estimates ...fails to take into account the heterogeneity of responses and hence the additional welfare costs due to misallocations. Existing studies also fail to include the larger welfare costs of the negative externalities of using debt, such as systemic risk, the probability of default and the social costs of business cycle fluctuations. Finally, they do not take into account the distortions created by debtshifting activities and misallocation due to international tax arbitrage and administrative and compliance costs (de Mooij, 2011b). Consequently, the welfare impact of the debt bias can be assumed to be higher than what has been found in the literature so far."
2. Banking Systems and Debt Shifting: "Keen and de Mooij (2012) ...show that taxes influence the capital structure of banks and that, despite capital requirement constraints, the size of the effects of corporate taxation on the financial structure of banks is close to those for non-financial firms." In other words: capital rules do not induce any significant changes in banks behaviour when it comes to funding of banking activities: debt incentives still drive leverage up. Furthermore, "Hemmelgarn and Teichmann (2013) have found that bank leverage, dividend payouts and earnings management (in terms of loan loss reserves) react to changes in the domestic statutory CIT (corporate income tax) rate. ...In the three years after a tax increase by 10 percentage points, the results predict an increase in leverage of 0.98 percentage points or a relative increase by about 1.1 % (in relation to the equity ratio it would mean a notable relative decrease, of 8.9 % of equity)." Core conclusion: "These results suggest that a reduction in the preferential treatment of debt would result in a significant decrease in bank leverage. In addition, the results also show that regulatory capital requirements in the banking sector alone do not seem to be a prime determinant of financial structure. ... the effect of taxation conflicts with the aim of current regulatory reform to increase capital in the context of Basel III."

20/6/2013: Heroes of our times and earnings...

Latest data on (annual) earnings, to highlight the vast gains in Irish 'competitiveness'

And the heroic folks who earned a 4.2% (second highest) earnings premium are... well... see below:

http://www.cso.ie/en/media/csoie/releasespublications/documents/earnings/2012/earnlabcosts2012.pdf has more on the same...

19/4/2013: Decomposition of Irish GDP & Gross Operating Surplus: 2012

Recent CSO data release shows decomposition of 2012 Irish GDP and Gross Operating Surplus (defined as GDP less taxes and compensation of employees, plus subsidies). Here are annual dynamics:

 Overall,

• Households' contribution in 2012 to the GDP rose 5.66% y/y and is down 21.02% on peak
• Government's contribution in 2012 to the GDP declined -1.76% y/y and is down 12.04% on peak
• Financial Corporations' contribution in 2012 to the GDP rose 2.98% y/y and is down 10.75% on peak
• Non-Financial Corporations' contribution in 2012 to the GDP rose 3.03% y/y and is down 7.27% on peak
• Not-sectorised areas of activity contribution in 2012 to the GDP rose 4.34% y/y and is down 35.70% on peak

 Per chart above,

• Households' contribution in 2012 to the Gross Operating Surplus rose 11.12% y/y primarily due to subsidies increases, and is down 19.86% on peak. Subsidies to households rose 18.30% y/y in 2012.
• Government's contribution in 2012 to the Gross Operating Surplus declined -7.29% y/y and is down 14.89% on peak
• Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 6.01% y/y and is down 14.68% on peak
• Non-Financial Corporations' contribution in 2012 to the Gross Operating Surplus rose 2.50% y/y and is down -2.1% on peak
• Not-sectorised areas of activity contribution in 2012 to the Gross Operating Surplus rose 2.94% y/y 
• Overall Gross Operating Surplus rose 4.58% y/y and is down 9.75% on peak

Now, on to the relative importance of each broader sector in main areas of determination of the Gross Operating Surplus:

Note that in the above, Government share of any activity defining Gross Operating Surplus ranges from  zero for taxes and subsidies, to 25-27% for compensation of employees, to11.4-13.0% for GDP and overall Government accounts for only 3.18% (2002-2007 average) and 3.31% (2012 average) of the Gross Operating Surplus in the Irish economy. In other words... does it really matter that much?

Consider the disparity:

• In 2002-2007 on average, Households accounted for 17.4% of all GDP generation, a share that declined to 15.87% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04% - significantly less during the boom years and marginally less in 2012.
• In 2000-2007 on average, Households accounted for 26.49% of all Gross Operating Surplus in the economy, with that share sliding to 24.84% in 2012. For the Government, the same figures were 3.18% in 2002-2007 and 3.31% in 2012.
• Notice the gaps?

Consider another interesting thing:

• In 2002-2007 on average, Non-Financial Corporations (NFCs) accounted for 50.4% of all GDP generation, a share that rose to 52.4% in 2012. Meanwhile, for the Government, the same figures were 11.41% and 13.04%. So as GDP share goes, NFCs were much, much more important than the Government, by a factor of 4.
• In 2002-2007 on average, NFCs accounted for 55.6% of all Employees compensation generation, a share that rose to 53.3% in 2012. Meanwhile, for the Government, the same figures were 24.8% and 27.1%. So as Employees compensation share goes, NFCs still more important than the Government, but now only by a factor of less than 2.
• In 2000-2007 on average, NFCs accounted for 56.9% of all Gross Operating Surplus in the economy, with that share rising to 60.6% in 2012. For the Government, the same figures were 3.2% in 2002-2007 and 3.3% in 2012.
• Now, again, consider the above gaps...

12/7/2012: Wealth taxes - coming up next to Europe near you...

And so wealth taxes (on those who are not all that wealthy, in fact) is a matter of EU-wide policy now, thanks to Schauble: link here and here. Note, the idea is to tax property assets in excess of €250,000 - with an additional one-off levy of 10% on top of other taxes and presumably, as per talk in one of the links about 'capital taxes' other assets can be included. And the original source for the grand idea is here.

Thus, the logic goes, you've saved for the retirement (which requires at least as much in provisions as the tax bound) and you are not a drag on social pensions system. Off you go, pay up...

One question - what happens if two years from now property values drop and your property 'wealth' declines to below €250K... do you get a refund?.. Question two - what happens when tax is levied and as the result, property markets go into further contractions, forcing question one above to the forefront?.. Question three - what happens in the long run when taxes have depleted not only disposable (investable) incomes, but also investable (and largely illiquid) wealth - do pensions provisions go up?.. do Governments step in to provide cheap capital for investment?.. does Schauble and his friends drop their own pensions demands to compensate economy for €230 billion they've sucked out of investment pool?..

Idiots squad has never been so much enforced in Europe as today.