DofF Forecast: does it hold any water?

I have a serious question to ask of our Government: Do budgetary projections by the DofF in (e.g those contained in their January 2009 Addendum covered here) hold any water?

In particular, no one has yet taken the DofF forecasters to a task of explaining how on earth, with projected:

• shrinking GDP (-€7.6bn in 2009 in nominal terms relative to 2008) and GNP,
• negative inflation (-1%),
  
• rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%), and
• rising, not falling, Net Current Expenditure (+4.3bn in 2009),
  

does DofF come up with a revenue fall-off of just €3.9bn for 2009 relative to 2008 and total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009? (Those of you who are impatient enough, see one potential answer at the end of this post)...

These numbers - the backbone of Irish Government plans for the year - are suspiciously incongruous. Not only because they do not seem to add up. But also because we have no reason to trust DofF forecasts on the basis of their historical accuracy.

Do Government numbers hold up to scrutiny?
This week, it came to media attention that the entire Department of Finance employs only one PhD-level economist. As far as I am aware, we do not know:

1. Where and when did this person obtain her/his degree?
2. Was her/his degree in the field of macroeconomic modeling?
3. Has he/she ever published peer-reviewed research in the areas of taxation and/or macroeconomic forecasting?

In other words, we have no idea how qualified this economist is to carry out macroeconomic forecasting, policy evaluations and risk analysis.

Furthermore, per my knowledge, no one knows who exactly is responsible for supervision and execution of forecasting in DofF and what model is being used. Searching DofF website for Chief Economist reveals no such person. We do not know whether forecasting function is, indeed, an established and managerially resourced function of the Department. Ditto on the Risk Analysis side, which requires both an expert in microeconomic risk modeling and macroeconomic risk specialist.

It is simply not sufficient to say that accountancy or previous budgetary experience, potentially possessed by some DofF employees (how many?) qualifies the Department to deliver any sort of economic analysis or projections. Certainly not the ones which can used by the Government to argue about the need for one reform or another.

In fact, to see the absolute poverty of economic policy research output produced by DofF one should go straight to the source: here. They might as well publish these reports in Gaelic only, for no serious economist would recognize this as proper economics.

One example: in the sole document relating to economic reviews and outlook for 2008, titled Irealnd's Contribution to the Public Consultation Process on the Review of the EU Budget (I am not kidding - they couldn't even spell Ireland correctly). Here, DofF's 'Research' team devotes only 4 pages to the entire analysis of a vital fiscal policy process. The issue of EU-wide tax - something that was a hot topic of debate in Ireland throughout 2007-2008 is given 148 words! Of course, DofF gives five times this much to the discussion of CAP - suggesting, perhaps, our Finance boffins are more comfortable in the cow sheds than in the world of macro-finance and macroeconomics.

Getting basic research wrong - something that is being done by virtually all Irish Government departments on a routine basis - is a serious issue. Brandishing as a major reform a promise to get policies onto an 'evidence-driven' platform, as our Government did last week (see here: 3rd bullet point under Taxation heading), while having no capability to prepare proper economic analysis is hardly a responsible way of governing.

When even the mighty fail by poor research
Few months back, I was sent a research note from PIMCO's cult giant, Bill Gross. Gross is an archetypal salesman, in my view, who has fantastic intuitive understanding of the market (which is way more than our public sector mandarins and politicians have). This is, in most instances, sufficient to earn high rates of return and to contain downside risks.

But, it is not enough to do two things -
(a) provide rigorous analysis of your position in the market at any point in time - past, present, or future; and
(b) explain to others why your intuitive searchlight is capable of picking the right opportunities out of the mass of potential investment strategies.

Published in June 2008 (see here: those of you who attended my class last Fall in TCD's MSc in Finance would recognize it) the note contained a rant about US inflation indices. Specifically, Gross expended some 4 pages of small print arguing that

1. US inflation has been historically higher than measured by the CPI;
2. True US inflation should be much closer to the 'global' average (including such economically stable and developed countries like Venezuela, Indonesia, Brazil, Philippines, Thailand, Columbia, Turkey, Ecuador and Vietnam - out of a sample of 24 countries chosen, seemingly, to deliver Gross' point).
   

All of this led to the following conclusion:
"What are the investment ramifications [of the 'fact' that U.S. inflation is closer to worldwide levels than previously thought]? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars."

Lacking:

• serious analysis - Gross tweaked the evidence to support his own premise;
• proper investigation of academic and practitioner research - Gross ignored the fact that several Congressional and academic investigations since the early 1990s have concluded that CPI actually overestimates the true extent of inflation in the US by between 0.5% and 1% pa,

he produced a call to arms for investors that cost PIMCO and those who follow its strategy an arm and a leg. How? Gross' advice - issued in June 2008 -

• has missed a significant H2 2008 rally in Treasuries, Munis and TIPS;
• calling for heavier weighting for commodities-linked economies came at the time of extreme valuations of these economies (e.g Russia and Brazil both have peaked in June-August 2008), before they fell off the cliff in H2 2008;
• led to an unprecedented cancellation of dividends by several PIMCO munis funds - the first time in known history any fund suspended payouts for what is, in effect, a monthly yield-generating securities class.

I do enjoy the fact that, being criticised at the time for arguing against Gross' June note, I did turn out to be right about both his call on inflation (he was concerned with hyper-inflation as the world was teetering on the verge of deflation) and on emerging markets.

Back to DofF numbers
But I am not telling this story with some malice towards Gross or PIMCO in mind. At the very least, the man can spell Ireland better than our DofF boffins can. Instead, I am using it as an illustration as to the importance of proper research in backing any strategy - investment and/or policy-related. PIMCO's operations are much more superior to what is going on in our DofF and the rest of civil service when it comes to the quality of research and analysis. This implies that if people like Gross can get things spectacularly wrong, people that occupy our DofF - quipped with one token PhD level economist - simply have no chance at getting anything right.

Remember their latest numbers:

• shrinking GDP (-€7.6bn relative to 2008),
• negative inflation (-1%),
  
• rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%),
• a revenue fall-off for the Exchequer of just €3.9bn for 2009 relative to 2008, and
  
• a total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009

Well, of course to get these things to add up, one has to assume that tax increases passed in the Budget 2009 will not reduce tax revenue. In other words, that the Laffer Curve does not work. We shall see, of course, but empirical studies provide little comfort that such an assumption is a reasonable one. Ditto the numbers on retail spending in the NI and South of the border, SuperQuinn's plan to shut down supermarket located near Newry and loads of anecdotal evidence showing that Irish shoppers are fleeing the Republic for that VAT heaven of NI.

This spells serious trouble for the Government. Suppose that due to increases in the income tax, VAT and other taxes, the revenue were to decline by, say, 2.1% of GDP - as it did in less recessionary 2008. This would imply that tax increases will still be contributing positive revenue growth for the Exchequer, although on a much smaller scale. In such a scenario,

• the net Exchequer borrowing will jump from 6.3% of GDP to 8.4% of GDP,
• the General Government Deficit will rise by €3.8bn in 2009 - from 9.1% of GDP projected by DofF assuming €2bn in savings goes through, to over 12%.

Now, suppose tax increases wipe out any revenue gains by 2010 - the deficit will then rise to above 13% of GDP in 2009 and 15% in 2010.

Add to this the fact that while DofF was basing its numbers on -4% growth rate in GDP for 2009, the economy quite probably will contract by at least 5% - balooning potential deficit to 15-16% this year.

A scary thought, indeed, because even the IMF will not lend Mr Cowen a penny with such financial performance on the plans. So much for Brian, Brian&Mary's 'evidence-based' policies...

Debt Mountain 'Ireland Inc'

For those of you who missed my yesterday's article in the Indo on this topic, see here. The article was filed before we had latest figures on the stupendous amount of negative net worth on Irish corporate balance sheets (here).

JohnM was right in his comment that the State has been 'dumping' risk on taxpayers. The irony is - the state has been 'dumping' risk also onto the shoulders of debt-loaded companies, households and even the stock markets. About the only segment of the population that escaped this 'benevolence' of our Leaders is the public sector. Although one must recognise that some workers in the public sector are being paid too little, given that a few of them are actually productive in their jobs, just as one must recognise the fact that not everyone in Fianna Fail is happy to support what the Government has been doing to us.

The above caveats aside, it is, thus, the difference between ZanuPF and ZanuFF that the former cronies are wearing military uniforms, while the latter favours grey suits of the civil service and bearded folks from the unions.

Mushroom Cloud Redux II

Per excellent comment (see here and scroll to comment) to an earlier post on this matter, here are comparatives for Irish Banks index vis-a-vis European Banks. The first chart plots, as before, time series of indices.
In many ways, the series do indeed co-move much closer together until about October 2008, when things are starting to go per-shape for Ireland. This trend of significant deviations in Irish Banks from their peers in Europe accelerated through today, although to see this more clearly, consider the second chart below.
If you look at the correlations between Irish bank shares and both indices, it should be pretty clear that a relatively close link between Irish and European financials broke down around September 29th and was never repaired since. (Note that these are weekly moving correlations, so that a date of 13/10/2008 corresponds to data from 7/10/2008 through 13/10/2008.)

In fact things have spun completely out of sync starting in mid November - precisely when Irish Government got busy 'repairing' our Banking sector. In fact, things got much more dramatic in terms of Irish v EU Banks than in terms of Irish Banks v EU markets since the end of December.

Overall, my strategy still stands, but it is even more pronounced in terms of Irish Banks v European Financials: "Lenihan/Cowen are about to speak? Short Ireland, long Europe"... The only thing worth examining at this junction is whether 'long Europe' might be inferior to, say, 'long US' or UK. But that has nothing to do with our Government's ability or with the topic of this post.

Update: Irish bank shares correlations with both EU Financials and EU total price index are now moving down - ca 96% last night's close (in weekly moving correlations terms) to 86% today... Watch these!

Mushroom Cloud Redux

Per my earlier posts, here are the latest comparisons between our Financials and the broader European markets.

A new dip is courtesy of our Government's 'Best 5 Ways to Ruin a Country' Framework that I released yesterday (beating the Irish Times in bringing it to public attention by some 12 hours - here).

But enough bragging - back to charts.

The first one is self-explanatory:Mass of volatility (risk) being dumped onto Irish shares by our Government wobbling on economic crisis and banks is self evident. If the Government was really accountable for its actions, maybe investors could have taken it to courts for value destruction.

Alas, this is not how the real world works. Here, on Planet reality, Brian-Brian-Mary prevaricate (in taking hard decisions), we pay. And so it looks like we've had a bear rally and now we are back on a downward track. The only hope - it might bottom out at somewhere above 550 for ISEQ FIN this time around, fingers crossed.

It is the second chart that opens up a more detailed picture of the latest outbreak of the Irish markets disease.
As shown above, weekly correlation between Irish Financials (ISEQ FIN) shares index and the broader Eurozone markets had a series of rollercoaster rides ever since the current Government took up a task of 'fixing' our economy. In particular, Irish markets forays outside the 'No Hedge' territory - into low positive (below 0.25 or negative) correlation values implies that at virtually every point of change in the Government policy, an investor would have done better by betting against the Irish market and in favour of the broader European indices. As powerful of an indication as one can get that markets do not trust this Government in resolving Ireland's economic crisis.

I mean, how bad can the things get for a Government if selling into Brian-Brian-Mary's statements can become a winning strategy for investors?..

Government's Plan for Ireland: Exclusive... Part 5

Per earlier posts, italics are my


5. Work together to implement a reform agenda

(i) to implement an agenda for enterprise and competitiveness based on the Framework for Sustainable Economic Renewal: Building Ireland’s Smart Economy including:

• building on strengths in the Agriculture, Fisheries and Food sectors (back to De Valera's Dream, then?)
  
• developing the ideas economy with intensified R&D activity and greater commercialisation of the output of that research (more MIT Media Labs and E-voting machines?)
• supporting the manufacturing sector (How?)
• encouraging entrepreneurship and business start-ups (by raising taxes and taking more money out of families' pockets?)
• pursuing opportunities to expand the services sector, in particular international services (by doing what?)
• realising the long-term potential of the tourism sector (How? By setting a minimum wage that makes our labour uncompetitive? By hiking VAT rates and adding new taxes on tourism?)
• improving trade, investment and tourism links with new and fast-developing markets (more junkets to exotic destinations for the Cabinet?)
• pursuing opportunities in the Green Enterprise sector, including in the area of energy efficiency (aka we take your money and your light bulbs?)
  

(I have commented on this plan before. It is a road map to nowhere for a number of reasons outlined here and here. But what is truly egregious in all of this is that the ‘plan’ above comes after the promise of carrying out only evidence-based expenditure programmes, despite most of it being based on no evidence at all and parts of it having the preponderance of evidence against them.)

(ii) to develop a new approach to upskilling and reskilling those in employment and those outside the labour market; we will convene a Jobs and Skills Summit in March 2009 to devise innovative approaches to maintenance of employment, creation of new employment and early and active engagement with those losing their jobs; we will also seek to maximise eligible support from the European Globalisation Adjustment Fund for initiatives to support those who are made redundant

(Read: we'll get FAS to fly back to see NASA and beg the EU to give us some handouts to pay for their trips)

(iii) to ensure that sheltered sectors of the economy, including professional services, bear their full share of the burden of adjustment

(This Government cannot even force its own employees to take a cut, imagine them going after protected professions? But what they will do is tax. Tax anyone with a degree - for people who invested in their education tend to earn more. Tax anyone with skills - for people with skills tend to earn more. Tax anyone with experience - for... well - you get the wind.)

(iv) to implement the employment rights provisions in the Towards 2016 Transitional Agreement

(And raise wages and perks for the least productive in our economy?)

(v) to deliver measurable public service reform to improve the efficiency and quality of public services, based on the Government’s Statement on Transforming the Public Service published in 2008

(Since 2008, the Government sat on its hands, doing absolutely nothing about this. Will they change their mind? Not. The entire programme proposed by Mr Cowen today is a give-away to the public sector trade unions and politically-connected lobbies. Mark my words - there will be no change!)

(vi) to continue implementation of the Health Service Reform Programme, including utilising the Health Forum under Towards 2016

(After a gratuitous increase in pay for consultants in exchange for no new responsibilities or any work load increases, there hardly anyone in the country who believes in this drivel)

(vii) to finalise a comprehensive framework for future pension policy which responds to the challenges facing the Irish pensions system in the years ahead

(Read: mandatory pensions, claw back of tax benefits for pensions savings and vast transfers of pensions-linked wealth from the private sector. In other words - another tax!)

(viii) to ensure our approach to regulation, accountability and corporate governance delivers a sustainable society and economy

(Mr Cowen's speak for more red tape on ordinary businesses!)


6. Conclusion

The Government and Social Partners commit to work intensively over the immediate period ahead to develop specific measures to finalise and then implement a Pact based on this framework.

Ends

This 'plan' is a classic example of “How to Destroy a Country in Five Easy Steps” guide:
1) Raise taxes in a recession;
2) Yield on everything to the narrow interest groups;
3) Spend precious taxpayers cash on feel-good Government waste;
4) Pile on more regulation and delegate democracy to an unelected group of public sector lobbyists;
5) Keep rolling back your previous promises and commitments (i.e Mr Lenihan’s repeated promises that he will not raise taxes)

If this is Mr Cowen’s way, his philosophy, would the last person leaving this country turn of the lights, please!

Government's Plan for Ireland: Exclusive... Part 4

Continued, as earlier italics are my:

Part 3:


An Equitable Approach

The Government and Social Partners believe that support for these adjustments will be strengthened by measures which demonstrate that the burden is being shared equitably across society. This includes:

• the need to ensure that moderation in respect of executive remuneration is seen to contribute meaningfully to the adjustment required
• that those who benefited most from the economic boom should make a particular contribution to the adjustment required
  

(This is it? Given that wages in the public sector earn 40%+ premium on pay in comparable private sector occupations, who, Mr Cowen, has benefited most from the boom?)


Delivering the Fiscal Stabilisation Framework

The Government and Social Partners agree that a credible response to the fiscal situation requires a further adjustment at this stage of the order of €2 billion in 2009.

(But this is the same response Mr Lenihan announced in July. This means that either the Government finds no need to change its response to the crisis as it evolved since July, or that Brian-Brian-Mary are simply dumping more than 90% of the budget deficit for 2009 onto the shoulders of the private sector alone, with the unionized public sector carrying less than 10% of the burden. Is this their version of evidence-based equitable policy?)

In addition to this immediate adjustment required in 2009, the Government and Social Partners commit to working together under the Pact to support the further adjustments required to reduce the General Government Deficit below 3% over the remainder of the five year period.

(Can the authors of this document explain how on earth can this Partnership deliver on cuts of €4bn in 2010, €2bn in 2011, €1.75bn in 2012 and €1.25bn in 2013 – as envisioned by the DofF January 2009 forecast (see here http://trueeconomics.blogspot.com/2009/01/doff-instability-report.html) if the same Partnership is having such a hard time delivering a €2bn cut this year? Furthermore, observe that there is not a word about cutting excessively high public sector pay, freezing public sector wages or reforming public sector pensions and perks. None! This leaves the cuts to come solely from the service side.)

4. Short-term Stabilisation of the Economy

In order to maximise economic activity and employment in the short-term, the Government will:

• provide a fiscal stimulus in 2009 and 2010 by maintaining capital investment at a high level by both international and historical standards

(In other words, their emergency response is to continue with NDP investment planned well before the crisis hit. This is equivalent to doing nothing, Brians)

• re-prioritise this capital expenditure in 2009 and 2010 in order to support labour-intensive activities where possible
• bring forward further proposals to support enterprises during this extremely difficult period, recognising in particular the pressures arising from currency movements, and thereby support those in vulnerable employments
  

(What does this mean? There are no details on any of these measures and it is impossible to determine what exactly can the Government do to achieve these objectives)

• act quickly to improve competitiveness including increasing competition across the economy and reforming price regulation in areas such as energy

(ditto)

It is recognised that stabilising the financial and banking sector is essential to secure a banking system which is fit for purpose. Accordingly, Government action will seek to:

• assist those who get into difficulties with their mortgages; in early 2009 a new statutory Code of Practice in relation to mortgage arrears and home repossessions will be brought forward, and the mortgage interest scheme will be reviewed

(Again, no details on a crucially important promise.)

• maximise the flow of credit to the enterprise sector and ensure early introduction of a code of practice on business lending

(This is pure financial and economic nonsense. The Government cannot ‘maximize’ credit flows and short of requiring the banks to issue sub-prime equivalent high risk business loans at knock down rates, no ‘code of practice’ will help restaring credit flows to failing businesses. Subsequently, this section simply proves economic and financial illiteracy of our leaders.)

• introduce controls on the remuneration of senior executives, in accordance with the recommendations of the independent committee established by the Minister for Finance...
• maximise sustainable employment in the sector
  

(What sector? How about maximising sustainable employment of proof-readers for future Government programmes?)

Recognising that unemployment will rise significantly in the period ahead, the Government and Social Partners will work together to maximise employment and help those who lose their jobs by:

• designing a flexicurity approach appropriate to Irish conditions which keeps people working where feasible and equips people to return to employment as quickly as possible by maximising the availability and impact of education, upskilling and training supports

(Flexicurity is an unproven approach to labour market regulations that can be cost-prohibitive to the society at large and ineffective in delivering real employment gains. The Government, having committed itself earlier in the document to ‘evidence-based’ policies has just committed to a policy which was never debated and the evidence in support of which is thin and contradictory. What is far worse than that however, is that the entire labour market policy of Ireland has been at the will of the Government surrendered to an unelected, unaccountable to the taxpayers Partnership. This is an afront to democracy.)

• redeploying resources to ensure efficient and timely delivery of direct State supports to those who lose their jobs including social welfare payments, redundancy payments and payments to workers in cases of insolvent companies

The Government and Social Partners will address the serious and urgent difficulties facing private sector pension schemes.

(Again, after wobbling through a list of secondary measures, a major area where reforms in the public sector and private sector are truly needed is left unadressed!)


More to come, stay tuned...

Government's Plan for Ireland: Exclusive... Part 3

Continued as before, italics are my:

Part 2

Framework for a Pact for Stabilisation, Social Solidarity and Economic Renewal

3. Stabilising the Public Finances

The Government and Social Partners are agreed on the necessity to progressively reduce the level of Exchequer borrowing over the next five years in order to reduce the General Government Deficit to below 3% by 2013 through an appropriate combination of expenditure and taxation adjustments.

Public Expenditure

The adjustment to be achieved through reductions in expenditure will be based on the following criteria:

• ensuring a fair and equitable spread of the burden of adjustment
• maximising the level of sustainable employment
• solidarity with those now losing their jobs
• maintaining high-priority public investments
• careful forward priority planning
• increased efficiency, effectiveness and a focus on outcomes
  

(Recap the above bullet points: if the new Framework were to deliver careful forward planning, does the Government now admit that such was not used in the past? Can anyone explain to me how any of these bullet points constitute any sort of a forward-looking programme to deal with the crisis?)

The scale of the necessary adjustment requires scrutiny of all areas of public expenditure including agreeing measures on how to constrain growth in public sector pay and pension costs.
(Don't hold your breath - when we get to these in a second, you'll see that there is scarcely any change in Government's traditional modus operandi on public expenditure...)

Taxation

The adjustment to be achieved through further taxation measures will be informed by the following principles:

• Changes to be fair and equitable with a higher proportion falling on higher incomes while minimising distortionary effects between different forms of tax

(No details are given, but given that a further tax increase on those earning €100K pa are going to yield only a modest, if not negative, revenue increases to the Exchequer, expect ‘higher incomes’ to mean middle class – i.e. YOU! Of course, notice that the above means everyone’s taxes will go up.)

• Support the productive sector of the economy to keep Ireland competitive

(How can this be achieved? This Government, has been blabbering about this objective since the beginning of this century and has managed to do nothing to deliver on it. Do any of us believe they can do any better this time around? With Mary Coughlan at the helm of ETE?)

• Ensuring that tax expenditures are fully evidence-based

(This a pure case of political ‘gibberish’. What does ‘evidence-based’ mean in relation to tax expenditure? Evidence of the money being spent? Of efficiency? When no one, neither in the Government, nor in the civil service is made accountable – with their jobs, pensions, perks – for any failure in delivering on promises made, who cares if their spending decisions are ‘evidence-based’ or ‘we-just-feel-like-doing-it’-based? Does anyone care if Mr Cowen has evidence to support his lofty Building Ireland's Smart Economy ideas? It simply cannot work - evidence or none (see here)!)

• Broaden the tax base and make changes that are straight forward, easily understood and easy to administer

(Broadening tax base means finding new taxes to pin onto us. Oh, but the above is not enough, so…)

• Additional progressive tax measures consistent with the social solidarity approach

Additionally, given the urgency of the situation and the role that taxation will have to play in bringing stability back to the public finances, the Government is asking the Commission on Taxation to identify appropriate options to raise tax revenue and to complete its report by September 2009.

(So, recap – general taxes will go up, new taxes will be thought up and then there will be more progressive tax measures. And in return, the over-worked civil servicemen and underpaid ministers are going to give us ‘evidence’. And compassion.)

Stay tuned for more...

Government's Plan for Ireland: Exclusive... Part 2

Here is the document I promised to post, with some of my own comments in italics.

Part 1:

28 January 2009

Framework for a Pact for Stabilisation, Social Solidarity and Economic Renewal

1. The Challenge
…While the uncertainty about international developments makes predictions difficult, Ireland now faces the prospect of:

• a reduction of up to 10% in national income over the 2008-10 period (January 9, 2009 Addendum to the Irish Stability Programme Update from the DofF states that we are expecting a cumulative of 6.2% decline in GDP and an 8.2% decline in GNP. Where is the ‘up to 10%’ figure is coming from?)
  
• a loss of more than 120,000 jobs over 2009 and 2010 (this is consistent with DofF latest forecast, so if the Government expects national income to fall more than the DofF predicts, should the unemployment figure expectations be higher as well?)
• an increase in unemployment to more than 10%
• tax revenues in 2008 more than €8 billion below expectations, and a further fall projected in 2009, creating an unsustainable Exchequer deficit
• without further adjustments, a General Government Deficit in the range of 11% to 12% of GDP for each year up to 2013
  

There are in fact significant downside risks to these projections including:

• a steeper or more prolonged downturn in our main trading partners
• the possibility that global financial market problems deepen or persist for some time
• further exchange rate appreciation
• a further decline in international and domestic confidence and investment

(So nothing really to do with us, then? Clearly our leaders do not think that the loss of competitiveness, sky-high costs, climbing taxes, inept governance, lack of any economic development platform for the future and a host of other problems besieging Ireland Inc are not something we should be concerned in the future...)

This document therefore sets out a framework within which the Government and Social Partners have agreed to develop a Pact for Stabilisation, Solidarity and Economic Renewal.

2. Shared response through partnership

...In developing a Pact, the Government and Social Partners are fully committed to an approach in which all sectors of society contribute in accordance with their ability to do so, and conversely the most vulnerable, low paid, unemployed and social welfare recipients are insulated against the worst effects of recession.

(It will be interesting to see how the Government is going to achieve this. Is the Revenue going to treat those of us who become unemployed in 2009 when it comes to collecting taxes for 2008 with kid gloves by ‘insulating’ us from the need to pay back taxes if doing so puts our families over the edge or is this a case of caring going too far? The Government certainly gave it no thought when it raised taxes in Budget 2009.)

The Government and Social Partners believe that by making the correct decisions now, and committing to working together through the further difficult challenges which lie ahead, we can deliver reforms which allow us to still realise our shared goals for Irish society, most recently outlined in Towards 2016, while also laying the foundations for sustainable economic recovery.

(Need I remind you that Towards 2016 is a document primarily designed to reward public sector workers, offering nothing to the vast majority of our private sector employees, taxpayers and consumers. Furthermore, I personally fail to see how, if the Government expects the crisis to continue through 2013, can we deliver on what was originally conceived as an 10-year long plan within 2 last years of its existence?)

More to follow...

Government's Plan for Ireland: Exclusive... Part 1

Watch this space - I will be publishing Government's Briefing to the Social Partners - received from my academic sources - as soon as I read through the document. For now, part 1 of analysis...

Since the beginning of this week, a media circus surrounds the hot air factory we call the Upper Merrion Street.

Yet, ask anyone in the street what they think will be the outcome of the Social Partnership talks and the responses you get are pragmatic. "Taxes will go up for all!" "[the unions] will make us pay for public sector salaries and job security." "The Partners will get nowhere. Look, the Government can't control its own spending."

They are right. Common sense tells us that the Government that sat on its hands as the crisis unrolled through out 2008 is simply incapable of change. Our Cabinet has no progressive thinkers at the top.

When Mr Cowen took over from Bertie the reigns of this state, his first economic argument was in favour of preserving lavish wage increases granted to senior public sector employees and politicians. Incidentally, this was also the last thing Bertie did as far as economic policy is concerned. When President Obama sat down for his first day in office, he froze salaries of senior public officials.

Notice the difference? Right, it's that leadership thing that Obama seems to have, while our Brian- Brian- Mary Tri-Headed Hydra appears to absolutely lack.

But don't take my words for it. Look at the economic policy tofu they've been feeding to the markets and the Social Partners in the last couple of weeks.

Per sources advising the talks participants on economics side, the Government has forwarded a proposal to the Partners that includes:

• significant 'income adjustments',
  
• the adoption of budgetary 'stabilization' programme for 2009-2013,
  
• a nationwide 'jobs and skills summit' to be presided over by FAS,
  
• a reform of taxation – after the Commission on Taxation produces its recommendations, and
• unspecified public expenditure 'savings' after mid-2009, and a reform of pensions.
  

All of these ideas have been floated by the Government since July 2008 and none have seen any progress, with exception for the first round of 'income adjustments' (oops, tax increases) passed in Budget 2009.

In fact, the Government has now fallen so far behind the news curve, that it is undoing its own earlier plans. For example, Department of Finance January 2009 Stability Report factors into its budgetary deficit projections the minimum level of public expenditure savings of €16.5bn through 2013. Yet, according to the news coming out of the Partnership talks, the Government was asking for 'up to €15bn in spending cuts in 2009-2013'.

So much for the adoption of a budgetary stabilization programme. DofF's forecast is for the Exchequer deficit to run at 9.5% of GDP in 2009, 9% in 2010, 6.5% in 2011 and 4.75% in 2012, assuming the Government cuts €16.5bn starting now, not in the second half of 2009. Without these cuts – we are likely to be in an Icelandic deficit territory through 2020.

Surreal? Wait till you look closer at the rest of the Government proposals.

'Income adjustments' for 2009 and beyond are nothing else but tax increases on ordinary families and consumers who already face higher taxes (income and VAT), rising unemployment, falling wages and upwardly mobile public services costs. If anyone thought that a near tripling in personal bankruptcies in 2008 was a sign of a serious problem, wait until our Government's efforts to 'stabilize' the economy take a massive bite out of ordinary incomes.

No FAS-led "Jobs Fair" would be able to mop up even one tenth of the unemployment created by these Government-induced 'income adjustments'. FAS spends ca 7 times the average annual wage per each job created. At this rate 85,000 jobs that the Department of Finance forecasts to be lost in 2009 will take a cool €20bn 'Job Fair' to replace. And 85,000 is the number not counting in the jobs lost by the rapidly evaporating foreign migrants.

Finally, don't be fooled by the lofty ideals of reforming taxation and pensions. The official brief has only one stated purpose for such reforms – to raise more revenue out of the private sector economy to pay for more spending. Public sector's favorite folly is to tie us all into a mandatory pension scheme and then take away tax incentives to save.

Not to help up to 250,000 homeowners who will be stuck in the negative equity by the end of 2009, nor to aid families crippled by childcare costs or healthcare bills. Most certainly – not to give an inch back to the pensioners and savers whose funds have been devastated by the collapsed market.

Our only hope is that a handful of economically literate Partners might stand their ground in these absurd talks. Otherwise, as a fellow panelist of mine exclaimed at a recent radio discussion concerning our economic future, "We all will be truly screwed…" By those who are supposed to serve us, I might add.

Corporate wipe-out and homeowners

Figures released by ICC Information today show that 21% of trading companies in Ireland have a ‘Negative Net Worth’. In other words, their balance sheet liabilities exceed the value of their assets. Net worth is composed primarily of all the money that has been invested since company inception, as well as retained earnings for the duration of its operation.

“A total of 28,513 trading companies in Ireland have a negative net worth according to their latest filed accounts. Not surprisingly the largest number of these were in the ‘Construction’ sector with 17.2%. However, in terms of actual monetary value ‘Leasing and Renting’ were top with a total negative net worth of over €7 billion.”

This is a scary sign of corporate debt overload, but it is also a sign of the unsustainable nature of many business models, especially those that emerged in 2003-2007 period of construction boom, based on cheap credit, over-supply of liquidity and overly optimistic valuations of demand.

This goes to the heart of debate about credit supply to Irish corporates.

Majority of these companies should not be rescued by cheaper fresh lending, as their businesses are no longer sustainable in the environment of much slower growth.

However, there is a second argument to be made against increasing the pressure on the banks to lend. Currently, some 140,000 households are in negative equity – with the value of their mortgages exceeding the value of their homes. Factoring in the down payments, stamp duty and closing costs, I would estimate that some 180,000 Irish households are actually in the negative equity territory, implying an insolvency risk rate of ca 9% for homeowners.

Large scale corporate bailouts and credit extensions will inevitably come at the expense of consumers and homeowners. Will this drive homeowners insolvency rates to 21% on par with the corporates? Imagine the number of financially bankrupt families in excess of 315,000…

Market view

US dividends are being cut at a record pace (see here) and this is a welcomed news as it marks the beginning of a turning point in the market. I do not mean the turning point for an upward swing in equity prices, at least not yet. I mean a turning point from the relentlessly accelerating down trend and into a flattening section of the U-curve.

Here is the logic - corporate profits are lagged at the very least one-to-two quarters from real demand. This suggests that an accelerating fall in the dividends reflects the economic reality of Q3-Q4 2008. Assuming the real side of the US economy is going to start settling into the bottom section of the U-shape correction sometime in February-March, the current reporting season will be pricing exactly this forecast. Any pick up in growth from the low figures of December-January will be a bonus point to Q2 dividends.

Regardless of such a pick up, equity markets downgrades in the next few weeks will bring share prices down to reflect dividend cuts.

This will set the stage for the next move. End of Q2 is likely to see some upturn in the US economy. Real GDP growth is likely to stay negative in annual terms, but the latter part of Q2 will be marked by a rise in growth from the lows of Q1.

Equity markets will lead this trend with a potential rally in late Q1 - early Q2. Dividend cuts anticipations for Q2 will already be priced in by then, so aggressive cost cutting measures - implying lower sensitivity of Q2 profits to any further economic slowdown in Q1 2009 - will provide some additional potential mid-Q2 boost to the share prices.

A late Q1-early Q2 rally will be a payoff to today's realism...

Global trade protectionism: politics at its worst

To start with, here is a great quote from Jagdish Bhagwati - courtesy of the Cato Institute's Center for Trade Policy Studies:

"[L]abour union lobbies and their political friends have decided that the ideal defence against competition from the poor countries is to raise their cost of production by forcing their standards up, claiming that competition with countries with lower standards is “unfair”. “Free but fair trade” becomes an exercise in insidious protectionism that few recognise as such."
"Obama and Trade: An Alarm Sounds," Financial Times. January 9, 2009.


Lest anyone thought that one party controlling the Congress and the White House is such a handy idea, there is a welcome package for the EU's exporters being prepared by the Democrats.

According to the reports in today's press, President Obama's much-awaited $825bn stimulus package will include a “Buy America” clause - the American Steel First Act. The act will ensure that only US-made steel will be used in $64 billion of federally financed infrastructure projects.

Clearly, Anyone-but-the-Republicans EU leadership is going to see some nasty surprises from the new Administration - if not courtesy of Mr Obama himself, then certainly thanks to the good old protectionist traditional Democrats that Europeans love so much.

The initiative has already secured the House of Representatives Appropriations Committee blessing and is about to trigger a new Steel War with Europe. The EU Commission is already making noises about taking the US to WTO. The US, of course, signed and ratified the WTO's Government Procurement Agreement which requires it to grant fair access to its federally financed projects to all competitors.

If course, some EU states themselves are toying with 'Buy Domestic' types of rescue packages. France, usually the leader of the protectionist pack despite being economically open when it comes to French sales and investments abroad has squeezed in a €6bn aid package for its automakers that includes a commitment for them to purchase on French-made components.

In the UK, plans to give state aid to car makers are also reportedly to include assurances from the comapnies not to use funds outside the country.

A similar €4bn package of aid to Saab and Volvo in Sweden also came with the same strings attached.

And then there is a decision to reintroduce dairy export subsidies by the EU's Agricultural Commissioner, Mariann Fischer Boel. The measure is not only protectionist, but came despite the EU commitment in November 2008 not to introduce new trade barriers in order to allow the troubled Doha Round of global trade talks to be finalised with some face-saving dignity for the WTO.

So maybe in the end Mr Obama is an EU-like President?

Of course, the developing nations are also moving in quickly to shut some of their markets to foreign competition, but this is hardly a reasonable ground for EU and US to start erecting their own trade barriers. History offers a somber reminder: passage of the 1930 Smoot-Hawley Tariff Act in the US triggered a wave of tariff increases across the world. Within a year, average foodstuffs tariffs went up 53% in France, 60% in Austria, 66% in Italy, 75% in Yugoslavia, 80% plus in Czechoslovakia, Germany, Romania and Spain and more than doubled in Bulgaria, Finland and Poland. We all know what that led the world...