Carry trades, Dubai and the direction of the dollar:
Dubai's impending collapse shows that the epicenter of 'Development on Drugs' model implosion is now finally shifting from the US into Middle East and is risking new wave of contagion into Europe. Most of Dubai development has been financed by petrodollars (domestic and inter-regional), but also via carry trades from Europe (intraregional) with Euro area banks dominating the entire Emirate's landscape in foreign banking. This is bound to have long-reaching impact, with as far on-shore as Irish Nama potentially being possibly saddled with loans cross-linked to Dubai property. Bank of Ireland took part in a $5.5 billion (€3.7bn) syndicated loan facility to Dubai World in June 2008, according to stockbroker Davy. Per report in Irish Times today: "The firm said its initial participation in the facility was $93 million (€62 million) but it is understood that the bank’s debt currently stands at about €50 million."
Am I the only one who noticed that Irish investors, semi-states - e.g Aer Lingus, corporates - see here, even Enterprise Ireland succumbed to Dubai's lure: here - have financed the peak of this bubble?
Oh, and is Nama going to end up holding any of this (more here)? Nama folks are saying they know nothing about the Bad Bank taking on Dubai-related loans... Sure... they would know! And what about cross-linked loans? Developers with dual exposures?
So what does Dubai debacle mean globally?
Start with oil: the only way the Emirates are going to escape a meltdown (with domino effect spreading from Dubai to Abu and so on) is by turning on oil taps. An added incentive here is that while autocratic rulers of the Emirates would not blink twice before saddling Western investors with all debts, the structure of Islamic finance used in Dubai developments implies that although junior debt holders have no explicit guarantees on their debt, Emirates simply will not be able to stomach defaulting on Islamic loans. Oil prices will be under pressure for a long period of time before Dubai's debt mountain is cut to size and this will give support to the weakened dollar on asset demand side of the dollarised carry trades involving commodities.
Bigger question is whether Dubai events might trigger the unwinding of the carry trades. This, of course, depends on the value of UAE currency and the main currency pairs used in the region. In my view, devaluation of massive proportions will be required in the short run, putting pressure on the Euro and, again, aiding the dollar.
Another force acting here will be investor confidence. If Dubai served as an island for divestment out of dollar assets in the region, this island is now fully submerged under financial tsunami. Treasuries are to firm up and dollar alongside these. Ditto for gold.
On a separate note, another net positive (longer term) for the dollar is China. President Obama's visit played out as a play of avoiding the issues of yuan, and yielded absolutely no commitment to revalue Chinese currency. This, strangely enough, implies that once revaluation does take place, it will be much more pronounced and abrupt than if the Chinese authorities were to offer President Obama some concessions this month. Here is why. Absent Chinese commitment to play cooperative game with the US on currency front, Obama Administration will let Europeans put pressure on China through bilateral channels and G20. Europe cannot afford to hold the bag in the global devaluation game as it is exports oriented economy. Developing and emerging economies will fight by imposing capital controls, but EU will have to bring this battle to Chinese shores. Thus, in the long run, the stage is now set for overshooting revaluation of the yuan well above its long-term target and firming up of the dollar.
In the medium term, all this uncertainty about the ultimate rebalancing of the FX markets will be pushing on gold. This is likely to coincide with the emerging markets shocker from Dubai and capital controls impositions, further enhancing demand for the store of value assets such as precious metals. Not to be sensationalist, but if we are at the starting point of Wave II of the crisis (even if it is only a smaller aftermath to the 2008 one), is gold at $1,500-$1,700 oz a possibility?
Just asking...
Saturday, November 28, 2009
Economics 28/11/2009: Net investment position, 2008
CSO released Ireland's net investment positions for 2008 yesterday. Full release is available here. My analysis of this data follows:
Table shows outflows of Irish-owned investment from Ireland to foreign destinations (negative values) and the share of each destination in total outflows. Note the significant jump in outflows to the offshore centres, which has risen between 2006 and 2007. It will be interesting to see if this trend – moderated in 2008 – resumes in 2009 in the wake of significant increase in taxation burden in Ireland. Per more detailed breakdown in CSO data, the offshore centres received only a modest share of Irish capital in the form of reinvested earnings, and virtually none in equity purchases, suggesting that most of the outflow to these destinations was in form of business investment and cash.
Another interesting feature of this data is that significant outflows continued to the UK in 2008. Margin calls? These related to equity purchases and reinvested dividends and a significant uptick in ‘other capital’ outflows (margin calls covers on buy-to-let and other risky investments covers?).
Over the same period of time, outflow of investments to the US has fallen off the cliff in 2008. Equity purchases in the US peaked in 2007 at almost 5 times the levels of 2006 and then collapsed to a quarter of 2007 levels in 2008. Someone was buying into the top of the bubble in the US stock markets… Meanwhile, reinvested dividends remained relatively stable. Other types of capital have fallen off the cliff from almost €3 billion in 2006 to €746mln in 2007 to €77mln in 2008. Given that the US property prices peaked in 2006, this also suggests that we were buying at the top of the market there.
Table above shows inward investment inflows to Ireland. Negative values imply that foreign investors took out net amount of capital from Ireland. Offshore centres sent in about as much as 40% of the inflows from entire European area. Any alarms ringing at the Financial Regulator’s office? Notice dramatic swing from net inflows to net outflow vis-à-vis Lux and the Netherlands in 2007-2008? Equity and other capital outflows dominated here. Tax optimization in action, especially on capital taxes side.
Amazing figures from the US. Between 2007-2008, a surplus of inward inflows of €15.2bn swings into a deficit of net outflows of €14.6bn – a spread of €29.8bn or 17.4% of 2009 GDP! Interestingly, equity and reinvested earnings were still in net positive in 2008, and going strong, so the massive net outflows were the result of something else. Capital flight? Deposits crunch? Losses taking?
Net deterioration in our inward investment position between 2007 and 2008 was over €31.7bn or -18.54% of our 2009 GDP. Net improvement in our inward investment position between 2006 and 2007 was €13.63bn or +7.97% of our 2009 GDP. Massive volatility even for a small open economy, but what does it tell us about Government's idea that Ireland Inc will be rescued not by our own actions, but by foreign investors coming back to our shores?
The totals suggest that Ireland has bled a massive €36.8bn worth of investments (equivalent to 21.5% of our 2009 GDP) out of the country in 2006-2008 alone. This hardly accounts for the full extent of deterioration in the capital values of the remaining investments by foreigners in Ireland and Irish own investments abroad. But even without taking into account our current crisis, at the peak of our markets valuations in 2006-2007, we were hardly generating much real growth out of our own and foreign investments into the country. Wonder why? Me too.
Table shows outflows of Irish-owned investment from Ireland to foreign destinations (negative values) and the share of each destination in total outflows. Note the significant jump in outflows to the offshore centres, which has risen between 2006 and 2007. It will be interesting to see if this trend – moderated in 2008 – resumes in 2009 in the wake of significant increase in taxation burden in Ireland. Per more detailed breakdown in CSO data, the offshore centres received only a modest share of Irish capital in the form of reinvested earnings, and virtually none in equity purchases, suggesting that most of the outflow to these destinations was in form of business investment and cash.
Another interesting feature of this data is that significant outflows continued to the UK in 2008. Margin calls? These related to equity purchases and reinvested dividends and a significant uptick in ‘other capital’ outflows (margin calls covers on buy-to-let and other risky investments covers?).Over the same period of time, outflow of investments to the US has fallen off the cliff in 2008. Equity purchases in the US peaked in 2007 at almost 5 times the levels of 2006 and then collapsed to a quarter of 2007 levels in 2008. Someone was buying into the top of the bubble in the US stock markets… Meanwhile, reinvested dividends remained relatively stable. Other types of capital have fallen off the cliff from almost €3 billion in 2006 to €746mln in 2007 to €77mln in 2008. Given that the US property prices peaked in 2006, this also suggests that we were buying at the top of the market there.
Table above shows inward investment inflows to Ireland. Negative values imply that foreign investors took out net amount of capital from Ireland. Offshore centres sent in about as much as 40% of the inflows from entire European area. Any alarms ringing at the Financial Regulator’s office? Notice dramatic swing from net inflows to net outflow vis-à-vis Lux and the Netherlands in 2007-2008? Equity and other capital outflows dominated here. Tax optimization in action, especially on capital taxes side. Amazing figures from the US. Between 2007-2008, a surplus of inward inflows of €15.2bn swings into a deficit of net outflows of €14.6bn – a spread of €29.8bn or 17.4% of 2009 GDP! Interestingly, equity and reinvested earnings were still in net positive in 2008, and going strong, so the massive net outflows were the result of something else. Capital flight? Deposits crunch? Losses taking?
Net deterioration in our inward investment position between 2007 and 2008 was over €31.7bn or -18.54% of our 2009 GDP. Net improvement in our inward investment position between 2006 and 2007 was €13.63bn or +7.97% of our 2009 GDP. Massive volatility even for a small open economy, but what does it tell us about Government's idea that Ireland Inc will be rescued not by our own actions, but by foreign investors coming back to our shores?
The totals suggest that Ireland has bled a massive €36.8bn worth of investments (equivalent to 21.5% of our 2009 GDP) out of the country in 2006-2008 alone. This hardly accounts for the full extent of deterioration in the capital values of the remaining investments by foreigners in Ireland and Irish own investments abroad. But even without taking into account our current crisis, at the peak of our markets valuations in 2006-2007, we were hardly generating much real growth out of our own and foreign investments into the country. Wonder why? Me too.Economics 28/11/2009: Irish labour market snapshot
An interesting paper on labour market published last week provides a good insight into pre-crisis comparatives for Ireland vis-à-vis other Euro area states, the UK and the US. In general, in labour markets, there are processes of job creation and destruction, which are related (but not necessarily perfectly) to workers’ hirings and separations.
Literature on these suggests that “idiosyncratic firm-level characteristics shape both job and worker flows in a similar way in all countries”. But is it so? Do national characteristics matter?
Andrea Bassanini and Pascal Marianna of OECD (IZA Discussion Paper 4452) used cross-country data based on comparable methodologies “to examine key determinants of these flows and of their cross-country differences”. In general, the authors found “that idiosyncratic firm (industry, firm age and size) and worker (age, gender, education) characteristics play an important role for both gross job and worker flows in all countries. Nevertheless, …even controlling for these factors, cross-country differences concerning both gross job and worker flows appear large and of a similar magnitude.”
In summary, “both job and worker flows in countries such as the US and the UK exceed those in certain continental European countries by a factor of two [suggesting much more enhanced worker mobility and jobs creation and destruction in the UK and US]. Moreover, the variation of worker flows …is well explained by the variation of job flows, suggesting that, to a certain extent, the two flows can be used as substitutes in cross-country analysis [in other words – the structures underlying jobs creation and jobs destruction are largely country-specific]. Consistently, churning flows, that is flows originating by firms churning workers and employees quitting and being replaced, display much less cross-country variation.”
You can read the whole paper here, but I will focus on summarizing its findings regarding Ireland. Authors used a limited sample for Ireland (2000-2003), but it was the sample that covered years before the property bubble. In other words, it was a sample closer to the real Irish economy in action, only less pumped up by the steroids of overspending and crazed investment boom.
Table below based on the paper findings, but recompiled by me to illustrate Irish comparatives, shows Ireland as a country with labor markets that are average in their behavior when compared to other developed economies. Contrary to the claims of our political leaders (who painted Irish labour markets as being ‘socially’ focused) and their opposition (who painted Irish labour markets in the hues of cut-throat capitalist competition), we are what we really are – average.
Note: Excess job reallocation is a measure of simultaneous and off-setting job creation and job destruction by different firms belonging to the same group. In other words, excess job reallocation represents the reallocation of labour resources between firms within the same group whereas the group’s absolute net employment change provides a measure of reallocation across different groups of firms (e.g. different industries). Table above shows probability of worker reallocations (changes in employment status or employer) per annum, probability of reallocation due to excess – excess in jobs turnover over the absolute change in net total employment, probability of new hiring in a year and probability of a layoff or firing (separation). Miracle is – we are very close to an average, even though Ireland was experiencing stronger growth in 2000-2003 than majority of the countries listed in the table.
Another table above shows that in terms of differences between reallocations and excess layoffs, hirings and separations, Ireland is sports a difference from the average only in terms of reallocations net of excess, or that component of the probability of changing work status or employer that is not accounted by movements of jobs within the same sector. In this area we have a higher rate than average, most likely reflective of former ICT sector workers being shifted to new sectors in the wake of the Tech Bubble collapse. Another area of difference relates to hirings in excess of separations, which implies that Irish economy was net additive of new jobs at the time at a strong rate. All other parameter readings are average.So for a pictorial representation next. Higher worker reallocation rates – similar to other growth economies of Denmark, Finland, Spain, UK and US. Similarly higher excess worker reallocation. Slightly above average hirings rates and average separations.
And as far as differentials go:
Below average excess less hiring reasons for reallocations, slightly above average excess less separations (jobs destruction was rather weaker in Ireland in this period than in the average economy in the sample) and above average hirings less separations – again for the same reason of rising jobs creation.So what about ‘gender issues’ in the workforce? Surely here we have lots of ground to gain as our Irish Times pundits on economy have been busy shouting about various gender gaps and glass ceilings?
Well, as far as hiring rates by gender go, we are below average for both men and women, and remarkably, there is no difference evident by gender whatsoever. The only other country with such levels of hiring ‘glass ceilings’ is… Sweden. That said, our overall mobility due to hiring was a bit weaker than the average. But not by much. Separations by gender? Do evil capitalists fire women more frequently than men in Ireland?
Yes, rates of separation from employer for women were in excess of those for men in Ireland, but both rates were below the group average and the differences across gender lines were less pronounced in Ireland than in… Sweden, Norway, Finland, Denmark, and Switzerland. Either these countries are even more sharkish capitalist economies or there is no evidence of Ireland’s labour markets being much tougher for women then for men.
Chart above shows that in terms of gender imbalances in reallocation rates by gender, Ireland was in the below-average tier of the sample countries. And that mobility gap between men and women was smaller than the one found in many other social(ist) democracies of our Europa Land. Average we were in this category as well.
If there was no real need for a radical Government intervention to protect Irish women from sharp labour market practices of employers, what about the famous age gap? May be here there we find a smoking gun?
Not really. All age groups in Ireland saw similarly below average rates of mobility due to hirings. And overall age gap was similar as that of the average economy. Nothing dramatic happened here, folks.
Nor were our separation rates by age category drama-filled either. Below average – reflective of tighter labour markets in general and employers’ desire to hold on to workers in the age of rising wage inflation. Only the older cohort of workers experienced more jobs turnovers than average, and then not by much. For a much younger society than our peers this suggests that there was hardly a difference by age in separations after all.
Worker reallocation rates by age – same story.Now, we’ve all heard about our marvelously educated labour force. With so much education, would Irish economy treat various education cohorts differently in the labour market? Afterall, a handful of less educated workers would really stand out in the sea of excellence that is Ireland Inc’s workforce.
Alas, the rates of hirings were below average in Ireland for all education groups, ecept highly educated. Now, here is a strange thing – if we had a highly educated labour force then, this would imply diminishing demand for such oversupplied ‘commodity’. In turn, demand rocketed. Either we all were working for high-education-intensive companies (MIT Media Labs?) or our ‘high’ levels of education were just average in quality/quantity…
Separations tell the same story – these are movements of workers out of jobs and they are… below average for highly educated and average for medium educated and low for low educated. People seemed to have been relatively happy to hold their jobs.And so on to reallocations rates:
Below average for all…And so, positing a question: in 2000-2003, were Irish labour markets closer to Boston or to Berlin? The answer, alas would be a disappointing neither. We were, in fact, closer to that inextant Kingdom of Average. Time to stop class warfare?
Friday, November 27, 2009
Economics 27/11/2009: Euro area data signals near 2% growth in November
Updated
Eurocoin - a leading barometer of future economic activity in the Eurozone - increased to 0.55 in November, the third positive reading in a row up from 0.33 in October. The reading points to an underlying growth in the Euro area of slightly above 2% on a annual basis. Gains have been led by consumer and business confidence as the main drivers, the stock market and industrial production contributed to a lesser extent. We are now back to H2 2007 level in Eurocoin reading.
So here is the forecast, as promised:
Notice that my forecast assumes ca 1.1% growth q-o-q in Q4 2009 and a dip to ca 0.3-0.4% in January 2010. Not a W, but a moderation nonetheless, driven primarily by what I believe will be a very weak Christmas season across Europe. In Ireland, as always there is an issue of extreme volatility in growth, but I will be watching Christmas sales for signs of serious weakness - there is a distinct possibility of large shut downs on retail and restaurants trade side the other side of holidays into January. Let's hope I am wrong (and I have been wrong in the past - my previous forecast for Q3 2009 Euro area growth was -0.5-1% and it came out at a 0.8 percentage points swing from my closer end of the estimate).
On a less economic side of news:
EU Commissioner for Internal markets for the next 5 years will be one French MEP Michel Barnier. Barnier will take portfolio with responsibilities for financial services. Barnier had so far distinguished himself as trade protectionist with strong opposition to the so-called 'Anglo-Saxon' model of economic development. That is to say he is firmly in favor of rules-based regulation of financial services. This is a net negative development, as currently Brussels is in the process of drafting a massive volume of regulations relating to financial services and such a process of reform requires a very balanced and sector-specific approach. Barnier is hardly fulfilling such a description. On July 28 this year, Le Monde (Barnier's home paper) described the possible appointment of Barnier to the Internal Markets portfolio as equivalent to "entrusting the surveillance of a chicken coop to a fox".
Why a chicken coop & fox analogy? Not because Le Monde is that much concerned over Barnier's credentials as over-regulation driven finance tsar, but because Barnier will be running financial sector across the EU at the time when President Sarkozy has a clearly defined (and publicly expressed) objective to make Paris a bigger financial services centre than London. It will be interesting to see how the battle between Barnier-the-European-Federalist and Barnier-the-French-Politico will be unfolding.
Forbes reports (here): "One former official who worked with Barnier said: 'He has always been very close to the French conservatives. He was close to Chirac and now he is close to Sarkozy. He will know that he is in that position thanks to Sarkozy.'"
If there is any more to add here it is that Barnier was Minister for Agriculture in France between 2007 and 2009 - a post that saw him preside over the most subsidised, most protected and least 'common market' of all sectors in Europe in a country that holds second place only to Ireland in per-farmer subsidies. He now will oversee the most mobile and least protected sector across the EU. Spot the irony...
And since we are on news digest - here is the story that caught my eye. This goes to heart of the debate as to what makes a state a pariah state. After all, Soviet Union used in place its Nobel Prize winners into exile or under house arrest in a remote city closed-off to the rest of the world, it even forced one to turn down his Nobel Prize, but stealing it away from a person? New low for the state that the West is courting with bouts of friendly rhetoric. And what an irony for the Nobel Peace Prize Committee, which awarded President Obama's prize this year in part for his renewing dialogues with rogue states like... Iran (here)...
Eurocoin - a leading barometer of future economic activity in the Eurozone - increased to 0.55 in November, the third positive reading in a row up from 0.33 in October. The reading points to an underlying growth in the Euro area of slightly above 2% on a annual basis. Gains have been led by consumer and business confidence as the main drivers, the stock market and industrial production contributed to a lesser extent. We are now back to H2 2007 level in Eurocoin reading.
So here is the forecast, as promised:
Notice that my forecast assumes ca 1.1% growth q-o-q in Q4 2009 and a dip to ca 0.3-0.4% in January 2010. Not a W, but a moderation nonetheless, driven primarily by what I believe will be a very weak Christmas season across Europe. In Ireland, as always there is an issue of extreme volatility in growth, but I will be watching Christmas sales for signs of serious weakness - there is a distinct possibility of large shut downs on retail and restaurants trade side the other side of holidays into January. Let's hope I am wrong (and I have been wrong in the past - my previous forecast for Q3 2009 Euro area growth was -0.5-1% and it came out at a 0.8 percentage points swing from my closer end of the estimate).On a less economic side of news:
EU Commissioner for Internal markets for the next 5 years will be one French MEP Michel Barnier. Barnier will take portfolio with responsibilities for financial services. Barnier had so far distinguished himself as trade protectionist with strong opposition to the so-called 'Anglo-Saxon' model of economic development. That is to say he is firmly in favor of rules-based regulation of financial services. This is a net negative development, as currently Brussels is in the process of drafting a massive volume of regulations relating to financial services and such a process of reform requires a very balanced and sector-specific approach. Barnier is hardly fulfilling such a description. On July 28 this year, Le Monde (Barnier's home paper) described the possible appointment of Barnier to the Internal Markets portfolio as equivalent to "entrusting the surveillance of a chicken coop to a fox".
Why a chicken coop & fox analogy? Not because Le Monde is that much concerned over Barnier's credentials as over-regulation driven finance tsar, but because Barnier will be running financial sector across the EU at the time when President Sarkozy has a clearly defined (and publicly expressed) objective to make Paris a bigger financial services centre than London. It will be interesting to see how the battle between Barnier-the-European-Federalist and Barnier-the-French-Politico will be unfolding.
Forbes reports (here): "One former official who worked with Barnier said: 'He has always been very close to the French conservatives. He was close to Chirac and now he is close to Sarkozy. He will know that he is in that position thanks to Sarkozy.'"
If there is any more to add here it is that Barnier was Minister for Agriculture in France between 2007 and 2009 - a post that saw him preside over the most subsidised, most protected and least 'common market' of all sectors in Europe in a country that holds second place only to Ireland in per-farmer subsidies. He now will oversee the most mobile and least protected sector across the EU. Spot the irony...
And since we are on news digest - here is the story that caught my eye. This goes to heart of the debate as to what makes a state a pariah state. After all, Soviet Union used in place its Nobel Prize winners into exile or under house arrest in a remote city closed-off to the rest of the world, it even forced one to turn down his Nobel Prize, but stealing it away from a person? New low for the state that the West is courting with bouts of friendly rhetoric. And what an irony for the Nobel Peace Prize Committee, which awarded President Obama's prize this year in part for his renewing dialogues with rogue states like... Iran (here)...
Wednesday, November 25, 2009
Economics 26/12/2009: International report on Irish Air Tax
So in few hours from now, Ryanair will launch a report commissioned by them, Aer Lingus and CityJet that comprehensively destroys any argument in favour of the Irish Travel Tax. Here are the exerts from the report - well ahead of all other media. Note: this research was carried out by consultants who earlier this year convinced authorities in Holland to revoke their own travel tax in order to improve economic performance of their air transport sector. My comments are in brackets below.
“Aer Lingus, Ryanair and CityJet, which account for 83% of total departing passengers from Irish airports, are currently endeavouring to persuade the Irish Government to withdraw the Irish Air Travel Tax (ATT), which has applied to flights out of Ireland since 30 March 2009. The ATT imposes a tax of € 10 per passenger on all flights from Irish airports to airports which are situated more than 300 kilometres from Dublin Airport. For flights from Irish airports to airports within this limit a reduced rate of € 2 applies.
“It is envisaged that the revenue of the ATT would have been approximately € 130 million per annum if no demand reduction had occurred as a result of the imposition of the ATT. However, economic theory and empirical evidence clearly demonstrates that passengers will react to higher travel costs, which will inevitably reduce demand for air travel.
“If airline capacity had been maintained at 2008 levels and the ATT was to be passed on in full to passengers in the form of higher fares, it is estimated that the total resulting demand reduction would be between 0.5 and 1.2 million departing passengers based on a price elasticity range of between –0.5 and –1.5. On this basis, ATT revenue would be between € 117 million and € 124 million but total revenue losses for airlines, airports and the tourist sector would range from a minimum of € 210 million up to € 465 million, dependent on the elasticities assumed While some revenue losses may be absorbed by the relevant sectors in the form of resulting cost savings, there will still be a significant adverse effect on the Irish economy. These losses are compounded further down the supply chain as companies purchase fewer goods and services.
“In particular, there will be a direct loss of jobs of at least 2,000 to 3,000 affecting airports, airlines and the tourism industry dependent upon the extent to which companies are willing to accept the inherent diseconomies of scale from a reduction in demand. The direct consequences of the reduction in passenger demand as a result of the ATT would give rise to significant reductions in government revenues in the following categories:
Less revenues from income tax (as well as higher unemployment costs)
Less revenues from corporate tax
Less revenues from sales tax (value added tax (VAT))
“While it is not possible to quantify the scale of these revenue losses, the level of expected job losses as a consequence of the ATT would, assuming that every lost job results in additional costs of approximately € 20,000 per annum to the Government in the form of reduced income tax and social welfare payments, give rise to an additional cost to the Irish government of the order of € 50 million or more. These costs are related to social welfare payments as jobs are unlikely to be replaced in the short to medium term. Over the longer term, as the economy recovers from the recession, the net loss of jobs may reduce as labour switches to less productive employment in a new economic equilibrium.
“In reality, airlines have not been able to pass on the ATT to passengers in the form of higher fares but have reacted by a combination of absorbing the tax by lowering fares and redeploying capacity outside of Ireland to locations where no travel tax is applicable. Consequently, actual revenue losses across the various sectors as a result of the ATT have been significantly higher than might have been expected due the impact of higher prices alone, estimated at between € 428 - € 482 million based on activity by Aer Lingus, CityJet and Ryanair alone, with ATT revenue estimated to be € 116 million. The resulting loss of revenue on the part of the Government will also be significantly higher as a result of the additional loss of jobs.
“Our analysis clearly demonstrates that the imposition of the ATT has resulted in a decline in revenue to specific sectors of the Irish economy of a far greater magnitude than the amount of tax likely to be collected. Based on the actions of airlines to date and the revenue impact on the airlines, who have had to absorb the tax in lower fares to maintain volumes, it is likely that the level of capacity will further reduce as airlines continue to redeploy their resources to lower cost markets in the European Union where no travel tax applies. This will have a further detrimental impact on the Irish economy and the tourism industry in particular. In addition, the resulting reduced airline network will reduce air service connectivity to Ireland, making it less attractive to visit and a less attractive place to do business, which may also serve as an impediment to economic regeneration more generally.”
[My comment: I have nothing to add, other than – I told you so months ago!
But let me ask this question - economics aside, why no one has questioned the ethical authority of this Government to levy an arbitrary tax on air travel? After all, air travel involves a voluntary transaction between a passenger and an airline. Use of airport infrastructure is already charged for. Vat and other taxes are already factored in. Income taxes were paid. What service does the state claim to provide to justify this surcharge? None. Not even in theory should the Government have a right to levy a tax that is so apparently ad hoc and serves solely the purpose of discriminating against one group of people (those undertaking overseas travel for personal or business reasons) in favor of generating cash revenue for general spending purposes. You disagree? Ok, should we have a marriage tax next? Or a tax on private libraries? X-box use surcharge? I-phone listening levy? Children walking assessment? Where does the abuse of power to tax stop?]
“Aer Lingus, Ryanair and CityJet, which account for 83% of total departing passengers from Irish airports, are currently endeavouring to persuade the Irish Government to withdraw the Irish Air Travel Tax (ATT), which has applied to flights out of Ireland since 30 March 2009. The ATT imposes a tax of € 10 per passenger on all flights from Irish airports to airports which are situated more than 300 kilometres from Dublin Airport. For flights from Irish airports to airports within this limit a reduced rate of € 2 applies.
“It is envisaged that the revenue of the ATT would have been approximately € 130 million per annum if no demand reduction had occurred as a result of the imposition of the ATT. However, economic theory and empirical evidence clearly demonstrates that passengers will react to higher travel costs, which will inevitably reduce demand for air travel.
“If airline capacity had been maintained at 2008 levels and the ATT was to be passed on in full to passengers in the form of higher fares, it is estimated that the total resulting demand reduction would be between 0.5 and 1.2 million departing passengers based on a price elasticity range of between –0.5 and –1.5. On this basis, ATT revenue would be between € 117 million and € 124 million but total revenue losses for airlines, airports and the tourist sector would range from a minimum of € 210 million up to € 465 million, dependent on the elasticities assumed While some revenue losses may be absorbed by the relevant sectors in the form of resulting cost savings, there will still be a significant adverse effect on the Irish economy. These losses are compounded further down the supply chain as companies purchase fewer goods and services.
“In particular, there will be a direct loss of jobs of at least 2,000 to 3,000 affecting airports, airlines and the tourism industry dependent upon the extent to which companies are willing to accept the inherent diseconomies of scale from a reduction in demand. The direct consequences of the reduction in passenger demand as a result of the ATT would give rise to significant reductions in government revenues in the following categories:
Less revenues from income tax (as well as higher unemployment costs)
Less revenues from corporate tax
Less revenues from sales tax (value added tax (VAT))
“While it is not possible to quantify the scale of these revenue losses, the level of expected job losses as a consequence of the ATT would, assuming that every lost job results in additional costs of approximately € 20,000 per annum to the Government in the form of reduced income tax and social welfare payments, give rise to an additional cost to the Irish government of the order of € 50 million or more. These costs are related to social welfare payments as jobs are unlikely to be replaced in the short to medium term. Over the longer term, as the economy recovers from the recession, the net loss of jobs may reduce as labour switches to less productive employment in a new economic equilibrium.
“In reality, airlines have not been able to pass on the ATT to passengers in the form of higher fares but have reacted by a combination of absorbing the tax by lowering fares and redeploying capacity outside of Ireland to locations where no travel tax is applicable. Consequently, actual revenue losses across the various sectors as a result of the ATT have been significantly higher than might have been expected due the impact of higher prices alone, estimated at between € 428 - € 482 million based on activity by Aer Lingus, CityJet and Ryanair alone, with ATT revenue estimated to be € 116 million. The resulting loss of revenue on the part of the Government will also be significantly higher as a result of the additional loss of jobs.
“Our analysis clearly demonstrates that the imposition of the ATT has resulted in a decline in revenue to specific sectors of the Irish economy of a far greater magnitude than the amount of tax likely to be collected. Based on the actions of airlines to date and the revenue impact on the airlines, who have had to absorb the tax in lower fares to maintain volumes, it is likely that the level of capacity will further reduce as airlines continue to redeploy their resources to lower cost markets in the European Union where no travel tax applies. This will have a further detrimental impact on the Irish economy and the tourism industry in particular. In addition, the resulting reduced airline network will reduce air service connectivity to Ireland, making it less attractive to visit and a less attractive place to do business, which may also serve as an impediment to economic regeneration more generally.”
[My comment: I have nothing to add, other than – I told you so months ago!
But let me ask this question - economics aside, why no one has questioned the ethical authority of this Government to levy an arbitrary tax on air travel? After all, air travel involves a voluntary transaction between a passenger and an airline. Use of airport infrastructure is already charged for. Vat and other taxes are already factored in. Income taxes were paid. What service does the state claim to provide to justify this surcharge? None. Not even in theory should the Government have a right to levy a tax that is so apparently ad hoc and serves solely the purpose of discriminating against one group of people (those undertaking overseas travel for personal or business reasons) in favor of generating cash revenue for general spending purposes. You disagree? Ok, should we have a marriage tax next? Or a tax on private libraries? X-box use surcharge? I-phone listening levy? Children walking assessment? Where does the abuse of power to tax stop?]
Sunday, November 22, 2009
Economics 22/11/2009: News Flash - our taxes are already killing FDI
If you missed my today's article in Sunday Times, here is the unedited version below.
Before that, a quick news flash - my source close to DETE has informed me last week that in September-October this year three large multinational companies currently not present in Ireland have told our international investment development agency that they have no interest in locating in Ireland. These statements came after several months of negotiations to attract these companies into Ireland. Significantly, all three indicated that the upper marginal tax rate in Ireland, which inclusive of levies and charges rises to a whooping 56% of individual income was the main reason for them not to locate their European headquarters here, as they deemed this level of tax on executives' earnings to be prohibitive.
As Ireland is facing the prospect of one of its toughest Budgets in history, the debate about what to cut and by how much has firmly displaced all other issues on the news agenda. Different views, arguments and policy proposals abound. Virtually all side one way or the other with the idea that any reduction in public spending will be deflationary in this economic environment. Cut public deficit financing, say proponents of tax-and-spend or borrow-and-spend policies, and you will be cutting consumption, triggering a decline in GDP, and more layoffs.
This argument is not new. Many economists, let alone policy pundits, subscribe to it. But is it really true? If the Irish Government were to reduce public consumption or state wage bill today, will the Irish economy crash?
The debate centres on the question as to how large is the fiscal policy multiplier. To understand it, suppose that the fiscal multiplier is greater than 1, say 1.5. In this case, a €1.00 increase in government purchases raises the aggregate demand for goods and services in the economy by more than one euro, or in example above, by €1.50. If the original euro was borrowed at 5% per annum, then the net return to the economy is 42.9%. Sounds magical? If this indeed were true, economic prosperity for all can be achieved by simply endlessly running ever-rising deficits to finance more and more public spending. Enter SIPTU/ICTU/CPSU programmes for State spending. Clearly something is amiss in this logic.
But forget the theory, perhaps fiscal policy alchemy works in practice?
Well, even in the case of the US – the most thoroughly researched economy in the world - there is confusion as to what exactly deficit financing of public expenditure does in a recession.
In a recent research note Professor Christina Romer, Chair of President Obama’s Council of Economic Advisers, asserted for each $1 spent by the Federal Government in a recession, US economy grows by $1.95. So far so good – borrowing at, say 5% per annum and getting 51.3% return makes sense. So much so, that her own employer – the said Council of Economic Advisers – thought this paper was a grand candidate for publicly justifying President Obama’s stimulus package.
The problem, of course, was that Professor Romer’s estimates did not fully for the fact that the largest part of President Obama’s stimulus came in the form of tax cuts, not spending increases. The former accounted for roughly $66bn of the total spending of $151.4bn in March-August 2009, while conventional public spending accounting for just $30.6bn. The rest of stimulus was taken up by aid to the states ($38.4bn) much of which went to offset earlier local tax increases and Government investment ($16.5bn).
In response to Professor Romer, Professor Robert Barro of Harvard University argued in January 2009 that historically, US fiscal multiplier was very close to 1, suggesting that deficit-financed spending earns no real economic return. And Barro’s findings are echoed by an earlier study by Roberto Perotti of Bocconi University, Italy. Perotti looked at fiscal multipliers for the OECD countries between 1960 and 2001. His main conclusions were that post-1980 there is no evidence of fiscal multipliers being in excess of 1. Over time, with a 5% coupon on a 10-year Government bond, deficit financing for Ireland Inc today, under Perotti’s findings will end up costing our economy at least 62 cents on each euro spent net of any benefits we might receive from growth. Furthermore, Perotti found evidence that government spending stimuli hurt private consumption and investment, whereas tax cuts do not. This suggests that cutting taxes, although not necessarily more productive than a fiscal stimulus in the short run will at the very least be less costly to the economy in the longer term.
So dynamic effects of deficit-financed fiscal stimulus over time do matter. And here lies the crux of our debate: dynamic effects depend on country characteristics. Majority of studies on the matter of fiscal multipliers were carried in the US – a country that hardly resembles Ireland for several reasons. Firstly, it is a large and a relatively closed economy. Secondly, it has independent monetary policy, prints its own currency and has a global market for its bonds. Ireland, in contrast, is a small open economy, with no monetary policy independence, extremely tight and saturated markets for its bonds and with exchange rates that are flexible vis-à-vis its main trading and investment partners (the US, UK and the rest of the non-euro world).
And this brings us to the last point of our tour de force through the world of fiscal multipliers and deficit-financed state spending programmes. To make the most accurate assessment of the potential effects of the public sector cuts proposed for the Budget, we must consider empirical evidence for countries similar to Ireland. A recent (October 2009) study published by the Centre for Economic Policy Research looked at 45 countries (20 high-income and 25 developing), spanning 1960 through 2007. What the authors found confirms the results attained by Romer and Perotti, and paints a picture of just how dangerous the deficit financing myth can be for a country such as Ireland.
For a small open economy, like Ireland, the study found cumulative total fiscal multiplier starts with a negative (yes, a negative) -0.05 effect on economic growth and in the long run (over 6 years) reaches a negative -0.07. In no time does the average cumulative multiplier exceed 0.4%. Now, add to this a realisation that Irish economy operates in the world where the Euro is in a virtual free-float against the Pound Sterling and the US Dollar. The same study estimates that for economies with flexible exchange rates, the impact effect of fiscal stimulus is -0.04 and the cumulative long-run effect is -0.31.
This means that were we to pursue a policy of higher fiscal spending based on deficit financing, as the Men of the Liberty Hall suggest, we would be facing immediate losses of at least between 4-5 cents on each euro of the entire stimulus. Over time – say by around 2013-2015, these losses will accumulate to something in the neighbourhood of 31-40 cents on the euro per annum. And this is before the cost of financing these deficits is factored in.
Even were ICTU/SIPTU were right on our ability to raise funding without any cost to the real economy (although their proposals would imply severe tax hikes for ordinary men and women of this country), Irish economy would still be wasting money if transferring wealth from the so-called rich (aka pretty much everyone with a decent job) to public expenditure.
Love it or hate it, but real world economics simply has no room for our Social Partners’ latest ideas on fiscal management.
Box-out:
At a recent conference, a French colleague asked me if Ireland is a low tax and low public spending economy.
The only way to answer this question is to consider the overall size of the Government expenditure in Irish economy. Back in 2008, Irish Government spending accounted for approximately 48% of our GNP, or one percentage point above the EU average and about half a percentage point above the UK. Forget for a moment that the UK has a functional and a sizeable military.
Focus on 2009 numbers. Due to continued increases in public spending throughout
this year, and to a rapid decline in our GNP, Irish Government spending is likely to account for between 53% and 54% of our domestic economy. In other words, over half of all goods and services supplied in Ireland is being swallowed by the State.
To put this number into perspective, the heaviest taxed economy in Europe in 2008 was Sweden, where the ratio of public spending to domestic economy was just over 53%. Yet, navigating through the recession, Swedes cut their taxes in 2009 as we raised our. Thus, by December 31 this, Ireland will be the holder of the dubious title of the heaviest taxed economy in the EU.
Now, give a thought another fact. Top personal income tax rate in Denmark in 2008 was 59%, in Sweden - 56.4%. In Ireland it is 56% after April 2009 Budget. Thus, we now have the third highest income tax band in Europe.
All of this means that Ireland is heading for a grim Christmas sales season shackled not by low consumer confidence, but by a lack of after-tax disposable income.
Saturday, November 21, 2009
Economics 21/11/2009: Public v private sector income inequality is up, again
Updated images files
There are many claims flying about our bearded men of Siptu and Ictu nowadays. None are more offensive than their claims that private sector has not been hit hard in terms of wages and earnings by the current crisis. Well, thanks to CSO's inability to collect timely and frequent data, we had to sit back for some time, tolerating these unionist claims. Alas, data for Q2 2009 is starting to show that those of us who said that private sector is suffering earnings declines while public sector is basking in the sunshine of rising earnings were right. Here are the numbers:
Now, chart above shows that wages have been rising across all (but one) public sector sub-sectors. Average public sector earnings are up 3.2% in a year to the end of Q2 2009, while average private sector wages are down 6.8% over the same time - a swing of 10 percentage points. Happy times for CPSU and the rest of the unions pack.
There are many claims flying about our bearded men of Siptu and Ictu nowadays. None are more offensive than their claims that private sector has not been hit hard in terms of wages and earnings by the current crisis. Well, thanks to CSO's inability to collect timely and frequent data, we had to sit back for some time, tolerating these unionist claims. Alas, data for Q2 2009 is starting to show that those of us who said that private sector is suffering earnings declines while public sector is basking in the sunshine of rising earnings were right. Here are the numbers:
Table 1 reports actual average weekly earnings based on CSO data sets. Yep, that's right -public servants make more money than the average managerial, professional and clerical grade in every other sector except financial services and insurance. Note, I separated electricity, water supply and waste management sector into quasi-public sector because it is heavily dominated by massively inflated earnings in ESB and other state monopolies.
Next, consider average weekly earnings for professional and clerical grades and for public sector overall. The reason for this is that our unionists keep on droning that public sector workers are so superior to the average worker in the rest of economy that they must be compared with higher grades. Forgive my disbelief that, say, CIE's bus drivers are so productive and so highly skilled that they should be benchmarked against branch managers of Irish banks, but let us indulge the Siptu/Ictu crowd:
Yes, it says that: between Q2 2008 and Q2 2009 more categories of public sector workers started to earn in excess of private sector average earnings for managers, professionals and clerical workers. And this is at the time when Jack O'Connor and the rest of Unions' leaders are talking about rising tide of income inequality (oh, give me a sec and I will get back to that concept).
Yes, it says that: between Q2 2008 and Q2 2009 more categories of public sector workers started to earn in excess of private sector average earnings for managers, professionals and clerical workers. And this is at the time when Jack O'Connor and the rest of Unions' leaders are talking about rising tide of income inequality (oh, give me a sec and I will get back to that concept).
Now, chart above shows that wages have been rising across all (but one) public sector sub-sectors. Average public sector earnings are up 3.2% in a year to the end of Q2 2009, while average private sector wages are down 6.8% over the same time - a swing of 10 percentage points. Happy times for CPSU and the rest of the unions pack.Of course, years ago, when we had fast growing private sector wages, the unions, CORI, the rest of the social pillar fringe were loudly bemoaning the rising tide of income inequality. So what can we say now? Check out the following table:
Yeps, that's right, applying Socialists' faulty economic logic, last year our Trade Unions' policies have led to a rise in income inequality between private and public sector in favor of higher income to public sector.
Yeps, that's right, applying Socialists' faulty economic logic, last year our Trade Unions' policies have led to a rise in income inequality between private and public sector in favor of higher income to public sector.If anything, the latest CSO data suggests that the next month's Budget 2010 should open with a significant across the board cut in public sector wages by at least 10% (to simply undo income inequality that has been generated since 2008), and only then proceed to all other cuts. Have a pre-Budget Addendum on Public Sector Earnings Inequality first, before you cut education, health and even social welfare, Minister.
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