With the euro unsteady against the dollar (post-10%+ drop in recent months from its highs over 1.50 in December 2009 to 1.35) there is a question to be asked - can dollar and euro act as reasonable hedges for each other. In other words, should euro-overweight Europeans hold dollars, while dollar-overweight Americans, Asians and Latin American hold euros? In my view – neither.
This view is formed by my belief that both currencies will continue to fluctuate along a short-term weakening of the euro rend, followed by an equally volatile, but flat trend in the medium term, moving into a dollar appreciation trend in the long run.
Why? Because two economies fundamentals are currently very similar, and only the long term view affords a potential for the US to pull away from the structurally sicker European partners.
In absolute terms, the EU27 is the largest ‘economy’ in the world – some 16.2% greater in terms of PPP-adjusted GDP than the US ($14.2 trillion) economy. But the eurozone itself is equivalent to just 74% of the US total output, despite being 10 million ahead of the US in population terms. Taken as such, one can argue that on average, the euro currency and the US dollar cores are roughly the same.
Both had pretty tough time through the downturn. 2009 US GDP was down 2.7% outperforming Eurozone where GDP fell 4.2%. Unemployment is running pretty much in line, but US unemployment is usually more willing to subside once recovery begins. On financial sector side, euro area has taken roughly 40% of the required corrections of the banks balancesheets as of Q4 2009, while the US banks have taken 60%.
Inflation in the US has been running ahead of the EU16 (2.7% as opposed to 0.6% in 2009). But this inflation differential means two things – it reflects differences in the timing and the size of fiscal and monetary interventions and it reflects the effects of devaluation of the dollar. US recovery has begun, while EU16 is still languishing at around 0% growth and there are growing signs of a possible double dip hitting Berlin, Paris, Rome and Madrid, not to mention the peripherals.
Greeks are the star performers when it comes to the circus of fiscal recklessness in the Northern Hemisphere: 12.2% deficit (more likely closer to 13%). Last week’s plan to trim 2% off that number is, assuming it actually comes into being, equivalent to being 5.875% short of the cost of financing the Greek debt annually. In other words, Greek debt is priced at 6.3% per annum. It stands at 125% of GDP, which means that 7.875% of the GDP is spent every year by the Greeks on interest payments on the debt alone. It will take Greece 4 years of consecutive 2% cuts to just cancel out the existent interest on the debt.
For Ireland, the figures are hardly more pleasant. 11.6% deficit planned for in 2010 Budget (a net cut of just 0.1% on 2009 figure) and with our debt (ex-Nama) heading for €90 billion (over €100 billion with recapitalization factored in) or 56% of expected 2010 GDP, at the latest yield of 5%, means that our debt burden is currently taking up 2.8-3.2% of GDP annually. At the current rates of budgetary adjustments (per Budget 2010), it will take Ireland Inc over 30 years to bring the budget into offsetting the interest costs on the current debt.
Ok, I hear your protests, the actual cut was closer to €3.3 billion or 2.04% of GDP, but further deterioration in expenditure due to social welfare and unemployment increases has scaled this back to 0.1%. Fine – at 2.04% cuts, it will take Ireland 1.5 years to offset the interest bill. Factoring in Nama and expected deficits in 2010-2014, 3 years of consecutive cuts of the same magnitude as Budget 2010 would do the job.
The important thing here, of course, is to remember that in both cases (Greece and Ireland) these cuts will not be denting the deficit at all, just offsetting the rising interest rate bill. And we made no assumptions about the direction of the bonds yields.
But Greece, Ireland and the rest of APIIGS aside, the EU and euro area are fiscally marginally better than the US. The EU16 average deficit will be 6.9% of GDP in 2010 – some 3.7 percentage points below that of the US. Similarly for the debt levels: euro area is currently at 84% of GDP, rising to 88% in 2011 and over 100% by 2014. In the US, current debt is already at 87% of GDP and will rise to 100% by 2012.
Of course, there are three things worth mentioning. EU forecasts are done by the EU Commission with historic accuracy record of tea leafs readers. US forecasts are done by the US Budget Office, with rather decent forecasting powers. The US is more willing to deflate out of its debt problems than the EU16.
Finally, the numbers above do not reflect the fact that there is a higher risk of a double dip in the euro area. Nor do they reflect the fact that EU16 banks are still facing severe liquidity and capital shortages amidst untaken writedowns.
In other words, expect euro area deficit and debt to go up erasing the difference between the US and EU in fiscal terms.
So what really perpetuates US dollar vastly more powerful position in the reserve vaults of the banks worldwide is the legacy. Central banks simply cannot unwind their massive holdings of the dollar without destroying their own balancesheets. This process will have to be stretched over time.
The thing is – with the latest revelations concerning Greek financial mechanics in the past and the EU’s inability to face the reality, majority of the central banks around the world which might have started reducing their dollar exposure in the recent past are now reversing that strategy. Going into dollar became fashionable once again.
But the dollar is not a safe heaven in the medium term. And neither is, per above, the euro. One analyst recently described the current shift back into the dollar as “exchanging your ticket on the Titanic for a ride on the Hindenburg”.
So really, folks, last time this happened – parallel inflation in the euro and the dollar and economic weakening of both, with public finances coming under pressure – back in 2007, the markets response was an age-old one. Gold and commodities went up, debt went down, stocks went out of the window. It looks like we are in 2006 once again, sans economic boom, but with a new rebalancing. I would expect gold to continue firming up, commodities to lag behind on the same trend and stocks and FX bouncing violently at the bottom.
Sunday, March 7, 2010
Saturday, March 6, 2010
Economics 06/03/2010: Pensions Plan that confirms my worst fears
Per comments to my blog posts on pensions:
Article 4.2.3. of the National Pensions Framework states (emphasis is mine):
"The individual will be provided with a range of investment choices reflecting different levels of risk, accompanied by suitable, easily understood information about the level of that risk and the benefits expected. The range of funds will include very low risk options to provide members with a high level of security on their savings. The Government will not, however, provide any guarantees on investment returns."
This resolves the issue of asymmetric nature of returns: we will be compelled to invest, but Government is not compelled to guarantee.
At the same time, provision of very low risk option plans – traditionally fixed income only funds – does not disqualify these funds from purchasing Irish Government bonds, implying that the funds are not shielded from the Government ‘borrowing’ against our pension savings. This, coupled with direct State oversight over the approved funds (see next quote) means that it will be difficult to create functional Chinese walls between the State and our cash.
“The limited number and types of funds (which will be required to have life-styling built in) available under the scheme will be provided by the private sector through a competitive process run by the State.”
So rationing is the State objective, making the funds subject to potential State interference and influence.
“Members will have the option of choosing between these approved funds or providers, or else they will be enrolled in one of the low risk default options. Charges will be kept to a minimum as marketing expenses and investment advice are minimised.
How is this automatic enrollment into ‘one of the low risk default options’ be determined – who will select a specific provider option? The State? Some proportional competitive formula? Either way, someone else will decide what to do with the money some of us will be compelled to part with. It is, therefore, a tax, especially absent guarantee of a return.
The last sentence above is beyond any belief. This the State pushing on a retail client a major financial undertaking, while promising to keep advice to a minimum?!
Per my concern with contractual aspects of the plan, the entire NPF makes no mention of any contractual arrangements under the proposed plans. This means that either the authors of the document did not understand the importance of securing pension holders’ rights, or they omitted this consideration to exempt the state from committing to any sort of a scheme-related obligations. My questions regarding the legal validity of this ‘pension’ arrangement in the future are, therefore, correct and justified.
There are no references to any value-for-money frameworks within the document, which puts it in direct contrast to the green paper on pensions (the latter being full of cheerful promises of delivering this golden fruit of all public sector schemes).
There is no economic impact assessment, and there is no actuarial evaluation of the new plan, which means that the Government has promised not to guarantee returns which may or may not resolve the problem of the pensions funds shortfall in 2030-onward. If this still qualifies as a well thought-through proposal, I am off fly-fishing for the rest of my life.
Page 19 of the NPF states: “…the Government will seek to sustain the value of the State Pension at 35 per cent of average weekly earnings and will support this through the PRSI contribution system.”
This clearly states that the Government does not contractually guarantee the benefit for which it imposes a tax. I would love to 'seek to sustain' my tax contributions to the State at the current rates, but hey, I am actually obliged to do so. The opposite is not true for the state's duties to me. Again, asymmetry inherent in the rights and obligations of taxpayers vis-à-vis the State are re-affirmed here.
Even more insulting is the NPF statement concerning the State employees Defined Benefit pensions which reads (page 46): “However, only these core benefits granted plus revaluations to date would be guaranteed, and this would be underpinned by regulation.” So while not guaranteeing ordinary taxpayers anything at all, the State guarantees a large proportion of the Defined Benefit Rolls-Royce pensions to its own employees.
With respect of tax relief ‘reform’ NPF states (page 30) that “Another reason is that people are often unsure about the value of the incentives provided by the State to encourage pension provision. By providing a matching contribution equivalent to 33 per cent tax relief, the Government will introduce more transparency to the system – allowing people to see the exact value of the Exchequer support.”
This is pure hogwash – if people are unsure about the speed limit on the road being in miles or kilometers per hour, does the state change the number on the speed signs? And why not provide relief at 41%, or better yet – at 50%, since the Government is now taking half of the paycheck for many employees in this country?
With respect to opt-outs:
Section 2.3.2 page 17 states: “If people decide that retirement saving is not feasible, they can opt-out but there will be a once-off bonus payment for people who contribute to the scheme for more than five years without a break in contributions.”
In other words, the State will restrict competition in pensions provision by subsidizing the ‘approved’ plans mentioned earlier. In effect, to discourage people from undertaking purely private pension provision.
Page 32 states: “Employees will be permitted to opt out of the auto-enrolment scheme after a period of three months. Employees can opt in again whenever they wish but, in any event, they will be automatically re-enrolled every two years... Once a person remains in the scheme for six months, their contributions will be held in a pension account and no withdrawals will be allowed.”
So I am right to state that there can be instances of double payment into pensions funds by individuals who opt-out for a private pension. And that there has not been any thought given to how this can be avoided and how duplication of pensions will be prevented.
Page 34: “To ease administration costs, contributions will be collected through the PRSI system. In addition, the opting in/opting out arrangements will be made as straightforward as possible. The Government recognises, however, that any additional labour and administration costs will have an impact on small firms, particularly in the current economic environment.”
So it is a tax that will impact more smaller firms. And it will be the State who will collect the funds and then, somehow (how – remains to be determined) disburse these funds to ‘approved’ providers and to the ‘low risk option’. The latter, of course, being some new state quango managing the new retirement tax windfall. How will our choice of provider be entered into? How can we switch from one provider to another? How can we carry our pensions out of the state if we move places of work, including with the EU? Which open up another question – is this proposal actually in compliance with EU directives on portability of benefits?
There is an amusing table 4.1 on page 32 that illustrates just how dire is both the analytical part of the NPF is and how dangerous the Government promise to provide minimal advice can be. The table calculates replacements and returns on pension savings under the new scheme using an assumption of, hold your breath, 7% investment returns per annum! This, in the view of the report authors represents a safer type of investment…
I really rest my case here. Good luck to anyone who still believes this proposal to be a well thought-through idea.
Article 4.2.3. of the National Pensions Framework states (emphasis is mine):
"The individual will be provided with a range of investment choices reflecting different levels of risk, accompanied by suitable, easily understood information about the level of that risk and the benefits expected. The range of funds will include very low risk options to provide members with a high level of security on their savings. The Government will not, however, provide any guarantees on investment returns."
This resolves the issue of asymmetric nature of returns: we will be compelled to invest, but Government is not compelled to guarantee.
At the same time, provision of very low risk option plans – traditionally fixed income only funds – does not disqualify these funds from purchasing Irish Government bonds, implying that the funds are not shielded from the Government ‘borrowing’ against our pension savings. This, coupled with direct State oversight over the approved funds (see next quote) means that it will be difficult to create functional Chinese walls between the State and our cash.
“The limited number and types of funds (which will be required to have life-styling built in) available under the scheme will be provided by the private sector through a competitive process run by the State.”
So rationing is the State objective, making the funds subject to potential State interference and influence.
“Members will have the option of choosing between these approved funds or providers, or else they will be enrolled in one of the low risk default options. Charges will be kept to a minimum as marketing expenses and investment advice are minimised.
How is this automatic enrollment into ‘one of the low risk default options’ be determined – who will select a specific provider option? The State? Some proportional competitive formula? Either way, someone else will decide what to do with the money some of us will be compelled to part with. It is, therefore, a tax, especially absent guarantee of a return.
The last sentence above is beyond any belief. This the State pushing on a retail client a major financial undertaking, while promising to keep advice to a minimum?!
Per my concern with contractual aspects of the plan, the entire NPF makes no mention of any contractual arrangements under the proposed plans. This means that either the authors of the document did not understand the importance of securing pension holders’ rights, or they omitted this consideration to exempt the state from committing to any sort of a scheme-related obligations. My questions regarding the legal validity of this ‘pension’ arrangement in the future are, therefore, correct and justified.
There are no references to any value-for-money frameworks within the document, which puts it in direct contrast to the green paper on pensions (the latter being full of cheerful promises of delivering this golden fruit of all public sector schemes).
There is no economic impact assessment, and there is no actuarial evaluation of the new plan, which means that the Government has promised not to guarantee returns which may or may not resolve the problem of the pensions funds shortfall in 2030-onward. If this still qualifies as a well thought-through proposal, I am off fly-fishing for the rest of my life.
Page 19 of the NPF states: “…the Government will seek to sustain the value of the State Pension at 35 per cent of average weekly earnings and will support this through the PRSI contribution system.”
This clearly states that the Government does not contractually guarantee the benefit for which it imposes a tax. I would love to 'seek to sustain' my tax contributions to the State at the current rates, but hey, I am actually obliged to do so. The opposite is not true for the state's duties to me. Again, asymmetry inherent in the rights and obligations of taxpayers vis-à-vis the State are re-affirmed here.
Even more insulting is the NPF statement concerning the State employees Defined Benefit pensions which reads (page 46): “However, only these core benefits granted plus revaluations to date would be guaranteed, and this would be underpinned by regulation.” So while not guaranteeing ordinary taxpayers anything at all, the State guarantees a large proportion of the Defined Benefit Rolls-Royce pensions to its own employees.
With respect of tax relief ‘reform’ NPF states (page 30) that “Another reason is that people are often unsure about the value of the incentives provided by the State to encourage pension provision. By providing a matching contribution equivalent to 33 per cent tax relief, the Government will introduce more transparency to the system – allowing people to see the exact value of the Exchequer support.”
This is pure hogwash – if people are unsure about the speed limit on the road being in miles or kilometers per hour, does the state change the number on the speed signs? And why not provide relief at 41%, or better yet – at 50%, since the Government is now taking half of the paycheck for many employees in this country?
With respect to opt-outs:
Section 2.3.2 page 17 states: “If people decide that retirement saving is not feasible, they can opt-out but there will be a once-off bonus payment for people who contribute to the scheme for more than five years without a break in contributions.”
In other words, the State will restrict competition in pensions provision by subsidizing the ‘approved’ plans mentioned earlier. In effect, to discourage people from undertaking purely private pension provision.
Page 32 states: “Employees will be permitted to opt out of the auto-enrolment scheme after a period of three months. Employees can opt in again whenever they wish but, in any event, they will be automatically re-enrolled every two years... Once a person remains in the scheme for six months, their contributions will be held in a pension account and no withdrawals will be allowed.”
So I am right to state that there can be instances of double payment into pensions funds by individuals who opt-out for a private pension. And that there has not been any thought given to how this can be avoided and how duplication of pensions will be prevented.
Page 34: “To ease administration costs, contributions will be collected through the PRSI system. In addition, the opting in/opting out arrangements will be made as straightforward as possible. The Government recognises, however, that any additional labour and administration costs will have an impact on small firms, particularly in the current economic environment.”
So it is a tax that will impact more smaller firms. And it will be the State who will collect the funds and then, somehow (how – remains to be determined) disburse these funds to ‘approved’ providers and to the ‘low risk option’. The latter, of course, being some new state quango managing the new retirement tax windfall. How will our choice of provider be entered into? How can we switch from one provider to another? How can we carry our pensions out of the state if we move places of work, including with the EU? Which open up another question – is this proposal actually in compliance with EU directives on portability of benefits?
There is an amusing table 4.1 on page 32 that illustrates just how dire is both the analytical part of the NPF is and how dangerous the Government promise to provide minimal advice can be. The table calculates replacements and returns on pension savings under the new scheme using an assumption of, hold your breath, 7% investment returns per annum! This, in the view of the report authors represents a safer type of investment…
I really rest my case here. Good luck to anyone who still believes this proposal to be a well thought-through idea.
Economics 06/03/2010: Do friendships matter in a workplace?
An interesting article on workplace organization/networks and productivity of workers, forthcoming in the next month's issue of Review of Economic Studies, Vol. 77, Issue 2, pp. 417-458, April 2010 (link here; authors: Bandiera, Oriana, Barankay, Iwan and Rasul, Imran, Social Incentives in the Workplace).
The article shows evidence that social incentives in the workplace, namely the effect of the presence of those that workers are socially tied to on their own productivity, matter a great deal.
Controlling for possible workplace externalities, such as co-sharing of tasks and technology, the authors combine data on individual worker productivity with information on each worker’s social network of friends in the firm.
"We find that compared to when she has no social ties with her co-workers, a given worker’s productivity
aggregate performance is positive.
These are interesting results and have implications for organizational structure of the workplace. They suggest that
Since social effects on productivity can counteract each other (e.g. due to mean convergence, better workers might reduce productivity while poorer workers might increase it), there is a clear need to align pay rewards structures with the nature of the workplace setting and the extent and nature of social interactions that can be supported by the workplace. The results suggest that:
The article shows evidence that social incentives in the workplace, namely the effect of the presence of those that workers are socially tied to on their own productivity, matter a great deal.
Controlling for possible workplace externalities, such as co-sharing of tasks and technology, the authors combine data on individual worker productivity with information on each worker’s social network of friends in the firm.
"We find that compared to when she has no social ties with her co-workers, a given worker’s productivity
- is "significantly higher when she works alongside friends who are more able than her", and
- significantly lower when she works with friends who are less able than her.
- workers who are more able than their friends are willing to exert less effort and forgo 10% of their earnings (in other words - they have 10% lower productivity);
- workers who have at least one friend who is more able than themselves are willing to increase their effort and hence productivity by 10%.
aggregate performance is positive.
These are interesting results and have implications for organizational structure of the workplace. They suggest that
- workplace arrangements that reduce social interaction between heterogeneous workers (e.g. extremely dis-franchised workplaces with nomadic flows of temporary workers and workers who are not anchored to a specific location) might suboptimally reduce productivity;
- peer pressure within social networks is mean-convergent, with lower quality human capital being pushed up the quality chain and higher quality human capital being compressed downward;
- more heterogeneity in social networks would suggest a higher productivity mean; and
- workplaces that discourage social interactions are also potentially reducing productivity.
Since social effects on productivity can counteract each other (e.g. due to mean convergence, better workers might reduce productivity while poorer workers might increase it), there is a clear need to align pay rewards structures with the nature of the workplace setting and the extent and nature of social interactions that can be supported by the workplace. The results suggest that:
- more depersonalized, less interactive workplace settings should use greater pay incentives geared toward lower quality workers (wage compression);
- less depersonalized and more socially interactive workplaces should reward higher performers more (to counter potential quality of worker compression through wage widening)
Friday, March 5, 2010
Economics 05/03/2010: More questions on pensions plan
In a recent post (here) I have asked 12 questions concerning the new Government plan for pensions.
Here are more questions to follow. But before we begin, let me state the following:
Question 13: Given that the Government will be forcing people of all ages to save 8% of their income per annum for pensions provision, the plan is not even sufficient to provide reasonable pension protection for the 22-year olds who will be enrolled into it. How will it help to defuse the demographic (aging-induced) time bomb the Government is facing?
The Government is hoping to start enrollment in 2014. It is facing pensions system meltdown around 2030-2035, which will cover by then retired generations born between before 1965. These generations by 2014 will be of age 49 or more, with 18 years or more left to go before a pension. This, in turn means that their pension provisions should be in excess of 20% of their income, assuming they are starting anew at 2014. Massively more than 8% the Government has in mind.
At the same time, the younger generations pension savers will be facing a dependency ratio of less than 2 workers per retiree by 2050. This means their total provision for pensions as well should be around 18-20% of their income annually. With 1/4 of this delivered in a promissory Government offer of 35% AE state pension, even assuming the Government will keep its promise, the unfunded contribution required is around 13.50-15% of income annually. Not 8% set by the Government.
Then there is a third sub-component of those who are in the older (pre-1970) cohorts who are currently outside private pensions schemes. They will require savings of more than 25% of their income annually to underwrite reasonable pensions provision. Again, 8% state run pension is not going to cover their shortfalls.
Question 14: If the funds were to go into the NPRF, then the life-span of the cash in the fund is about 5-10 years before the money is spend on some new emergency, e.g. another banks bust or another fiscal crisis (potentially the one induced by the collapse of the public sector pensions scheme). How will the Government protect our money from itself? It was not able to do so with the current NPRF set up and the signs are not good for any future funds security.
Question 15: Given that public sector pensions insolvency is already a known, the best for the Government to do is to reform the Rolls-Royce pensions it provides to its own employees. Why is the Government not leading by example?
Question 16: Anyone who has been outside the state scheme for 2 years will be automatically re-enrolled into the system. In the period of time between the re-enrollment and a new opt-out (which can be months), a taxpayer will be liable to pay into two pensions simultaneously (her own private plan and her state plan). Is this the case? How will the Government compensate such families who will incur overdraft charges due to such double pension provisioning courtesy of the state? How will the state actually monitor the opt-outs and whether people in the opt-out are still in a pension plan?
Question 17: What is the feasibility of the entire proposal ever being implemented, given the logistical nightmares it would entail?
So why is the Government engaging in the scheme at all?
Since 'resolving the pensions problem' is clearly not on the cards (see above), one possible explanation is to get its hands on more cash through 'borrowing' against the funds raised. Another possible explanation - to raise tax (unimaginable otherwise) on business.
Remember -
This pensions proposal is a tax on employers (+2%) and a tax on people (+4%). And this tax will have the greatest negative impact on smaller businesses and entrepreneurs, since MNCs and larger companies are already offering much better pensions.
The Government might have solved the conundrum it faced courtesy of the EU Competition rules. Unable, since 2003, to charge differential tax rates on domestic and multinational businesses, it now devised a 'pensions' scheme to charge smaller companies more through a new levy. And it didn't have to raise official corporate tax rate to do so...
Of course, there is always a better solution than what our folks in the Government Buildings can deliver. That solution would be -
Here are more questions to follow. But before we begin, let me state the following:
- Lack of clarity on any of the questions raised by myself and other observers,
- The fact that these questions can be raised in the first instance; and
- Two independent confirmations of my questions validity from the industry sources
Question 13: Given that the Government will be forcing people of all ages to save 8% of their income per annum for pensions provision, the plan is not even sufficient to provide reasonable pension protection for the 22-year olds who will be enrolled into it. How will it help to defuse the demographic (aging-induced) time bomb the Government is facing?
The Government is hoping to start enrollment in 2014. It is facing pensions system meltdown around 2030-2035, which will cover by then retired generations born between before 1965. These generations by 2014 will be of age 49 or more, with 18 years or more left to go before a pension. This, in turn means that their pension provisions should be in excess of 20% of their income, assuming they are starting anew at 2014. Massively more than 8% the Government has in mind.
At the same time, the younger generations pension savers will be facing a dependency ratio of less than 2 workers per retiree by 2050. This means their total provision for pensions as well should be around 18-20% of their income annually. With 1/4 of this delivered in a promissory Government offer of 35% AE state pension, even assuming the Government will keep its promise, the unfunded contribution required is around 13.50-15% of income annually. Not 8% set by the Government.
Then there is a third sub-component of those who are in the older (pre-1970) cohorts who are currently outside private pensions schemes. They will require savings of more than 25% of their income annually to underwrite reasonable pensions provision. Again, 8% state run pension is not going to cover their shortfalls.
Question 14: If the funds were to go into the NPRF, then the life-span of the cash in the fund is about 5-10 years before the money is spend on some new emergency, e.g. another banks bust or another fiscal crisis (potentially the one induced by the collapse of the public sector pensions scheme). How will the Government protect our money from itself? It was not able to do so with the current NPRF set up and the signs are not good for any future funds security.
Question 15: Given that public sector pensions insolvency is already a known, the best for the Government to do is to reform the Rolls-Royce pensions it provides to its own employees. Why is the Government not leading by example?
Question 16: Anyone who has been outside the state scheme for 2 years will be automatically re-enrolled into the system. In the period of time between the re-enrollment and a new opt-out (which can be months), a taxpayer will be liable to pay into two pensions simultaneously (her own private plan and her state plan). Is this the case? How will the Government compensate such families who will incur overdraft charges due to such double pension provisioning courtesy of the state? How will the state actually monitor the opt-outs and whether people in the opt-out are still in a pension plan?
Question 17: What is the feasibility of the entire proposal ever being implemented, given the logistical nightmares it would entail?
- The proposal would require massive bureaucracy (and invasion of privacy) to verify - e.g. Revenue data being used by another State agency to generate demand for enrollments, re-enrollments and clear opt-outs. Is this even legal?
- The proposal will require the state to engage in the areas in which it has no expertise, running an investment undertaking with retail clients. What are the implications of a massive state monopoly with statutory enrollment powers to the market for pensions and financial services in Ireland? How long and how expensive will be the state battle with the EU Competition authorities to clear this scheme?
- How big will the paper trail be if the state were to require continued monitoring of compliance with the opt-outs? What will be the cost of this to businesses and employees? How many paper pushers will the state need to hire to keep the track of these mountains of evidence?
So why is the Government engaging in the scheme at all?
Since 'resolving the pensions problem' is clearly not on the cards (see above), one possible explanation is to get its hands on more cash through 'borrowing' against the funds raised. Another possible explanation - to raise tax (unimaginable otherwise) on business.
Remember -
- corporate tax is a sacred cow of the State;
- personal income tax is already high and will rise again in the next Budget;
- indirect taxes are crippling and the local authorities will be coming for more of their cut in the next few years.
This pensions proposal is a tax on employers (+2%) and a tax on people (+4%). And this tax will have the greatest negative impact on smaller businesses and entrepreneurs, since MNCs and larger companies are already offering much better pensions.
The Government might have solved the conundrum it faced courtesy of the EU Competition rules. Unable, since 2003, to charge differential tax rates on domestic and multinational businesses, it now devised a 'pensions' scheme to charge smaller companies more through a new levy. And it didn't have to raise official corporate tax rate to do so...
Of course, there is always a better solution than what our folks in the Government Buildings can deliver. That solution would be -
- set a flat income tax rate of 12% on all income and no exemptions except for a generous up front personal tax-free limit (to exclude the real working poor from taxation);
- And then tell people - including public sector workers - that they must invest at least 10% of their income in pensions of their choice, provided privately with real international competition in place (my preference would be to avoid compulsion, though);
- Make the entire pension contribution, up to 20% of gross income, tax deductible;
- Set up self-funded insurance scheme to underwrite pensions providers;
- Done. End of story and no need for white papers from over-paid and over-staffed task forces and for bureaucrats, lawyers, mountains of paper and pensions tzars.
Economics 05.03.2010: Greeks are paying the price
So you've heard by now that Greece 'escaped' the wrath of the market yesterday by placing €5bn worth of 10-year bonds. But don't be fooled - Greek's escape was nothing more than a respite: Greek taxpayers are now on the hook for paying a 6.3% yield on the 10-year paper - in line with near junk status of the bonds. This marks the highest spread for Greek debt since 2001.
Despite the issue being covered at 3x, there is a possibility for prices to tumble in the secondary markets (as happened with their 5-year paper last month) and there is an added concern that demand was underpinned by speculative investors with short-term horizons, as 'hold-to-maturity' types of investors (e.g insurance companies and pension funds) are cutting back on their holdings of PIIGS bonds. If the latter is true, then we can expect a serious pressure on yields to emerge in the next few days, with subsequent noises from the EU authorities about 'speculators' profiteering.
Big - albeit artificial - test for the euro will be March 16th when the EU Commission will rule on Greek fiscal consolidation plans. Expect approval, enthused speeches, and backroom talks on how to proceed forward with the country that
All of this resembles the debates in the Afghan government in 1979 - to invite the Soviets or not... And the really, really, really funny thing is - IMF is EU-led organization (of the two supernationals: the World Bank is traditionally reserved as the leadership game for the Americans, while the IMF leadership goes to the EU appointees). While the Greek taxpayers are now set to pay over ten years €184.22 per each €100 borrowed last night - a steep price for not calling in 'Your Own Bad Guys' from Washington.
Now, put the Greek pricing into a perspective. On 14 January 2010 the NTMA issued €5 billion of a new bond, the 5% Treasury Bond 2020. If Irish debt was priced at Greek yields, the total cost to Irish taxpayer from this deficit financing would have risen €21.33 from €62.89 per €100 borrowed. In other words, our expected annual deficit for 2010 alone would be some €4,050 million more expensive over 10 years.
Despite the issue being covered at 3x, there is a possibility for prices to tumble in the secondary markets (as happened with their 5-year paper last month) and there is an added concern that demand was underpinned by speculative investors with short-term horizons, as 'hold-to-maturity' types of investors (e.g insurance companies and pension funds) are cutting back on their holdings of PIIGS bonds. If the latter is true, then we can expect a serious pressure on yields to emerge in the next few days, with subsequent noises from the EU authorities about 'speculators' profiteering.
Big - albeit artificial - test for the euro will be March 16th when the EU Commission will rule on Greek fiscal consolidation plans. Expect approval, enthused speeches, and backroom talks on how to proceed forward with the country that
- plans to cut 2% of its GDP-worth off the deficit this year, but
- is unlikely to deliver on this target, whilst
- needing to cut a whooping double the planned amount just to stay afloat toward the 3% deficit goal for 2014-2015.
All of this resembles the debates in the Afghan government in 1979 - to invite the Soviets or not... And the really, really, really funny thing is - IMF is EU-led organization (of the two supernationals: the World Bank is traditionally reserved as the leadership game for the Americans, while the IMF leadership goes to the EU appointees). While the Greek taxpayers are now set to pay over ten years €184.22 per each €100 borrowed last night - a steep price for not calling in 'Your Own Bad Guys' from Washington.
Now, put the Greek pricing into a perspective. On 14 January 2010 the NTMA issued €5 billion of a new bond, the 5% Treasury Bond 2020. If Irish debt was priced at Greek yields, the total cost to Irish taxpayer from this deficit financing would have risen €21.33 from €62.89 per €100 borrowed. In other words, our expected annual deficit for 2010 alone would be some €4,050 million more expensive over 10 years.
Economics 05/03/2010: Losing capital in a recession
Live Register additional tables are signaling that the latest 'improvement' (or as I would call it - a bounce) in LR figures for February was driven by exits of the unemployed not into gainful employment, but into emigration.
In February 2010 there were 355,690 Irish nationals and 81,266 non-Irish nationals
on the LR:
Among non-Irish nationals the largest number on the Live Register, were nationals from the EU15 to EU27 States (45,649) - aka the Accession States or EU10 states - while the smallest number were from the EU15 States outside of Ireland and the UK (4,139). This is, of course, reflecting levels, not proportionate terms.
Non-Irish nationals represented 18.6% of all persons on the Live Register in February 2010 against their share of the labour force being around 14.7%.
I said earlier (here) that the Live Register improvements are driven by three factors:
Hence, we are now in a really tough position, whereby the recession is causing:
In February 2010 there were 355,690 Irish nationals and 81,266 non-Irish nationals
on the LR:
- a monthly increase of 149 (0.0%) in Irish nationals and
- a decrease of 129 (-0.2%) in non-Irish nationals.
Among non-Irish nationals the largest number on the Live Register, were nationals from the EU15 to EU27 States (45,649) - aka the Accession States or EU10 states - while the smallest number were from the EU15 States outside of Ireland and the UK (4,139). This is, of course, reflecting levels, not proportionate terms.
Non-Irish nationals represented 18.6% of all persons on the Live Register in February 2010 against their share of the labour force being around 14.7%.
I said earlier (here) that the Live Register improvements are driven by three factors:
- emigration;
- exits to Fas-led 'training' and exits from the labour force (the two are equivalent in my mind, as I see no real hope for Fas to actually provide employable skills); and
- exits to education (a better alternative to Fas, but still not a guarantee of education).
Hence, we are now in a really tough position, whereby the recession is causing:
- fire sales and exports of capital (with banks taking posessions of machinery, equipment, stocks of goods and selling these through distressed sales - including to foreign buyers); and
- exits of human capital.
Economics 05/03/2010: Can immigration help our Smart Economy?
Does targeted immigration policy (focusing on skills and capability) deliver the results for research, science and engineering? This question is important to Ireland, since
Higher H-1B visa admissions are shown to increase immigrant science and engineering employment and patenting by inventors of Indian and Chinese origin in cities and firms dependent upon the program when compared against cities and firms which do not avail of the visa.
There is only a limited effect on native science and engineering employment or patenting, ruling out displacement effects, with only small crowding-in effects. Total science & engineering employment and invention increases with higher admissions primarily through direct contributions of immigrants.
“A 10% growth in the H-1B population corresponded with a 1%-4% higher growth in Indian and Chinese invention for each standard deviation increase in city dependency”. Anglo-Saxon origin inventors continue to account for approximately 70% of all domestic patents. Crowding-in is small, with a 10% growth in the H-1B population corresponding to a 0.3%-0.7% increase in total invention for each standard deviation growth in the degree of city dependency on participation in the visa programme.
Tests also confirm that these positive results “are not due to endogenous changes in national H-1B admissions following lobbying from very dependent groups."
"Total patenting shares are highly correlated with city size, and the three largest shares of US domestic patenting for 1995-2004 are San Francisco (12%), New York City (7%), and Los Angeles (6%). Ethnic patenting is generally more concentrated, with shares for San Francisco, New York City, and Los Angeles being 22%, 10%, and 9%, respectively. Indian and Chinese inventions are even further agglomerated. San Francisco shows exceptional growth from an 8% share of total US Indian and Chinese patenting in 1975-1984 to 26% in 1995-2004, while New York City share declines from 17% to 10%."
- we have ambitious objectives in driving up R&D and science activity; and
- we do not have a meritocratic immigration policy here (aside from by-now virtually stifled 'green card' scheme, our immigration policy is geared toward almost exclusively on internal EU27 migration)
Higher H-1B visa admissions are shown to increase immigrant science and engineering employment and patenting by inventors of Indian and Chinese origin in cities and firms dependent upon the program when compared against cities and firms which do not avail of the visa.
There is only a limited effect on native science and engineering employment or patenting, ruling out displacement effects, with only small crowding-in effects. Total science & engineering employment and invention increases with higher admissions primarily through direct contributions of immigrants.
“A 10% growth in the H-1B population corresponded with a 1%-4% higher growth in Indian and Chinese invention for each standard deviation increase in city dependency”. Anglo-Saxon origin inventors continue to account for approximately 70% of all domestic patents. Crowding-in is small, with a 10% growth in the H-1B population corresponding to a 0.3%-0.7% increase in total invention for each standard deviation growth in the degree of city dependency on participation in the visa programme.
Tests also confirm that these positive results “are not due to endogenous changes in national H-1B admissions following lobbying from very dependent groups."
"Total patenting shares are highly correlated with city size, and the three largest shares of US domestic patenting for 1995-2004 are San Francisco (12%), New York City (7%), and Los Angeles (6%). Ethnic patenting is generally more concentrated, with shares for San Francisco, New York City, and Los Angeles being 22%, 10%, and 9%, respectively. Indian and Chinese inventions are even further agglomerated. San Francisco shows exceptional growth from an 8% share of total US Indian and Chinese patenting in 1975-1984 to 26% in 1995-2004, while New York City share declines from 17% to 10%."
Thursday, March 4, 2010
Economics 04/03/2010: Another grab of taxpayers cash?
Update 1: 04/03/2010: 10:15pm
Yesterday, the Government announced a plan to reform pensions provision system in Ireland by creating a mandatory pension scheme with a limited opt-out clause. The announcement is covered here. While lacking specific details we can only ask questions and await for some answers, here are my top-level views.
Question 1: Will additional contributions required from the taxpayers yield additional cover over the already committed state scheme that supplies 35% of the average earnings in exchange for PRSI contributions?
Question 2: What will determine the return on top-up pension? While the state is quick at setting the cost to the taxpayer (4%) and employers (2%) there is absolutely no reference to the returns to be earned from the scheme. Is the rate of return fixed? Guaranteed? Market-related? Who will underwrite this return?
Question 3: Who will manage the assets? NPRF? NTMA? Private providers? Who will actually write the policy - if any policy will be written at all.
Question 4: The plan exempts those on defined benefit pensions - aka public sector workers. Thus, in effect, the plan opens up two massive problems:
Question 6: What are the contractual rights of the taxpayers paying top up rates with respect to the pension benefits?
A private sector pension is governed by a clear contract. This contract is fully enforceable in the court of law. State pensions (with exception of those provided to public workers) are not. If you doubt this statement - check numerous legal cases where this has been deemed to be the case.
And look no further than the change in the statutory retirement age that the Government is planning to enact. In effect, forcing retirement age 2-3 years forward means that all of us who have paid PAYE are now entitled to 2-3 years less of the benefits. If this was done by your private pension provider, you would have a legal case against a unilateral change in the terms of the contract. But because it is done by the Government and we have no written legally binding contract with the Government relating to pensions provision, the State simply can cut our benefits, while still requiring us to keep our end of the deal - continuing to pay into the PAYE pot.
So the biggest issue of all is - will the new top-up requirement be legally binding for both sides of the deal or will it remain asymmetric (and therefore subject to the risk of arbitrary changes in the terms and conditions by the Government)?
Question 7: The new pension system would re-enroll people who quit every two years. This begs a question - will this 're-enrollment' be performed with crediting for years lapsed or not. If yes, then the risk of underpayment due to interruptions will be borne by the collective pool of funding. Which means that everyone paying into the system will be at a risk of bearing the cost of higher jobs exits and unemployment. If no, how will the recovery of underpayment take place? Simply requiring people who dropped out to repay the shortfall accumulated over two years of absence will not work, as it will impose huge burden on those with uncertain employment prospects.
Question 8: How will the system manage those in part-time employment, self-employment and those with hybrid income sources (multiple jobs, etc)?
Question 9: Since top-up clause requires private pension plan with employer contribution in excess of 4%, can the new plan be deemed anti-competitive? For example, if a self-employed person obtains no contribution from the employer, does the new pension mandate commit a person to a minimum contribution of 6%, thereby forcing them out of other private pension arrangements they might have, which may include single payment/lump sum contributions?
Question 10: If a person is forced to switch away from a smaller pension plan into the 'top up' Government plan, given that Government plan is not comparable in terms of risk of payout to a private plan, will this not in effect reduce the quality of pension that the employee will obtain? In other words, the Government scheme might result in a reduced quality of pensions for some savers.
Question 11: Will the new top-up arrangement cancel out PRSI contributions, or will it be on-top of the PRSI levies? If the former, who will fund the 35% promisory note of statutory state pensions? If the latter, this constitutes a massive increase in taxation burden in this economy.
Question 12: How will the Government reimburse those of us who might have higher pensions contributions by employers, but whose employers will now opt for a default position and drop their contribution to the effective minimum of 2%?
So far, the proposal is yielding more questions than answers. Which, of course, simply indicates that there is a good chance that the Government has not thought through the whole scheme and might be risking entering into another 'Policy-based evidence' scenario for which we, as a country, are so well known around the world.
On the net, however, given the nature of the top-up arrangement, unsecured contractual status of the proposal and the fact that the State decided to exempt its own employees from the obligation, the whole proposal looks like another tax by the Exchequer.
Yesterday, the Government announced a plan to reform pensions provision system in Ireland by creating a mandatory pension scheme with a limited opt-out clause. The announcement is covered here. While lacking specific details we can only ask questions and await for some answers, here are my top-level views.
Question 1: Will additional contributions required from the taxpayers yield additional cover over the already committed state scheme that supplies 35% of the average earnings in exchange for PRSI contributions?
Question 2: What will determine the return on top-up pension? While the state is quick at setting the cost to the taxpayer (4%) and employers (2%) there is absolutely no reference to the returns to be earned from the scheme. Is the rate of return fixed? Guaranteed? Market-related? Who will underwrite this return?
Question 3: Who will manage the assets? NPRF? NTMA? Private providers? Who will actually write the policy - if any policy will be written at all.
Question 4: The plan exempts those on defined benefit pensions - aka public sector workers. Thus, in effect, the plan opens up two massive problems:
- Defined benefit pensions are the ones that are facing the largest shortfall and they are also being managed by the agent (the State) who will control our top-up pensions. How is this conflict of interest going to be resolved? Will public sector pensions hole be plugged using top-up pension funds?
- Defined benefit pensions are contractually guaranteed, while top-up pensions are not (see below), so in effect the opt-out potentially directly exposes ordinary taxpayers to underwriting the public sector pensions through both their statutory pension (already the risk we are bearing) and through the top up. If so, the top-up element of the proposal is nothing more than a tax on ordinary income earners that can be used to cover public pensions shortfalls.
Question 6: What are the contractual rights of the taxpayers paying top up rates with respect to the pension benefits?
A private sector pension is governed by a clear contract. This contract is fully enforceable in the court of law. State pensions (with exception of those provided to public workers) are not. If you doubt this statement - check numerous legal cases where this has been deemed to be the case.
And look no further than the change in the statutory retirement age that the Government is planning to enact. In effect, forcing retirement age 2-3 years forward means that all of us who have paid PAYE are now entitled to 2-3 years less of the benefits. If this was done by your private pension provider, you would have a legal case against a unilateral change in the terms of the contract. But because it is done by the Government and we have no written legally binding contract with the Government relating to pensions provision, the State simply can cut our benefits, while still requiring us to keep our end of the deal - continuing to pay into the PAYE pot.
So the biggest issue of all is - will the new top-up requirement be legally binding for both sides of the deal or will it remain asymmetric (and therefore subject to the risk of arbitrary changes in the terms and conditions by the Government)?
Question 7: The new pension system would re-enroll people who quit every two years. This begs a question - will this 're-enrollment' be performed with crediting for years lapsed or not. If yes, then the risk of underpayment due to interruptions will be borne by the collective pool of funding. Which means that everyone paying into the system will be at a risk of bearing the cost of higher jobs exits and unemployment. If no, how will the recovery of underpayment take place? Simply requiring people who dropped out to repay the shortfall accumulated over two years of absence will not work, as it will impose huge burden on those with uncertain employment prospects.
Question 8: How will the system manage those in part-time employment, self-employment and those with hybrid income sources (multiple jobs, etc)?
Question 9: Since top-up clause requires private pension plan with employer contribution in excess of 4%, can the new plan be deemed anti-competitive? For example, if a self-employed person obtains no contribution from the employer, does the new pension mandate commit a person to a minimum contribution of 6%, thereby forcing them out of other private pension arrangements they might have, which may include single payment/lump sum contributions?
Question 10: If a person is forced to switch away from a smaller pension plan into the 'top up' Government plan, given that Government plan is not comparable in terms of risk of payout to a private plan, will this not in effect reduce the quality of pension that the employee will obtain? In other words, the Government scheme might result in a reduced quality of pensions for some savers.
Question 11: Will the new top-up arrangement cancel out PRSI contributions, or will it be on-top of the PRSI levies? If the former, who will fund the 35% promisory note of statutory state pensions? If the latter, this constitutes a massive increase in taxation burden in this economy.
Question 12: How will the Government reimburse those of us who might have higher pensions contributions by employers, but whose employers will now opt for a default position and drop their contribution to the effective minimum of 2%?
So far, the proposal is yielding more questions than answers. Which, of course, simply indicates that there is a good chance that the Government has not thought through the whole scheme and might be risking entering into another 'Policy-based evidence' scenario for which we, as a country, are so well known around the world.
On the net, however, given the nature of the top-up arrangement, unsecured contractual status of the proposal and the fact that the State decided to exempt its own employees from the obligation, the whole proposal looks like another tax by the Exchequer.
Wednesday, March 3, 2010
Economics 03/03/2010: Live Register and Retail Sales
Live register and retail sales are out for today - and:
LR is down in seasonally adjusted terms. A whooping 2,300 down, driving implied unemployment rate from 12.7% in January to 12.6% in February. Sounds like a good deal at last. And, of course, it is, except:
A chart (courtesy of the Ulster Bank economics team) to illustrate:
One clearly needs a microscope to spot the improvements in the overall picture, although the trend in moderating LR growth rate is clearly visible. Another interesting sighting is the dead-cat-bounce in October 2009. Are we in the same pattern now? I don't know, but dynamically, the chart above suggests we are at the flat part of the U-trend. How long will it take before we get through that part? How steep will be the upward part of the U?
The key risk indicator at this moment is QNHS which, I would expect, will show further contraction in employment and more aggressive exits from the labour force.
Meanwhile, retail sales are also bumping up, limp, lifeless, but twitchy. Chart below - courtesy of the Ulster Bank economics team (I will do my analytics later tonight, so stay tuned) illustrates:
The volume of retail sales (i.e. ex effects of price changes) is down 4.8% in January 2010 compared to January 2009 and down a whooping 17.3% in monthly terms. There was a monthly decrease of 17.3%. Ex-motors, volumes are down 4.7% annually and up 0.1% monthly. would the natural (and man-made) disasters of January help here? Quite possibly - electrical goods, furniture, lighting and clothing are up as people had to counter adverse weather and replace those washers and dishwashers frozen in the cold spell.
The value of sales fell 8.4% in January 2010 in annual terms and 15.6% in monthly terms as deflation at retail level continued to bite, primarily at Motor Trade levels: ex-motors, monthly change was +0.6%.
My slight concern here is that the release of retail sales data covers December 27-January 23rd, which means that while it missed a slow-to-go last week on retail sales in January, it also over-states retail sales due to capturing December 27-30 - the busiest sales period in the entire year. And, due to inclement weather, fewer people were able to travel to the North, so more shoppers stayed in the Republic, although many of these stayed at home.
LR is down in seasonally adjusted terms. A whooping 2,300 down, driving implied unemployment rate from 12.7% in January to 12.6% in February. Sounds like a good deal at last. And, of course, it is, except:
- Actual Liver Register still rose by 20 new signees;
- The rise of 810 in over 25 year olds was offset by a fall of 790 for the under 25 year olds, which makes me wonder - was the former a real increase in unemployment, while the latter a sign of younger kids abandoning the workforce to join training schemes, social welfare (with unemployment benefits for the under-25 year olds being reduced in two budgets) or going off to greener pastures elsewhere (i.e emigrating);
- Whichever way you spin the numbers, 432,400 people on the LR is a sizable number and to me still constitutes a massive crisis. 348,100 of these are over-25 year olds - prime employment age workers (down just 800 on January in seasonally adjusted terms);
- Average net weekly change to the LR in February was a much more modest +5 relative to January's +2,668 - a good sign, if one stretches the term 'good'
A chart (courtesy of the Ulster Bank economics team) to illustrate:
One clearly needs a microscope to spot the improvements in the overall picture, although the trend in moderating LR growth rate is clearly visible. Another interesting sighting is the dead-cat-bounce in October 2009. Are we in the same pattern now? I don't know, but dynamically, the chart above suggests we are at the flat part of the U-trend. How long will it take before we get through that part? How steep will be the upward part of the U?
The key risk indicator at this moment is QNHS which, I would expect, will show further contraction in employment and more aggressive exits from the labour force.
Meanwhile, retail sales are also bumping up, limp, lifeless, but twitchy. Chart below - courtesy of the Ulster Bank economics team (I will do my analytics later tonight, so stay tuned) illustrates:
The volume of retail sales (i.e. ex effects of price changes) is down 4.8% in January 2010 compared to January 2009 and down a whooping 17.3% in monthly terms. There was a monthly decrease of 17.3%. Ex-motors, volumes are down 4.7% annually and up 0.1% monthly. would the natural (and man-made) disasters of January help here? Quite possibly - electrical goods, furniture, lighting and clothing are up as people had to counter adverse weather and replace those washers and dishwashers frozen in the cold spell.
The value of sales fell 8.4% in January 2010 in annual terms and 15.6% in monthly terms as deflation at retail level continued to bite, primarily at Motor Trade levels: ex-motors, monthly change was +0.6%.
My slight concern here is that the release of retail sales data covers December 27-January 23rd, which means that while it missed a slow-to-go last week on retail sales in January, it also over-states retail sales due to capturing December 27-30 - the busiest sales period in the entire year. And, due to inclement weather, fewer people were able to travel to the North, so more shoppers stayed in the Republic, although many of these stayed at home.
Economics 03/03/2010: IL&P results FY2009
IL&P – the folks who pushed their mortgages lending to 300% of their deposit base – in the style of Northern Rock – have released their FY 2009 results this morning. Overall operating loss of €196 million for 2009 represents a swing of €537 million against the profit of €341m in 2008 reported in 2008. This takes some doing to achieve for a book of loans valued roughly at €39 billion (and that is widely optimistic – the total lending book declined from €40.1bn in 2008 to €38.6bn in 2009 – a decline that is hardly reflective of the peers).
When considered against the Irish Life division operating profit of €102 million (down from €284 million in 2008) the Permanent bit of IL&P is emerging as a seriously weak link. The bank posted a loss of €270 million with operating loss of €280m – a swing of €310 million on €30 million profit in 2008. Bad debt provisions are set at €376 million – assuming relatively static deterioration in 2010 compared to 2009. Total expected provision for 2009-2011 crisis period is standing around €900-950 million. I am not sure this is realistic, given the fact that mortgages are now starting to show increasing stress – with anticipated lag of legal process and for work-through of savings cushions by distressed households. In contrast with all rational expectations, IL&P management commented that home arrears growth was slowing. Good luck to them.
Capital ratios remain flat over 2009 - Total Tier 1 of 9.2% - hefty, healthy, but… one has to remember that IL&P has a much heavier T1 requirement due to life insurance business side. Translated into banks ratios, this implies effective banking side Tier 1 of roughly 6-6.5% - still better than AIB or BofI, but has some room for improvement. Given the overall reluctance of the Permanent side to take realistic writedowns on mortgages, I would suspect there will be renewed pressure on Tier 1 in months to come.
Tuesday, March 2, 2010
Economics 03/03/2010: IDA's new campaign
IDA have launched their new long-term strategy document that is worth taking a look. Here are my own observations:
“I am delighted to take up the role of chairman of IDA as we launch a new strategy... There are great challenges before us but there are also great opportunities. The sweeping changes in technology and the world economy outlined in this document promotes [sic] an increased sense of urgency as we change the way IDA performs its mission. I have full confidence that the expertise and energy IDA staff bring to the task will ensure we remain one of the world’s most admired agencies for promoting FDI.” [a bit of self-loving here?]
Liam O’Mahony, Chairperson, IDA Ireland
I must confess, I like IDA guys. They and Enterprise Ireland side are the exceptionally rare parts of the public sector that actually work. One can question them from the point of the return on the euro spent (I have no knowledge of the metric, so this is a rhetoric question) but one cannot question their engagement with their work.
Thus, I actually looked forward to today’s release of the IDA strategy 2020 document. And as before, I loved the core theme of their imagery – signifier (perhaps too optimistic) of what Ireland should look like – modern, expressive and smart (not just in terms of technical brains, but in terms of broader, diversified creativity - alas, the signifiers did not match the strategy exactly).
Now, IDA has two very competent, and professionally admired people at the helm – Liam O’Mahony and Barry O’Leary. This should get IDA moving. Maybe not quite into 2020, but certainly into 2010-2011.
So let me not pour too many accolades, and focus on what I usually do – challenges. And there are some in the 2020 strategy document. These are, as I say, challenges. It would have been nice to see them addressed in greater depth in Horizon 2020 document.
Tax policy - absent
Take the first and foremost policy instrument for IDA and for general economic development in Ireland – tax. IDA is keen to recognize the overarching importance of tax policy to attracting MNCs. But it fails to take stock of the more recent changes in tax regime and the ongoing changes in the business development and corporate investment environments.
“We have a young, highly skilled workforce and easy access to the best young talent across Europe. Our tax regime is compelling,” says strategy document.
Really? At 50%+ marginal tax rate on highly skilled and experienced talent? "Compelling" as in second highest in Europe? And adjusted for benefits what do we, the taxpayers, get in exchange for this rate?
Spatial Pipe Dreams
Oh, and there is another little thingy there – the mandate to “support regional development”. Yes – the Spatial Development Plan (or rather our Spatial Development Pipe Dream) is still there, folks. Hasn’t gone away along with all those empty country-side estates that were supposed to be ‘Gateways to Excellence”.
Of course, this is not IDA’s fault - both tax policy and spatial development illusion are domain of policymakers, but still – couldn’t internationally-aware guys like Barry O’Leary and Liam O’Mahony quietly slip this ‘regional development’ schlock into an addendum to an appendix of sorts?
Human capital? Whoa?!
Another interesting omission – also relating to the tax on human capital – is the lack of analysis of the threat to our demographic base from foreign competition for talent.
“With a comparatively younger population, with just 14% of Irish people over 65, Ireland will have a relatively larger proportion of highly skilled and educated workers from which to draw. [Well, that is actually not a foregone conclusion – having younger population does not mean one automatically ends up with a relatively larger proportion of highly skilled and educated workers] Ireland also remains a vibrant and attractive place for younger workers from within the EU, making it easier for multinationals locating here to attract young talent from the whole of the 500 million-strong European Economic Area.”
Really? Are we sure this will be the case? Even when Germany, France, and the rest of ageing EU starts paying higher wages to younger workers to attract them from abroad and to keep their own? Even when other locations worldwide start offering better quality of life and higher wages to younger workers? No, folks, to get that ‘demographic dividend’ we need to work hard to compete for talent globally. And this means putting in place things that IDA strategy does not mention:
- lower tax on higher skilled and better educated workers;
- greater quality of public services for lower price to the taxpayers;
- greater quality of goods and services delivered within domestic economy (competition and market liberalization agendas come to mind here),
BRICs: back to the future
I liked IDA’s specific focus on BRICs, but the section on these countries is too thin on details as to how the agency plans to make serious in-roads in these markets. And there are deeper questions here:
- By 2010, BRICs are hardly a new frontier - these are middle income (in case of Russia, officially a developed country) economies with steep competition from other locations for their investment. Shouldn't IDA aspire to broader geographies?
- BRICs are heterogeneous and lumping them into one section is a difficult task - more definition is needed to understand what exactly is the strategy that IDA is planning to pursue here
Regulation - spot on
Creativity mark - C
In a departure with the past, IDA strategy does attempt to deal with the issue of business processes innovation and even strays into business model innovation. This is a fitting change from traditionally 'hard' innovation-driven agency. And it might, just might, sound like a warning shot to domestic sectors - 'Shape up, or lose out'.
But I thought a major weakness of the strategy can be found in the fact that in the entire document, words
But I thought a major weakness of the strategy can be found in the fact that in the entire document, words
- ‘creative’ – as in creative industries/sectors, and as in the business-operative word relating to creative innovation;
- ‘design’ –as in the driver of new products and markets;
- ‘management innovation’ – as in a major driver of systems productivity;
- ‘traded services’ – as in the areas that account for more than 50% of global trade already (note, ‘manufacturing’ is featured in 8 instances in the report),
- 'urban' - as in ca 80% of our economic activity will be by 2015
- 'high value' - as in high value added sectors
In the age of Twitter, technology is a direct outcome of creativity, not the other way around. In fact, the failure to more comprehensively deal with non-ICT, non-biotech, non-labcoat innovation and sectors puts a massive dent into the entire document. It makes me wonder – does IDA realize that Google, Twitter, Facebook, Apple, IBM, Microsoft – you name a success story in today’s IT & ICT world – are driven more by ‘soft’ innovation and only as a corollary – by technological platforms? I think they don’t – and this mutes that wonderfully designed, creative and aesthetically sophisticated advertising campaign that they feature on the inside cover of their report.
Again, to be fair to IDA - good effort is made to move from previously undefined 'Financial Services' objective toward more specific services-related areas. A bit of an eye-catching is the focus on Financial Analytics - an area where much needs to be done before we can attract into the country leading financial analysis firms. Perhaps, more realistic here would be to develop capabilities by using Ireland as a platform for attracting start-ups and early-stage companies in this area. Bary O'Leary does mention the latter (although not specific to the Fin An sector) in his key note, but again, the document could have had this specified in more detail.
Again, to be fair to IDA - good effort is made to move from previously undefined 'Financial Services' objective toward more specific services-related areas. A bit of an eye-catching is the focus on Financial Analytics - an area where much needs to be done before we can attract into the country leading financial analysis firms. Perhaps, more realistic here would be to develop capabilities by using Ireland as a platform for attracting start-ups and early-stage companies in this area. Bary O'Leary does mention the latter (although not specific to the Fin An sector) in his key note, but again, the document could have had this specified in more detail.
So overall, a slight sense of disappointment, but also some hope that next time (and before 2019) IDA strategy will reflect deeper and more real change in the way the organization is actually starting to see the future. Encouraging signs are present in today’s document.
Economics 02/03/2010: Exchequer (still) Singing Blues
Exchequer returns are in for February (DON'T PANIC sign on the cover) - and things are going just as poorly as was predicted. Well, slightly worse, actually. Few charts to illustrate the trends:
Monthly receipts and expenditures are showing divergent trends. While receipts are showing some improvement relative to 12 months ago, expenditure is showing deterioration. Worse - January 2010 improvement on January 2009 is now gone and February numbers have fallen below long run trend line.
Total expenditure is improving. But exchequer surplus is deteriorating.
What's going on?
At €1.66 billion, receipts in the month were a modest €64 million or 1.3% behind DofF budget forecast. On annualized basis this means something to the tune of €455 million shortfall… small stuff… but.
February income taxes are tanking – down 11.8% on 2009 (-€246 million).
But wait, this was actually the second best performing tax head of all… Table below illustrates
Now, February, seasonally is a low tax revenue month – accounting for around 5% of annual revenue. But this time around, February total tax receipts were down 17.8% on 2009. In two months of the year, the same figure is 17.7% - not much of a change… certainly not enough to say things are improving. Oh, sorry, no – they are actually deteriorating!
How come DofF can be happy about these dismal results? Well, for the first time in over 2 years of this crisis, DofF estimates are sticking! Even if only for two months so far. Budgetary projections assume tax revenue of €31.05bn in 2010 or 6.02% below 2009 figure. So far, seasonally-speaking, we have seen roughly 15% of annual tax revenue coming in at roughly speaking 18% below 2009. So should the trend continue flat from here on, we have lost 2.7% or almost half of the allotted annual deterioration! Slightly better than Nama spending its entire legal costs allowance for the year in two months of work, but still... not a record to be proud of.
And on the spending side things are a bit bleak and bleaker: most of the spending decline to date has been on the capital side. In fact, capital expenditure – remember, Brian Cowen and Brian Lenihan have both claimed in 2008 that capital spending will be our stimulus – is down 25% in February (annual terms). In January, this decline was 21%, so the drying up of the ‘stimulus’ is accelerating.
Of course, it is current expenditure where most of fiscal waste rests and where the entire structural deficit is hidden. So one would assume that here, there should be some sizeable cuts. In January 2010, in order to, presumably, impress ‘international markets’, DofF cut current spending by 12% in year-on-year terms. Happy times? Not really – in February this figure eased back to 8%. Even at a half this rate of a ‘forward retreat’, we will end 2010 with spending well in excess of 2009 total.
But, so far, through February 2010 total savings on current spending side add up to €567mln. Now, our structural deficit is roughly 8-9 percent after the Budget 2010 measures take place. Which means we need to cut roughly €5.5 billion in annual spending. At the rate of current cut-backs we are achieving €3.4 billion, under very optimistic assumptions that the current rate of cutbacks will be sustained.
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