Economics 16/03/2010: What's wrong with 'spend now' economic development

Please, tell me if I have woken up on some planet called 'Wealth, Prosperity and Boom Times'? The last couple of weeks have positively turned into some sort of a macabre Hollywood serial where by every other day some new 'Group', 'Taskforce' or a plain 'White Paper' or 'Strategy' comes out with a cheerful idea of spending more money we do not have on thing we do not really need. All of this is cloaked in a veil of economic 'programmes' and 'targets' that inevitably promise thousands/tens-of-thousands/hundreds-of-thousands of new and ever-better-paying jobs sometime in the next 10 years.

I stretch my arms, rub my eyes and slowly rise to the dawn of the 'new prosperity'. For prosperity, with a massive capital 'P' is what it will take to actually get a single job out of the Innovation Task Force, the TASC L28, the Farmleigh Report... and now, the ideas that some of our University heads have.

So let me briefly outline another Grand Project 'Irish Awakening' installment. Albeit more modest (it would only cost a handful of million to set up and as much to operate annually), the idea of setting up a separate Minister (with her own Department) for the 3rd level education, floated out by DCU president Prof Ferdinand von Prondzynski in the end bears about the same relation to addressing the real problems of Ireland Inc as Eskimos' annual seals hunt does to flyfishing in New Zealand.

Prof Prondzynski is right in identifying continued underfunding of our universities as a major problem. I agree with him here, although we disagree (and only partially) on what this funding should deliver and also on where it should come from.

But setting aside these differences, how can such an experienced and accomplished university head confuse the appointment of a high office of a Minister with a functional policymaking and regulatory/funding outputs? All that a separate Ministry would do is suck massive amounts of funding to finance pay and perks of its own employees, sprinkled with rows upon rows of addictive junkets for the Minister and her entourage.

Take current 50 bureaucrats administering Universities funding. Put them into a separate Department, appoint a senior minister for that and you have 80-100 headcount of new paper pushers. The cost? Oh, at an average wage in the public sector, plus trimmings, plus employment-associated costs, junkets and so forth - conservatively starting at €8 million per annum. Oops, there goes a large chunk of funding for some 3rd level institution.

More fundamentally, to say that adding a new layer - whether independent or not - of bureaucrats to the already cumbersome, nearly Byzantine system of controls, budgetary appropriations and regulatory constraints will make Universities funding any more visible or transparent is a strange sort of logic.

The problems with our Universities funding can be ranked, in terms of their gravity, and thus priority, as follows:

1. Lack of direct relation between university performance (in terms of quality of its academic research and teaching) and funding (disconnect between end-user / customer - corporate and students). This can only be resolved through introducing fees-based competition and through more direct corporate funding of research (not as a pure substitute for public funding, but as enhanced addition to it). Setting a Ministerial office for 3rd level institutions will do nothing here;
2. Lack of direct managerial capability over staffing (the problems of centralized wage setting and tenure). Again, this cannot be addressed through a Ministerial remit, but will have to involve decentralization of management and finances to give Universities more autonomy;
3. Lack of private sector funding for R&D - a problem that is extremely acute and cannot be resolved through any Ministerial diktat. Only significant improvement in research system transparency, allowing the best universities and researchers (including those from DCU, where Prof Prondzynski should be credited with achieving serious and positive transformation on research front) to directly and openly compete for research funding can do the job. If anything, Universities research funding activities must be also seen as a potential avenue for exports from Ireland of knowledge economics and in this, Universities can and should be assisted by Enterprise Ireland and other export-development agencies. Again, however, a separate Minister for 3rd level education will do absolutely nothing here.
4. Difficulty of accessing new R&D funding streams (e.g EU funds). Again, to address this problem Universities need to become more competitive and more aggressive in cutting through the fog of 'collaborative research' simulacra. Only truly productive collaborative research should be pursued and the idea that collaboration is of value on its own - as currently pursued by our funding authorities - must be dealt away with. This cannot be done through more centralization of decision making - as consistent with single Ministerial authority.

So none of the real problems and opportunities faced by our Universities require a new Ministerial post. And, of course, our budgetary constraints hardly permit such a lavish addition to the ranks of policy boffins.


And thus, returning back to the general theme of economic policy by 'borrow more now to get hundreds of thousands of jobs tomorrow', let me tell you an ancient fable that aptly describes what I think of all the proposals for setting spending-based targets for future growth. Back in the Middle Ages - around 13th century - there was a great character employed by Sultan. His name was Hoca Nasreddin. One day he came to his friends to tell them that he was just employed by Sultan to teach Sultan's pet donkey how to read. His friends were alarmed, as none of them believed this can be done. They were concerned that Sultan, upon learning of Nasreddin's inevitable failure to perform the task will have Nasreddin's head cut off. "Do not worry, my friends," replied Nasreddin. "In ten years, when contract is up, either Sultan will be dead, the donkey will be dead or I will be dead."

Ditto for all the promised hundreds of thousands of jobs by 2020 - how many heads of authorities or political leaders responsible for producing these targets today are likely to be there in 2020 to account for these plans? Of course, in the mean time, they all want us to pay for these now. Spot the fools in this scheme?

Economics 15/03/2010: The failure of the state is a failure of society

Here is an unedited version of my article in the current issue (March-April 2010) of Village magazine.

Pull Quote: “Replacement of foreign élites with domestic elites was the main objective of Ireland’s change.”

“It only stands to reason that where there's sacrifice, there's someone collecting the sacrificial offerings…The man who speaks to you of sacrifice is speaking of slaves and masters, and intends to be the master”. Ayn Rand.

“”Sacrifices needed for recovery”, says Cowen.” Irish Times headline 5^th Feb 2010


The fundamental problem with Irish politics is not our much-decried proportional representation electoral system or the absurd subatomic fragmentation of politics into parish-pump power brokerages. The most rotten aspect of our political environment is the culture of clientelism that underlies the foundation of society. To understand this, take a quick detour back in time. The American Revolution and the Irish struggle for self-determination had a common adversary – the British Empire. But this is where the similarities end.

American Model

The US was founded on the core idea that without British rule, the ordinary people could improve their own governance. The Declaration of Independence is rooted in the Enlightenment, which informs its outline of where the Brits have gone wrong: not so much in underwriting the entitlements of the people, but in directing the policies of the land. Although most scholars tend to focus on the opening lines of the Declaration, denigrating the remainder as a laundry list of British offences, in reality both parts of the Declaration are pivotal to the balance of power between the individual and the state. The Declaration clearly posits the state as the tool for implementation of the new order. Not as the order itself. In Ayn Rand’s terms, American statehood is not about sacrifice of an individual for the sake of the collective, but about removing the state from the position of delineating slaves from masters. The US was formed not as a sacrifice of the few for the sake of the many, but as a project for improvement of opportunities for all.

Irish Model

The Irish state was born out of a more limiting premise - that, without British rule, native elites can be just as effective (or ineffective). Replacement of foreign élites with domestic ones was the main objective of Ireland’s change. In religion, administration, property rights, culture, society and economics, the Irish Revolutionary movement, justifiable as it may have been, accomplished only the equivalent of a coup d’état, leaving ordinary people in semi-servitude to the new, this time around native, political and administrative master-class.

Out of the necessity to bow to modernity, we added a second tier to our traditional economic structure. Ireland Inc - multinationals and exporters responding to global markets and incentives – is now juxtaposed against the clientelist domestic sector run on the back of parochial interests. Ireland’s gross public expenditure in 2009 reached €76.2 billion or 57.3% of our national output. Including our semi-states and state-licensed activities, over 70 cents of each Euro circulating within Ireland is now state-controlled. Irish domestic economy in thus equivalent to a teenager with a job at a fast-food joint who lives with his parents. Over 65% of the population is in some sort of direct dependency on the state – either as its employees or as the recipients of its subsidies. This in itself accounts for the weddedness of so much of the population to the strong state.

Constraining the State

Last month, MIT Professor Daron Acemoglu, published a paper entitled, Institutions, Factor Prices and Taxation: Virtues of Strong States? As Acemoglu shows, strong states conduce to redistribution of resources and thus, to an even greater capture of the state powers. The fraught UK experience implies that efficient, functional states require more external checks and balances, not the vesting of more autonomy and power in the state institutions. This flies in the face of the Irish political ethos, which sees the state as a combination of a powerful autonomous bureaucracy and the clientelist political establishment. But it also puts into a historic perspective the serial failures of Irish society to revolutionise our state structures.

Ireland never had England’s Cromwellian experience of the renewal of élites. Nor did we have a full-blown industrial revolution to deny the idea of clan-based power. We missed out on the Thatcherite revolt against the ideological elevation of society over individual rights. Once again, Ayn Rand captures the point: “Individual rights are not subject to a public vote; a majority has no right to vote away the rights of a minority; the political function of rights is precisely to protect minorities from oppression by majorities (and the smallest minority on earth is the individual)”. Whatever position one might occupy in terms of party politics in Ireland, we must surely agree that any society based on the insistence of SIPTU-ICTU-CPSU that the Social Partnership overrides the individual, is simply incompatible with liberal democracy protective of individual rights.

Liberalism Vs. Statism

Rand’s scepticism about the compatibility of state interests and universal personal liberty separates the liberalism (that Ireland’s national institutions never managed to learn) from neoliberalism (to which we have developed a cross-party devotion). Stephanie Lee Mudge of the European University Institute defines neo-liberalist politics as “struggles over political authority that are bounded by a particularly market-centric set of ideas about the state’s responsibilities… and the state’s central constituencies (business, finance and middle class professionals)”. Of course neoliberalism is nothing more than a conservative, status quo preserving ideology - it's struggles against authority are a form of resistance against a change of elite, not in favor of change. Unlike neoliberalism, liberal principles do not identify specific interest groups as the pillars of society. Liberty and reliance on central constituencies – whatever the latter might be – can coexist in a democratic society if and only if society has an advanced system of political, administrative, judicial and social checks and balances.

In Ireland, no such checks and balances exist. NAMA and the rescue of bank shareholders and bondholders at the expense of taxpayers could never have happened in societies with modern state infrastructures. It did not happen in the US, where TARP was instantaneously altered to a much more robustly enforceable direct lending and equity takeover. It did not happen in the UK, which adopted a similar approach. It did happen in Ireland and other parts of Europe. Why? In Europe, the judiciary is a function of the political establishment that appoints it, the state is subjugated to the interests of the permanent civil service, and the political realm is dominated by the cartel of vested interest groups i.e. the Social Partners. In Europe, neoliberalism today is an a-ideological deus ex machina for continued propagation of the élitist State in exactly the same way as fascism and socialism were engines of elitism in their turn.

Ironically for their promoters, minorities, the poor and the downtrodden would do much better in a society based on liberal (or in American terminology libertarian) ideals than in their gold-gilded cage of Social Partnership. As Rand noted, libertarians believe that all minorities - rich and poor alike - are the same. To our political élites on the other hand, minorities are divided into Leninesque ‘useful idiots’ (the Social and Environmental Pillars) whose consent to the status quo can be bought for tuppence worth of State subsidies; and ‘powerful conservators’ (Big Business and the Unions) who can provide the power and money necessary for perpetuation of this status quo.

To An Ever Braver World

The maze of interchanges in a small country between sectoral vested interests – political and executive, social, environmental and economic – is informing our ideological and electoral positions. The state is seen as an (at least occasionally) benevolent defender of the interest to which one is aligned. The stronger state, therefore, is just that, a stronger defender. From the intellectual laziness of our academics, to the nearly unadulterated parochialism of our regulatory and legislative interests, to our clan-based politics, the ills of our society are traceable to the historically conditioned inability of Irish society to accept the basic tenet of liberty. We have never learnt that any vested interest, no matter how small, must be treated at a political level as a monopoly-seeking cartel. This, of course, coupled with the recognition that the state itself is a collection of those vested interests, means that the pursuit of liberty for all, requires a coherent limit on the State. The power and financial privileges that have accrued to nearly all of us, as vested interests, have prevented us seeing that.

Economics 13/03/2010: Why Farmleigh report falls flat

I must confess, last week produced a bumper crop of new (and old) 'proposals' for fixing Ireland. Tasc had one (the Letter of 28) - it was utterly unworkable, self-interested and dogmatic - despite the fact that its desired objectives were predominantly positive. Task Force on Innovation had one - it was painfully lengthy, saccharine and dogmatic in its own way. An idea that Ireland can create high-tech jobs bu busloads was simply beyond any support and the analysis produced in Chapter 13 to support this assertion is exceptionally naive.

In between, largely unnoticed, was the missive issued by the Department of Foreign Affairs titled simply "Progress Report on Follow up to The Global Irish Economic Forum".

This unassuming publication is, nonetheless, the official endorsement of the expensive, though originally ambitious (deflated by the DofFA bureaucrats/organizers who went through the original list of invitees with a red pencil removing any potential 'trouble makers' - aka original thinkers) undertaking back in September 2009. It is full of woolly and teary-in-the-eyes stuff that doesn't deserve much attention, except that it puts Ireland Inc to international public view. DofFA aims this report not so much at us, the residents, but at the foreign 'diaspora' - and through them - at international markets.

So let's take a quick scalpel to that boil.

Per DofFA: "The emphasis in the Budget [2010] on encouraging innovation, maintaining Ireland as a friendly and supportive environment for international business, and highlighting emerging strengths in areas such as renewable energy, green technology, scientific research and innovation, all reflect the concerns and views put forward by those present at Farmleigh."

Of course, DofFA would do well to read the Budget. It has a tax break for booze (un-passable to consumers) and a tax break for new cars (passable to German, Japanese and other producers of these). Which part relates to 'encouraging innovation' etc? On Green - there is a new tax, but no 'highlighting emerging strengths'. Page 3 of the said DofFA report therefore already contains a very sever stretch of 'truth in reporting' concept.

The report, worryingly, brings up numerous references to direct and indirect Exchequer financing for expanded post-Farmleigh 'Network' of 'Global Irish' (or shall we call them 'Glorish'?). On our knees economically, we, the resident population will be floating financially such worthy causes as 'regional' Farmleigh-style gatherings around the world, Ministers participation at these, an hereto invisible organization called Irish Technology Leadership Group in Silicon Valley, and one Irish Innovation Centre, plus other activities. 'Glorish Youth Farmleigh' junket is planned as well.

Perhaps the most grotesque (and from my point of view is the idea of going to the Irish diaspora worldwide hat-in-hand to get some cash for the Exchequer. "Diaspora Bond: the Minister for Finance announced in Budget 2010 that the NTMA and his Department will develop a National Solidarity Bond which will be available for investment in 2010. Initially, the bond is expected to be available to Irish residents. The NTMA, the Department of Finance and relevant Departments are examining the feasibility of extending it to non-residents and how to successfully market it abroad, including through Irish Diplomatic Missions."

I commented before on the notion that our Government (and some of its close allies on the Left) have somehow gotten into their minds that they can sell this 'Tin Whistle & Shamrocks' bond for more than they are selling ordinary bonds. It is simply naive. Any yield offered on these bonds will require a premium over ordinary bonds issued to the international investor community. Why? Because this Government has shown to the entire world that it is willing to sacrifice domestic investors for the sake of protecting foreign bond holders. They are doing this with the banks. And as a result, any investor in a 'special' bond will ask for extra return in exchange for surrendering the protection granted to institutional foreign investors.

But read carefully above - there is an idea that such a bond can be marketed to retail investors outside Ireland via our diplomatic missions. Have they heard of MiFID or its equivalent regulations around the world? Imagine:

Our diplomatic mission in, say NYC, with a sign: 'Paddy Bonds: Buy Em Here'. A bureaucrat/ diplomat at the desk. A gentleman walks in and says: "Can you tell me about this fine bond offer?" Our man starts blabbing about Budget support for innovation and the fantastic opportunity to get X% on your investment, should you buy this Y-year bond. Another man walks in. Shows a little card, saying "SEC" at the top and asking to see our mission representative's authorization to sell retail investment products. Zoom forward ten second. The bureaucrat is led in handcuffs, Fox News outside with a camera crew and SIPTU/CPSU rep running after them shouting "Social partners will not stand for such treatment of ordinary workers!". NYTimes headline next day: "Erin Bonds Bust". Within a week - the same happens in all civilized nations protecting their citizens from unauthorized dealers in financial products.

Anyone in Farmleigh scratched their head over this possibility? Or did they all think we can get our missions staff to re-train (in our knowledge economy) to become authorized advisers all around the world? Nope - swept in a collective enthusiasm for 'radical, man, thinking' they just popped out this pearl of wisdom.


Forget all the nearly macabre pedaling of the tourism offers in the report - the ones that occupy several pages. Take a look at the beefy parts:

Section 32: "A new €90 million National Energy Retrofit Programme, ...was announced in Budget 2010. The programme will draw together existing retrofit programmes into a more coherent, overarching framework, leveraging the relationship between energy companies and their customers to promote energy efficiency improvement measures and energy services to end-users. This new programme has the potential to be the most innovative, ambitious, energy-related initiative ever introduced in Ireland. The 2010 activity alone, disbursing €130 million, will support energy efficiency improvements in up to 60,000 homes in 2010, support 6,000 jobs directly and will create energy efficiency savings worth a total of €570 million over their lifetime."

Ok, figures check: how can a €90 million programme disburse €130 million? Do money now grow on the Gov offices lawns? And notice the reference to 'energy companies' and their customers. Of course, most of this funding is therefore destined to settle into ESB, Bord Gais, and Bord na Mona coffers. To promote energy efficiency of the least efficient generators who happen to - courtesy of the state protection - be the dominant market players. But wait, 130 million for 60K homes runs to an average of €2,167 per home. Now apply arithmetic: at least 20-30% of every Government programme is consumed by admin and own costs. Then there's VAT on services and supplies. In real terms, we will be lucky if the €1,198 per house actually gets disbursed. It is better than nothing, but it is hardly qualifies as having "the potential to be the most innovative, ambitious, energy-related initiative ever introduced in Ireland".

The idea is good, don't take me wrong. It is just being devised to suit the wrong crowd - the crowd that got us where we are in terms of inefficient, severely polluting and excessively expensive energy market.

Incidentally - has this anything at all to do with Farmleigh? Nope - it was announced two years before Farmleigh took place and was budgeted for the first time in 2008.


The entire section on economic development - from mid page 8 through mid page 10, accounting for 1/5 of the substantive sections of the report has absolutely nothing to do with Farmleigh. In the end, roughly 1/3 of the report relates to ideas discussed in Farmleigh, with the rest being

• either tripe as the talk about the St Patrick's Day junkets for ministers (as if these never happened before Irish Diaspora gathered in Dublin last September), or
• something that has been announced/planned for before the Farmleigh, e.g. Dermot Desmond's 'Culture Ireland' Uni (don't get me started here).
  

What Farmleigh report does well, then? It shows a deep degree of incompetence and insecurity amongst the political and bureaucratic masters of Ireland Inc. It's comprehensive lack of new ideas, lack of departure from the status quo are frustrating, especially since we know - many of those who were at Farmleigh last September really do have good ideas.

It is simply that DofFA and this Government had no desire to hear them speak their minds. Which brings me to the revelation that was not made before (to my knowledge) about Farmleigh. In months of preparation for Farmleigh, DofFA took over the lists of invitees, prepared by the idea originators and mercilessly cut out all potential invitees they did not approve of. From that list gone were a number of public figures very active in policy debate in this country and internationally. They then added a number of those, deemed by the bureaucrats as representative of the Social Partnership. How do I know this? The original owners of the Farmleigh idea actually told me this a week before Farmleigh took place!

Sounds familiar? Yes - Farmleigh, despite sporting some very good corporate leaders, was just another state-run, state-owned junket, designed to appease our ruling elite. The 12 page report on it that took DofFA 4.5 months to compile reflects exactly this reality.

Economics 12/03/2010: Anglo's latest fun in the sun

In latest development: as Mr Alan Dukes – retired politician extraordinaire – takes over as the Chairman and Executive Chairman of the Anglo. Presumably he will no longer be acting in the interest of the taxpayers – which would, of course, be a conflict of interest for a Chairman and Executive Chairman.

There was a nice question put Mr Dukes on Newstalk – about the extraordinary €10 billion worth of ‘Master Loan Repurchase Agreements’ carried on the banks books (per Anglo’s latest annual report). Mr Dukes didn’t answer that question. But here is what we know:

MLRepos are in effect Central Bank of Ireland repurchase agreements that are so toxic, the ECB refuses to accept them as a collateral for its own discounted lending. So our Central Banks stepped in to hover these off the Anglo’s balance sheet.

Which begs several questions – and I do hope Mr Dukes actually answers these:

1. What exactly are these MLRepos and why are they held by the CB and not ECB?
2. Does Anglo continues to engage in such derivative operations vis-à-vis Irish CB?
3. Is this equivalent to the CB ripping out the decks to keep Anglo afloat – after all, in all banking finance theory, special purpose Repos held by the lowest rank lender of last resort can only be viewed as the last chance corral for a financial lender?

In a Newstalk interview, Mr Dukes did not deny the existence of the MLRepos, but said that these were not a part of the normal funding for the bank. I guess we knew this much already. Anglo, you see, is hoping to move away from this sort of shenanigans in some time in the future, when the normal property markets return, so the bank can too start lending in normal ways.

Really? How many tens of billions of taxpayers funds later would that be, Mr Dukes?

I wish Mr Dukes well in his role. And I am sad to see Donal O'Connor leaving the post - he has great experience and did his best to keep the sinking Titanic afloat.

Economics 12/03/2010: Industrial production

If you believe in fairies and elves and the story of the MNCs carrying out Ireland out of the slump driven by collapse of domestic economy, then you are in a recovery, friend.

On an annual basis production for Manufacturing Industries for January 2010 was 2.3% higher than in January 2009 (chart) per CSO’s latest data.The drivers of this change were:

• Computer, electronic and optical products (-37.2% oops)
• Basic pharmaceutical products and preparations (+11.8% - more like it).
  

In other words, really, folks – fewer PCs many more Viagras. Time to pop that vintage champagne out.

Hold on – there’s seasonality here, clearly, plus volatility. So the seasonally adjusted volume of industrial production for Manufacturing Industries for the 3 month period November 2009 to January 2010 was 2.7% lower than in the preceding three month period.

What happened there?

The “Modern” Sector, comprising a number of high-technology and chemical Sectors – all are MNCs led – showed an annual increase in production for January 2010 of 4.8%.

A decrease of 3.6% was recorded in the “Traditional” Sector (the one our folks at L28 wanted to stimulate via expensive borrowing and semi-state companies – good luck extracting here any sort of meaningful returns on ‘investment’).

More significantly, the seasonally adjusted industrial turnover index for Manufacturing Industries fell 1.5% in the three month period November 2009 to January 2010 compared with the preceding three month period. On an annual basis turnover was 8.8% lower when compared with January 2009. This makes me worry – turnover is down output is up and there is no deflation globally. What’s happening? Have falling value of the Euro been impacting the revenue we collect on transfer-pricing from the US? Likely – inputs prices are appreciating with the dollar, output prices are falling with the euro. In the end, less dosh for us.

PS: what do you think these figures are doing to the hopes of the high value-added private sector jobs creation - the one that promises us to deliver 105K new jobs via IDA and another 150K new jobs via FAS/DETE etc 'Innovation frameworks'?

Let me tell you a quick tale: on the day of Taoiseach's launch of the Innovation taskforce report, TCD academics received a 'No' answer to their joint (with Innovation Centre) application for a post of a lecturer in entrepreneurship and innovation. Knowledge economy, it seems, per some decision-makers somewhere, does not need research and teaching in either entrepreneurial aspects of innovation or business aspects of the same. So much for 'commercializable R&D'... Oh, yes, the post was planned to be self-financing via expanded teaching programmes, as far as I am aware.

Economics 11/03/2010: Replying to Prof Krugman

Updated: 14/03/2010

I have a choice today - to either deal with the notoriously influential article by Paul Krugman, or respond to a large number of responses to my commentary on the Letter of 28.

I will do both in proportional terms, relative to their substantive weight.

On L28 debate:

I received a number of supportive comments, including from the people who are self-identifying with the Left in their traditional views. Many thanks to all who commented. Please, continue to read the blog and comment on its posts.

I received a number of negative comments:

• A large number of simple 'I do not agree...' ones. Thank you for you comments. Hope you continue reading this blog and commenting on other posts in better force;
• A very small number (3) public comments in other venues that were constructive, engaging, one even funny (Mrs G posted one on her Facebook). I linked one of them (the best one, to my judgment) on the original post. Thank you for these. I strongly disagree with their main points, but I am sure we will continue debating these and I am looking forward to this;
• a large number of anonymous, outright rude and bizarre comments.
  

Now to Professor Krugman.

You are all familiar with his article in New York Times (link here). What's wrong with Prof Krugman's exposition?

"Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac."

Sloppy job. Ireland had one Social Partnership and one 'last standing Socialist' Government of Bertie Ahearn (with Bertie's famous exclamation on the point as "I'm one of the last socialists left in Irish politics," (December, 2004)). This dynamic duo (see Mr Ahern's speech on the role of Social Partnership here, especially the sections on Community and Voluntary Sector incorporation into this structure - a clear sign of Social Partnership becoming over-weight on 'Social' agenda) presided over the gravy train of Exchequer (and local authorities, semi-states, Quangoes and Social Partners) feeding off the property boom. If this was not equivalent to the Federal and Local Authorities in the US fueling property boom through their policies, I am not sure what is.

Note: the World Bank confirms the 'social' nature of the Partnership here.

We had a 20% social housing 'dividend' which inflated prices and restricted supply. Local authorities had an option of either exercising the 20% allocation in full, or substituting in financial contributions from developers. They took charge of this subsidy and run with it. We had zoning and planning laws and practices (perpetuated and perpetrated by the State in its various guises) that:

• pushed development into marginal areas,
  
• reduced supply of suitable land,
  
• curtailed re-development of poorly utilized properties,
  
• supported rural small-scale build up and
  
• lavished tax breaks aligned with the National Spatial Strategies and National Development Plans on shoe-box apartments in depressed and depressing areas where few sustainable buyers would opt to live.
  

We had the Government that was taking over 40% of the value of each new unit built in this country in taxes and levies, thus directly benefiting from this artificial scarcity-driven boom.

We topped the cake with a cherry of one Grand Socialist Scheme that envisioned moving people around the country physically - the Decentralization. It required 'volunatry' relocations, but in the end boiled down to giving public sector workers a fine choice - keep your current job or get re-asigned to something else. No matter what, alongside with the State purchasing vast amounts of 'Decentralization'-bound real estate (that now sits unoccupied) the promise of tens of thousands of public sector employees moving to new locations contributed to expectations of price appreciation in remote areas.

We had some other - Stalinesque in the planning terms (not execution, fortunately) schemes - remember the promises of investment and jobs flowing to BMW, the West, the North West? The Western Rail Corridor? Hardly 'market forces' at their best, these boosted expectations of future returns on property. Taking the case of Luas driving appreciation of land in Dublin and applying this to Western Rail Corridor implies that land and property values in the relatively de-populated parts of the country along the northern arm of the route have increased by 15-20% instantaneously upon the scheme announcement.

Just because we did not have the State pushing jumbo mortgages underwritten by state-owned mortgage lenders onto low income households, does not mean that the hands of the Government and its Partners are not imprinted on the facade of our own property bubble.

Instead of all the American Acts, we had the Social Partners telling the Government "we need more construction for our constituents". The Government did as it was told and collected tax revenue in sacks. It run rings around the handsomely paid and complacent regulators and supervisory authorities, who sat on their hands as the bubble was inflating. Most were appointed into their positions as the 'retirement perk' from their life-long complacency filled civil services jobs. Others - because they were 'friends' of the regime (recall Mr Ahearn famous admission on RTE). The Social Partners weren't cheering them on, they were shouting 'We need more...'. Inchdoney Accord resulted. And appointments of their friends to the positions of power.

The new NDP - with it 'social investment' taking up a third of the funds allocated for the entire 'capital' programme followed. Social housing lists swell in response, as did the coffers of local authorities, who spent the cash on grandiose Palaces of Peoples - their own headquarters. And Gateways to Excellence - shining campuses for FAS and numerous ITs - that remain empty or half-empty. The merry-go-round was spinning.

So we pushed jumbo mortgages from our non-State banks onto ordinary folks to pay for the above largess of the 'Social' State and its 'Social Partners'. Hardly the forces of 'market capitalism' these were.

We distorted returns on every other form of capital:

• Productive physical capital carried a 25% direct rate of tax or 12.5% corporate rate, or both - depending on whether you were a small or a medium business;
• Human capital was taxed at 42%, then 41%, now up to 56% margins;
• Currently vacant apartments sit taxed at 0%.
  

The 'Left' did occasionally protest against the latter - never against the former, and often against the 'low' physical capital taxes. But these protests were not about the bubble - they were about the Irish Left's demands for even more state transfers. By 2005-2007 they were calling on the Government to start pushing property development into becoming a vehicle for financing not only domestic welfarist policies, but even the aid to foreign countries.

The squeeze on the property market was complete - the supply was artificially restricted, demand was artificially inflated and the Government was actively 'talking the market up'. The banks were encouraged to lend and the regulators were directly selected to be complacent, inactive and on some occasions - outright unsuited to run the complex world of finance. Our former Governor of the Central Bank had no idea he could do anything to alter reserve requirement ratios on Irish banks - he was a career bureaucrat, not a central banker.


Prof Krugman says that "What really mattered was free-market fundamentalism." And refers to Ronald Reagan. Ireland never had a single Ronald Reagan moment in its history. Where Reagan believed in the right of people to engage in free enterprise, Irish Government only believed in the right of the State to tax the free enterprise. Post 2002 EU ruling, most of the taxing took place through indirect means, while the Government maintained a low tax rhetoric. Before 2003, during the height of the 'free-market fundamentalism' we had two-tiered tax system, with a 10% or less tax for big MNCs and a punitive 32% for mere mortals. MNCs were encouraged into this country by the wavers and indirect subsidies that reduced their indirect taxes which were levied through the system of state-controlled bodies and companies. This can fool outsiders like Prof Krugman and some insiders (e.g. the Letter 28 authors) to believe that Ireland was some sort of the Friedmanite Happy Land of free markets, but it does not change the reality.

Let me postulate the following theorem to Prof Krugman:

"Independent of how many fingerprints a forensic analyst can collect at any economic crime scene, invariably, there will be one set of fingerprints always present - that of the State"

And a corollary:
"These fingerprints will invariably lead an investigator to something with a word 'Social' or its derivative on it as a core entity partaking in the event".

'Social' as in 'Socialist'. Doesn't really chime with 'free-market fundamentalism'...

Per arguments above, QED.


Note: Hat tip to Anonymous on typos.

Economics 11/03/2010: Debt figures confusion reigns at RTE?

Per RTE report yesterday (emphasis is mine, see original here)

“New figures from the Central Bank show that at the end of January Irish residents - mostly companies and institutions - had an outstanding debt of €1.1 trillion. Figures for issued debt securities indicate that €790 billion worth of this debt is denominated in euro, while the remaining €270 billion is denominated in foreign currencies."

This, indeed, is misleading enough for the non-economist. While RTE choice of words ‘outstanding debt’ might imply ‘total debt’, in reality, of course, the Central Bank note (available here) is dealing only with securitized debt: bonds, notes and debt securities issued, plus equity issued. But it does not include non-securitized loans, mortgages, corporate loans, over drafts, credit cards, corporate invoice-discounting, and even massive volumes of investment fund shares/units.

This, if course, explains how the figures issued today differ from our real total debt measure: the Gross External Debt of all resident sectors, published quarterly (with one quarter delay) by CSO. Q4 2009 is still due for release later this month, but per latest CSO data, in Q3 2009, the gross external debt of all resident sectors in Ireland stood at €1,637bn or €51bn down on the Q2 2009 level – some €537 billion more than what RTE’s note mistakenly labelled to be Ireland’s outstanding debt.

The liabilities of Ireland-based monetary financial institutions (aka our financial system inclusive of IFSC) were virtually unchanged quarter on quarter at €691bn with their share of total debt rising from 41% in Q2 2009 to 42% in Q3.

Similar dynamic took place in Other Sectors – comprising insurance companies and other financial enterprises, plus non-financial companies – where debt as of Q3 2009 stood at €618 billion or 38% of the total, up from 37% in Q2 2009.

Virtually all of the quarterly decrease in our indebtedness came from the Central Bank funds changes. This is why excluding the Central Bank and Government liabilities, total economy debt rose from €1.513 trillion in Q2 2009 to €1.508 trillion in Q3 2009.

Since Q3 2007, the overall debt levels in Other Sectors rose by a cumulative of 15.6%, in Direct Investment sector by 9.3%, and our total debt rose by 8.33%. At the same time, our wealth - or assets side - have collapsed by over 60%.

Only banks have so far managed to de-leverage in Ireland (down 9.8% on Q3 2007) thanks to the taxpayers’s cash. Which brings us to a sad but inevitable conclusion – while banks use our money to write down their bad debts, is it any surprise that the real debt burden in the Irish economy is not declining?

Now, paired with Central Bank information note, if we subtract from the total debt figure in Q3 2009 the approximate IFSC-related debt of €850-900 billion (reflecting both securitized and non-securitized debt held, keeping in mind that most of the IFSC debt is securitized), this leaves Irish resident companies, households, banks, financial services providers and the public sector in the hole for roughly €730-790 billion.

Take this into a perspective: this number is equivalent to

• €165,273-176,485 debt per every man, woman and child in this country – resident and citizen (per latest CSO population data, here)
• Assuming paydown in the amount of our annual public deficit projected for 2010, this debt mountain will take us 41-44 years to pay down without any interest accruing on it (just think of 44 years of austerity and you get the picture)
• At the current interest rate charged on Government borrowing, the annual interest bill relating to our economy’s debt mountain adds up to €36.85-39.35 billion or more than 50% of the total annual Exchequer expenditure (just a reminder, we are being offered a plan to borrow more by the Letter of 28 - here - because, apparently, we have not borrowed yet enough)
  
• Given the average family size in Ireland (2.82 persons per household) and the latest average house price (€242,000 per Q4 2009 daft.ie report), this level of indebtedness is equivalent to 2 houses per every family in the Republic

Shall I go on? Sadly, reading RTE report one might conclude that things are ok: most of our outstanding debt is owed by the IFSC, so no need to worry, folks. Alas, that would be as wrong as calling today’s data release from the Central Bank a true reflection of our debt mountain.

Economics 08/03/2010: 28 Alices in Wonderland of Tasc economics

Update: one of the signatories to the Letter of 28 is responding to my comment here.



After a very lengthy period of navel gazing, Irish left has produced its own platform for economic policy (here). And what a marvel it is. Right out of Alice in Wonderland.

The letter of 28 social scientists published in the Irish Times is worth a read, if only to see what passes for ‘independent thinking’ in our country. Here are few pearls.

“Consumer spending has collapsed while at the same time unemployment and emigration have soared. Crucially, investment has plummeted off the chart. Not only have Government policies failed to stem this haemorrhage, they have actively contributed to this collapse.”

No one can deny these facts. But there are serious omissions here. Investment collapse in Ireland is driven foremost by the collapse in construction sector – the sector that accounted for over 70% of total private investment in this country until 2007. So no - the Government has not contributed to this.

Investment the authors have in mind is the NDP-related allocations, which are less than 50% about real capital and more than 50% about ‘soft’ investments – in equality, poverty reductions, etc (all noble objectives, but hardly affordable in current circumstances).

Note, however, that the 28 ‘leading’ policy lights do not mention draconian tax increases here as the contributing factors. Oh, no – this article is about how good more public spending would be to our country.

“The most damaging are cuts in transfers to low-income groups which, along with general tax increases on low and average pay in 2009, have reduced spending power in the economy at a time when it was most needed.”

Really? Social welfare payments were cut by 4% in Budget 2010. They were raised by 3.3% in Budget 2009, which means that in nominal terms, post-Budget 2010 our welfare recipients are only 0.83% worse off than they were in 2008. And then there was deflation – in 2009 CPI fell 4.5% and HICP declined 1.7%. Say we use HICP, since majority of those on social welfare don’t have a mortgage – their housing costs are usually covered by the taxpayers. This means that in real terms post-Budget 2010 Ireland’s welfare recipients are still 0.883% better off than they were in December 2008. Is that so deflationary, folks?

“Equally damaging have been the cuts in public investment at a time when private investment has plummeted. This has laid the foundations for a low-growth, high-debt future where unemployment will remain high and inequality endemic.”

One can relate to this statement. The problem is that while some of the cuts were to productive investment, the real error of the Government policy has been the lack of systematic approach to assessing the value-for-money of various projects and freezing or canceling outright the ones that do not yield sufficient returns. For example, parts of road building programmes relied on the outdated and often utterly unrealistic expectations of development in remote locations. Binning these ‘investments’ is ok – they are the luxury we cannot afford. Ditto for Metro North – which in its current incarnation is a White Elephant.

And how on earth cuts in public investment are going to make income inequality endemic? During the Celtic Tiger era, income inequality rose (judging by the works of some of the 28 experts), yet public investment also rose. So public investment boosts did not work then for income inequality. Any reason they should do so now?

Irony has it, the 28 ‘wise ones’ have failed to grasp the idea that far from stimulating public investment, we should be stimulating productive private investment – that is what creates sustainable jobs and growth. And to do that we need lower taxes, and less borrowing by the Exchequer, so our banks have no Government bonds to roll over at the ECB lending window.


“Budgetary policies have been short-termist and reactive. Instead of cutting real waste in the public sector by increasing productivity and efficiency, the Government has cut public services and the living standards of those who can least afford it, further reducing domestic demand and, thus, employment.”

I agree with this. The Government has wasted a golden opportunity to have real reforms in the public sector and public spending, as well as taxation. So why would the 28 'wise ones' give even more dosh to such a wasteful Exchequer?


The authors do not understand that increasing consumption – by borrowing at 5-6% per annum to give the money to our welfare system and to pay public sector’s obese wages is taking money out of investment. Instead, they seem to think that both: welfare payments increases and public sector wages can be sustained while increasing state spending on capital projects.

So do the simple additions. To maintain NDP investment at previously planned levels, on top of the current budget deficit we will need some odd €6-7 billion more. To return welfare payments to their 2009 levels, and to reverse pay cuts in the public sector and reductions in employment there, we will need additional €3.4 billion. These are all net of receipts. So the Exchequer will be borrowing some €29 billion this year - 18% of our GDP. What would the Greeks say with their current 12.7% GDP deficit and heading for 10.7%?

What would the bond markets say? Ah, here we come to the interesting part that the folks in Tasc did not care to consider. At 18% defict, Ireland Inc's bonds would rise to a yield of ca 7.5%. Ok, let us split the difference and say, 7%. Then scroll below for some calculations...


“These policies are weakening the economy’s ability to cope with growing debt levels.”

Really? Most of the non-banking debt – almost 100% of it – in this country is held by private sector firms and ordinary workers. How is paying more in welfare payments going to help deflate this debt? How is public spending on capital projects going to do the job? Oh, by the way, read further to find what the 28 think about savings (which, remember, in the long run = investment).


“We urgently need measures to tackle five key areas which require fundamental reforms: our substantial physical infrastructure deficits; our poor social infrastructure – early childhood education, ...primary and community healthcare..., housing lists..., ...Irish public transport ...; our high levels of relative poverty and income inequality; our under-performing indigenous business sector – which needs appropriate support to contribute to our export base, RD and innovation capacity; and our unsustainable reliance on carbon-heavy resources and activities.”

Well, if that is not a shopping list we’ve seen before in the Irish Times… We do need more schools, and we do need some other capital. But simply to say ‘more!’ is not enough. One must face the reality of constraints on funding. The 28 do not seem to be bothered by the fact that Irish middle classes simply cannot bear any more of their droning about the need for more ‘public sector’ stuff and shorter housing lists. We’ve got mortgages to pay, folks, never mind your housing lists. And their environmental taxes are simply a ploy to tax income even more.

The irony is - word 'reforms' is equated in the 28 minds with 'more spending'. Again, we've heard this before from some of the signatories.

The 28 also seem to not understand where our exporting capacity comes from. Far from being the domain of domestic enterprises, it is reliant on MNCs, who would flee Ireland were the 28’s ideas implemented.


“It may seem astonishing that we face such economic and social deficits after 15 years of boom but these are the consequences of pursuing a failed low-tax, low-spend model which sought short-term gains from the speculative activity of a small but powerful golden circle.”

Really? I didn’t notice a low tax, low spend economy. The Government accounted, pre-crisis for EU-average level of spending in terms of GNP, and removing the MNCs out of Ireland’s income accounting, leaves the Irish Government in control of over 60% of the entire economy. Low tax? Our taxes are now second highest in the EU at the upper margin level. All of this before you factor in some of the highest indirect taxes and charges.

But wait, to be really wise, the 28 must have done some thinking – low taxes compared to what? To the services and benefits we receive? One has to be ignorant to suggest that given the poor quality of healthcare, the abysmal quality of our transport, and pretty much every other service supplied by the State, our taxes are low. Compared to the French and the Swedes, and the Germans, we are paying through the nose for the little service we get.


“We can employ the strength of our combined public enterprises – their off-balance sheet borrowing and investment capacity to invest in our infrastructure and create new indigenous enterprises, both public and private.”

Please, help me – does anyone actually believe that our semi-state companies are that good in creating 'new indigenous enterprises’? More CIE? ESB? Bord na Mona? Aer Lingus?


“We can further employ new funding vehicles – enterprise development bonds (eg green bonds), municipal bonds and the new National Solidarity Bonds – which can leverage our current high savings ratio and international investment.”

Again, there is apparently not a single person authoring this letter who understands basic finance. At what rate would you borrow through these bonds? Current yield is 5%. Greece at 6.3%. To make these bonds attractive to anyone, you’d have to price them around 7%. Are the 28 suggesting that returns to these bonds will be in the region of 10% (to cover issuance costs and administrative margins)?

Suppose we borrow at 7% for 10 years, invest in new private (not public) enterprises. The rate of survival for start ups in Ireland is, historically, around 25-30% over 5 years. In 10 years – it will be around 15%. To get 10% return on these bonds, the state will need to invest in new ventures that will survive through 10 years slog while yielding over 22% annually! Enterprise Ireland never had this spectacular of a record, even during the boom time. Even Michael O’Leary is not that good.


But wait, the above passage is about taking our savings and spending these on public investment and state enterprises. How is that going to help our families with their debt? And how is that going to provide financing for companies and private sector in general? What effect will this expropriation of personal savings (for it will require compulsory expropriation, given that the bonds will have to be self-financing, aka priced at yields of below 2-2.5% pa - the expected rate of real growth in the economy over the next 10 years) have on consumption? The minute we start even talking about destabilizing peoples savings, all cash will flee the country and consumers will tighten even more their expenditure. Sadly, none of the 28 'leading lights' seemed to have heard of the precautionary savings motive - the one that drives our current savings ratios.


And so they conclude – having established not a single fact or provided not a single relevant statistic or estimate that: “The resources and labour to finance this modernisation drive are there. We just need the political vision and will to make it happen.”


NB: The 28 call for reforming tax system – I agree, this is needed. They are also calling for abolition of tax breaks. I agree – they unnecessarily complicate tax code and should be yielded in exchange for simple low flat tax rate on all income. But we do not need an additional tax band for higher income – we need to bring people on lower incomes into tax net to make them real stakeholders in this society. Again, this can be done by simply dropping the income tax rate and with it – the deductions.

Economics 07/03/2010: Consensus governance and failures to compete

Yesterday I tweeted about the case of attempted suppression of academic freedom in France (see here). An interesting paper, published in February 2010 by the Department of Economics, Tilburg University, titled Academic Faculty Governance and Recruitment Decisions sheds some light on the potential impact of the practices of suppressing dissent within our Universities.

In this paper, the authors analyzed the implications of the governance structure in academic faculties for their recruitment decisions. It turns out that “the value to individual members through social interaction within the faculty depends on the average status of their fellow members.” Which, of course, can be interpreted in common English as ‘cronyism’ or ‘collusion’. “In recruitment decisions, existing [faculty] members trade off the effect of entry on average status of the faculty against alternative uses of the recruitment budget if no entry takes place [i.e. getting their own hands on the pot of cash].” The study shows that “the best candidates join the best faculties but that they receive lower wages than some lower-ranking candidates”. The main policy implication raised by the study authors is that “consensus-based faculties, such as many in Europe, could improve the well-being of their members if they liberalized their internal decision making processes.”

Now, I’ve said on many occasions that our consensus-driven model of academic staffing would have never allowed people like Friedrich Hayek, or for that matter Milton Friedman, to be given tenure in Ireland. This is true, because hiring decisions in Irish universities – and I am speaking here from evidence relayed to me over the years in a number of actual cases – are based on social cliques (often organized around political and internal agendas, with loose affiliation with certain political ideologies). Anyone falling outside consensus, or threatening to ‘rock intellectual boat’ of dogmatic thinking and vested interests would never be allowed anywhere near a permanent post.

Of course this does not mean that everyone hired through the consensus process is not up to their jobs. Certainly such an assertion would be wrong. But it does mean that Irish academia is missing on critical thinking - a key ingredient in knowledge creation.

Ditto for our public sector. One example comes to mind.

Last year, the Central Bank was hiring a very senior research director. Amongst the applicants, there was a certain senior employee of the US Fed who holds, in addition to his Fed role, several senior academic positions worldwide in the area of Central Banking-related research. This person already held an exactly comparable position in the Fed for over a decade. He also has a list of central banking-related publications that would exceed those of any other academic in Ireland. This person was not even short-listed for the CB position, which subsequently went through an internal promotion to someone who has no publications on the subject, never had academic or practical experience in the area at the same level, but is a life-timer of the Irish public sector.

Consensus-based hiring at work, folks…

Economics 07/03/2010: A long term view of the currency markets

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.

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.

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

• 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.
  

Social incentives imply that

1. 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);
   
2. workers who have at least one friend who is more able than themselves are willing to increase their effort and hence productivity by 10%.

The distribution of worker ability is such that the net effect of social incentives on the firm’s
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.

The aspects that are descriptive of the strength of social interactions used by the authors include pre-existing friends as co-workers, reciprocal friends, sharing in supermarket shopping, eating together, lending/borrowing money and sharing problems with each other.

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)