Economics 26/11/10: Contagion is spreading to Spain & Italy

Another day, another spike of contagion from Ireland's Sovereign bonds to other Eurozone countries:
Yesterday's closing bell marked another day in which markets have completely disagreed with the EU officials and Irish Government view of the reality of our and PIIGS' ability to weather out the current crisis.

Economics 23/11/10: How much will Government need to borrow in 2011

So we topped the European chart again today:
And a quick one for the start of the day tomorrow:

Let's do some arithmetic again:
Leni's Proposition 2: Through 2011 IRL Gov will need

• €18bn in deficit financing +
  
• €30-40bn in deposits shoring +
  
• €15bn in banks capital (note - some this can be spread over couple of years)+
  
• Banks losses cover of, say, another €10bn =
  
• Grand Total of 73-83bn.
  

Check: is that right, Leni? No answer so far... oh, well... we did the sums, as he asked.

Economics 22/10/10: Bailout that is losing steam by an hour

The immediate fallout from the Irish bailout package is:

• short sales closing on Irish sovereign markets means profit booking, yields down (although surprisingly slightly -0.323%)
• Germany gets relief (Irish-German spread is actually up 0.503%) and
  
• short seller moving on to new targets: the rest of the PIIGS:

Makes you wonder if Portugal, Italy and Spain bonds brokers have been pushing their clients into losses as hard as our own did...

Contagion is clearly far from over, which simply exposes the fact that EU's EFSF and IMF short-ending for the insolvent sovereigns is not a solution to the PIIGS problems and that the EU has no plan B.

Economics 22/11/10: November 12 - on the record re 'bailout'

This is an unedited version of my November 12 article in the Irish Examiner. Of course, since then the events have taken over the core premises of the article, but for archival purposes and also to posit the article into the context (at the time of print, the official position was 'we don't need a bailout'), I am posting this here.

Despite all the intensifying talk about the EU support, despite the growing number of assurances from the various officials and social partners that we can ‘grow out of our difficulties’, this week has clearly shown that Ireland is nearing the end game of the crisis. Tellingly, even the usual official policies cheerleaders, our stockbrokers, have by now one by one deserted the State-side of the arguments. As one analyst from IFSC put it earlier this week: ‘you know the game’s up when you can’t round up your own sales team to sell Irish bonds’.

The game is almost up. Were we to go into borrowing today, Irish debt will be more costly to finance than that of any other developed country, save Greece. On the assumption of a 70% recovery rate, the Irish 10 year Credit Default Swaps imply an 85% probability of Ireland defaulting sometime in the next 10 years. This, of course, is not the real probability, but an estimate. However, in comparison, even countries that availed over the last 3 years of IMF assistance, including Iceland, are enjoying much greater confidence of the markets.

We all know how we got into this predicament. Three years into the crisis, Irish Government continues to spend well beyond its means. Our current spending keeps rising. Tax revenue, despite significant tax hikes, is running below 2008 levels.

The markets know that the Irish Government has by now exhausted all means for extracting more cash out of this devastated economy. If, as expected, Minister Lenihan hikes taxes in the Budget 2011 again, he will be shifting more of our economic activity into the grey market where the taxman is a distant and powerless overlord.

Much anticipated Budget 2011 is unlikely to solve this problem. Cuts of €6 billion from the deficit this year will do very little to restore any credibility to the Government policy. As anyone with an ounce of common sense will know in the current conditions, the whole exercise will be equivalent to taking money out of one pocket – Government total spending – and putting it in the other – the banks, bondholders, social welfare and pay and pensions bill.

By avoiding soaking the bondholders from the start of this crisis, the Government has boxed itself into a proverbial corner. Instead of standing on a morally and economically high ground and soaking the bondholders early on in the crisis, as Iceland did, we have created a full-blown contagion from the banks to the sovereign. With liquidity evaporating from the shorter end of the banks funding market, this contagion is now a two-way street. Untangling this today, without going into a renegotiation of the sovereign bonds and/or guarantees, cannot constitute a credible policy position.

All of this comes before we even consider the real economy-side of the matters. With private investment on its knees, and companies, starved of trade and operational credits, operating outside the realm of normal corporate finance, can anyone really claim that we have a private sector capacity to escape a restructuring of the private or public or both debts?

Irish families are now so deep in debt and negative equity that consumption and household investment stalled, while deposits are vanishing to pay rising state and semi-state bills. Squeezed on both ends of their incomes – by falling earning and rising taxes and charges – these very households cannot be expected to provide more funding for our fiscal policy pyramid scheme.

But the final straw that broke the proverbial camel’s back is the belated realisation that the EU has no plan B for dealing with this crisis. In fact, it doesn’t even have a plan A. This was made absolutely clear by the vacuous nature of statements issued by the EU Commissioner Olli Rehn during and after his visit to Dublin this week.

The fundamental EU problem is that the much-lauded EFSF (European Financial Stabilization Facility) – the fund used to put Greece into a bond markets deep-freezer earlier this year – is not designed to address the problems we face. EFSF is designed to help cash strapped governments for a period of 3 years at ‘near market’ rates. Ireland is not cash-strapped. Nor are ‘near-market rates’ a sustainable lending option for us.

We are plain insolvent when one takes three to five years forward view. Our sovereign debt to GNP ratio is likely to exceed 140% by the end of 2015 and this is before we factor in the highly probable wave of mortgages defaults. Our household and corporate debts are more than double those of Greece. And we are staring at the abyss of rising interest rates and strong euro into the next 3-5 years.

EFSF is simply not fit for the purpose of rescuing Ireland.

At current yields, Ireland will need to grow its economy at some 6.5-7% on average annually for the next decade to counterbalance the mountain of debt we are carrying. At the ESFS rates – at ca 4.5%. Anyone expecting this to happen without radical and extremely painful structural reforms of the economy (not just budget cuts) should really go back to the basics of economics. With exception of exporting sectors our economy has slipped into a coma. Jolting it out of this state will require complete rethinking of our fiscal and economic policies.

As an optimist, I can tell you that this can be done. As a pragmatic observer of the current policy and economic environment, I have little hope that it can be done without restructuring our debts – either public or private or both – and issuing a new policies mandate for the political leadership.

Economics 21/11/10: How much funding will we need?

I've run through some figures for the expected amount of bailout drawdown for Ireland. Here are the sums:

• 2011-2014 deficit financing: €17bn in 2011 (accounting for expected increase in interest payments), €16bn in 2012-2014 annually (allowing for €15bn adjustment in 2011-2014 framework to be published by the Government) = €65bn
• Banks capital demand: €37bn in residual capital losses including Nama and incorporating expected mortgages defaults of €12bn
• Bonds redemptions forthcoming (hat tip to Brian Lucey): commercial paper =€ 6.4bn in 2011, redeemable out of IMF loan and thus non-replicative over 2012-2014, bond issues €4.4bn in 2011, €5.6bn in 2012 and €6bn in 2013, to the grand total of €22.4bn
• Banks liquidity supply - immediate draw on IMF funds - €28-35bn

Adding these up: total demand for funds in the amount of €152.4-159.4bn

Government has available ca €20bn (nominal) reserves from NTMA and ca €12bn in liquid funds from NPRF that can be accessed, implying net demand on IMF/ECB funding is €120-127bn.

Assuming the expected haircut on all bondholders in Irish 6 covered institutions implies additional savings of ca €10bn not factored in the above. However over the years 2012-onward I expect Nama to start showing losses. In addition, I suspect that the Exchequer will have to cover losses in the Central Bank of Ireland relating to their lending to the Anglo, which can be in excess of €10bn.

Interest charge on the IMF/ECB loan is likely to be around 5%, providing for a demand for €6bn in annual interest repayments.

Economics 20/11/10: Irish labour taxes are too restrictive

We often think of Ireland as low tax economy. We also think of ourselves as inhabiting flexible labour markets and enterprising world of work-hungry people.

Here is an interesting angle from which we can look at the labour markets. Suppose the cost of labour for an hour of work goes up 1% - due to an earnings increase or benefits rise. What does a worker get to keep out of this?

The higher the number is, the greater is the incentive to supply labour post wage/earnings or employer social security tax increases. The lower it is, the lesser are the incentives to work in the face of rising earnings or social security contributions.

Ex-ante, we would expect Ireland to see significantly higher returns to workers efforts from rising earnings and/or social security (PRSI) contributions by employers (reduced burden on employees and higher expected future benefits of PRSI funding). This, however, is not true.

Here are few charts from the latest OECD data set - for 2009, so not reflective of the Budget 2010 changes in taxes.

OECD defines the main parameter under consideration as: "Net income is calculated as gross earnings minus personal income tax and employees' social security contributions family benefits. The increase reported [in charts below] represents a form of elasticity. In a proportional tax system the plus elasticity would equal 1. The more progressive the system at these income levels, the lower is the elasticity."

Now, as you look at these charts, remember, the Irish Times crowd love droning on about the lack of 'progressive' tax system in Ireland.

First chart shows single person returns to 1% increase in labour costs with 3 sub-groups identified by their earnings:
AW refers to average wage.

Clearly, single people in Ireland have little incentives to supply more labour in response to an increase in their earnings. Alternatively, we do have a severely progressive system of taxation for labour when it comes to single individuals. Actually, for a single person earning 100% of average wage, Ireland is second to Hungary in the OECD in terms of progressivity of our labour income taxes. That's right - we have second lowest incentives to supply more labour (or in other words, we keep second lowest amount of added cost of labour in our pockets) in the entire OECD. For a higher earners (167% of AW) the picture is not much better - we are actually fourth from the bottom of the OECD league (or 4th highest degree of progressivity).

Now on to families with 2 kids:
Here, we have a slightly improved picture. For a family with 1 earner bringing in 100% of AW, we are ranked 16th in the OECD in terms of incentives to provide more work in return for increased earnings or contributions. For a family with one earner on 100% AW and another on 67% of AW, the same rank is 14th. Progressivity of our labour taxes in all 3 scenarios in the chart above is still above the average for the OECD.

Now on to comparing single person with no children and a family with 2 children:
Doesn't look like there's a great deal of premium to being married in Ireland, does it? Nope. If labour costs go up by 1 Euro, a single person on 167% of AW would keep 74 cents, a family with 2 kids with exactly same combined income will keep 80 cents. Both are worse off in Ireland than their counterparts in 27 countries (single person with no children) and 13 countries (married couple with two earners and 2 kids). Again, much of Irish Times-loved progressivity in either household income taxes.

What if we take lower earning individuals for the above comparison?
Here, the picture changes - average wage earners face much smaller progressivity of tax system than higher earners (notice, this is 'smaller progressivity', not 'smaller burden of tax').

But does having children actually help or penalises working households? Take a look below:
So working households with both parents working and 2 kids are allowed by our tax system to keep less of their higher income than their childless counterparts and single childless earners. That's really does begin to look like a perverse system of income tax 'justice'.

Let me summarise the data in a handy table:
By all metrics and for all categories, Ireland simply qualifies as a country where

• labour income taxation is significantly more progressive (in 7 out of 8 categories of earners it is more progressive than OECD average, 5 out of 8 than EU15 average and 5 out of 8 than advanced economies average)
• labour income taxation is significantly more restrictive of incentives to supply labour in response to higher earnings than the OECD or EU15 average

Not exactly a flexible market with great incentives to work, is it?

Economics 17/11/10: The road we traveled

Amidst this crisis, it is worth taking a look back at the road that we have traveled on our way to the current predicament. It is fashionable today to make claims that the past - the recent past in fact - has been a place of greater fiscal responsibility, the age of 'sustainable' public finances. But is the claim true? Have lost our way all of a sudden around 2005-2007, or have we always been traveling along the same route.

Here are few charts looking back to 1983...
In absolute levels terms, spending and tax receipts have clearly grown dramatically over the years. These are nominal figures, of course. But notice that total expenditure line almost invariably exceeds total receipts levels. The chart also shows pretty dramatic changes that took place since 2007.


Now, let's take a look at the decomposition of the Exchequer balance sheet:
Clearly, gross current spending has been a core of the overall Exchequer financing. The most dramatic departure from 'investment' focus toward current spending focus took place around the turn of the century. Looking at the comparatives across the shares of GNP taken up by capital and current spending shows this even more dramatically. If during 1985-2000 period current expenditure declined as a share of GNP, capital spending first fell (through 1988) then stagnated (through 1997), and then rose through 2002. Capital spending stagnated in the boom years of 2003-2007 and then rose again (due to contraction in GNP) through 2009. However, from 2006 through today, current spending went through the roof.

Another interesting feature of the chart above is that during the current crisis there was not a single year when the current expenditure declined - either in terms of absolute level of spending or in terms of spending relative to GNP.

Total government spending both in levels and as a share of GNP is expected to fall this year for the first time since the beginning of the crisis. This, of course, is driven solely by the decline in capital spending, as charts above indicate.

Now, let us plot primary Exchequer balances - the difference between the total receipts and expenditure.
In broad terms, over the long run, Irish Exchequer has been historically on a non-sustainable path. In only 3 years since 1983 did our total receipts cover total expenditure: 1999, 2000 and 2006.

It is worth noting that we are, despite what Minister Lenihan says, firmly back into the 1980s territory:

• Our current expenditure will stand around 48.7% of GNP this year - a level consistent with 1986-1987 average
• Our capital expenditure as the share of GNP is now 5.7% - the level also attained in 1986
• Our total government expenditure stands at 54.4% this year - the level close to the one last seen in 1986 (54.7%)
• In 2008 our balance was -9.8% which was between 1986 and 1987 levels of balance
• In 2009-2010 we have posted worse deficits than in any other year recorded in the abvoe charts.

So what about good cop - bad cop game of blame going across the Dail isles?
It turns out that on average annual basis, Brian Cowen leads the recent history team of profligate Taoisigh with a whopping (albeit obviously crisis-related) average annual shortfall of €26.5bn so far. Together - Bertie & Cowen come distant second with €5.5bn in annual shortfalls. But overall, there is not a single Toiseach in the modern history of Ireland who managed to balance the books at the primary level. Hardly a sign of any fiscal 'golden age' in the past.

Economics 13/11/10: EFSF, Ireland and a matter of contagion

let me ask the following question: if Ireland is nearing (or already in - see here) a bailout from the EFSF, what does this imply to the overall Euro area stability? Funny thing - it turns out that a little old Ireland can give a big young Euro quite a headache because of the way EFSF is structured.

Let’s step back and take a look at the promise EFSF attempts to deliver.

The fund, set up back in May this year, was supposed to provide an emergency funding backstop to countries finding themselves in a liquidity squeeze (unable to borrow in the markets).

There two basic problems with this idea from the point of view contagion from Ireland

• Ireland’s crisis is that of insolvency, not of a liquidity squeeze 9although it is increasingly looking like the latter will come in the end). If EFSF were to be explicitly used to address Ireland crisis, then Irish Government will be de facto borrowing from the fund with no hope of repaying it ever back (recall – the lending rates under EFSF should be set close to the market rates, which means, say 7-8% currently, which in turn automatically means we can’t be expected to repay this). If so, then any borrower, I repeat – any borrower – from EFSF will not repay the funds borrowed. And this means EFSF borrowings will have to be covered collectively out of the joint funds of the entire Eurozone. You can pretty much count PIIGS out of funding it – they’ll be the very same borrowers. Which leaves it to France and Germany (Belgium hardly can pay much and Austria has it’s own problems etc) to cover the entire fund.
• EFSF own structure implies high risk of contagion from Ireland.
  

That second point is slightly technical and requires some explaining to do.

One can make an argument that Ireland, if it borrows from EFSF, will trigger an increase in the Euro zone systemic risk. EFSF is set up similar to Collateralized Debt Obligation (CDO) with a "credit enhancement" that allows the senior debt tranche to retain higher risk rating because junior tranches are the ones that will carry the first hit on the whole package in the case of default.

The lags in the disbursement of funding and the capped nature, plus ‘enhancement’ bit of the CDO implies that countries in trouble will have to get into the funding stream as early as possible – as there is quick exhaustion of drawdown funds in the EFSF due to the knock on effect on CDO rating. This is known as an accelerated negative feedback mechanism – as sovereign comes under pressure, sovereigns are encouraged to race into EFSF, which removes their own bonds and capacity to carry debt out of the senior CDO tranche and increases their presence in the junior tranches.

So the guaranteed pool of liabilities increases by the amount country borrows from the fund, but the senior pool decreases by the contribution of this country to the fund. This means that as Ireland joint EFSF, it’s past ‘good credit’ rating falls to zero in the senior CDO tranche, its ‘bad debt’ risk contributes to the reduced quality of the liabilities held by the EFSF. Pressure rises on AAA rating of EFSF, unless EFSF draws more of AAA-rated countries debt into its senior tranche to offset this. EFSF will have to expand to be able to do both: lend out to Ireland and maintain AAA rating. Which, of course means that other EFSF contributors will need to issue more debt to recapitalize EFSF. Which means their own AAA ratings are becoming threatened as well.

You see where it all leads, now, don’t you?

The greater is the number of countries seeking help and/or the greater is the overall demand for EFSF funds, the greater the required buffer funding increases from the remaining EFSF-lending AAA-rated sovereigns. All of which, in plain English means that the EFSF will run into its own lending limits quicker if Ireland were to go into borrowing from it. Much quicker than a simple level of our borrowing would suggest.

Now, any sovereign with an once of sense now will know that a race to tap EFSF is on. The faster you get to it to borrow from it, the more likely you’ll arrive to the borrowing window before the limits are reached. Portugal, Spain and possibly even Italy are in the race.

This is why the markets have never been easy about the entire EFSF – they know that Ireland tapping into EFSF simply does two things:

1. It delays the inevitable restructuring of the massive debts accumulated on the Irish economy side – either sovereign or banks or households or any two or all three. EFSF does not remove the need for such a restructuring. It simply delays it.
2. It signifies an exponential increase in the probability of EFSF acting as a conduit for contagion from the PIIGS to the rest of the Euro area.
   

Economics 9/10/10: Bond market comparatives

Another day, two tables courtesy of CMA ... Greece improves, Ireland... well:
CPD refers to the priced probability of default. 40.83% for Ireland within 5 years on 40% loss at recovery.

Economics 8/10/10: We are not Ireland

I just had to reproduce this statement in full (hat tip to Brian Lucey)... the link to the source is here.

LONDON, Nov 8 (Reuters) - Greek Finance Minister George Papaconstantinou on Monday argued that his country was not suffering the same banking problems as Ireland. Speaking in London he also said that he expected the country's deficit would be 5.5 percentage points lower by the end of the year. "Greece is not Ireland, it doesn't have banking stability problems," he said in a speech.


Well, I'd say Minister Lenihan could have said 'We are not Greece, we don't have a liquidity crisis... yet'... but then he won't be really far from his usual rhetorical corner. For another Reuters story tonight showed that we are heading for a possible liquidity crunch:

"LONDON, Nov 8 (Reuters) - A widening in bid/offer spreads on Irish and Portuguese sovereign bonds this month is possibly an even bigger worry than the rising premium these bonds offer over German Bunds or widening credit default spreads.

Liquidity is the grease in the wheels of financial markets and if there is a reduction in liquidity then this will show up in the way prices move and in bid/offer spreads.

While the bid/offer spread on the Irish 10-year cash bond is not as wide as it was before the European Central Bank said in May it was prepared to buy government bonds in the secondary market, it has definitely broken higher.

Since the ECB's May announcement, the bid/offer spread had largely stayed below 30 basis points. However, it has now widened to 40 basis points.

Ignoring such price action in its early stages can be risky since it could lead to a vicious spiral. This is what happened with Greek debt in March when a widening in bid/offer spreads was ignored, leading to a significant deterioration in the supply/demand dynamics.

Those holding long positions became increasingly keen to dump their holdings while those who might have potentially taken on new long positions refrained for fear of catching the proverbial falling knife.

What has been of concern over the last few sessions is that the widening in bid/offer spreads has also started to shift to the medium- to short-end of the yield curve.

There has even been an acceleration in the widening in the bid/offer spreads for two-year and five-year Irish sovereign debt.

This widening has continued even though the latest data shows the European Central Bank resumed its government bond buying programme after a three-week pause.

That suggests the ECB needs to step up its intervention beyond the 711 million euros it spent last week if it is to meet its aim of ensuring "depth and liquidity in those market segments which are dysfunctional".

Unless there is a marked escalation in the ECB's bond purchases, contagion-related risks suggest the potential for a further widening in Spanish yield spreads against Bunds. Against this backdrop, investors might prefer to focus on the relative value trade of a widening in the 10-year Spain/Italy yield spread."

Ouch!

Economics 7/11/10: Irish competitiveness - myths and facts

As of late, the official Ireland - from the Central Bank to the Minister for Finance, to a host of 'attached' economics experts have been drumming up the tale of our rapidly improving competitiveness. In fact, in his speech this week, Minister Lenihan once again referred to the topic, saying:

"Price and earnings data confirm that significant competitiveness adjustments have taken place since 2008." The press release to accompany DofF latest efforts to predict the near term future also stated that "Further details on the nature of the adjustment for 2011 and the distribution and composition of the measures over the remaining years of the forecast period will be announced in the Four-Year Plan. In addition the Plan will outline a programme of structural reform, which will help to further restore competitiveness and support economic growth."

All of these alleged 'competitiveness gains' are routinely attributed to the heroic efforts of the Government.

But:

• Are these claims true? Did our competitiveness increase significantly over the recent months?
• Have increases in Irish competitiveness been exceptional (as would be consistent with Government claims to credit) compared to our peers in the EU?

Here are some facts. Source for data below is the European Central bank. Keep in that in all charts, higher numbers imply lower competitiveness.

First chart shows two alternative metrics for harmonized competitiveness indicators for Ireland. The first metric is deflated by GDP, showing much higher degree of competitiveness than the second metric - deflated by the unit labour cost.
So per chart above, our competitiveness has been underpinned by the direct outcome of recession (GDP effects) and less by the labour costs relative to labour productivity (allegedly - a policy target). Table below details some of the less than pleasant dynamics in the two series:
To summarize the above data: our competitiveness gains so far -

• In the last 12 months through Q2 2010 our competitiveness gains were, in absolute terms ranging between 5.96% and 7.4% with GDP effects outweighing labour costs effects by ca 25%
• In the last 24 months the same gains were more impressive - 12.03% to 12.68%
• But over the crisis years in total these gains were five times higher for GDP effects than for labour competitiveness gains: 11.41% (not all too great to begin with) and just 2.67% - a tiny number barely noticeable on the charts
• Per averages, since 2000 on we had pretty poor record of competitiveness overall and year to date performance is pretty much a disaster.

In my opinion, the claim of 'gains in competitiveness' is about as true as a 'glass half-full' claim. The gains are there, but they are small by historical standards and we are only back to Q1 2007 levels of labour competitiveness, after experiencing a wholesale destruction of this economy during this crisis.

Ok, enough of the absolute numbers, let's compare ourselves to our EU peers. All comparisons are based on unit labour cost HCIs.

First, all countries together:
All's clear in this picture -

• We are the least competitive country in the union.
  
• And were such since Q3 2005.
• All countries experienced improvement in their competitiveness during the crisis
• Many countries have experienced as fast of an adjustment in competitiveness as Ireland, while experiencing far slower wages deflation than us. In other words, it appears that in many other countries productivity of the workforce was growing faster than it was in Ireland during this crisis.

Let's look at the least healthy countries in Europe - the PIGS (Italy will be treated separately, as it is a large economy):
Same story as with the total EU group. Ireland is far from catching up with any of the countries in the group in terms of labour competitiveness.

Of course, what matters is how we do compared to our immediate trade and investment peers - the small open economies of Europe. Chart below illustrates:
No reason to comment on the above - the picture says it all.
The really sad thing is - we are not even competitive compared to the larger, less mobile, EU states. Embarassingly, Italy and Spain are beating us. I am not sure if their Governments brag about 'great sacrifices that lead to improved competitiveness', but given the figures above - they should.

Chart above relates relative competitiveness in Ireland to the EU16 as a whole. Again, the chart is self-explanatory, but couple of points worth mentioning:

• In the last year, our gains in competitiveness have been on average almost exactly identical to those in the EU16
• The above is also true for the last 3 years

Summarizing in a table:Should I say it? Well, the figures above show that

1. Irish gains in competitiveness during this crisis have been rather smaller than asserted; and
2. Irish Government hardly had much to do with these gains, as the gains were pretty much matched by changes across other EU countries, so unless Messrs Lenihan and Cowen have some secret effect on EU16, it's hard to single out Ireland as a 'uniquely' competitiveness improving land of promise.
   

Economics 6/11/10: Is Modern Academia Failing?

A very interesting paper titled "Withering Academia?" by Bruno S. Frey was published by CESIFO Working Paper 3209, October 2010 (download here).

From the abstract: "Strong forces lead to a withering of academia as it exists today. The major causal forces are:

• the rankings mania,
  
• increased division of labor in research,
  
• intense publication pressure,
• academic fraud,
  
• dilution of the concept of “university,” and
  
• inadequate organizational forms for modern research.

Academia, in a broader sense understood as “the locus of seeking truth and learning through methodological inquiry,” will subsist in different forms. The conclusion is therefore pessimistic with respect to the academic system as it presently exists but not to scholarly endeavour as such. However, the transformation predicted is expected to be fundamental."

This some pretty strong stuff.

"Today, in many disciplines, the importance of a scientific idea and the position of a scholar are defined by rankings. What matters nowadays is the recognition produced by a general rankings system, normally based only on the quantity of scientific output, irrespective of quality. If quality is considered, this is done by counting the number of citations. Rankings provide simple measures of relative position in science... Dependence on rankings has been substituted for consideration of content."

"The scientific production process has increasingly been divided into neatly separated steps. ...The division of labor has led to a more efficient and rapid output of scientific results but favors partial views and discourages comprehensive considerations." Interestingly, Frey refers here to the tendency to co-author papers, not to the more worrying (from my point of view) reduction in researchers' ability to think across disciplines and deeper into broader subjects.

"The incentives to publish are not necessarily the ideal ones to gain valuable new knowledge." The need to publish as much and as well as possible may influence the choice of:

• Subjects studied
• Methods used
• Type of collaboration
• Presentation of the results
• "Extent scholars are ready to engage in “academic prostitution,” that is, to revise their paper according to the “suggestions” of the referees even if they know that they are questionable or even plainly wrong (see Frey 2003)."
  

"The stronger the publication pressure, the stronger are these deviations from how scholars
are ideally assumed to behave (Anderson et al. 2007). Overall, such practices undermine
the claim of academia to pursue true knowledge."

We've recently seen a massive scale exposure of these outcomes of research pressures in the case of environmental science publications. But Frey's arguments are much stronger than that - they are systemic in nature.

"It can be predicted that academic misconduct and fraud have increased over recent
decades. The major reason is not that scholars are less moral then they used to be. Instead, the incentives to cheat have greatly increased due to higher stress in academia." Frey offers an excellent, iconclastic outlook on the drivers and methods used in fradulent 'research' - well worth reading.

Frey also deals with the issue of grade inflation and courses overproliferation that can lead to reduced standards of teaching, research and general public good inquiry. "The high reputation of a university is a public good shared by all professors and students, but it is undermined by having too many students of lower quality."

In my view - this is an excellent paper that is worth reading for anyone concerned with the nature of learning and discovery as well as broader concept of academia in our modern society. It is strongly polemical, provocative and certainly deserves a deeper debate.

But let me add to Frey's concerns - based on personal experieince - modern academia, in pursuit of quantitive (teaching & research) targets has lost much of its real societal relevance. Vast majority of senior faculty members are withdrawn from broader social and scientific debate, residing in their own isolated towers of specialist knowledge. This problem is most acute in social sciences, where the unwritten and often unspoken rules for younger faculty are:

• Don't engage in political, social and economic policy debates outside academic research,
• Don't engage with broader community outside the walls of academia.

As a young academic, I was told on numerous occasions that writing in press is 'below academic standards', that speaking at non-academic conferences 'doesn't earn one any credit within the University walls', that 'peers don't look kindly on those who disagree with their philosophies in public', etc. The victim in all of this will be the entire academia, which is at a risk of ceasing to be “the locus of seeking truth" risks becoming a Faculty of Useless Knowledge, irrelevant to the society.