31/3/2013: Structural Reforms in Ireland: Far From Best-in-Class

Some interesting charts from the ECON review of the peripheral countries' structural reforms implementation during the crisis (full report is available here):

Note that by both measures, Ireland is not the 'best pupil in the class':

• By unadjusted metric, we are second in the 'class' in terms of responsiveness rate, but
• Once adjusting for the difference in reforms implemented and underlying conditions, we are only in the fifth (note: ECON chart is taken from the chart produced by the OECD, reproduced below which clearly shows our position to be worse than that of Italy)

In part, the above is driven by the fact that we have started our reforms earlier than other countries, hence, for example, in terms of labour market changes, we have most of the gains in the Gross Value Added per hour worked peaking in 2009-2010. Also, notice that our performance relative to other peripherals has deteriorated in 2011-2012 and is expected to remain there in 2013.

In part, however, the adjusted score is driven by structural differences in reforms adopted. And this implies that per OECD we are still ranked only fifth in the peripheral economies group when it comes to the adjusted scores over the broader period of 2009-2010 to 2011-2012:

31/3/2013: Are European Brahmins Cypriot crisis-free?

In an Orwelian Universe that is the EU, the rules are different for different castes... the Brahmins are, obviously, the top of the pile. Not surprisingly, amidst deposits outflows from Cyprus immediately prior to the EU sanctioned expropriations, there are strands of Cypriot Brahmins rushing out of their banks. Here's the report by Rossija 24 - Russian news agency on the topic:

 via a tweet:

Let's translate verbatim the above:

"Greek press has found compromising material on Cypriot President. According to the Greek media sources, few days before the Eurogroup decision to bail-in deposits, relatives of President Nicos Anastasiades took emergency steps to save their funds. The issue concerns the amount of EUR21 million in funds. A company, which belongs to the relatives of the President, transfered these funds from Laiki bank to London, as reported by the Rossija 24 TV channel. The Laiki Bank is currently undergoing restructuring, and haircuts on clients' funds can reach up to 80 percent."

We should note, of course, that this is just one report, albeit here is a Cypriot press report from just 30 minutes ago covering the same: http://www.incyprus.com.cy/en-gb/Top-Stories-News/4342/33996/money-movements-questioned and Greek reports: http://www.imerisia.gr/article.asp?catid=26517&subid=2&pubid=113018547 and http://www.nooz.gr/economy/suggeneis-anastasiadi-evgalan-kata8eseis-apo-ti-laiki31313 and http://www.zougla.gr/kosmos/article/ligo-prin-to-eurogroup-melos-tis-ikogenias-tou-anstasiadi-figadefse-xrimata .

31/3/2013: Unique Ireland? Why not... per IMF working paper...

Here's an interesting case of Ireland's uniqueness:

Eyraud, Luc and Moreno Badia, Marialuz, "Too Small to Fail? Subnational Spending Pressures in Europe" [(February 2013). IMF Working Paper No. 13/46] paper looks at the re-distribution of spending between national and sub-national governments within the EU over time, covering the period of the crisis. Due to the size of the banking sector measures and their impact on the Government budgets in Ireland, the paper excludes Ireland from the dataset when running analysis.

In other words, we are so out of line with the rest of Europe in terms of resources we threw at the banks during the crisis, that our data is no longer meaningfully comprable to the rest of EU.

Here are two charts illustrating this 'uniqueness':

31/3/2013: Bank Leverage, Systemic Crises and Debt v Equity Funding: Tax Asymmetry

As the readers of this blog would know, I have been advocating more symmetric tax treatment of equity and debt, both in terms of public and private bonds and lending taxation. Here's a recent IMF paper on the topic that provides evidence that asymmetric taxation of debt and equity, with preferential treatment of debt over equity, generated internal instability in the system, making it more prone to crises.

Mooij, Ruud A., Keen, Michael and Orihara, Masanori paper "Taxation, Bank Leverage, and Financial Crises" (February 2013). IMF Working Paper No. 13/48 argues that "that most corporate tax systems favor debt over equity finance is now widely recognized as, potentially, amplifying risks to financial stability. This paper makes a first attempt to explore, empirically, the link between this tax bias and the probability of financial crisis."

The study "…finds that greater tax bias is associated with significantly higher aggregate bank leverage, and that this in turn is associated with a significantly greater chance of crisis. The implication is that tax bias makes crises much more likely, and, conversely, that the welfare gains from policies to alleviate it can be substantial far greater than previous studies, which have ignored financial stability considerations, suggest."

The paper "aims to provide a first attempt to establish and quantify an empirical link between the tax incentives that encourage financial institutions (more precisely, banks, the group for which we have data) to finance themselves by debt rather than equity and the likelihood of financial crises erupting; and then to try to quantify the welfare gains that policies to address this bias might consequently yield."

The paper combines two elements in a causal chain:

"The first is that between the statutory corporate tax rate and banks’ leverage. This has received substantial attention in relation to non-financial firms, but very little in relation to the financial sector. Keen and De Mooij (2011), however, show that for banks too a higher corporate tax rate, amplifying the tax advantage of debt over equity finance, should in principle lead to higher levels of leverage; the presence of capital regulations does not affect the usual tax bias applying, so long as it is privately optimal for banks to hold some buffer over regulatory requirements (as they generally do).

[In other words, capital requirements regulations are not sufficient to address the problem created by skewed incentives. The authors state that "Regulation, of course, has historically had the dominant role in addressing such problems of excess leverage in the financial sector, and the higher and tighter capital requirements of Basel III should to some degree reduce the welfare costs of debt bias."]

Empirically too, Keen and de Mooij (2012) find that, for a large cross-country panel of banks, tax effects on leverage are significant—and, on average, about as large as for non-financial institutions. These effects are very much smaller, they also find, for the largest banks, which generally account for the vast bulk of all bank assets. …Importantly, the finding that tax distortions to leverage are small for the larger banks, which are massively larger than the rest, does not mean that the welfare impact of tax distortions is in aggregate negligible: even small changes in the leverage of very large banks could have a large impact on the likelihood of their distress or failure, and hence on the likelihood of financial crisis."

The second link in the causal chain is the link "between the aggregate leverage of the financial sector and the probability of financial crisis. We estimate such a relationship for OECD countries, …capturing data on the recent financial crisis… The results suggest sizeable and highly nonlinear effects of aggregate bank leverage on the probability of financial crisis."

"… we consider three tax reforms that would reduce the tax incentive to debt finance:

• a cut in the corporate tax rate; 
• adoption of an Allowance for Corporate Equity form of corporate tax (which would in principle eliminate debt bias); and 
• a ‘bank levy’ of broadly the kind that a dozen or so countries have introduced since the crisis."

"The implications of these reforms for aggregate leverage are readily estimated using the results above.

1. We suppose, as before, that a 1 percentage point reduction in the CIT rate reduces banks’ aggregate leverage by somewhere between 0.04 and 0.15. 
2. This means, for instance, that the bank levy of 10 bp would reduce financial leverage by between 0.1 and 0.4 percentage points, for example from 93 percent to 92.9 or 92.6. 
3. Eliminating debt bias altogether with an ACE would reduce leverage by 2.2 percentage points under what we shall take to be the central estimate of 0.08: say, from 93 to 90.8; with the upper bound estimate of 0.15, leverage would fall by 4.2 percentage points."

The above clearly suggests that ACE approach, basically removing disincentive to equity funding compared to other policy alternatives. It also shows that in impact terms, lower corporate tax rates are not sufficient to eliminate or reduce the adverse effects of the asymmetric treatment of debt against equity.

31/3/2013: German Hartz IV reforms - evidence

Another interesting paper, worth a read: Krebs, Tom and Scheffel, Martin, "Macroeconomic Evaluation of Labor Market Reform in Germany" (February 2013). IMF Working Paper No. 13/42.

Back in 2005 Germany undertook a massive reform of social welfare systems, known as Hartz IV reform. This "amounted to a complete overhaul of the German unemployment insurance system and resulted in a significant reduction in unemployment benefits for the long-term unemployed".

The IMF paper used "an incomplete-market model with search unemployment to evaluate the macroeconomic and welfare effects of the Hartz IV reform". The model was calibrated to German data before the reform followed by simulation of the calibrated model to identify the effects of Hartz IV.

"In our baseline calibration, we find that the reform has reduced the long-run (non-cyclical) unemployment rate in Germany by 1.4 percentage points. We also find that the welfare of employed households increases, but the welfare of unemployed households decreases even with moderate degree of risk aversion."

For all the debate about the merits of such reforms, it is pretty darn clear that Hartz IV-styled reforms - currently being advocated by the IMF and the EU for the peripheral states - cannot take place in the environment of protracted and structural Euro area-wide and national recessions and especially in the presence of other exacerbating factors, such as debt overhangs,  insolvency regime breaks, dysfunctional banking sector, monetary policy mismatch, etc.

Put simply, in 2005, German economy was into its second year of (anaemic at 0.7% in 2004 and 0.84% in 2005) growth with unemployment at an uncomfortable 11.2% still leagues below the current rates in the peripheral state. German government deficit in 2005 was at relatively benign 3.42% compared to the deficits in the peripheral states, with structural deficit at even lighter load of -2.6% of p-GDP and primary deficit at 1.0%. German debt/GDP ratio on Government side was at 68.5% of GDP. All of these parameters clearly indicate that Germany was in a much better starting position for consolidating social insurance systems than the peripheral states find themselves today.

31/3/2013: Draghi calling President Napolitano: a nasty precedent

Here's one of the best examples of the total departure of the EU institutions from the normal democratic constraints on their mandate vis-a-vis national affairs:

The story link is: http://www.reuters.com/article/2013/03/31/us-italy-vote-draghi-idUSBRE92U01W20130331?feedType=RSS&feedName=businessNews

For a reply:

That is correct (assuming the reported call did take place): the ECB represents a sub-section of the executive pillar of power in the EU (and via the national central banks - in the member states), just as the US Fed. Neither the Fed nor the ECB have any business in influencing or restricting the legislative pillar (in the case of the above incident - the electoral process) or the entire executive pillar (in the above case - pertaining to the Presidency to which monetary policy institutions are accountable or co-accountable whenever oversight over monetary policy institutions co-rests with legislature) or the judiciary (presumably, Mr Draghi might call on European or national judges too, should their workings approach the issues related to OMT or other aspects of the monetary policy).

To see this, simply replace ECB's Draghi with, say, General X of the Common Security & Defence Policy calling President Napolitano to express concerns about Italian elections. How fast will 'military interference in political affairs' rise to media headlines?

Europe is now clearly on a dangerous path that can lead to subversion or manipulation of democratic institutions and processes. 

31/3/2013: Entrepreneurship and the Great Recession

Staying on the theme of 'catching up with my reading' today - a very interesting paper by Fairlie, Robert W., "Entrepreneurship, Economic Conditions, and the Great Recession" (February 28, 2013). CESifo Working Paper Series No. 4140.

From the abstract:

"The “Great Recession” resulted in many business closings and foreclosures, but what effect did it have on business formation?

On the one hand, recessions decrease potential business income and wealth, but on the other hand they restrict opportunities in the wage/salary sector leaving the net effect on entrepreneurship ambiguous.

The most up-to-date microdata available -- the 1996 to 2009 Current Population Survey (CPS) -- are used to conduct a detailed analysis of the determinants of entrepreneurship at the individual level to shed light on this question.

• Regression estimates indicate that local labor market conditions are a major determinant of entrepreneurship. 
• Higher local unemployment rates are found to increase the probability that individuals start businesses. [Note: authors do not control for quality of entrepreneurship, e.g. survivorship rates for entrepreneurial ventures founded by 'forced' entrepreneurs out of unemployment spells]
• Home ownership and local home values for home owners are also found to have positive effects on business creation, but these effects are noticeably smaller. 
• Additional regression estimates indicate that individuals who are initially not employed respond more to high local unemployment rates by starting businesses than wage/salary workers. The results point to a consistent picture – the positive influences of slack labor markets outweigh the negative influences resulting in higher levels of business creation. Using the regression estimates for the local unemployment rate effects, I find that the predicted trend in entrepreneurship rates tracks the actual upward trend in entrepreneurship extremely well in the Great Recession."

Wait, what was that about 'home ownership' and 'local home values'? Sure this is not suggesting that negative equity might have an effect on entrepreneurship? Irish Government & our 'Green Jerseys' say that it only matters when one decides to move...

See three posts from 2010 that I wrote on the topic of Negative Equity effects in Ireland: Post 1, Post 2 and Post 3) and another link from 2010 on the topic of Negative Equity and entrepreneurship (here).

31/3/2013: R&D and tax policy: income tax or targeted tax credits?

And while we are on innovation vs policy topic, here's another interesting study, looking into policy drivers for R&D. Ernst, Christof, Richter, Katharina and Riedel, Nadine, "Corporate Taxation and the Quality of Research and Development". CESifo Working Paper Series No. 4139, February 2013.

The paper "examines the impact of tax incentives on corporate research and development (R&D) activity. Traditionally, R&D tax incentives have been provided in the form of special tax allowances and tax credits. In recent years, several countries moreover reduced their income tax rates on R&D output.

Previous papers have shown that all three tax instruments are effective in raising the quantity of R&D related activity. We provide evidence that, beyond this quantity effect, corporate taxation also distorts the quality of R&D projects, i.e. their innovativeness and revenue potential.

Using rich data on corporate patent applications to the European patent office, we find that a low tax rate on patent income is instrumental in attracting innovative projects with a high earnings potential and innovation level. The effect is statistically significant and economically relevant and prevails in a number of sensitivity checks. R&D tax credits and tax allowances are in turn not found to exert a statistically significant impact on project quality."

All is fine, folks, but what does one do when the two countries compete for R&D projects allocations in the environment where both have already set zero tax on patent income?

31/3/2013: World Trade Drivers: policy or simple innovation?

A very important issue of logistics and transport innovation effect on trade flows is tackled in the study by Bernhofen, Daniel M., El-Sahli, Zouheir and Kneller, Richard, titled "Estimating the Effects of the Container Revolution on World Trade" CESifo Working Paper Series No. 4136, February 2013.

[Note: Italics are mine]

From the abstract: "The introduction of containerization triggered complementary technological and organizational changes that revolutionized global freight transport. Despite numerous claims about the importance of containerization in stimulating international trade, econometric estimates on the effects of containerization on trade appear to be missing. Our paper fills this gap in the literature. Our key idea is to exploit time and cross-sectional variation in countries’ adoption of port or railway container facilities to construct a time-varying bilateral technology variable and estimate its effect on explaining variations in bilateral product level trade flows in a large panel for the period 1962-1990."

Per findings: "Our estimates suggest that containerization did not only stimulate trade in containerizable products (like auto parts) but also had complementary effects on non-containerizables (like automobiles). As expected, we find larger effects on North-North trade than on North-South or South-South trade and much smaller effects when ignoring railway containerization. Regarding North-North trade, the cumulative average treatment effects of containerization over a 20 year time period amount to about 700%, can be interpreted as causal, and are much larger than the effects of free trade agreements or the GATT. In a nutshell, we provide the first econometric evidence for containerization to be a driver of 20th century economic globalization."

Now, 700% over 20 years is a massive uplift in what was already a much-advanced trade system (North-North). With South-South and North-South trade flows now rapidly converging in terms of volumes and type of goods traded to those of North-North, I would suspect we will see an equally massive positive impact on these trade flows as well, and as a result on global trade.

The evidence presented in the study is of huge importance. It shows just how impactful can a simple, non-formal-R&D driven innovation can be and it also puts into the context the scope for policy intervention vs organic business-led innovation intervention in delivering market outcomes.

30/3/2013: A simple, yet revealing, exercise in house prices

Based on the latest reading for the Irish Residential Property Price Index, I computed three scenarios for recovery, based on 3 basic assumptions of:

1. Steady state growth of 5% per annum in nominal terms (roughly inflation + 3% pa)
2. Steady state growth at the average rate of annual growth clocked during 2005-2007 period, and
3. Steady state growth at inflation + 1% pa

Note, Scenario 3 is the closest scenario consistent with the general evidence from around the world that over the long run, property returns are at or below inflation rates.

Table below summarises the dates by which we can expect to regain 2007 peak in nominal terms:

Yep, turning the corner (whenever we might do that) won't even be close to getting back into the 'game'...

30/3/2013: Retail Sales in February: Deadman Still Walking

With all the Cypriot Meltdown excitement as the newsflow, Irish data releases slipped into 'noise background' this week, so time to fix that.

March 28th we saw the release of the retail sales data for Ireland for February 2013. The headline from CSO read: "Retail Sales Volume increased 0.3% in February 2013" which obviously is the good news. Except, in reality, reading below headline we discover that:

"The volume of retail sales (i.e. excluding price effects) increased by 0.3% in February 2013 when compared with January 2013 while there was no change in the annual figure.  If Motor Trades are excluded, the volume of retail sales decreased by 0.2% in February 2013 when compared with January 2013 and there was an annual increase of 1.0%."

Wait a second, ex-motors, retail sales fell 0.2% in volume in m/m terms, but were still up 1.0% y/y. Oh, and durable goods (e.g. Electrical Goods) sales were down again.

And in value terms? The stuff that makes retail businesses actually hire or fire workers and pay or not pay taxes?.. Much the same:

"The volume of retail sales (i.e. excluding price effects) increased by 0.3% in February 2013 when compared with January 2013 while there was no change in the annual figure.  If Motor Trades are excluded, the volume of retail sales decreased by 0.2% in February 2013 when compared with January 2013 and there was an annual increase of 1.0%."

Let's see some dynamics:

• Value of sales ex-motors averaged 96.6 in 3mo through February 2013 against 97.0 in previous 3mo period. 6mo average through February 2013 was 96.8 (virtually identical to 3mo average), implying effectively zero growth over 6 months period, although previous 6mo period average was 95.5.
• Over longer horizons: 2006-2007 average of the index stands at 112.1, which was down to 2010-2011 average of 96.6 and 2012 full year average of 96.0, and January-February 2013 average of 96.5. You can tell the that whole volume 'activity' is just a flat trend since January 2011 with some volatility around it.
• Volume of activity slipped on 3mo average through February 2013 to 100.1 from 100.6 in 3 months through November 2012. The rate of decline on 3mo averages basis in volume was more pronounced than for value index, which is a story consistent with pretty much the entire crisis - retailers are only able to shift volumes at the expense of revenues they get. Consumers are getting better deals, but this also means employment in the sector is unlikely to increase.
• 2012 average of 99.6 is pretty much matched by january-February 2013 average of 99.7 - again, flat line growth trend. And as before that one runs from January 2011.

I keep tracking Consumer Confidence here, to show that the whole idea of 'confidence' when not underpinned by supportive fundamentals is not a reasonable concept for anchoring one's expectations about real economic performance.

Here, per usual, updated charts linking (or rather showing the lack of links) confidence to retail sales indices:

Lastly, recall that I run my own index of Retail Sector Activity (RSAI) that is a much stronger correlative for retail sector indices:

Two things jump out from the chart above:

1. The overall flat-line trend in activity in the retail sector over January 2009-present period, showing that, in principle, there is no recovery and there is no sustained signal of one coming so far in the short term future.
2. Forward-looking RSAI has slipped (on 3mo average basis) from 107.9 in 3 months through November 2012 to 106.0 in 3 months through February 2013. M/m RSAI is down 1.83% and y/y it is up 1.84%, tracking correctly the overall dynamics in the CSO indices.

Hence, my expectation is for more of the same in the next 3 months, with retail sales slipping slightly in volume and value, posting closer to zero growth in y/y terms over Q2 2013. The deadman is still walking, for now... and the 'turning point' is still some corridors away...

30/3/2013: Irish Debt Deleveraging 2012: Not much happening

Over the recent years we have been told ad nausea that all the economic suffering and pain inflicted upon us was about 'deleveraging' our debt overhang, 'paying down our debts', 'repairing balancesheet of the economy' and so on. Well, surely, that should mean reduction in our total economic debt levels, right?

Wrong! Our debt levels, vis-a-vis the rest of the world are up on the crisis trough and on pre-crisis peak (EUR580bn in 2007 to EUR651.2bn in 2012), and our net position (foreign assets less foreign liabilities) is down from EUR119.4bn deficit in 2007 to EUR153.7bn deficit in 2012:

 The above exclude IFSC.

Meanwhile, IFSC continues to grow in size, both in absolute and relative terms:

• Foreign assets up from EUR1,810bn in 2007 to EUR2,319bn in 2012
• Foreign liabilities up from EUR1,727bn in 2007 to EUR2,322bn in 2012
• Proportionally to our total foreign assets and liabilities the IFSC has grown from 79.7% in 2007 to 82.3% in 2012 on assets side and from 74.9% in 2007 to 78.1% in 2012 on liabilities side.

Back to non-IFSC balancesheet (as our policy makers and civil servants love treating ISFC as some sort of a pariah when it comes to counting its liabilities, and as some sort of a hero when it comes to referencing it in terms of employment, tax generation etc):

Chart above shows frightening trends in terms of our foreign liabilities as a share of GDP and GNP. Put simply, in 2007, non-IFSC foreign liabilities stood at a massive 357.5% of our GNP. Last year, they reached a n even more dizzying 488.1%.

You might be tempted to start shouting - as common with our officials and 'green jerseys' - that the above are gross figures and that indeed we have vast assets that are worth just so much... Setting aside the delirium of actually thinking someone can sell these 'assets' to their full accounting / book value etc, err... things are not looking too bright on the net investment position (assets less liabilities) side:

In 2007, Irish net investment position vis-a-vis the rest of the world was a deficit of 63.3% of GDP and 73.6% of GNP. In 2012 the net position was in deficit of 93.9% of GDP and 115.2% of GNP. Put differently, even were the Irish state to expropriate all corporate, financial and household assets held abroad and sell them at their book value, Ireland would still be in a deficit in excess of 115% of our real economy.

But back to that question about 'deleveraging' our debt overhang, 'paying down our debts', 'repairing balancesheet of the economy' and so on... the answer to that one is that Ireland continues to increase the levels of its indebtedness. The composition of the debt might be changing, but that, folks, is irrelevant from the point of view that all debts - government, banking, household, corporate, etc - will have to be repaid and/or serviced out of our real economic activity, aka you & me working...