17/5/2013: Welcome to Surreal Irish National Accounts

A significant, but only because it is now 'official', confirmation that Ireland's GDP and GNP figures are vastly over-exaggerated by the distorting presence of some MNCs in Ireland has finally arrived to the pages of FT: http://www.ft.com/intl/cms/s/0/eb114bda-be3f-11e2-9b27-00144feab7de.html#axzz2TYJudjwo

As one of those who said this time and again, starting with my work in the Open Republic Institute in 2001 and through today, I am grateful to Jamie Smyth for pointing this out.

The ESRI, which - being tasked directly with doing research on Irish economy and being paid for doing such research - has slept through the years of boom as the Government wasted resources in chasing imaginary investment/GDP and spending/GDP targets. After years of the Social partnership bulls**t, we only now, driven into desperation by necessity of the crisis, are beginning to face the reality that we are poorer than our GDP and GNP levels actually imply.

I take heart that all those who never once before voiced their concern about the distorting nature of our MNCs-dependent economic variables are now quoted in the FT voicing that concern. Since the beginning of the crisis I put forward consistently a three-points position countering Ireland's official sustainability analysis when it comes the economy being able to sustain current levels of Government debt:

1. Despite all the focus in Irish and international media and official circles, it is the total economic debt mountain (household, government and non-financial corporate debts) that matters in determining sustainability of our economic development;
2. Irish economy's capacity to carry the above debt burden is determined not by GDP, but by something closer to an average of GNP and Total Domestic Demand which, in 2012, stood at 81.54 and 75.21% of our official GDP.
3. Irish exports growth is now becoming decoupled from the real economy as it is primarily driven by services exports which are dominated by a handful of tax arbitrage plays with little real connection to value added generated in this country.

The ESRI note cited in FT - detailed and well-research as it is - only scratches the surface of tax arbitrage effects on our official statistics. 

The note is available here: http://www.esri.ie/UserFiles/publications/RN20130102.pdf

16/5/2013: There are jobs & then there are...

Off the start - there is nothing wrong with debt collection as business when it is properly delivered and regulated / supervised. And there is nothing wrong with debt collection agency growing its workforce.

But, then again, there is nothing particularly laudable about this either.

Unless, that is, you are an Irish Government Minister who cares none but for a headline grabbing opportunity.

Capita - some background on the company is given here: http://www.rte.ie/news/2013/0516/450722-capita-jobs/ and http://namawinelake.wordpress.com/2010/08/15/capita-aka-crapita-%E2%80%93-service-provider-for-one-of-nama%E2%80%99s-most-lucrative-contracts/ - is to double its workforce in Ireland by bringing in 800 new jobs. There is no information on the split of Capita's activities in the ROI, but one can venture a guess that booming business of debt collections here will take up the bulk of the new jobs 'created'.

Irony has it - Capita's new HQs in Dublin will be at the heart of the pride of Irish economy: the Barrow Street cluster that houses top firms in law and ICT services, but also has the dubious distinction of housing Ireland's 'bad bank' Nama. Nothing like calling the 'knowledge economy neighbourhood meets debt collectors' a 'vote of confidence in the Irish economy'.

Have we lost all bearings and compases?

I, for one, can't wait for the next congratulatory flyer from FG to my home - it will undoubtedly explain how the misery of thousands of Irish homeowners facing repossessions benefits my local economy of Ringsend-Irishtown with blessed new jobs.

16/5/2013: On That Impossible Monetary Policy Dilemma

At last, the IMF has published something beefy on the extraordinary (or so-called 'unconventional') monetary policy instruments unrolled by the ECB, BOJ, BOE and the Fed since the start of the crisis in the context of the question I been asking for some time now: What happens when these measures are unwound?

See http://liswires.com/archives/2102 and http://trueeconomics.blogspot.ie/2012/10/28102012-ecb-and-technocratic-decay.html

The papers: UNCONVENTIONAL MONETARY POLICIES—RECENT EXPERIENCE AND PROSPECTS and UNCONVENTIONAL MONETARY POLICIES—RECENT EXPERIENCE AND PROSPECTS—BACKGROUND PAPER should be available on the IMF website shortly.

Box 2 in the main paper is worth a special consideration as it covers Potential Costs of Exit to Central Banks. Italics are mine.

Per IMF: "Losses to central bank balance sheets upon exit are likely to stem from a maturity mismatch between assets and liabilities. In normal circumstances, higher interest rates—and thus lower bond prices—would lead to an immediate valuation loss to the central bank. These losses, though, would be fully recouped if assets were held to maturity. [In other words, normally, when CBs exit QE operations, they sell the Government bonds accumulated during the QE. This leads to a rise in supply of Government bonds in the market, raising yields and lowering prices of these bonds, with CBs taking a 'loss' on lower prices basis. In normal cases, CBs tend to accumulate shorter-term Government bonds in greater numbers, so sales and thus price decreases would normally be associated with the front end of maturity profile - meaning with shorter-dated bonds. Lastly, in normal cases of QE, some of the shorter-dated bonds would have matured by the time the CBs begin dumping them in the market, naturally reducing some of the supply glut on exits.]

But current times are not normal. "Two things have changed with the current policy environment: (i) balance sheets have grown enormously, and (ii) assets purchased are much longer-dated on average and will likely not roll-off central bank balance sheets before exit begins."

This means that in current environment, as contrasted by normal unwinding of the QE operations. "…valuation losses will be amplified and become realized losses if central banks sell assets in an attempt to permanently diminish excess reserves. But central banks will not be able to shrink their balance sheets overnight. In the interim, similar losses would arise from paying higher interest rates on reserves (and other liquidity absorbing instruments) than earning on assets held (mostly fixed coupon payments). This would not have been the case in normal times, when there was no need to sell significant amounts of longer-dated bonds and when most central bank liabilities were non-interest bearing (currency in circulation)."

The IMF notes that "the ECB is less exposed to losses from higher interest rates as its assets— primarily loans to banks rather than bond purchases—are of relatively short maturity and yields of its loans to banks are indexed on the policy rate; the ECB is thus not included in the estimates of losses that follow." [Note: this does not mean that the ECB unwinding of extraordinary measures will be painless, but that the current IMF paper is not covering these. In many ways, ECB will face an even bigger problem: withdrawing liquidity supply to the banks that are sick (if not permanently, at least for a long period of time) will risk destabilising the financial system. This cost to ECB will likely be compounded by the fact that unwinding loans to banks will require banks to claw liquidity out of the existent assets in the environment where there is already a drastic shortage of credit supply to the real economy. Lastly, the ECB will also face indirect costs of unwinding its measures that will work through the mechanism similar to the above because European banks used much of ECB's emergency liquidity supply to buy Government bonds. Thus unlike say the BOE, ECB unwinding will lead to banks, not the ECB, selling some of the Government bonds and this will have an adverse impact on the Sovereign yields, despite the fact that the IMF does not estimate such effect in the present paper.]

The chart below "shows the net present value (NPV) estimate of losses in three different scenarios." Here's how to read that chart:

• "Losses are estimated given today’s balance sheet (no expansion) and the balance sheet that would result from expected purchases to end 2013 (end 2014 for the BOJ, accounting for QQME). 
• "Losses are estimated while assuming everything else remains unchanged (notably absent capital gains or income from asset holdings)… [so that] no stance is taken as to the precise path and timing of exit. ...These losses—which may be significant even if spread over several years—would impact fiscal balances through reduced profit transfers to government. 
• "Scenario 1 foresees a limited parallel shift in the yield curve by 100 bps from today’s levels. 
• "Scenario 2, a more likely case corresponding to a stronger growth scenario requiring a steady normalization of rates, suggests a flatter yield curve, 400 bps higher at the short end and 225 bps at the long. The scenario is similar to the Fed’s tightening from November 1993 to February 1995, which saw one year rates increase by around 400bps. Losses in this case would amount to between 2 percent and 4.3 percent of GDP,  depending on the central bank. 
• "Scenario 3 is a tail risk scenario, in which policy has to react to a loss of confidence in the currency or in the central bank’s commitment to price stability, or to a severe commodity price shock with second round effects. The short and long ends of the yield curve increase by 600 bps and 375 bps respectively, and losses rise to between 2 percent and 7.5 percent of GDP. 
• "Scenarios 2 and 3 foresee somewhat smaller hikes for the BOJ, given the persistence of the ZLB.

And now on transmission of the shocks: "The appropriate sequence of policy actions in an eventual exit is relatively clear.

• "A tightening cycle would begin with some forward guidance provided by the central bank on the timing and pace of interest rate hikes. [At which point bond markets will also start repricing forward Government paper, leading to bond markets prices drops and mounting paper losses on the assets side of CBs balance sheets]
• "It would then be followed by higher short-term interest rates, guided over a first (likely lengthy) period by central bank floor rates (which can be hiked at any time, independently of the level of reserves) until excess reserves are substantially removed. [So shorter rates will rise first, implying that shorter-term interbank funding costs will also rise, leading to a rise in lone rates disproportionately for banks reliant on short interbank loans - guess where will Irish banks be by then if the 'reforms' we have for them in mind succeed?] 
• "Term open market operations (“reverse repos” or other liquidity absorbing instruments) would be used to drain excess reserves initially; outright asset sales would likely be more difficult in the early part of the transition, until the price of longer-term assets had adjusted. Higher reserve requirements (remunerated or unremunerated) could also be employed." [All of which mean that whatever credit supply to private sector would have been before the unwinding starts, it will become even more constrained and costlier to obtain once the unwinding begins.]
• For a kicker to that last comment: "The transmission of policy, though, is likely to somewhat bumpy in the tightening cycle associated with exit. Reduced competition for funding in the presence of substantial excess reserve balances tends to weaken the transmission mechanism. Though higher rates paid on reserves and other liquidity absorbing instruments should generally increase other short-term market rates (for example, unsecured interbank rates, repo rates, commercial paper rates), there may be some slippage, with market rates lagging. This could occur because of market segmentation, with cash rich lenders not able to benefit from the central bank’s official deposit rate, or lack of arbitrage in a hardly operating money market flush with liquidity. Also, there may be limits as to how much liquidity the central bank can absorb at reasonable rates, since banks would face capital charges and leverage ratio constraints against repo lending." [But none of these effects - generally acting to reduce immediate pressure of CB unwinding of QE measures - apply to the Irish banks and will unlikely apply to the ECB case in general precisely because the banks own balance sheets will be directly impacted by the ECB unwinding.]
• "There is also a risk that even if policy rates are raised gradually, longer-term yields could increase sharply. While central banks should be able to manage expectations of the pace of bond sales and rise in future short-term rates—at least for the coming 2 to 3 years—through enhanced forward guidance and more solid communication channels, they have less control over the term premium component of long-term rates (the return required to bear interest rate risk) and over longer-term expectations. These could jump because leveraged investors could “run for the door” in the hope of locking in profits, because of expected reverse portfolio rebalancing effects from bond sales, uncertainty over inflation prospects or because of fiscal policy, financial stability or other macro risks emerging at the time of exit. To the extent a rise in long-term rates triggers cross-border flows, exchange rate volatility is bound to increase, further complicating policy decisions." [All of which means two things: (a) any and all institutions holding 'sticky' (e.g. mandated) positions in G7 bonds will be hammered by speculative and book-profit exits (guess what these institutions are? right: pension funds and insurance companies and banks who 'hold to maturity' G7-linked risky bonds - e.g peripheral euro area bonds), and (b) long-term interest rates will rise and can rise in a 'jump fashion' - abruptly and significantly (and guess what determines the cost of mortgages and existent not-fixed rate loans?).]

And so we do  it forget the ECB plight, here's what the technical note had to say about Frankfurt's dilemma:  "The ECB faces relatively little direct interest rate risk, as the bulk of its loan assets are linked to its short-term policy rate. However, it may be difficult for the ECB to shrink its balance sheet, as those commercial banks currently borrowing from the ECB may not easily be able to repay loans on maturity. The ECB could use other instruments to drain surplus liquidity, but could then face some loss of net income as the yield on liquidity-draining open market operations (OMOs) could exceed the rate earned on lending, assuming a positively-sloped yield curve, if draining operations were of a longer maturity." [I would evoke the 'No Sh*t, Sherlock" clause here: who could have thought Euro area's commercial banks "may not easily be able to repay loans on maturity". I mean they are beaming with health and are full of good loans they can call in to cover an ECB unwind call… right?]

Obviously, not the IMF as it does cover the 'geographic' divergence in unwinding risks: "But the ECB potentially faces credit risk on its lending to the banking system for financial stability purposes. In a “benign” scenario, where monetary tightening is a response to higher inflation resulting from economic growth, non-performing loans should fall and bank balance sheets should improve. But even then, some areas of the eurozone may lag in economic recovery. Banks in such areas could come under further pressure in a rising rate environment: weak banks may not be able to pass on to weak customers the rising costs of financing their balance sheets." [No prize for guessing which 'areas' the IMF has in mind for being whacked the hardest with ECB unwinding measures.]

So would you like to take the centre-case scenario at 1/2 Fed impact measure for ECB costs and apply to Ireland's case? Ok - we are guessing here, but it will be close to:

1. Euro area-wide impact of -1.0-1.5% GDP shaved off with most impact absorbed by the peripheral states; and
2. Yields rises of ca 200-220bps on longer term paper, which will automatically translate into massive losses on banks balancesheets (and all balancesheets for institutions holding Government bonds). 
3. The impact of (2) will be more severe for peripheral countries via 2 channels: normal premium channel on peripheral bonds compared to Bunds and via margins hikes on loans by the banks to compensate for losses sustained on bonds.
4. Net result? Try mortgages rates rising over time by, say 300bps? or 350bps? You say 'extreme'? Not really - per crisis historical ECB repo rate averages at 3.10% which is 260bps higher than current repo rate... 

Ooopsy... as some would say. Have a nice day paying that 30 year mortgage on negative equity home in Co Meath (or Dublin 4 for that matter).

16/5/2013: Euro Area 'Austerity' in One Chart

Frankly, folks, there is nothing like making a factual argument across emotive subject lines... I have put up two posts on Euro area 'austerity' - here and here - and the readers want more numbers, usually in hope of finding a hole in my arguments.

Here is, perhaps a better, summary of the Euro area Austerity in its own numbers - in levels of nominal expenditure and revenues:

I hope this settles the issue:

1. Euro area austerity has meant revenues collected by the governments are up
2. Euro area austerity has meant that Government spending is up

Tell me if this is a 'savage cuts' story or a 'tax burden rising' story...

15/5/2013: Italy v Spain in Big 4's Sickest Economy contest

More unpleasant stuff from the Euro zone. Headlines in the morning today:

• Italian banks suffer the worst credit crunch in their history with banks credit down 2.12% in March 2013 y/y, according to the Italian Banking Association (ABI);
• Meanwhile, bad loans have reached €64.3bn in March, rising by 4.3% y/y and by 33% m/m. 
• Italian banks loans to households and non-financial companies dropped 3.1% in March y/y, falling to €1.46bn. 
• Italian industrial production fell 5.2% in March y/y, the worst figure in the Eurozone’ Big 4 economies. Industrial production was down 1.5% in Germany in March and 1.6% in France.
• The Italian housing market activity its now at lowest level since 1985. Last year 448,364 properties were sold, or 27.5% fewer than in 2011 and only 18,000 ahead of 1985 sales. 

It looks like Italy is going head on into competing with Spain for the title of the Big 4's sickest economy.

15/5/2013: Straight from 1984... The Department of Stabilisation...

Fir the fun of reading between the lines, follow my italics:

"IMF Executive Board Approves €1 Billion Arrangement Under Extended Fund Facility for Cyprus

The Executive Board of the International Monetary Fund (IMF) today approved a three-year SDR 891 million (about €1 billion, or US$1.33 billion; 563 percent of the country’s quota) arrangement under the Extended Fund Facility  (EFF) for Cyprus in support of the authorities’ economic adjustment program. [Given that Greece has more than double time to 'repay' its 'facilities' and Cyprus is likely to face an economic collapse worse than that experienced in Greece, good luck betting on that 3-year window not staying open less than a decade] The approval allows for the immediate disbursement of SDR 74.25 million (about €86 million, or US$110.7 million).

The EFF arrangement is part of a combined financing package with the European Stability Mechanism (ESM) amounting to €10 billion. It is intended to stabilize the country’s financial system [completely destabilised by the Troika arranging 'stabilisation' of the Greek economy], achieve fiscal sustainability [by pushing the GDP down by close to 13% in 2013 and likely another 15% by the end of the 'stabilisation' period], and support the recovery of economic activity [devastated by the Greek 'rescue' by the Troika and botched 'rescue' of Cyprus] to preserve the welfare of the population [who now need welfare as their jobs and savings are being vaporised by the economic 'stabilisation' measures of the Troika]."

15/5/2013: What IMF assessment of Malta has to do with Ireland?

Here's an interesting excerpt from the IMF Article IV conclusions for Malta, released today (italics are mine):

"In the longer term, regulatory and tax reform at the European or global level could erode Malta’s competitiveness. The Maltese economy, including the financial sector and other niche services, has greatly benefitted from a business-friendly tax regime. Greater fiscal integration of EU member states and potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output, and fiscal revenues."

Now, Ireland is a much more aggressively reliant on tax arbitrage than Malta to sustain its economic model and has been doing so for longer than Malta. One wonders, how come IMF is not warning about the same risks in the case of Ireland?


Another thing one learns from the IMF note on Malta: "The largest banks will be placed under the direct oversight of the ECB from 2014. The MFSA should work closely with the ECB to ensure no reduction in the supervisory capacity of these banks."

Wait, we've all been operating under the impression that direct oversight from ECB is designed to increase quality and quantity of oversight. Quite interestingly, the IMF is concerned that it might reduce the currently attained levels of supervision.

14/5/2013: Ending German Austerity... and then what?

Everyone is running around with the latest catch-phrase designed to phase out thought: Germany must end austerity. So, folks, what will happen should Germany really end austerity?

Whatever it might mean, suppose end of austerity implies Germany moves from the currently projected general government deficit of -0.31% of GDP to a deficit of -3.31% of GDP, thus increasing Government spending by EUR81 billion in 2013. What then?

1. Historically (since 1997 through forecast for 2018 by the IMF) EUR1 billion increase in German GDP is associated with EUR0.21 billion rise in German Current Account, although the relationship is not strong enough to call it statistically. In other words, Germans do not spend their surpluses on goods, like other economies do. They are more likely to increase their current account surpluses when income rises.
2. Also, historically, EUR1 billion in German GDP growth is associated with EUR0.67 billion rise in German investment. 
3. Furthermore, shrinking Government deficits in Germany are associated with widening of current account deficits (see chart below) and declining overall investment in the economy
4. EUR81 billion in the euro area overall context is nothing but pittance, even before it gets diluted by German own internal demand.

Note: Change in current account balance is negative when current account deficit is falling

Let's not draw many causal conclusions out of the above, but the clear thing is: Germans do not tend to spend their budget deficits on imports of goods and services at any rate worth mentioning.

Herein rests the problem for the policy idiots squad: if Germans spend EUR81 billion more on Government, short of mandating that Berlin ships cheques out to the Euro Periphery, what on earth will this end of austerity do to help Ireland, Portugal, Spain, Greece or Italy? Add German tourists' bodies on the beaches of Italy and Greece? Fly truckloads of German youths to Spain for booze-ups? Increase sales of Fado music 700-fold? Restart bungalows sales craze in Lahinch? Open German savings accounts in Cyprus? Will these end Euro area periphery crises?

Neither one of the countries in the Euro periphery makes much of what Germans want. Irish trade with Germany is robust, but it is dominated heavily by the non-Irish corporates who channel tax arbitrage via trade, leaving little on the ground in Ireland to call 'national income'. 

So what if Germany 'ends austerity'? German demand for goods and services will go up. But it will be demand for German-made and Core-made goods and services, plus stuff from Asia Pacific. It will also push German unemployment from 5.6% to 5.4% or maybe 5.3%, depending on how many more peripheral countries' emigrants Germany can absorb. 

These might be good things for Germany. But sure as hell, if German stimulus were to work like neo-Keynesianistas hope it will, pressure on ECB to keep rates low and banks liquidity ample will be reduced, while internal German rates imbalance will amplify. German bond yields might also rise, which will only add to the already hefty debt servicing pressures in euro periphery. Does anyone think it might be a good idea for ECB to hike rates then? No?

Truth is - there is no substitute for getting Euro periphery's economies in order. German stimulus or 'end of German austerity' can sound plausibly nice, but the real problem in the EU is not German sluggish demand (it is a part of German problem, to be frank, but not the major one when it comes to the Euro area as a whole). The real problem in the EU is lack of real, tangible, non-leveraged growth sources.

14/5/2013: Corporate Tax Haven Ireland Weekly Links Page

Corporate Tax Haven Ireland in the news... again:
http://www.bloomberg.com/news/2013-05-13/europe-eases-corporate-tax-dodge-as-worker-burdens-rise.html

Update: Twitter in the news: http://www.telegraph.co.uk/technology/twitter/10056570/Twitter-CEO-resigns-as-UK-boss-after-accounting-fiasco.html
Note Irish connection.

Keep track of 'Tax Haven' view of Irish economic policies by following the links, starting here:
http://trueeconomics.blogspot.ie/2013/05/352013-not-week-goes-by-without-tax.html

Update 17/5/2013:
Three more stories, both relating to Google operations in Ireland:
http://www.independent.co.uk/news/business/comment/ben-chu-lets-not-get-bamboozled-by-google-in-the-global-tax-avoidance-debate-8620046.html
and
http://www.guardian.co.uk/technology/2013/may/16/google-told-by-mp-you-do-do-evil
and
http://www.independent.ie/business/irish/no-apology-for-low-tax-regime-as-google-debate-drags-on-richard-burton-29274843.html

I find it bizarre that Minister Bruton feels anyone on earth is asking for Ireland's apology. I think the point of this debate about the role of tax havens, like Ireland, is that policymakers around the world are seeking to close the loopholes through which companies engage in aggressive tax optimisation. Minister Bruton should focus on how Ireland can deal with this threat, as well as on how Ireland can develop a business platform (low tax is an important part of this platform) that actually operates on adding value here and not on beggaring our trading partners.

Minister Bruton's point about the need to create jobs in Ireland is nonsensical in the above debate. If we create jobs here on foot of value added in the Irish economy, then there is no problem with our MNCs activities globally, because low tax regime applies only to value added created here. Our trading partners have a problem with Ireland acting as a conduit for tax minimization whereby there is zero value added created in Ireland, but instead value added created elsewhere is booked via Ireland into tax havens. These forms of tax arbitrage do not create any jobs here in Ireland and generate no tax revenue here.

14/5/2013: Sunday Times May 12, 2013: UK, Europe and Ireland

This is an unedited version of my article for Sunday Times, May 12, 2013.

Loosely based on the famous quip by the US ex-Secretary of Defense, Donald Rumsfeld, uncertain events that present significant risks of disrupting the established status quo can be classed into three categories: the unknown knowns, the known unknowns, and the unknown unknowns.

The former category represents risks we can continuously monitor, assess and price in our policy decisions and everyday lives. For example, a known presence of foreign exchange risk relates to the unknown bilateral exchange rate price, prompting investors and businesses alike to hedge against the potentially adverse changes in the rate.

At the other extreme, the unknown unknowns are what Nassim Taleb called the 'Black Swans'. Neither the extent of their impact, nor the nature of the risk they present are known to us, making hedging against such risks completely impossible.

The case in between the two extremes relates to the uncertain events often called the 'Grey Swan'. This is the most challenging of all forms of uncertainty. On the one hand we know that something very disruptive can happen in the case of approaching risk, but we have no ability to gauge with any precision as to the extent of this risk.

The best current example of such a 'Grey Swan' from Ireland's perspective is the uncertainty surrounding the future of the UK participation in the EU.

Consider first the background that shapes the risk. Aside from significant cultural, historical, institutional and familial links between the two countries, Ireland shares physical and maritime borders with the UK.

As the result of the above links, the UK today is a singularly the largest trading and financial investment partner for Ireland, as far as bilateral trade between nation states is concerned.

In 2012, bilateral merchandise trade between Ireland and the UK stood at EUR 31.7 billion, 23.5% more than our merchandise trade with the US and Canada combined. Ireland-UK trade flows in goods amounted to 61% of our bilateral trade with the entire EU27 (excluding the UK). Ireland's bilateral trade with the UK in services amounted to EUR 25.2 billion in 2011 - the latest year for which data is available. This places the UK as the second largest services trading partner for Ireland after the US. Ireland's trade balance in services with the UK is in strong EUR 5 billion annual surplus, contrasting a trade deficit of EUR 19 billion in our services trade with the US.

On investment side, in 2011, Irish residents held some EUR 261 billion of UK portfolio securities, representing second largest portfolio of overseas investments after those in the US. Of these, over EUR 170 billion of securities related to Irish private sector non-financial corporations' assets. While Irish resident banks deleveraging saw their UK assets holdings fall from EUR140.5 billion in 2009 to EUR 90.4 billion in 2011, Irish resident corporate holdings of UK assets rose from EUR 120.2 billion to EUR 170.2 billion. Irish FDI into the UK at the end of 2011 stood at EUR 50.2 billion against UK FDI into Ireland at EUR 22.2 billion, making the UK our second largest bilateral FDI partner.

The trade and investment links are built on a complex web of economic and institutional inter-connections between our two countries. In addition to direct services trade figures, bilateral economic relations between Ireland and the UK extend to include shared services provision. For example, Irish IFSC heavily dependent on providing back-office and other specialist support to the UK-based institutions. Likewise, our research and development, education and other core professional services and functions rely heavily on institutional cross-links with the UK universities, professional services and research firms and clients.

Beyond purely economic ties, the UK position within the EU is more closely aligned to that of Ireland and our interest than for any other member state.

Both, Ireland and the UK share in the common agenda of seeing increased liberalisation in trade in services across the EU, and in accelerating the painfully slow process of implementation of the EU Services Directive. Both economies, focused on developing new markets and increasing global reach of their industries, require significant autonomy within and devolution of the EU policymaking. In more ways than Dublin is willing to admit, the UK position within the EU as an independently-minded, skeptical and cautious player that constantly acting to test the EU decisions against national economic and social interests serves Ireland much better than the Continental modus operandi of serial surrender of national interests to German and French diktat.

In other words, like it or not, Dublin is closer to London than it is to Berlin. Looking beyond the current crisis, this proximity is based on an equal partnership and symmetry of objectives, rather than on hierarchical hegemony of geopolitical power that is shaping the rest of the EU.


This realisation presents us with a dilemma. A UK referendum on the country continued membership in the EU can lead only three possible outcomes, all with serious implications for Ireland.

In the best-case scenario, UK achieves successful renegotiation of the terms and conditions for its membership in the EU. This will result in the UK continuing to position itself as a cautious outsider to the European core, providing counterbalance to Franco-German axis of geopolitical and economic power that smaller states with strong pro-growth interests, like Ireland, require in order not to succumb to dictate from Berlin or Brussels. This will also mean that our trade and investment links with the UK can continue offering us risks and markets diversification opportunities that we have enjoyed to-date.

In a less benign scenario, the UK remains in the EU, while failing to renegotiate its membership conditions. In this case the UK will be required to rapidly converge with the Continental core on major policies. These will include reforms of corporate taxation codes, harmonisation of other tax systems, and regulatory systems and enforcement institutions consolidation. The result will be reduced diversification of European institutions and increased vulnerability of these institutions to adverse economic and political shocks. Greater centralisation of power and decision making in Berlin and Paris, with London joining the Core, will leave Ireland on the margins of Europe alongside a small number of other demographically younger and economically more dynamic countries, such as Finland, Sweden, and the Netherlands. UK’s inevitable joining of the euro will seal the end of Irish economic model of providing a platform for trade and investment entry into the euro area.

The worst-case scenario, however, is that associated with the possibility that the UK might exit the EU. Even if unlikely, this outcome deserves some serious consideration if only for the impact it can have on Irish economy.

An exit can trigger an outright trade war and capital flows controls between the EU and the UK. There is little love lost between German and French elites and the UK position within Europe, and past experiences with Norway, Switzerland, Lichtenstein and Bulgaria show that EU is capable of acting as a bully in the schoolyard. The consequences of such a conflict will be disastrous for Ireland.

Trade flows disruption, while not necessarily cutting off all exports and imports between the two countries, can shave off as much as 5 percentage points of our GDP overnight. In the longer-run, the impact of reduced joint projects development and co-shared services provision across the border will further reduce our access to the UK markets.

Disruptions to co-located financial services, from banking to pension funds, investment funds and insurance business, as well as in retail, logistics, and wholesale sectors will be significant. Rising cost of services, associated with lower competitive pressures, will benefit some Irish vested interests, such as a number of our semi-state companies, but at the expense of all consumers.

Changes within the EU in the wake of a possible UK exit will undoubtedly harm Irish economic growth prospects. Absent the UK critical assessment and testing of the EU drive for integration and enlargement, Brussels will be free to pursue aggressive tax reforms along the lines currently being developed under the 'enhanced cooperation' procedures by Berlin and Paris. The EU Services Directive agenda will be killed off completely by Paris and Berlin, neither of which want to see increased competition in protected services. Even in its current initial stage the directive promises to boost Irish GDP by 0.5-1% per annum. Research from Open Europe, published this week, estimates that Ireland can gain up to 2.1% of GDP from enhanced liberalization of trade in services beyond the current Services Directive.

Long run impact of the UK adopting a direct competitive stance vis-a-vis the EU can cost Ireland up to 10-12 percentage points off our economy's potential output with little on offer to replace this lost activity.

Bleak as the picture above might be, it offers a clear direction for Irish position vis-a-vis the ongoing debate within the UK and in Europe about both the role of our closest neighbour in the European project and the future of the EU itself.

Ireland needs a strong UK that continues to act as check and balance on the EU's persistent drive toward more integration and bureaucratization of the common policies and governance space. Ireland also needs a strong EU with diversified and flexible institutions capable of absorbing various shocks and creating a functional policies laboratory for possible responses to adverse global and internal challenges. We to support continued UK participation in Europe while respecting our neighbor’s national agenda by encouraging the EU to proactively engage with London in modernizing the terms of the UK membership within the EU.

Box-out:

The 2013 QS University Subject Rankings published over the last few weeks should provide some food for thought for Ireland’s higher education mandarins. From the top of the rankings, only one Irish university, Trinity College, Dublin (ranked 67th in the world) makes it into top 100, with our second-best university, UCD, ranking in 131st place. UCC (ranked 190th) completes the trio of Irish universities in top 250 worldwide institutions. In subject rankings, Irish universities are performing poorly across a number of core disciplines. In Mathematics, Environmental Science, and Earth and Marine Sciences no Irish University ranks in top 150. In Chemistry, TCD is the only university to make top 100. No Irish university makes global rankings in Materials Science. No Irish university ranks in top 100 in Physics and Astronomy, Chemical Engineering, Civil and Structural Engineering and in Electrical and Electronic Engineering. TCD is the only university in Ireland with a Computer Science and Information Systems faculty ranked in top 100. The list of mediocre results goes on and on. Put simply, Ireland needs a complete overhaul of its higher education system if we were to even being matching the Government rhetoric about the quality of our workforce with reality.

14/5/2013: The Sick Man of Europe is... Europe

An excellent set of stats on the decline of public legitimacy of the EU between 2012 and 2013 from Pew Research: http://www.pewglobal.org/2013/05/13/the-new-sick-man-of-europe-the-european-union/

Certainly worth a read and confirms similar trends captured by other surveys.

14/5/2013: Negative Equity and Entrepreneurship: Local Evidence from the US

I have written before about the role positive/negative home equity has on entrepreneurship and real economic activity. Remember, the Irish Government and media believe that negative equity matters only when/if the household wants or needs to move home and that it has no effect outside this scenario.

A recent (March 2013) paper (linked below) from NBER argues very clearly that positive/negative equity has a real positive/negative effect on employment and business creation and that this effect is local to property prices region. In other words, unlike FDI or other foreign investments, home equity impacts domestic investment, locally anchored, and with it - domestic jobs creation.

Adelino, Manuel, Schoar, Antoinette and Severino, Felipe paper "documents the role of the collateral lending channel to facilitate small business starts and self-employment in the period before the financial crisis of 2008. We document that between 2002 and 2007 areas with a bigger run up in house prices experienced a strong increase in employment in small businesses compared to employment in large firms in the same industries. This increase in small business employment was particularly pronounced in (1) industries that need little startup capital and can thus more easily be financed out of increases in housing as collateral; (2) manufacturing industries where goods are shipped over long distances, which rules out that local demand is driving the expansion. We show that this effect is separate from an aggregate demand channel that relies on home equity based borrowing leading to increased demand and employment creation."

Some more granularity to the top-level results [italics are mine]:

"Overall, the evidence we present in this paper identifies the causal effect house prices in the creation of new small firms. These results show that access to collateral allowed individuals to start small businesses or to become self-employed. We conjecture that without access to this collateral in the form of real estate assets, many individuals would not have made the transition from unemployment to starting a new business or self-employment.

We show that the effect of house prices is concentrated in small firms only and had no causal effect  on employment at large firms. [In other words, there is no measurable effect on location competitiveness from house prices. Irish Government claims that residential property prices declines improved Irish competitiveness are not supported by the evidence from the US.]

Importantly, our results also hold when we exclude industries that are most likely to be affected by local demand shocks and when we restrict our attention to manufacturing industries. The effect of house prices is also stronger in industries where the amount of capital needed to start a new firm is lower, consistent with the hypothesis that housing serves as collateral but is not sufficient to fund large capital needs." [This goes to the issue of which types of firms creation benefit most from collateral access. The evidence suggests that smaller firms do so. But the fact that capital constraints bind also suggests that by typology, services firms, which are human capital intensive and require low levels of physical capital, benefit also more than average. Now, Ireland is human capital intensive economy, so draw your own conclusions.]

Adelino, Manuel, Schoar, Antoinette and Severino, Felipe, House Prices, Collateral and Self-Employment (March 2013). NBER Working Paper No. w18868. Available at SSRN: http://ssrn.com/abstract=2230758