26/1/16: 'More than 1,000 jobs per week' Government Claims v Reality

One senior TD and a Junior Minister with position relating, indirectly, to employment and the labour market has just posted an interesting statement. A part of the statement goes thus: “we used the Action Plans for Jobs process to drive job creation, creating more than a 1000 jobs a week”.

Now, let’s raise two points. One philosophical, another purely arithmetic.

Philosophically, I am not aware of any Government that claims creation of jobs. Technically, public jobs are either created by the Civil Service or another Public body, as opposed to the Government itself. Practically, any jobs creation, in public or private sector is enabled by the economy (people working in, investing in, paying taxes in and interacting with public and private sectors) and not by the Government. Thus, Government may facilitate jobs creation by enacting supportive legislation or providing legislative and/or regulatory strategy, or not impede one, but it cannot create jobs. Minister can act as PR middle(wo)men and announce jobs created, but that is about as close to jobs creation as they ever get.

Aside from this, there is a simple matter of arithmetic.

Recall that the current Government came into power at the end of 1Q 2011. Let us suppose the Government really got down to ‘creating jobs’ by 1Q 2012. Which means the Government has been at its jobs game for roughly 14-15 quarters through 3Q 2015 or, at the lower end 3 years and a half. That means that the Government should have created “over” 182,000 jobs in that period. This benign to the Minister claim, because if we are to look at the record of the entire duration of the Government, his claim would have equated to roughly 221,000 jobs created.

Let us note that 1Q 20912 was the lowest point in employment levels during the crisis, so comparatives to that base should improve Government position: prior to 2Q 2012 jobs were being destroyed in the economy, past the end of 1Q 2012 they were being added.

Keep the two numbers in your mind: we are told that the Government has ‘created’ either more than 182,000 or more than 221,000 jobs over its tenure, depending on where one starts to count.

Now, consult CSO QNHS database - the source of official counts for numbers in employment. Between the end of 1Q 2012 and 3Q 2015 (the latest for which we have data), total employment rose 158,000. But wait, these are not all jobs. 4,500 of that increase is in the category of Assisting Relative. And 121,200 of these additions are employees, including schemes. Beyond this, the above increase also includes 30,100 new (added) self-employed with no employees.

It is hard to assume that the Government can claim it 'created' self-employment jobs where there is not enough activity to hire staff, or that it increased the need to help relatives.

So put things together in a handy table:

Numbers speak for themselves. By the very best metric, Government is more than 1/2 year shy of the lowest end of the claim of 'more than 1,000 jobs created per week'. It is more than 1/2 year shy of the claim that there were '1,000 jobs created per week'.

This Government deserves credit for helping sustain conditions for the recovery. Some of these conditions trace to the policies put in place by its predecessor and continued by the present Government, some are down to Troika and implemented by this Government, some are undoubtedly facilitated by the efforts of the current Government. The economy is recovering and, by some metrics, very robustly. And jobs are being created by the economy (yes, by entrepreneurs, enterprises, their employees and their clients and investors, but not by the Government).

This is not to take away from the positives the Government should rightly claim. But it is to point out that some of the outlandishly bombastic claims are not quite warranted.

26/1/16: Russian External Debt: Deleveraging Goes On

In previous post, I covered the drawdowns on Russian SWFs over 2015. As promised, here is the capital outflows / debt redemptions part of the equation.

The latest data for changes in the composition of External Debt of the Russian Federation that we have dates back to the end of 2Q 2015. We also have projections of maturities of debt forward, allowing us to estimate - based on schedule - debt redemptions through 4Q 2015. Chart below illustrates the trend.

As shown in the chart above, based on estimated schedule of repayments, by the end of 2015, Russia total external debt has declined by some USD177.1 billion or 24 percent. Some of this was converted into equity and domestic debt, and some (3Q-4Q maturities) would have been rolled over. Still, that is a sizeable chunk of external debt gone - a very rapid rate of economy’s deleveraging.

Compositionally, a bulk of this came from the ‘Other Sectors’, but in percentage terms, the largest decline has been in the General Government category, where the decline y/y was 36 percent.

Looking at forward schedule of maturities, the following chart highlights the overall trend decline in debt redemptions coming forward in 2016 and into 2Q 2017.

Again, the largest burden of debt redemptions falls onto ‘Other Sectors’ - excluding Government, Central Bank and Banks.

The total quantum of debt due to mature in 2016 is USD76.58 billion, of which Government debt maturing amounts to just 1.7 billion, banks debts maturing account for USD19.27 billion and the balance is due to mature for ‘Other Sectors’.

These are aggregates, so they include debt owed to parent entities, debt owed to direct investors, debt convertible into equity, debt written by banks affiliated with corporates, etc. In other words, a large chunk of this debt is not really under any pressure of repayment. General estimates put such debt at around 20-25 percent of the total debt due in the Banking and Other sectors. If we take a partial adjustment for this, netting out ‘Other Sectors’ external debt held by Investment enterprises and in form of Trade Credit and Financial Leases, etc, then total debt maturing in 2016 per schedule falls to, roughly, USD 59.5 billion - well shy of the aggregate total officially reported as USD 76.58 billion.


So in a summary: Russian deleveraging continued strongly in 2015 and will be ongoing still in 2016. 2016 levels of debt redemptions across all sectors of the economy are shallower than in 2015. Although this rate of deleveraging does present significant challenges to the economy from the point of view of funds available for investment and to support operations, overall deleveraging process is, in effect, itself an investment into future capacity of companies and banks to raise funding. The main impediment to the re-starting of this process, however, is the geopolitical environment of sanctions against Russian banks that de facto closed access to external funding for the vast majority of sanctioned and non-sanctioned enterprises and banks.


Next, I will be covering Russian capital outflows, so stay tuned of that.

25/1/16: Russian Sovereign Funds: Down, but Not Out, Yet…

In the context of 2016 Budget, Russian sovereign reserves dynamics are clearly an important consideration. For example, in his recent statement, former Russian Finance Minister, Kudrin, has suggested that if Budget deficit reaches above 5% of GDP in 2016, the entire cushion of liquid foreign reserves held by the Government will be exhausted by the end of the year, leaving Russia exposed to big cuts in the budget for 2017. This is similar to the positions of Russia's Economy Minister Alexei Ulyukayev and the current Finance Minister Anton Siluanov.

The expectations are based on three considerations:
1) 2015 dynamics of Russian sovereign wealth funds;
2) Funds outflows expected under the external debt repayment schedules; and
3) A potentially massive call on Russian reserves from the VEB capital requirements.

I covered the last point earlier here. So let’s take a look at the first point.

Russia’s main and more liquid Reserve Fund shrank substantially last year as it carried out its explicit mandate to provide support for fiscal balance. Set up in 2008, the fund holds only liquid foreign assets and 2015 became the first year since the Great Recession and the Global Financial Crisis (2009-2010 in Russia’s case) when it experienced net withdrawals. The value of the fund fell from roughly USD90 billion to ca USD50 billion by the end of December 2015.

However, the key to these holdings is their Ruble equivalent, as Russian budgetary expenditures are in domestic currency. By this metric, the Fund has been doing somewhat better. By end of December 2015, the Reserve Fund held assets valued at RUB3.6 trillion, amounting to almost 5 percent of Russian GDP or roughly 1.7 times Budget 2016 requirement for deficit coverage. Budget 2016 is based on expectation that the Reserve Fund will supply some RUB2.1 trillion to cover the deficit.

The sticking point is that Budget 2016 - in its current reincarnation - is based on oil price of USD50pb. The Ministry of Finance is currently preparing amended Budget based on USD30-35pb price of Brent, but we are yet to see the resulting deficits projections. What we do know is that the Government has requested up to 10 percent cuts across public expenditure for 2016. Absent such cuts, and if oil prices remain around USD30pb mark, the deficit is likely to balloon to the levels where 2016 deficit will end up fully depleting the Reserve Fund.

Added safety cushion, of course, will be provided by devaluation of the Ruble. This worked pretty well in 2015, but the problem going into 2016 is that required further devaluations will likely bring Ruble into USDRUB 90+ range, inducing severe redistribution of losses onto the shoulders of consumers and cutting hard into companies investment in new equipment and technologies.

Bofit provided a handy chart showing the dynamics of Fund resources and a breakdown of these dynamics by key factors

Aside from the Reserve Fund, Russia also has the National Welfare Fund which was set up to underwrite public pensions. The Fund has been used to provide capital and funding to Russian banks shut out of the international borrowing in form of bonds purchases and deposits with the banks, as well as to some Russian companies, in form of debt purchases. These deposits and loans, however, are not liquid and, therefore, not available for fiscal supports. About only hope for some liquidity extraction from these allocations is via Russian corporates using cash flows from exports to repay the Fund - something that is unlikely to create significant buffers for the Budget.

At the end of 2015, the National Welfare Fund held assets valued at USD72 billion, of which USD48 billion (or RUB3.5 trillion) was held in relatively liquid foreign-currency assets and the balance held in assets written against domestic systemically important banks and companies. Even assuming - optimistically - that 10 percent of the residual assets can be cashed in over 2016, the liquidity available from the Fund runs to around USD50 billion.

Thus, total liquidity cushion held by two Russian SWFs currently amounts to USD100 billion without adjusting for liquidity risks and costs, and if we are to take nominal adjustments for these two factors, liquidity cushion probably falls to USD75-80 billion total.

It is worth noting, however, that Russia has other international reserves at its disposal. Per official data, as of the ned of December 2015, total International Reserves stood at USD368.4 billion, down USD17.06 billion on December 2014 and down USD222.17 billion on all time peak. In accessible reserves, Russia has International funds (excluding SDRs and IMF reserves) of USD363.07 billion.

I will be covering funds outflows schedule for 2016 in a separate post, so stay tuned.

25/1/16: Nordic Model: Not Too Heavy Handed on Corporate Profits

Much of the tax debate nowadays has been around tax base erosion and corporate taxes. But the old issue of what to tax: capital or profits is still unresolved. One interesting myth, associated with this debate, is that Nordic countries run a more ‘balanced’ tax system that relies on corporate profit taxes and avoids the problem of so-called harmful tax competition commonly attributed to Anglo-Saxon models where, again allegedly, corporations are treated softly with low tax rates and more benign tax regimes.

Well, a myth is a myth. And a recent paper, titled “Taxing Mobile Capital and Profits: The Nordic Welfare States” by Guttorm Schjelderup (CESIFO WORKING PAPER NO. 5603 NOVEMBER 2015) goes in depth to dispel it.

Per author: “The Nordic countries have traditionally been characterized by an extensive welfare state, a homogenous population and labour force, and redistributive taxation. This has changed in recent years.”

First point of interest is WHY has it changed. Author attributes the change to

• Increased immigration, 
• Ageing population, and 
• “Competition for capital among countries”

These factors “…have put pressures on public finances and the welfare state. These changes can be attributed to the globalization process whereby national economies become more integrated. Economic integration takes place in terms of increasing factor mobility, in particular mobility of capital, and rising volumes of trade in goods and services.”

Now, we have our first lesson: if you run a globally-integrated economy, while you have a modern (aka post-baby boom society) you will see these three factors at play in your economy too. No one’s immune.

“An argument frequently used by political lobby groups is that with free capital mobility corporations shouldn't be taxed at all and that taxing investment income is actually bad for workers. The argument is that if you cut taxes on investment income, more investment is encouraged. More investment means people have more equipment and technology to work with, which should increase the productivity of labour and thus wages and economic growth. Put differently, a tax on mobile capital would lead to an outflow of capital that would cause wages to fall; effectively shifting the full burden of the tax on capital onto workers. It is then better to tax workers directly and levy a zero tax on capital.”

Ok, we’ve heard this before. But is it making any sense?

Per author: “The argument above relies on strong assumptions, among them that labour is immobile and cannot evade taxation, that there are no country specific rents, and that domestic firms are not owned in part by foreigners.” However,

• “If domestic firms, say, are partly owned by foreigners, taxing capital would imply that some of the tax burden is shifted onto foreigners and that part of the welfare state is then financed by foreigners. This alone may warrant a positive tax on investment capital.”
• “If industrial agglomeration is concentrated in one single country, a government may, through a positive source tax on capital, be able to exploit the locational rent created by agglomeration forces and thus increase welfare.”

More importantly, “the zero tax on capital result is also difficult to confirm empirically. Yagan (2014), for example, …finds that it caused zero change in corporate investment in U.S. unlisted firms and that it had no impact on employee compensation. It did, however, have an immediate impact on financial pay-outs to shareholders. Alstadsæter et al. (2015)… find that the Swedish 2006 dividend tax cut did not affect aggregate investment but that it affected the allocation of corporate investment. In particular, …relative to cash-rich firms, cash-constrained firms increased their investments after the dividend tax cut.”

Key, however, is that corporate tax acts as “…a “backstop” to the personal income tax. If a country abolished the corporate tax rate, wealthy individuals in particular would be given an incentive to reclassify their labour earnings as corporate income, typically using offshore corporate structures and escape tax. The corporate tax might also be needed to avoid excessive income shifting between labour income and capital income. Finally, the corporate tax also acts as a withholding tax on equity income earned by non-resident shareholders, who might otherwise escape taxation in the source country.”

Now onto evidence regarding evolution of tax regimes. 

“Countries throughout the world have reduced their corporate taxes in an effort to attract or retain corporate investments. The Nordic countries have pioneered what is commonly known as the dual income tax (DIT). It combines a flat tax rate on capital income with progressive taxation of labour income. One of the arguments in favor of the DIT is that it allows policy makers to lower the corporate tax rate to reduce the risk of capital flight, whilst at the same time tax distributed dividends to personal shareholders.”

But there are “challenges of taxing capital for small open economies. Although the corporate tax share of GDP in most countries is only around 3-4%, it is an important tax because it acts as a “backstop” for the personal tax rate. …The pressures of tax competition are exacerbated by tax planning and income shifting to low tax countries by multinationals. Studies show that multinationals pay less tax than domestic firms and this may give them a competitive edge over domestic firms. The long term effects may be changes in ownership structure that affect competition in markets and make the corporate tax base more tax sensitive. Profit shifting is undertaken through transfer pricing and thin capitalization (excessive debt).” Care to spot Irish trends here? Why, they are pretty obvious.

But back to the Nordics vs Anglo-Saxons arguments. Per paper, “It is interesting to note that the Nordic countries seem to have gone further in terms of abolishing redistributive capital taxes than countries traditionally associated with polices much less tuned to redistribution. Aaberge and Atkinson (2010) shown how income inequality at the top of the distribution has increased in Anglo-Saxon countries, whereas the same rise in top income shares was not experienced by Continental European countries. They find that the Norwegian and Swedish experience over the twentieth century is similar to the Anglo-Saxon countries in that top shares, and the concentration among top incomes have first fallen and then risen. Norway differs from Sweden in that that the top shares rose more sharply in the period 1990-2006. Between 1980 and 2004, for example, the share of the top 1 per cent more than doubled in Norway, but rose less than half in Sweden.”

What are the reasons for these trends?

“Several explanations have been put forward to explain why Norway sets itself apart. The implementation of the 1992 tax reform abolished the dividend tax and lead to a sharp increase in dividends and capital gains among the richest in Norway. Capital taxation in Sweden was less favourable. Substantial oil production in Norway started some 15 years before the rise in inequality, but could still be an explanatory factor due to constrained cash in this sector in the initial phase of production. Capital market reforms with liberalization of interest rates and an upturn in business cycles are also important factors that are hard to disentangle, but they certainly played a role.”

Social impact of tax-linked inequality? “Capital taxation also affects income mobility, and concerns about rising inequality have often been countered by constant changes in the composition of top income earners. If so, the rise in top incomes may not translate into “economic power”. Aaberge et al. (2013) study who enters and leaves the top income groups in Norway in the period 1967-2011. Their main conclusion is that despite large changes in top income mobility over the last four decades, the magnitude of the effect of the changes in mobility on the income shares was moderate.”

What’s the future holds? “Competition among countries to attract mobile capital is a persistent phenomenon and will be a driver towards still lower taxes on mobile capital. A major change from the past, then, is less ability to redistribute, increasing income inequality, and rising immigration from poor countries. In sum these forces may affect trust between members of society. The level of trust is positively linked to economic growth. Herein lies a major challenge for the Nordic welfare states.”

And as an aside, here’s the actual draw on Nordic v Anglo-Saxon patterns in taxation: “In 2004, the classical welfare states in Scandinavia and continental Europe had lower ratios of statutory corporate to wage taxes than the Anglo-Saxon countries (except Ireland). In 2004, the corporate tax rate was only 63% of the wage tax rate for an average worker in Sweden, but 171% of the wage tax rate in the United States. Such differences are in striking contrast to the common perception that social democratic governments (as in Scandinavia and continental Europe) share a higher preference for redistribution, as compared to more conservative and free market oriented types of governments.”

Oops… who’s the neoliberal b*&ch now?..

24/1/16: House Prices, Local Demand and Homeownership Status

House prices bust was a major dimension of the recent Great Recession around the world. Nonetheless, contrary to all evidence, many political leaders have opted to dismiss the adverse impacts of shocks like negative equity (due to price declines and pre-crisis debt ramp ups) and wealth effects on aggregate demand (first order price effects).

An interesting study based on the U.S. data tests the aggregate impacts of house prices changes on consumption, while controlling for homeownership status (renters v owners).

Titled “House Prices, Local Demand, and Retail Prices” and co-authored by Johannes Stroebel and Joseph Vavra (CESIFO WORKING PAPER NO. 5607, NOVEMBER 2015) the study used “detailed micro data to document a causal response of local retail price to changes in house prices, with elasticities of 15%-20% across housing booms and busts. Notably, these price responses are largest in zip codes with many homeowners, and non-existent in zip codes with mostly renters.”

In other words, not only impacts of house price changes are significant, they are also bifurcated across two types of home occupiers - owners and renters, with renters exhibiting effectively no sensitivity to home prices changes in terms of their demand.

The authors “provide evidence that these retail price responses are driven by changes in markups rather than by changes in local costs. … Markups rise with house prices, particularly in high homeownership locations, because greater housing wealth reduces homeowners’ demand elasticity, and firms raise markups in response. Consistent with this explanation, shopping data confirms that house price changes have opposite effects on the price sensitivity of homeowners and renters.”

Overall, “taken together, our empirical results provide evidence of an important link between changes in household wealth, shopping behavior and firm price-setting. Positive shocks to wealth cause households to become less price-sensitive and firms respond by raising markups and prices.”

So do house prices matter for aggregate demand? They do. Does homeownership smooth or amplify effects of shocks to house prices on the aggregate economy? It appears to amplify them. Should monetary and fiscal policies be asymmetric for areas with high homeownership concentration as opposed to areas with high renters concentration? Yep. Ditto for countries, instead of areas.

Of course, in the Euro area, how does one structure differential monetary policies across countries so diverse as renters-concentrated Germany vs homeowners concentrated Holland or Ireland? Err… can we check that one as yet another problem with Euro architecture?..

24/1/16: European Financial Networks: Prepare for Bloodletting to Commence

A recent paper, titled "Transmission Channels of Systemic Risk and Contagion in the European Financial Network" co-authored by Nikos Paltalidis, Dimitrios Gounopoulos, Renatas Kizys, Yiannis Koutelidakis (Journal of Banking and Finance, gated) tackles a very interesting problem relating to the systemic stability of the European banking system and the bi-directional contagion channels shifting/transmitting systemic shocks between the banks and the sovereigns.

Following the euro area banking crisis of 2008-2012 (with residual effects of this crisis still strongly present in the so-called euro area 'periphery'), financial systems analysts and modellers came to the realisation that a number of key questions relating to overall system stability remain un-answered to-date. These include:

• What determines the intensity with which exogenous shocks propagate in the financial system as a whole (and how this intensity carries across banking systems)?
• How do we "identify, measure and understand the nature and the source of systemic risk in order to improve the underlying risks that banks face, to avert banks’ liquidation ex ante and to promote macro-prudential policy tools"? 
• How do systemic risks arise in the cases where such risks are endogenous to the banking system itself?
• How resilient is the euro area banking system (under improved regulatory and supervisory regimes) to systemic risk?
• How "…shocks in economic and financial channels propagate in the banking sector"? 
• And related to the above: "In the presence of a distress situation how the financial system performs? Have the new capital rules rendered the European banking industry safer? What is the primary source of systemic risk? How financial contagion propagates within the Eurozone?"

As the authors correctly note, "These fundamental themes remain unanswered, and hence obtaining the answers is critical and at the heart of most of the recent research on systemic risk."

Lacking empirical evidence (due to proximate timing of events and their extreme-tail nature) the authors create “a unique interconnected, dynamic and continuous-time model of financial networks with complete market structure (i.e. interbank loan market) and two additional independent channels of systemic risk (i.e. sovereign credit risk and asset price risk).”

Summary of the findings relating to sources of shocks:

1. “…A shock in the interbank loan market causes the higher amount of losses in the banking network”;
2. “…Losses generated by the sovereign credit risk channel transmit faster through the contagion channel, triggering a cascade of bank failures. This shock can cause banks to stop using the interbank market to trade with each other and can also lead banks to liquidate their asset holdings in order to meet their short-term funding demands.”
3. “Moreover, we evaluate the impact of reduced collateral values and provide novel evidence that asset price contagion can also trigger severe direct losses and defaults in the banking system.”

So the model does support the view that “the Sovereign Credit Risk channel dominates systemic risks amplified in the euro area banking systems and hence, it is the primary source of systemic risk.” Which is quite interesting from a number of perspectives:

• Firstly, we tend to think about the Global Financial Crisis as a mother of all systemic crises and we tend to attribute the degree of disruption in the crisis to the origins of the crisis shocks: the financialisation of the ‘bubbles’ in real assets (e.g. real estate), leading to liquidity crunch and then to solvency crunch. We think of the sovereign shock channel as being in play only because of banks-sovereign link. And we think that the second order contagion from the sovereign to the banks is secondary in magnitude to the GFC. It appears that things are much more complex and inter-connected both in terms of direction of contagion and orders of disruption caused.
• Secondly, we tend to ignore the relationship between the banks bailouts, QE programmes and equity markets. We think of them as related, but separate acts, e.g.: banks bailouts require funds which are supplied via sovereigns which need to obtain financial resources, which they do via QE, which simultaneously lowers the cost of investment and increases valuations of equities. But the problem is that we also have direct QE —> Equity valuations —> Banks balance sheet pathways. Just as asset prices collapse or illiquidity can trigger a liquidity run by the banks and defaults and losses within the banking system, so are asset prices increases can lead to improved liquidity conditions for the banks and improved banks balance sheets.
• Thirdly, the study provides “…novel evidence that systemic risk in the euro area banking system didn’t meaningfully decrease as it is evident that shocks in the three independent channels -interbank market, sovereign credit risk, asset price risk- trigger domino effects in the banking system.” Which sort of tells us what we suspected all along: the entire ‘firewalls have been built’ brigade of European politicos is eating hopium by truckloads. There are no ‘firewalls’. There are bits of wet cardboard stuck into the cracks and a perennial hope they stay well moisturised by occasional rains. 

Now, let’s give it a thought: since the end of the crisis, we’ve been told that solution to the problem of preventing future crises and alleviating the costs of those that still might happen is more coordination, harmonisation and integration of banking systems under the watchful eye of ECB. In other words, more internationalisation of domestic banks - more linking between them and banks operating in other economies within the Euro area. What does evidence have to say on that? “…we find that the cross-border transmission of systemic shocks depends on the size and the degree of exposure of the banking sector in a foreign financial system. Particularly, the more exposed domestic banks are to the foreign banking systems, the greater are the systemic risks and the spillover effects from foreign financial shocks to the domestic banking sector.”

Ya wouldn’t! No, ya couldn’t! But… baby… we had firewalls and we had EBU and more interconnected system of Euro area-wide banking supervision… and we now have?.. err… Yep, in the words of the authors: “Finally, the results imply that the European banking industry amid the post-crisis deleverage, recapitalisation and the new regulatory rules, continues to be markedly vulnerable and conducive to systemic risks and financial contagion.”

24/1/16: Improving on a Poor Base: Dublin in Global Financial Centres Rankings

Based on the Global Financial Centres 2015 rankings, Dublin is currently occupying a rather poorly 46th place - an improvement on 52nd in 2014, but still in a league of relative minnows like Casablanca, Istanbul, Bangkok et al. 

It is worth noting that Dubai is in a respectable 16th place. Of course, one can occasionally hear Irish development agencies staff bragging about how Dubai was always keen on copying Irish IFSC experience… well, apparently they’ve copied it better than we built it. 

Dublin does a bit better when pitched against European counterparts, ranking 11th in Europe alongside other tax havens of Jersey, Guernsey, Gibraltar and Isle of Man. But Luxembourg - a place of similar standing to Ireland on tax and other issues is ranked six place ahead of us.

Sadly, we do not get into top 12 in any (repeat, any) of sub-indices, including the ones we claim such a strong position in: human capital and business environment. What’s up, dudes?! Ah, well, it turns out the world is a competitive place and having Prime Minister who chirps about ‘best little country…’ is just not enough.

So moar diesel… folks… that IFSC engine is purring out smoke… 

24/1/16: Unobserved Ability and Entrepreneurship

Yesterday, I posted some links relating to non-Cognitive Skills, contextualising these into the Gig-Economy related issues. Here is another interesting study relating to human capital and linking unobserved (and hard to measure) ability to entrepreneurship.

From the policymakers' and indeed investors and other market participants perspective, the question of why do some individuals become entrepreneurs is a salient one.

Identifying the causal relationships between external conditions, systems and policy environments, as well as behavioural and other drivers of entrepreneurship is of great value for setting policies and systems for enhancing the rate of entrepreneurship creation in the economy. A recent paper, titled "Unobserved Ability and Entrepreneurship" by Deepak Hegde and Justin Tumlinson (Ifo Institute at the University of Munich, April 20, 2015) attempts to answer to key questions surrounding the formation of entrepreneurship, namely:

1. Why do individuals become entrepreneurs? and
2. When do they succeed? 

The authors "develop a model in which individuals use pedigree (e.g., educational qualifications) as a signal to convince employers of their unobserved ability. However, this signal is imperfect…" So far - logical: upon attaining a level of education, and controlling for quality of that education (complexity of degree programme, subject matter, quality of awarding institution, duration of studies, attainment of grades etc), a graduate acquire more than a sum of knowledge and skills attached to the degree. They also acquire a signal that can be communicated to their potential employer that conveys they lateen (hidden) abilities; attitude toward work, aptitude, ability to work in teams, ability to work on complex systems of tasks etc.

Problem is - the signal is noisy. For example, a graduate with 4.0 GPA from a second tier university can have better potential abilities than a graduate with 3.7 GPA from a first tier ranked university. But that information may not be clearly evident to the potential employer. As the result, there can be a large mismatch between what an applicant thinks their ability is and what their CV signals to the potential employer.

In the paper, theoretical model delivers a clear cut outcome (emphasis mine): "…individuals who correctly believe their ability is greater than their pedigree conveys to employers, choose entrepreneurship. Since ability, not pedigree, matters for productivity, entrepreneurs earn more than employees of the same pedigree."

The authors use US and UK data to test their model prediction (again, emphasis is mine): "Our empirical analysis of two separate nationally representative longitudinal samples of individuals residing in the US and the UK supports the model’s predictions that

• (A) Entrepreneurs have higher ability than employees of the same pedigree, 
• (B) Employees have better pedigree than entrepreneurs of the same ability, and 
• (C) Entrepreneurs earn more, on average, than employees of the same pedigree, and their earnings display higher variance."

Point C clearly indicates that entrepreneurs earn positive risk premium for effectively (correctly, on average) betting on their ability over their pedigree. In other words, the take chance in themselves and, on average, win. The real question, however, is why exactly do their earnings exhibit higher variance - is it due to distributional effects across the entrepreneurs by their ability, or is it due to risk-adjusted returns being similar, or is it due to exogenous shocks to entrepreneurs incomes (e.g. tax system-induced or contractually-structured)?

These are key questions we do not yet address in research sufficiently enough to allow us to understand better what the Gig-Economy and entrepreneurship in modern day setting imply in terms of aggregate consumption, investment, household investment and decision making by entire household in terms of labour supply, educational choices (for parents and children), etc.

As some might say... it's complicated...

24/1/16: High Yield Bonds Flash Red for Growth

An interesting regularity in the markets observed by JPM research: High Yield debt as a lead indicator of recessions… and of equities…

Self-explanatory…

Some more academic links on the high yield bonds forward prediction of business cycles:

• Via credit risk channel: Wang, Pengfei and Miao, Jianjun, "Credit Risk and Business Cycles" (September 8, 2010)
• Via productivity channel: Estevão, Marcello M. and Severo, Tiago, "Financial Shocks and TFP Growth" (Janurary 2010). IMF Working Papers, Vol. , pp. 1-35, 2010
• Via yield curve shape: Peña, Juan Ignacio and Rodríguez, Rosa, "On the Economic Link Between Asset Prices and Real Activity". Journal of Business Finance & Accounting, Vol. 34, Nos. 5-6, pp. 889-916, June/July 2007. 

23/1/16: Russian External Balance 2015

At the end of 2015, based on the preliminary estimates of 2015 balance of payments statistics from the Central Bank of Russia, Russian trade volumes with the rest of the world stood at just under 2010 levels. This is hardly new, as 2010 values of trade - both for exports and imports of goods and services - have been breached back in 3Q 2015. This erases gains between 2010 and 2013 (with 2013 posting all-time record high volumes and values of trade flows)

In 2015, exports revenues fell more than 30% in USD terms and 17% in Euro terms year on year. Imports expenditures fell 35% in USD terms and 22% in Euro terms. Perhaps somewhat surprisingly, 4Q figures came in broadly in line with annual figures. This is surprising due to imports and exports-lifting seasonal effects.

As exports shrunk less than imports, current account surplus actually rose both in level terms and relative to GDP. At the peak trade year of 2013, current account surplus was USD35 billion, rising to USD58 billion in 2014. 2015 preliminary estimate puts full year current account surplus at USD66 billion. Relative to GDP, current account surplus rose from 1.7% in 2013 to 5.4% in 2015.

These are remarkable figures, reflective of both devaluation of the ruble, the ability of the economy to take on imports contraction, and the relative resilience of exporters. Exports of goods and services were down massively, still, from USD593 billion in 2013 to USD389 billion in 2015. While trade balance in Goods fell from USD182 billion in 2013 to USD146 billion in 2015, trade deficit in services shrunk from USD58 billion in 2013 to USD37 billion in 2015.

The key to overall balance improvements, however, was in the category of “Other Current Account” - covering foreign earnings expatriation from Russia - here the deficit of USD89 billion in 2013 fell to USD76 billion in 2014 and to USD43 billion in 2015. Similarly, on the balance of payments side, “Fictitious Transactions” line of balance - covering Russian corporates exports of capital from Russia - fell from USD27 billion in 2013 to USD9 billion in 2014 and USD 1 billion in 2015. Balance of payments for Private Sector also improved, dramatically, with deficit of USD63 billion in 2013 ballooning to a deficit of USD152 billion in 2014 before falling to a deficit of USD57 billion in 2015.

BOFIT provides a neat summary table of latest Balance of Payments breakdown figures for 2013-2015:

Source: BOFIT

23/1/16: Corporate Profits v GDP: Not a Good Sign

One interesting relationship in recent weeks has been flashing red: the relationship between annual nominal GDP growth rates for the U.S. and the reported growth rates in corporate profits for non-financial corporations. 

Source: Author own calculations based on data from Fred

As shown in the chart above, growth rate in non-financial corporations’ profits has recently dipped below zero, posting -4.26% reading in 3Q 2015. The last time corporate profits took a nose dive was in 1Q 2014. Over the last four U.S. recessions, corporate profits growth rates have been a relatively consistent lead indicator of troubles brewing ahead.

Things are not exactly on a healthy side. While two quarters separated by more than a year of positive data may be just a glitch, it is worth noting that since 1989 on, there have been no period in which a recession was not preceded by decline in corporate profits, sometimes (1991 case) as far out as 2 years ahead.

But you can take my word with a grain of salt, so here’s Citi Index of corporate profits… 

Bloomberg headline that accompanied it: “Global earnings downgrades haven’t been this bad in 7 years”.

Ah, the repaired world…

23/1/16: Financial Globalisation and Tradeoffs Under Common Currency

A paper I recently cited in a research project for the European Parliament that is worth reading: "Trilemmas and Tradeoffs: Living with Financial Globalization" by Maurice Obstfeld. Some of my research on the matter, yet to be published (once the EU Parliament group clears it) is covered here: http://trueeconomics.blogspot.com/2016/01/19116-after-crisis-is-there-light-at.html and see slides 5-8 here: http://trueeconomics.blogspot.com/2015/09/17915-predict-conference-data-analytics.html.

This is one of the core papers one simply must be acquainted with if you are to begin understanding the web of contradictions inherent in the structure of modern financial flows (in the case of Obstfeld's paper, these are linked to the Emerging Markets, but much of it also applies to the euro).


The paper "evaluates the capacity of emerging market economies (EMEs) to moderate the domestic impact of global financial and monetary forces through their own monetary policies. Those EMEs able to exploit a flexible exchange rate are far better positioned than those that devote monetary policy to fixing the rate – a reflection of the classical monetary policy trilemma.” The problem, as Obstfeld correctly notes, is that in modern environment, “exchange rate changes alone do not insulate economies from foreign financial and monetary shocks. While potentially a potent source of economic benefits, financial globalization does have a downside for economic management. It worsens the tradeoffs monetary policy faces in navigating among multiple domestic objectives.”

Per Obstfeld, the knock on effect is that “This drawback of globalization raises the marginal value of additional tools of macroeconomic and financial policy. Unfortunately, the availability of such tools is constrained by a financial policy trilemma, [which] posits the incompatibility of national responsibility for financial policy, international financial integration, and financial stability.”

This, of course, is quite interesting. Value of own (independent) tools beyond flexible exchange rates rises with globalisation, which normally incentivises more (not less) activism and interference from domestic (or regional - in the case of monetary integration) regulators, supervisors and enforcers. In other words, Central Banks and Fin Regs grow in size (swelling to design, fulfil and enforce new ‘functions’). And all of this expensive activity take place amidst the environment where none of can lead to effective and tangible outcomes, because of the presence of the second trilemma: in a globalised world, national regulators are a waste of space (ok, we can put it more politically correctly: they are highly ineffective).

Give this another view from this argument: ‘national’ above is not the same as sovereign. Instead, it is ‘national’ per currency definition. So ECB is ‘national’ in these terms. Now, recall, that in recent years we have been assured that we’ve learned lessons of the recent crisis, and having learned them, we created a new, very big, very expensive and very intrusive tier of supervision and regulation - the tier of ECB and centralised European Banking regulatory framework of European Banking Union (EBU). But, wait, per Obstfeld - that means preciously little, folks, as long as Europe remains integrated into globalised financial markets.

Obstfeld’s paper actually is a middle ground, believe it or not, in the wider debate. As noted by Obstfeld: “My argument that independent monetary policy is feasible for financially open EMEs, but limited in what it can achieve, takes a middle ground between more extreme positions in the debate about monetary independence in open economies. On one side, Woodford (2010, p. 14) concludes: “I find it difficult to construct scenarios under which globalization would interfere in any substantial way with the ability of domestic monetary policy to maintain control over the dynamics of inflation.” His pre-GFC analysis, however, leaves aside financial-market imperfections and views inflation targeting as the only objective of monetary control. On the other side, Rey (2013) argues that the monetary trilemma really is a dilemma, because EMEs can exercise no monetary autonomy from United States policy (or the global financial cycle) unless they impose capital controls.”

Now, set aside again the whole malarky about Emerging Markets there… and think back to ECB… If Rey is correct, ECB can only assure functioning of EBU by either abandoning rate policy independence or by abandoning global integration (imposing de facto or de sure capital controls).

Of course, in a way, bondholders’ bail-ins rules and depositors bail-ins rules and practices - the very sort of things the EBU and ECB’s leadership rest so far - are a form of capital controls. Extreme form. So may be we are on that road to ‘resolving trilemmas’ already?..

Have a nice day... and happy banking...