22/7/2012: Banking sector deregulation and corporate innovation

An interesting study: “Credit Supply and Corporate Innovation” by Mario Daniele Amore, Cédric Schneider and Alminas Zaldokas (July 19, 2012, link) covers the impact of banking sector deregulation in the US on corporate innovation.

The authors present evidence that “banking development plays a key role in technological progress. We focus on firms’ innovative performance, measured by patent-based metrics, and employ exogenous variations in banking development arising from the staggered deregulation of banking activities across US states during the 1980s and 1990s. We find that deregulation had significant beneficial effects on the quantity and quality of innovation activities, especially for firms highly dependent on external capital and located closer to entering banks. Furthermore, we find that these results are partly driven by a greater ability of deregulated banks to geographically diversify credit risk.”

Figure 1 shows “the association between state-level innovative activity, as measured by the number of patents, and the total bank credit supply in the state. While it suggests that wider access to bank loans may be associated with a higher degree of innovation, this evidence is plagued by the endogeneity of financial development. Arguably, general economic conditions, industry characteristics and other unobserved factors may influence both firms’ innovation and credit availability, thus biasing the effect of finance on technological progress. In addition, the effect may even be reversed if firms with higher value-added projects create demand for more efficient financial institutions. Our contribution is to establish the causal effect of banking development on innovation.”

Main results:

Patents: 

“Our result suggests that deregulation had a beneficial effect on the number of patents over the analyzed period. In particular, allowing out-of-state banks to enter the state led to a significant increase in the number of granted patents after controlling for state and application year fixed effects.”

“allowing out-of-state banks to enter the state increased corporate innovation by 13.8%”

Overall: “the deregulation coefficient [is] both statistically and economically relevant, indicating a 12.6% increase in patenting” due to deregulation.

Quality of innovation:

The study also shows that deregulation has led to an increase in quality of innovation as measured by the quality and nature of patents. “…interstate banking deregulation led to a significant and economically relevant increase in the quality of patents. … indicating a 10.1% increase in expected forward citation counts.” “…interstate banking deregulation had a positive and significant effect on the generality of patents: firms subject to deregulation exhibited a higher propensity to patent within broader technological fields,” and “firms increased the originality of patents” in response to financial deregulation. “Taken together with our previous finding on citations, these results reinforce the notion that deregulation induced a change in the type of firms’ innovative activities. More general and original patents require a bolder innovation policy. The results also further suggest that firms did not simply patent existing innovation to provide hard information to out-of-state banks.”

Effectiveness over time:

Dynamic effects “…become larger as we move forward from the reform year, with the largest effect corresponding to six and seven years after interstate banking deregulation.”

Industry effects:

“…the positive effect of interstate banking deregulation on firm innovation is more pronounced for firms operating in industries that are highly dependent upon external finance.”

Effects on financial constraints:

“Turning our attention to firm-level characteristics, we further posit that our finding should be stronger for firms that were more dependent upon bank credit prior to deregulation. …the effect of deregulation on firm patents was positive and statistically significant both for young and non-young firms. However, the economic magnitude is much larger among young firms: while young firms subject to interstate banking deregulation experienced a 22.7% increase in patents, the effect is 11.7% for non-young firms.” So that “…the effect of interstate banking deregulation was economically more relevant among constrained firms…”

Alternative channels of funding: 

“Next, we sort firms according to whether they were assigned a long term bond rating by Standard&Poors. By allowing firms to access public debt markets, a bond rating is related to lower credit constraints …and, consequently, lower responsiveness to changes in bank finance. We construct two subsamples depending on whether a firm reports a bond rating or not in any year of the period 1985-95. …the deregulation effect on innovation is significantly larger for firms experiencing tougher access to the public bond market. In fact, … firms that do not have public bonds outstanding over 1985-95 experienced an increase in innovative activities after the interstate banking deregulation while there was no statistically significant effect for firms that were active in the public bond market.”

Effects on industry output:

“The last step of our analysis is to test the association between industry-level output growth and innovation following deregulation. We posit that the increased innovation stemming from deregulation fostered output growth favoring the most efficient firms within an industry. …we observe that the effect of deregulation laws on firm patenting was largest in primary metal, furniture and fixtures and petroleum refining and related industries. When we compare these industry-level effects to future industry growth, we find a close relationship. …A positive relationship, significant at 7%, suggests that industries where deregulation had a higher impact on patenting experienced a subsequent increase in output growth. For instance, the five industries with largest deregulation estimates grew, on average, by 4.9% annually over 1995- 2000. By contrast, the five industries with the smallest deregulation estimates grew, on average, by 0.2%. Furthermore, we find no difference in growth rates between these groups of industries prior to deregulation (in 1980-85), and also we find that the association fades away over a long period.”

21/7/2012: Two links on Information Theory and US Manufacturing

Two very interesting posts on Information Theory in economics from http://infostructuralist.wordpress.com
1) First post on Rational Inattention, and
2) Second post on Robustness

Another superb article from the Foreign Policy journal on the future of advanced economies competitiveness in manufacturing: link.

21/7/2012: Globe & Mail July 2012: Italian dilemma

My article on Italian debt v growth dilemma for Globe & Mail: link.

21/7/2012: Sunday Times July 15 - No growth in sight

This is an unedited version of my Sunday Times column for July 15, 2012.

This week, the Central Statistics Office published long-awaited Quarterly National Accounts for the first quarter 2012, showing that in January-March real Gross Domestic Product fell 1.1 percent to the levels last seen around Q1 2005. Gross National product is down 1.3% and currently running at the levels comparable with Q1 2003 once inflation is factored in. Rampant outflow of multinational profits via tax arbitrage continues unabated, as GDP now exceeds GNP by over 27 percent.

There is really no consolation in the statistical fact that, as the National Accounts suggest, we have narrowly escaped the fate of our worse-off euro area counterparts, who posted three quarters of consecutive real GDP contraction since July 2011. Our true economic activity, measured by GNP is now in decline three quarters in a row in inflation-adjusted terms.

Our real economy, beyond the volatile quarter-on-quarter growth rates comparatives, hardly makes Ireland a poster child for recovery. Instead, it raises some serious questions about current policies course.

Save for Greece, five years into this crisis, we are still the second worst ranked euro area economy when it comes to overall performance across some nineteen major indicators for growth and sustainability.

Our GDP and GNP have posted the deepest contraction of all euro area (EA17) states. Assuming the relatively benign 2012 forecast by the IMF materialise. Q1 results so far point to a much worse outcome than the IMF envisions. Total investment, inclusive of the fabled FDI allegedly raining onto our battered economy, is expected to fall over 62% on 2007 levels by the year end – also the worst performance in the EA17. Despite our bravado about the booming exporting economy, our average rate of growth in exports of goods and services since 2007 is only the fifth highest in the common currency area.

Ireland’s unemployment is up by a massive 220%, the fastest rate of increase in the euro zone. Employment rate is down 20% - the sharpest contraction relative to all peers. Other than Estonia, Ireland will end 2012 with the steepest increase in government spending as a share of GDP – up 18% on 2007 levels. We have the second worst average structural Government deficit for 2007-2012 excluding banks measures and interest payments on our debt. By the end of 2012, our net Government debt (accounting for liquid assets held by the state) will be up more than eight-fold and our gross debt will rise 354%. In both of these metrics Ireland is in a league of its own compared to all other member states of the common currency area.

The latest data National Accounts data confirms the above trends, while majority of the leading economic indicators for Q2 2012 are also pointing to continued stagnation in the economy through June.

Purchasing Manager Indices (PMI) – the best leading indicator of economic activity we have – are signalling virtually zero growth for the first half of 2012. Manufacturing PMI has posted a robust rate of growth in June, but the six months average remains anaemic at 50.7. The other side of the economy – services – is under water with Q2 activity lagging the poor performance achieved in the first quarter. 

In the rest of the private economy, things are getting worse, not better. Live register was up, again, in June, with standardized unemployment now at 14.9%. Numbers on long-term unemployment assistance up 6.8% year on year. Factoring in those engaged in State-run training schemes, total number of claimants for unemployment benefits is around 528,600, roughly two claimants to each five persons in full employment. Construction sector, the only hope for many long-term unemployed, posted another monthly contraction in June – marking the sharpest rate of decline since September 2011. Retail sales, are running below 2005 levels every month since January 2009 both in volume and value terms. Despite June monthly rise, consumer confidence has been bouncing up and down along a flat trend since early 2010.

Meanwhile, net voted government spending, excluding interest payments on Government debt and banking sector measures, is up 1.9% year on year in the first half of 2012 against the targeted full year 3.3% decrease. Government investment net of capital receipts is down 19.1%. This means that net voted current expenditure – dominated by social welfare, and wages paid in the public sector – is up 3.3% on same period 2011, against projected annual decrease of 2.2%. Although not quite the emergency budget territory yet, the Exchequer performance is woeful.

And the headwinds are rising when it comes to our external trade. By all leading indicators, our largest external trading partners are either stagnant (the US), shrinking (the Euro area and the UK) or rapidly reducing their imports from Europe (the BRICs and other emerging economies).

The question of whether Ireland can grow its economy out of the current crisis is by now pretty much academic. Which means we need radical growth policy reforms.

Look at the global trends. In every five-year period since 1990, euro zone average annual real economic growth rates came in behind those of the advanced economies. As a group, other advanced economies grew by some 15 percentage points faster than the euro area during the pre-crisis decade. Both, before and since the onset of the Great Recession, euro area has been a drag on growth for more dynamic economies, not a generator of opportunities. Within the euro zone, the healthiest economies during the current crisis – Germany, Finland and Austria – have been more reliant on trade outside the euro area, than any other EA17 state.

This is not about to change in our favour. Data for China shows that the US now outperforms EU as the supplier of Chinese imports. Europe’s trade with BRICs is deteriorating. Combined, BRICs, Latin America and Africa account for less than 5% of our total exports. In the world where the largest growth regions – Asia Pacific, Africa and Latin America are increasingly trading and carrying out investment activities bypassing Europe, Ireland needs to wake up to the new geographies of trade and investment.

Given the severity of economic disruptions during the current crisis, Ireland requires nominal rates of growth in excess of 6-7 percent per annum over the long term. To deliver these, while staying within the euro currency will be a tough but achievable task. This requires drastic increases in real competitiveness (focusing on enhanced competition and new enterprise creation, not wages deflation alone) in domestic markets, including the markets for some of our public sector-supplied services, such as health, education, energy, transport, and so on. We also need aggressive decoupling from the EU in policies on taxation, immigration and regulation, including that in the internationally traded financial services, aiming to stimulate internal and external investment and entrepreneurship. We must review our social policies to incentivise human capital and support families and children in education and other forms of household investments.

Like it or not, but the idea that we must harmonize with Brussels on every matter of policy formation, is the exact opposite of what we should be pursuing. We should play the strategy of our national advantage, not the strategy of a collective demise.

Box-out:

Recent decision by the Government to introduce a market value-based property tax instead of the site value tax is an unfortunate loss of opportunity to fundamentally reform the system of taxation in this country. A tax levied on the property value located on a specific site effectively narrows the tax base to exclude land owners and especially those who hold land for speculative purposes in hope of property value appreciation lifting the values of their sites. In addition, compared to the site value tax, a property levy discourages investment in the most efficient use of land, and reduces returns to ordinary households from property upgrades and retrofits. Perhaps the most ridiculous assertions that emerged out of the Government consideration of the two tax measures to favour the property levy is that a site value tax would be less ‘socially fair’ and less transparent form of taxation compared to the property tax. By excluding large landowners and speculative land banks owners, and under-taxing properties set on larger sites, a property tax will be a de facto subsidy to those who own land over those who own property in proximity to valuable public amendments, such as schools, hospitals and transport links. By relating the volume of tax levy to less apparent and more numerous characteristics of the property rather than more evident and directly comparable values of the adjoining land parcels, the property tax payable within any giving neighbourhood will be far less transparent and more difficult and costly to the state to enforce than a site value tax. In a research paper I compared all measures for raising revenues for public infrastructure investments. The study showed that a site value tax is an economically optimal relative to all other tax measures, both from the points of capturing privately accruing benefits from public investment and enforcement. This paper was presented on numerous occasions to the Government officials and senior civil servants in charge of the tax policy formation over the last three years. 

21/7/2012: Sunday Times July 8 - ESM deal for Ireland

An unedited version of my Sunday Times column for July 8, 2012.

Last week’s Euro zone rush to make some sort of a deal on the common currency debt crisis was originally heralded as a ‘path-breaking’ event. A week on, and the markets have largely discounted the deal, while internal disagreements between the member states are tearing it to shreds.

Within a few days following the summit, heads of Bundesbank, Deutsche Bank and Commerzbank came out opposing the core premises of the deal, including the banking union. Finnish, Dutch and Estonian governments strongly disagreed with the ideas of ECB engaging in direct purchases of sovereign bonds, and equal treatment of ESM debt alongside private bondholders. German and Slovak leaders have pledged to respect these countries positions. Austrian parliament’s approval of European Stabilisation Mechanism (ESM) fund came with some severe conditions attached, also altering the June summit conclusions. Lastly, the ECB’s Mario Draghi was clearly guarded about the deal implications for the ECB independence during his press-conference this Thursday.

Meanwhile, the markets have moved from an euphoric reaction to the deal last Friday back to shorting the euro zone by Thursday, despite the ECB interest rate cut.

Despite these, and other developments, the Irish Government continues to put much hope on the June 28-29 deal. Rhetoric aside, the new deal can, at the very best, allow Ireland to convert some of our government debts into the debt held against Irish consumers and mortgage-holders.

The Government assumes that under the deal, ESM will be allowed to retrospectively cancel government debts relating to banks bailouts and convert these into debts held against the banks themselves.

Assuming this is correct, even though the actual agreement does not mention any retrospective actions, Ireland will be able to move some unknown share of its €62.8 billion total exposure to the banking crisis off the government debt account. The Government has already admitted that it is unlikely to recover any of the NPRF funds ‘invested’ in the banks. Which leaves us with roughly €30-35 billion of promissory notes and other debts that can be in theory restructured via ESM.

On the surface, this looks like a great opportunity, to reduce our official Government debt from 117% of GDP to just over 100% of GDP.

However, the problem with this proposition is that it ignores the actual nature of the deal and the likelihood of such a deal going through.

Let’s start from the latter point.

For Ireland to restructure such a large amount of debt, will require one of the following two options. Either all of the states involved in ESM should be given similar retrospective considerations of past sovereign recapitalisations of the banks , or Ireland must be deemed to be a special case, warranting special intervention.

The former will mean that Germany, Belgium, the Netherlands, Austria, not to mention Spain, Portugal, Greece and Cyprus will all have to be granted access to the same restructuring process as Ireland. These states have collectively pumped some €400 billion worth of taxpayers’ funds into their own banking systems during the crisis. ESM’s lending capacity is €500 billion. In other words, ESM will effectively have not enough funds to cover the second bailout for Ireland and extensions of bailouts for Portugal and Greece, let alone provide any backstop for Italy and Spain.

Italy has just raised its forecast budget deficit for 2012 by some 50%, while Spain will require €7-10 billion of additional fiscal cuts to meet its 2012 target. Greece has been lax on tax collection during May and June elections. The likelihood of these countries needing additional funds in 2013-2014 is rising, just as ESM lending capacity is shrinking.

The latter possibility would require making a convincing argument that Ireland’s case is unique when it comes to the hardships of recapitalising the banks. In addition, it will require proving that we desperately need special help. This can only be done by admitting that our deficit and debt adjustments, as envisioned in the multiannual programme with Troika, are not sustainable. This would contradict all Troika assessments of the Irish fiscal stabilization programmes to-date.

Now, let’s take a look at the more important point raised above – the point about the actual nature of this deal. In a nutshell, even if successful, the restructuring of our banks-related debts via ESM, as envisioned by the Government, will accomplish little in terms of lifting the burden of unsustainable debts off the shoulders of the economy.

The reasons for this conjecture are numerous.

Firstly, ESM will still require repayment of all the debts transferred from the Government to the fund. Except, instead of the taxpayers, the onus for repaying these debts will fall on Irish consumers.

Even an undergraduate student of economics knows that when the market power is concentrated in the hands of a small number of players, any taxes and charges imposed onto them will be passed directly to consumers. Now, recall that under the Irish Government plans, Irish banking system is moving toward a Bank of Ireland, plus AIB duopoly. In such an environment, the repayment of banks debts to the ESM will simply involve higher banking services costs to mortgagees and bank accounts holders.

Only a regulated duopoly, under certain conditions, can be prevented from gouging consumers to pay charges, and even then imperfectly. Yet, under the deal, the Government will be ceding control over the banking sector to the ESM (who will own the banks and their debts) and the ECB (who will act as the pan-Euro area supervisor of the banks). This means we can expect mortgages and banking costs to rise and with them, foreclosures, personal insolvencies and business liquidations to accelerate.

Secondly, per Irish Government statements, last week’s deal will allow for relieving the burden of the banks debt and promises to restart our economy back to growth. If the former proposition, as argued above, is questionable, the latter is outright bogus.

Ireland’s crisis is not driven by who owns the banks debts. It is driven by too much debt accumulated in all of the corners of our economy: households, companies, Government, and the banks. But the swap of banks-related debts from the Government to the ESM will not reduce the volume of this debt.

And the Irish economy will have an even lower capacity to repay these debts after the swap.

The Government is already committed to taking €8.6 billion out of the economy between 2013 and 2015. Most of it - €5.7 billion – is officially earmarked for ‘cuts’ to the Government expenditure. However, majority of the expenditure cuts are really nothing more than a concealed tax, as these cuts reallocate the costs of services to the households. In the Budget 2012, single largest expenditure reduction measure was a hike on private insurance costs of medical services.

On top of this, further €1.5-1.8 billion will have to be clawed out of the economy due to changes in the EU funding and reductions in state revenues from banks guarantee and support schemes.

In short, put against the reality of Ireland’s struggling economy and battered by the internal disagreements within the euro zone, the so-called ‘seismic’ deal is now turning into a storm in a teacup.

Box-out:

Ireland’s much-awaited ‘return to the bond markets’ on Thursday was greeted in the media by a number of erroneous reports. The truth is simple as are the questions surrounding the NTMA motives for the auction. Firstly, Ireland returned not to the bond markets, but to a short-term T-bill market. Very short-term, in fact. The two markets are significantly different to pretend the auction was a major breakthrough. Greece, in May this year – amidst the on-going collapse of its economy and political turmoil, also ‘returned’ to the T-bill market. As did Portugal in April when it faced an unexpected need for banks supports. Ireland itself last dipped into this market back in September 2010, while facing an impending bailout. T-bills auctions, therefore, are not exactly the vote of confidence. Secondly, 3 months-dated bills are effectively risk-free and do not constitute a recognition of Irish economic revival. Instead, they are backed by the Troika funds. As per questions raised, one that stands out is why did NTMA need this auction to take place in the first place? There is no need for the Government to borrow any money short-term, as our receipts of the Troika funds are regular, fully funded and without any uncertainty. It appears the whole exercise was about a public and investor relations management by the Government. Thus, the only apparent net positive from the auction is that we did not get rejected by the markets. Then again, neither did Greece in May or Portugal in April.