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

13/5/2013: Banks Reputation Matters... for Borrowers too

Why banks reputations matter outside the interbank funding markets and regulatory offices? A question that is, perhaps, somewhat distant for Irish bank zombies, but ultimately the answer is not. It turns out, bank's reputation matters to the corporate borrower. And it matters materially.

Here's an interesting paper on this from Ongena, Steven R. G. and Roscovan, Viorel (see link below). As usual, italics are my own.

The authors argue that "banks play a special role as providers of informative signals about the quality and value of their borrowers. [Which is sort of trivial, when considered on 'accept' vs 'reject' or 0:1 basis. A '0' or 'reject' loan application signal provides information to the firm and to investors when the latter can observe the outcome of an application that the firm might be not as credit worthy as previously believed.]

Such signals, however, may have a quality of their own as the banks' selection and monitoring abilities may differ. [In other words, here's the core hypothesis: take two banks. Bank A has a lower capacity to price risk inherent in the firm than bank B. Over time, bank A repetitional capital should be lower than bank B. Now, firm 1 applies for a loan with A and B and gets rejected by B and accepted by A. Another firm, call it firm 2, applies for same loan and get accepted by B. Clearly, if the quality differential between A and B are known to the market, information about firms 1 and 2 experiences in applying for loans should matter in valuing firms 1 and 2.]

Using an event study methodology, we study the importance of the geographical origin and organization of the banks for the investors' assessments of firms' credit quality and economic worth following loan announcements. Our sample comprises 986 announcements of bank loans to US firms over the period of 1980–2003.

We find that investors react positively to such announcements if the loans are made by foreign or local banks, but not if the loans are made by banks that are located outside the firm's headquarters state. Investor reaction is, in fact, the largest when the bank is foreign.

Our evidence suggest that investors value relationships with more competitive and skilled banks rather than banks that have easier access to private information about the firms. [Confirming the core hypothesis above]"

Which is yet more bad news for Irish banks and the corporates stuck with them... and another reason why the banks reforms should deal with reputational fallout of this crisis as much as with macroprudential risks and regulatory capital cushions.


Ongena, Steven R. G. and Roscovan, Viorel, Bank Loan Announcements and Borrower Stock Returns: Does Bank Origin Matter? (June 2013). International Review of Finance, Vol. 13, Issue 2, pp. 137-159, 2013. http://ssrn.com/abstract=2262145

13/5/2013: Work Hours, Education Years and Wages

A fascinating fact: "An average person born in the United States in the second half of the 19th century completed 7 years of schooling and spent 58 hours a week working in the market. In contrast, an average person born at the end of the 20th century completed 14 years of schooling and spent 40 hours a week working. In the span of 100 years, completed years of schooling doubled and working hours decreased by 30%."

Restuccia, Diego and Vandenbroucke, Guillaume ask "What explains these trends?"

Their paper (link below) quantitatively assessed "the contribution of exogenous variations in productivity (wage) and life expectancy in accounting for the secular trends in educational attainment and hours of work."

And the result? "We find that the observed increase in wages and life expectancy accounts for 80% of the increase in years of schooling and 88% of the reduction in hours of work. Rising wages alone account for 75% of the increase in schooling and almost all the decrease in hours in the model, whereas rising life expectancy alone accounts for 25% of the increase in schooling and almost none of the decrease in hours of work."

Restuccia, Diego and Vandenbroucke, Guillaume, A Century of Human Capital and Hours (July 2013). Economic Inquiry, Vol. 51, Issue 3, pp. 1849-1866, 2013. http://ssrn.com/abstract=2261571

Aside 1: note that higher wages (when aligned with higher productivity) imply higher human capital intensity and lower hours of wrok supplied.

Aside 2: there seem to be no control for the reporting of hours supplied. In mid-19th century and even in first half of 20th century, most of work performed was time-sheeted. Today, majority of us do not have time cards, so on the surface, our contracts say 40 hours per week, in reality this means 60 hours per week.

13/5/2013: Unionisation and Innovation: Firm-level Data

A very interesting paper on the effects of unionisation of the workforce on firm-level innovation (italics are mine).

The authors find that "patent counts and citations, proxies for firms’ innovativeness, decline significantly after firms elect to unionize and increase significantly for firms that vote to deunionize. To establish causality, we use a regression discontinuity design relying on “locally” exogenous variation in unionization generated by union elections that pass or fail by a small margin of votes. The market reaction to firms that elect to unionize is negatively related to firms’ past innovation output [So if a firm had above average innovation output before the unionization, market reacts to bid down the firm value post-unionization in anticipation of the adverse impact]. Our evidence suggests unionization stifles innovation."

Slightly more specifically: "For instance, innovation quantity (quality) of firms that pass union elections within a margin of 2 percentage points is 42.8% (40.4%) lower than that of firms that do not pass union elections within a margin of 2 percentage points three years subsequent to union elections. We also estimate RDD on a sample of private firms over the same period. Consistent with our results for public
firms, we find that private firms’ innovativeness is negatively related to unionization."

Interestingly: "we attempt to identify possible underlying economic channels through which unionization impedes firm innovation. Inconsistent with the conventional view, we find little evidence that investment in R&D changes as a result of unionization. Our results suggest that the channel through which unionization impedes innovation is not an underinvestment in innovation input (i.e., R&D), but rather a decline in innovation productivity."

The whole paper is available here: Bradley, Daniel J., Kim, Incheol and Tian, Xuan, Providing Protection or Encouraging Holdup? The Effects of Labor Unions on Innovation (May 10, 2013). http://ssrn.com/abstract=2232351

13/5/2013: Cyprus CDS

It doesn't look like anyone (save for Olli Rehn) is betting on Cyprus' 'vast gas wealth' to be anywhere near its current account anytime within the next 5 years...

13/5/2013: Kauffman Index of Entrepreneurial Activity, 2012

Some absolutely fascinating data and insights on entrepreneurship in the US over the period of 1996-2012 in Fairlie, Robert W., Kauffman Index of Entrepreneurial Activity 1996-2012 (April 2013) (http://ssrn.com/abstract=2256032 or http://dx.doi.org/10.2139/ssrn.2256032)

The paper is based on the Kauffman Index of Entrepreneurial Activity - an "indicator of new business creation in the United States. Capturing new business owners in their first month of significant business activity, this measure provides the earliest documentation of new business development across the country. The percentage of the adult, non-business owner population that starts a business each month is measured using data from the Current Population Survey (CPS). In addition to this overall rate of entrepreneurial activity, separate estimates for specific demographic groups, states, and select metropolitan statistical areas (MSAs) are presented. The Index provides the only national measure of business creation by specific demographic groups."

The paper extends the Index to 2012 data "with consideration of trends in the rates of entrepreneurial activity over the seventeen-year period between 1996 and 2012."

Key findings for 2012 data update:

• "The rate of business creation declined from 320 out of 100,000 adults in 2011 to 300 out of 100,000 adults in 2012. 
• "The business creation rate of 0.30 percent translates into approximately 514,000 new business owners each month during 2012; it was 543,000 in 2011. 
• "The decline in the business creation rate to 0.30 percent in 2012 is …only slightly higher than pre-recessionary and long-term levels. The decline in business creation over the past year may be due to improving labor market conditions putting less pressure on individuals to start businesses out of necessity.
• "The overall decline in business creation rates was entirely driven by a substantial decline in business creation rates among men. Entrepreneurial activity remained unchanged in 2012 for women.
• "Immigrants were nearly twice as likely as were the native-born to start businesses each month in 2012. The immigrant rate of entrepreneurial activity decreased from 0.55 percent in 2011 to 0.49 percent in 2012.

• "Over the past seventeen years, Latinos, Asians, and immigrants experienced rising shares of all new entrepreneurs, partly because of rising rates of entrepreneurship, but also because of increasing populations. The oldest age group (ages 55–64) also experienced a rising share of all new entrepreneurs, mainly because it represents an increasing share of the population.
• "Although the entrepreneurship rate declined for high school dropouts from 2011 to 2012 (0.57 percent to 0.52 percent), this group has the highest rate of business creation, which may be due to more limited labor market opportunities than for more highly educated groups.

• "The construction industry had the highest rate of entrepreneurial activity of all major industry groups in 2012 (1.43 percent). The second-highest rate of entrepreneurial activity was in the services industry (0.41 percent).
• "The states with the highest rates of entrepreneurial activity were Montana (530 per 100,000 adults), Vermont (520 per 100,000 adults), New Mexico (520 per 100,000 adults), Alaska (430 per 100,000 adults), and Mississippi (430 per 100,000 adults). 
• "The states with the lowest rates of entrepreneurial activity were Minnesota (150 per 100,000 adults), Nebraska (170 per 100,000 adults), Michigan (180 per 100,000 adults), Wisconsin (180 per 100,000 adults), and Ohio (190 per 100,000 adults).

• "The states experiencing the largest increases in entrepreneurial activity rates over the past decade were Nevada (0.21 percentage points), Georgia (0.16 percentage points), Vermont (0.13 percentage points), California (0.12 percentage points), Louisiana (0.12 percentage points), and Massachusetts (0.12 percentage points).
• "States that experienced the largest decreases in entrepreneurial activity rates were Wyoming (-0.13 percentage points), Wisconsin (-0.12 percentage points), and South Dakota (-0.10).
• "Among the fifteen largest MSAs in the United States, Miami (0.56 percent) had the highest entrepreneurial activity rate in 2012, and Detroit (0.10 percent) had the lowest rate.

12/5/2013: Open Europe on Trade in Services

A very interesting piece of research from Open Europe thinktank, focusing on the potential economic impact from liberalising services trade within the EU: http://www.openeurope.org.uk/Content/Documents/Pdfs/kickstartinggrowthEUservices.pdf

Here are some highlights:

Chart below shows gains from the full implementation of the rather limited EU Services Directive:

And on to the extension of the EU Directive (notice that Ireland is in the higher benefits group of countries as our exports of services are both growing at the faster rate than EU average and constitute already a higher proportion of total external trade than EU average).

Also, recall that "The Economic Adjustment Programme for Ireland, February 2011 [states]: “Enhanced competition in the services sector modelled in the simulations…translates into a 0.1% increase in employment and a 0.5% increase in GDP over a 10-year period.” “[The Irish] Government will introduce legislative changes to remove restrictions to trade and competition in sheltered sectorsincluding: [the legal profession, medicalservices and the pharmacy
profession]”.

Lastly, comparing the relative significance of trade in services liberalisation to other potential means for boosting economic growth in Europe:

This is the debate that has, unfortunately, stalled in Europe with the onset of the crisis, as did the reforms under the Services Directive.

12/5/2013: How Bitcoin works

Good infographic on bitcoin: http://thumbnails.visually.netdna-cdn.com/bitcoin-infographic_5029189c9cbaf.jpg

h/t to @mbauwens

12/5/2013: On euro's future...

A very interesting contribution from Niall Ferguson to the debate about the future of the euro: here. Interestingly, one can juxtapose Ferguson's article against the list of most recent news briefings from the PressEurop:

12/5/2013: What Greek OSI will mean for IMF?

While this story is still speculative, the very idea that IMF can be forced to take a haircut on its holdings of Greek bonds is very much significant. In my view:

1. IMF will be dragged into OSI on Greek bonds, although the timing of this uncertain;
2. IMF deserves to be dragged into OSI on Greek bonds because the Fund has - begrudgingly - agreed to the EU formula for dealing with the Greek crisis that involved no OSI from ECB / EU which would have been required early on to ensure IMF gets repaid;
3. When IMF takes a hit, this will signal much more than the simple 'first time ever' precedent. Because the IMF's close links to the EU leadership have been directly implicated in the botched structuring of the Euro area member states rescues, the IMF leadership will undoubtedly start actively migrating away from the EU dominance toward the BRIC(S).

The disastrous decisions underwritten by the current and the pervious IMF heads in the case of EU will mean, in the end, the vanishing of the relatively unbiased and transparent international lender of last resort to be replaced by the geopolitically-motivated leadership of the BRIC(S).

This will stand in stark contrast to the reformed and much more transparent functioning of the World Bank, started under the leadership of Paul Wolfowitz.

12/5/2013: Much austerity? Not really... & not of the kind we needed

A week ago I published a blogpost exploring IMF data on austerity in Europe, based on a sample of 20 EU countries with advanced levels of economic development (excluding Luxembourg). You can read that post here. The broad conclusions of that post were:

1. There is basically no austerity in Europe, traceable to either changes in deficits, changes in Government spending or changes in debt. If anything, the European fiscal policies can be characterised by a varying degree of fiscal expansionism during the current crisis, relative to the pre-crisis 2003-2007 period.
2. This, of course, does not account for transfers between one set of expenditures (e.g. public investment reductions) and other lines of spending (e.g. banking sector measures).
3. The only area of fiscal policy where austerity is evident is on taxation burden side, which rose in the majority of sampled economies.

The numbers got me worried and in this post I am looking solely on deficits side of Government spending. If there is savage austerity in EU27, so savage it is killing European economies, surely it would show up in General Government deficit numbers. As before all data reported is based on averages and comparatives computed by me from IMF's WEO data as reported in April 2013 edition of the database.

Let's take a closer look.

Only 2 countries out of 20 have recorded a reduction in average deficits during the crisis period (2008-2012) compared to the pre-crisis average (2003-2007). These were Germany, where annual average deficits declined by 0.95 percentage points (pretty significant) and Malta, where annual average deficits fell 0.79 percentage points (also pretty sizeable drop).

On average, EU20 sample annual deficits have increased by a massive 3.44 percentage points over the pre-crisis period. In  non-Euro area states, the average increase was 3.16 percentage points. But in 'savagely austerian' Euro area, the increases averaged 3.51 percentage points.

So far, the Euro area analysts' rhetoric opposing austerity has been focused on 2012 as the year of highest - to-date - cuts. Was this so? Not really:

Again, as above, there is scantly any evidence of deficit reductions, and plenty of evidence that deficits are getting worse and worse. Again, the comparative is not to the absurd levels of spending during peak spending years of the crisis, but to pre-crisis averages. After all, stimulus is not measured by an ever-escalating public spending, but by increase in spending during the recession compared to pre-recession.

The same conclusion can be reached if we look at 2007 deficit compared to 2012 deficit.

In other words, folks, Europe has had, so far, only 3 measurable forms of austerity, none comfortable to the arguments we keep hearing from European Left:

1. Tax increases (remember, we want to soak the rich even more, right?)
2. Revenue re-allocations to banks measures (remember, no one on Europe's official Left has come out with a proposition that banks should not be bailed out) and to social welfare (clearly, the Left would have liked to spend even more on this)
3. Germany

Note: we must recognise the simple fact that social welfare spending will rise in a recession for a good reason. The argument here is not that it should not (that's a different matter for different debate), but that when it does increase, the resulting increase is a form of Government consumption stimulus.

So let's make the following argument: Euro area did not experience 'austerity' in any pure form in the reductions in deficits. Instead, it experienced a 'stimulus' that was simply wasted on programmes and policies that had nothing to do with growth stimulus (e.g. banks supports). Here are two charts to illustrate:

What the charts above clearly show is that Euro area can be divided into three types of member states:

• Type 1: states where cumulated 5 year surpluses over pre-crisis period gave way to cumulated 5 year deficits. These are: Estonia, Finland, Spain and Ireland.
• Type 2: states where cumulated 5 year deficits over the pre-crisis period were replaced by more benign deficits over the crisis period period. These are Germany and Malta.
• Type 3: all other euro area states where cumulated 5 year deficits over pre-crisis period were replaced by even deeper cumulated deficits over the 5 years of the crisis.

The only two types of fiscal policy that Euro area is missing in its entirety is the type where pre-crisis deficits gave way to crisis period cumulated surpluses (no state in the sample delivers on this) and the type where pre-crisis surpluses gave way to shallower crisis-period surpluses (only one European state - Sweden - qualifies here).

Oh, and one last bit relating to the chart above: all of the peripheral countries, save Italy, had a massive increase in deficits on cumulated basis during the crisis compared to pre-crisis period. Apparently this is the savage austerity that has been haunting their economies.


Updated:
An interesting issue raised by one of the readers:

And my response:

8/5/2013: Thomas Sowell on Language, Evidence & Inquiry

Thomas Sowell doing what he does best: asking uncomfortable questions. http://townhall.com/columnists/thomassowell/2013/05/08/words-that-replace-thought-n1588497?utm_source=thdaily&utm_medium=email&utm_campaign=nl

This got me thinking: there are, as Sowell puts it 'words that replace thought', but there are even more detrimental to inquiry 'words that prevent thought'. In fact, his example of word 'diversity' is one. It is virtually impossible to challenge anything relating to the thesis that 'diversity is intrinsically good' without being shut down on the grounds that any argument to the contrary of the thesis is automatically an argument in favour of some exclusion (racism, anti-semitism, sexism, and so on...).  The only possible by-pass to this problem is to argue that 'diversity has no effect'.

But this falls into the trap discussed briefly here http://andrewgelman.com/2013/05/06/against-optimism-about-social-science/
under the file-drawer bias in publishing.

8/5/2013: Blackrock Institute Survey: N. America and W. Europe, May 2013

Just as I published April update from Blackrock Investment Institute Economic Cycle surveys, here comes May one for North America and Western Europe:

 Now, note change in Ireland's position compared to April:

May summary:

And conclusions (italics are mine):
"This month’s North America and Western Europe Economic Cycle Survey presented a large shift on the outlook for global growth over the next 12 months – although a net proportion of respondents remains positive, this is now a figure of 41%, compared with a net 71% last month. [In other words, things are turning gloomier for global growth outlook]

With regards to the US, the proportion of respondents expecting recession over the next 6 months remains low, with the consensus view firmly that North America as whole is in mid-cycle expansion. [In other words, current growth rates are not expected to rise much as would have been consistent with early-cycle expansion]

In Europe, the view continues to be more disparate, with a generally stronger northern Europe contrasted by continuing weakness in Eurozone as a whole. Belgium, France, Greece, Italy, the Netherlands, Portugal and Spain in particular are described in a recessionary state, with the consensus view remaining in this phase at the 6 month horizon in each case."

8/5/2013: Olli Rehn Departs Reality Once Again

If one needs an example of out-of-touch, reality-denying and self-satisfied EU Commissioner, travel no further than Olli Rehn. Here's the latest instalment from Court's Favourite Entertainer of Things Surreal:
http://europa.eu/rapid/press-release_SPEECH-13-394_en.htm

The speech focuses on what went wrong in Cyprus.

In the speech, Mr Rehn commits gross omissions and conjures gross over-exaggerations.

Nowhere in his speech does Mr Rehn acknowledge that Cypriot banks were made insolvent overnight by the EU (including EU Commission, where Mr Rehn is in charge of Economic and Monetary affairs) mishandling of PSI in Greek government bonds.

Nowhere in his speech does Mr Rehn acknowledge that Cypriot banks were massively over-invested in 'core tier 1 capital' in the form of zero risk-weighted sovereign bonds (Greek bonds) on the basis of direct EU and Basel regulations that treated this junk as risk-free assets. Mr Rehn states that "The banking problems were aggravated by poor practices of risk management. Lacking adequate oversight, the largest Cypriot banks built up excessive risk exposures." But Cypriot banks largest risk mispricing took place on their Greek Government bond holdings and this was (a) blessed by the EU regulators and (b) made more egregious in terms of risks involved by the EU madness of Greek PSI.

Mr Rehn claims that "The problems of Cyprus built up over many years. At their origin was an oversized banking sector that thrived on attracting foreign deposits with very favourable conditions." Nowhere is Mr Rehn making a statement that the size of Cypriot banking sector was never an issue with the EU, neither at the point of Cyprus admission into the euro, nor at the accession to the EU, nor in any prudential reviews of Cypriot financial system. Mr Rehn flat out fails to relate his statement on deposits to the fact that the EU is currently pushing banks to hold higher deposits / loans ratios, not lower, and that higher deposits / loans ratio is normally seen to be a sign of banking system stability. Mr Rehn is also plain wrong on his claims about the nature of deposits in Cyprus. Chart below shows that Cypriot banks' deposits more than doubled in Q1 2008-Q1 2010 on foot of the EU-created mess in Greece and the rest of the periphery.

Source: @Steve_Hanke

And here's proof that Cypriot banks were running a shop with deposits well in excess of loans, implying low degree of risk leveraging, until Mr Rehn and his colleagues waltzed in with their botched 'rescue' efforts:

Source: Washington Post.

Olli Rehn could not be bothered to read IMF assessment of Cypriot economy from November 2011 (Article IV report) - despite him citing EU Commission June 2011 'warnings' - where IMF clearly states that the core problems faced by Cypriot banking system stem from Greece (page 14) and local commercial banks' loans, not depositors or foreign depositors. On deposits, IMF states (page 17 paragraph 21) "non-resident deposits (NRD) in Cypriot banks (excluding deposits raised abroad by foreign affiliates) are €23 billion (125 percent of GDP), most of which are short-term at low interest rates." Thus, IMF directly, explicitly and incontrovertibly contradicts Mr Rehn's statement about foreign deposits having been extended on "very favourable conditions".

IMF further states that when it comes to deposits, significant risk is also poised by "€17 billion in deposits collected in the Greek branches of the three largest Cypriot-owned banks could be subject to

outflows in response to difficult conditions in Greece. Outflows in the first half of 2011were close to €3 billion (nearly 15 percent of the total), although a portion of these returned to the Cypriot parents as NRD." ECB chart below confirms this risk materialising in the wake of Mr Rehn's structured disaster in Greece:

This outflow knocked out billions out of deposits cushion that Cypriot banks needed to reduce their financing needs. And Mr Rhen - the architect in charge of this disaster - has nothing to say about it.

I can go on and on. Virtually every paragraph of Mr Rehn's statement is open to critical examination. 

That is hardly news - Mr Rehn has made so many gaffes and outright bizarre statements in the past (including his assertions at every pre-bailout junction that each peripheral country heading into bailout was fully solvent, fiscally sustainable, etc), he became not just a laughing stock of the markets, but a contrarian indicator for reality. What is of concern is that Mr Rehn is still being given the task of speaking for the Commission on Monetary and Fiscal affairs.

Olli Rehn should read something more cogent than his own speeches on what has happened in Cyprus (e.g. business.financialpost.com/2013/03/28/seeds-of-cyprus-disaster-planted-months-ago-by-eu/ and www.reuters.com/article/2013/04/02/us-eurozone-cyprus-laiki-insight-idUSBRE9310GQ20130402 or http://online.wsj.com/article/SB10001424127887323501004578386762342123182.html) and preferably do so free of charge to European taxpayers, on his own time, while up-skilling for his next job.

7/5/2013: Irish Services Index, Q1 2013 data

Irish Services Index is out today for Q1 2013 and here are some details (monthly data analysis to follow). Keep in mind, data only starts from Q1 2009, so when referencing current levels of activity to peak, that refers to peak from Q1 2009 and not relative to pre-crisis activity.

• Value in Wholesale & Retail Trade, Repair of Motor Vehicles & Motorcycles sector declined in Q1 2013 to 105.2 q/q (down 3.22% from 108.7 in Q4 2012) and is down 5.40% y/y. Q4 2012 value index was down 1.36% y/y, so things are getting worse faster. Relative to peak (since 2009 Q1 data start) the index is now down 5.40%. 
• Value index for Transportation and Storage sector slipped marginally from 110.5 in Q4 2012 to 110.0 in Q1 2013 (-0.45% q/q) and is up 5.97% y/y. However, rate of annual growth declined in Q1 2013 compared to Q4 2012 when it stood at 8.97%. Relative to peak the index is still down 9.39%.
• Accommodation and food services activities index also slipped marginally from 104.7 in Q4 2012 to 104.3 in Q1 2013 (down 0.38% q/q). Y/y index is up 3.48% in Q1 2013 and this is a slight gain on 3.05% y/y growth in Q4 2012. However, relative to peak index reading is still down 14.86%.

• Information and communication sector index remained practically flat in Q1 2013 in q/q terms at 116.6 which is only 0.09% up on 116.5 in Q4 2012. Y/y index is up 3.83% and this shows deceleration in growth from +8.47% growth posted in Q4 2012. Despite this, Q1 2013 marks the peak of activity in this sector for any quarter since Q1 2009.
• In contrast with ICT sector activity, the knowledge economy core services sub-sector, Professional, scientific and technical activities index has suffered steep declines since 2009. In Q1 2013 the index stood at 91.2 (up 0.22% q/q) up only 0.55% y/y. This marks a minor reversal of a significant decline of -8.36% recorded in 12 month through Q4 2012. The index is down massive 29.14% on peak.

• Administrative and support service activities index has been a surprising performer during the crisis. In Q4 2012 it stood at 104.7 and Q1 2013 this increased to 110.4 a gain of 5.44% q/q. Index is now up 20.92% y/y and this compounds 11.38% y/y growth recorded in Q4 2012. Q1 2013 marks the peak quarter on record for the sub-sector.
• Overall services index slipped from 107.2 in Q4 2012 to 106.2 in Q1 2013 (-0.93% q/q), although activity is still up 0.85% y/y. Y/y growth in Q1 2013 marks a slowdown from 2.19% y/y expansion in Q4 2012. The index overall is 0.93% below the peak and is currently running slightly behind the level of activity recorded in Q1 2009.

Overall, quarterly data shows weakening in Services sectors performance, and stripping out the effects of ICT (dominated by tax transfers-booking MNCs), Services side of the economy is showing weaknesses that are alarming. Recall that exports of services growth in 2010-2012 acted to compensate for declines in domestic demand and weaker growth (turning negative) in exports of goods. Should Services activity continue to suffer even modest declines, our GDP and GNP growth will be impaired. 

To see more forward-looking data, read my analysis of Services PMI for April: http://trueeconomics.blogspot.ie/2013/05/352013-irish-services-pmi-april-2013.html

7/5/2013: Blackrock Institute: April 2013 Global Economic Conditions - 2

More updates from the Blackrock Investment Institute Economic Cycle surveys for April 2013. Here are core charts for regions not covered in the previous post.

Note of caution: some of the countries coverage in responses is thin, so data should be treated as only indicative. And the surveys are based on opinion of external experts, not Blackrock internal views.



EMEA:
"With caveat on the depth of country-level responses, which can differ widely, this month’s EMEA Economic Cycle Survey presented a generally bearish outlook for the region. However, there has been a marked improvement in the outlook for Eastern European countries at the 12 month horizon, compared to earlier reports this year.

The majority of respondents for the Czech Republic, Croatia, Egypt, Hungary, Poland, Slovakia, Slovenia, and the Ukraine describe these countries in a recessionary state; however only half of these -- Croatia, Slovakia, Slovenia and the Ukraine -- are expected to remain so by the majority of economists, at the 6 month horizon. 

At a longer horizon of 12 months, the outlook becomes more positive within Eastern Europe, with only the economies of Slovenia and Slovakia expected to continue to weaken."

Asia Pacific:

"...continuing bullish outlook for the region. Out of the 14 countries covered, only Singapore and Vietnam are currently described to be in a recessionary state. Over next 6 months the balance of consensus opinion shifts back to expansion for these countries, while in Australia the proportion of economists expecting recession increases to 50%. Australia stands out as the only country in the region where respondents expect the economy will weaken over the next year."

Latin America: 

"With a caveat on the depth of country-level responses, which differs widely, this month’s Latin America Economic Cycle Survey presented a generally bullish outlook for the region. Brazil, Mexico, Colombia, Peru and Chile are described to be in expansionary phases of the cycle and expected to remain so over the next 2 quarters, while Brazil is expected to mature from early-expansion to mid-cycle expansion and Chile is expected to move from mid-cycle expansion to late-cycle expansion. 

The exceptions to this theme within the region were Venezuela and Argentina. Both are described by the consensus of economists to be in a recessionary state, with growing proportion respondents expecting this to continue at the 6 month horizon." 

7/5/2013: Blackrock Institute: April 2013 Global Economic Conditions - 1

A number of updates from the Blackrock Investment Institute Economic Cycle surveys for April 2013. Here are core charts.

Note of caution: some of the countries coverage in responses is thin, so data should be treated as only indicative. And the surveys are based on opinion of external experts, not Blackrock internal views.

Global outlook: 

"...a positive outlook on global growth, with a net 71% of 127 economists expecting the global economy will get stronger over the next year, (2% higher from the March report), based on North America and Western Europe panel."

For the EMEA panel, "Respondents remain positive on the global growth cycle, with a net 57% of 64 respondents expecting a strengthening world economy over the next 12 months – however this is large downward shift from the net 74% figure last month."

Asia Pacific panel: "The global growth outlook remains positive, with a net of 71% of participants expecting a stronger global economy over the next 12 months; however this is a large step down from the net 84% figure in last month’s report."

Latin American panel: "The global growth outlook remains positive, with a net 47% of 49 participants expecting a stronger global economy over the next 12 months; however this is a large step down from the net 62% in last month’s report."

North America and Western Europe:

"With regards to the US, the proportion of respondents expecting recession over the next 6 months remains low, with the consensus view firmly that North America as whole is in mid-cycle expansion. 

In Europe, the view continues to be more disparate, with the UK and Eurozone as a whole described in a recessionary state. With caveat that the depth of country coverage varies significantly, the consensus view remains recessionary at the 6 month horizon for France, Greece, Italy, the Netherlands, Portugal, Spain and Belgium."

Note: Ireland results are based on very 'thin' data. 

More regions to follow in the next post.

6/5/2013: Self-contradictions & EU Commission

Trapped in their own failures, EU 'leaders' are no longer simply contradicting each other - they are now contradicting themselves. And, I must add, via ever more apparent and bizarre statements.
Behold the latest instalment of absurdity from one of the multiple EU 'Presidents': the man in charge of the EU economic policies and performance, European Commission chief Jose Manuel Barroso. As reported in the EUObserver (http://euobserver.com/economic/120040), Mr Barroso stated that "What is happening in France and Portugal is not Merkel's or Germany's fault … The crisis and their problems are not a result of German policy or the fault of the EU. It is the result of excessive spending, lack of competitiveness and irresponsible trading in the financial markets."
Thus,

1. Loose monetary policy by the ECB that was custom-tailored to suit German needs during 2002-2007 period had nothing to do with the crisis in the peripheral states, despite the fact that it triggered vast inflows of capital from Germany (and other core states) into the euro area periphery, inflating assets bubbles left, right and centre, and leading to unsustainable debt accumulation in these economies.
2. ECB (heavily influenced by German ethos and political economy) and EU Commission and regulatory bodies' insistence on treating all sovereign bonds issued by the euro area states as risk-free assets on banks balance sheets (the main trigger for Cypriot crisis and the reason for massive transfers of banking sector costs onto taxpayers in Ireland and other member states) had nothing to do with Berlin or with Berlin's insistence on closing its eyes on what was happening in regulation / enforcement EU-wide.
3. Berlin's inability to reign in German (among other) banks' gross misplacing of risks in interbank lending to other euro area banks had nothing to do with the crisis.
4. Berlin's insistence, repeated parrot-like by Mr Barroso and his colleagues in the Commission, that the whole crisis can be addressed via fiscal adjustments (recall, that was the position the EU Commission occupied for the last 6 years) and current account rebalancing has nothing to do with mis-shaped economic policy responses across the EU since 2008 crisis onset.
5. Berlin's 'guidance' toward internecine and economically illiterate Fiscal Compact, eagerly endorsed by Mr Barroso and his colleagues in recent past, has nothing to do with the failure of Europe to respond to the crisis.
6. Berlin's opposition to the half-baked EU ideas about stimulating growth in euro periphery that shut the door on any real stimulus has nothing to do with the crisis.
7. Berlin's opposition to increasing domestic demand and abandoning contractionary pursuit of current account surpluses, also noted by Mr Barroso's Commission in the past, had nothing to do with the crisis duration or depth.

Mr Barroso also claimed that Chancellor Merkel is "one of the only [leaders], if not the only leader at the European level who best understands what is going on."

Really? Suppose so. In this case, Mr Barroso has either no clue what is going on, or simply doesn't care to be consistent with his own exhortations of the recent past, because he openly and directly contradicted Ms Merkel couple of weeks ago by claiming that 'austerity was overdone' and had "reached its limits."

Irony has reached so far in Mr. Barroso's waltzing across the ideological & economic policy landscape that according to the EU's 'President', Ms Merkel's brilliance also encompasses the fact she is presiding over German economy currently sliding toward a recession. IMF analysis shows real GDP growth in Germany will fall from 4.024% and 3.096% in 2010 and 2011 to 0.865% and 0.613% in 2012 and 2013. This might be better-than-average record for the euro area, but it is hardly an achievement worth praising.

Someone should point to Mr Barroso that eating one's cake (taking a populist position against austerity, and thus Ms Merkel) and having it (taking an appeasing position toward the major architect of all economic policy blunders so far deployed in Europe since the onset of the crisis) is just something that doesn't happen outside the make-belief world of Brussels.

5/5/2013: Things are going according to plan... in Italy & Germany

That euro area 'policy' for dealing with the crisis is working marvelously, yeah?

Source: Euromoney Country Risk
Note: lower ECR score = higher sovereign credit risk

Yes, Italy's bonds are trading at much lower yields, and the country is issuing new debt at lower costs... but how much of that has to do with something / anything that Italian Government has done, as opposed to the overall shifts in markets sentiment / liquidity flows, who knows? One thing is for sure, absent yields changes, Italian fundamentals are getting worse, not better. Ditto, between, for all other 'peripherals'.

4/5/2013: European way?

Here's an interesting chart that summarises both, the source of European disease and the nature of the European response to the crisis:

Source

And the point is: during the current crisis, Europeans have opted not so much to reduce Government spending, as to hike taxes, state-controlled prices and charges. Transfer of income from households to banks and Government, exacerbated by the Great Recession and collapse of borrowing have meant a dramatic decline in households' contribution to the economy. End result: Europe is about to go into a Great Depression.

4/5/2013: Higher Income vs Higher Subjective Well-Being

A very interesting paper on the topic I had a chance to briefly discuss on twitter recently. Basically, does life satisfaction / happiness decline with income increases? In other words, is there a point at which people earning more are experiencing less happiness? Is there a point of saturation?

"Subjective Well-Being and Income: Is There Any Evidence of Satiation?" by Betsey Stevenson and Justin Wolfers, NBER Working Paper No. 18992 from April 2013 (http://www.nber.org/papers/w18992) attempts to shed some light on this question, often debated and subject of may research papers in the past.

Headline results [emphasis in italics is mine]: "Many scholars have argued that once “basic needs” have been met, higher income is no longer associated with higher in subjective well-being. We assess the validity of this claim in comparisons of both rich and poor countries, and also of rich and poor people within a country. Analyzing multiple datasets, multiple definitions of “basic needs” and multiple questions about well-being, we find no support for this claim. The relationship between well-being and income is roughly linear-log and does not diminish as incomes rise. If there is a satiation point, we are yet to reach it."

Some more beef from the paper (unfortunately - not available to general public, but here's a link to the authors more condensed article on it: http://www.brookings.edu/research/papers/2013/04/subjective-well-being-income).

"In 1974 Richard Easterlin famously posited that increasing average income did not raise average well-being, a claim that became known as the Easterlin Paradox." Needless to say, many scholars since then picked the idea and even advanced it to greater extremes.

Per authors, however, "in recent years new and more comprehensive data has allowed for greater testing of Easterlin’s claim. Studies by us and others have pointed to a robust positive relationship between well-being and income across countries and over time (Deaton, 2008; Stevenson and Wolfers, 2008; Sacks, Stevenson, and Wolfers, 2013).

"Yet, some researchers have argued for a modified version of Easterlin’s hypothesis, acknowledging the existence of a link between income and well-being among those whose basic needs have not been met, but claiming that beyond a certain income threshold, further income is unrelated to well-being. The existence of such a satiation point is claimed widely, although there has been no formal statistical evidence presented to support this view. For example Diener and Seligman (2004, p.5) state that “there are only small increases in well-being” above some threshold. While Clark, Frijters and Shields (2008, p.123) state more starkly that “greater economic prosperity at some point ceases to buy more happiness,” a similar claim is made by Di Tella and MacCulloch (2008, p.17): “once basic needs have been satisfied, there is full adaptation to further economic growth.”

"The income level beyond which further income no longer yields greater well-being is typically said to be somewhere between $8,000 and $25,000. Layard (2003, p.17) argues that “once a country has over $15,000 per head, its level of happiness appears to be independent of its income;” while in subsequent work he argued for a $20,000 threshold (Layard, 2005 p.32-33). Frey and Stutzer (2002, p.416) claim that “income provides happiness at low levels of development but once a threshold (around $10,000) is reached, the average income level in a country has little effect on average subjective well-being.”

It is worth noting the thresholds in income cited above - all are well below the median and mean incomes in the advanced economies today. The test carried out by the authors of the study cover incomes both below these thresholds and above, including to well above (multiples of almost 7 times the highest threshold mentioned).

"Many of these claims, of a critical level of GDP beyond which happiness and GDP are no longer linked, come from cursorily examining plots of well-being against the level of per capita GDP. Such graphs show clearly that increasing income yields diminishing marginal gains in subjective well-being.

"However this relationship need not reach a point of nirvana beyond which further gains in well-being are absent. For instance Deaton (2008) and Stevenson and Wolfers (2008) find that the well-being–income relationship is roughly a linear-log relationship, such that, while each additional dollar of income yields a greater increment to measured happiness for the poor than for the rich, there is no satiation point.

So now, to the paper itself. Some basics first:

"In this paper we provide a sustained examination of whether there is a critical income level beyond which the well-being–income relationship is qualitatively different, a claim referred to as the modified-Easterlin hypothesis.

"As a statistical claim, we shall test two versions of the hypothesis. The first, a stronger version, is that beyond some level of basic needs, income is uncorrelated with subjective well-being; the second, a weaker version, is that the well-being–income link estimated among the poor differs from that found among the rich.

"Claims of satiation have been made for comparisons between rich and poor people within a country, comparisons between rich and poor countries, and comparisons of average well-being in countries over time, as they grow. The time series analysis is complicated by the challenges of compiling comparable data over time and thus we focus in this short paper on the cross-sectional relationships seen within and between countries. Recent work by Sacks, Stevenson, and Wolfers (2013) provide evidence on the time series relationship that is consistent with the findings presented here.

"To preview, we find no evidence of a satiation point. The income–well-being link that one finds when examining only the poor, is similar to that found when examining only the rich. We show that this finding is robust across a variety of datasets, for various measures of subjective well-being, at various thresholds, and that it holds in roughly equal measure when making cross-national comparisons between rich and poor countries as when making comparisons between rich and poor people within a country."

Some actual results:

The above shows that the well-being-income gradient is strong for the rich countries and even stronger for the countries where income per capita exceed USD15,000 (GDP per capita). Per authors: "These data clearly reject both the weak and strong versions of the modified-Easterlin hypothesis." Authors attain qualitatively identical results for a number of other measures / surveys of well-being. "Each of these datasets strongly reject" the modified-Easterlin hypothesis. "Moreover, to
the extent that the well-being–income relationship changes, it appears stronger for rich countries."

Core conclusions: "While the idea that there is some critical level of income beyond which income no longer impacts well-being is intuitively appealing, it is at odds with the data. As we have shown, there is no major well-being dataset that supports this commonly made claim. To be clear, our analysis in this paper has been confined to the sorts of evaluative measures of life satisfaction and happiness that have been the focus of proponents of the (modified) Easterlin hypothesis. In an interesting recent contribution, Kahneman and Deaton (2010) have shown that in the United States, people earning above $75,000 do not appear to enjoy either more positive affect nor less negative affect than those earning just below that. We are intrigued by these findings, although we conclude by noting that they are based on very different measures of well-being, and so they are not necessarily in tension with our results. Indeed, those authors also find no satiation point for
evaluative measures of well-being."

Here is a slightly clearer chart from the blogpost by The Economist:

4/5/2013: Profit margins in Irish Services and Manufacturing: April 2013

Since I've been updating my database on PMI for Ireland (see Manufacturing PMI baseline results for April, as well as a post on Services PMI and a post on latest trends in employment as signalled by PMIs), it is also time to update dynamics analysis on profitability in both sectors.

Now, Services PMI survey covers profitability as a separate question, and it is reported in the post linked above. There is no comparative question in PMI for Manufacturing survey.

Over time, I have been tracking implied profitability changes in both sectors on a comparable basis as a difference between changes in input costs and output charges by the reporting firms. In a sense - it is a metric of profit margins dynamics that is comparable across both sectors.


Profit margins index for Services has declined from -14.29 in March 2013 to -16.39 in April. April reading was worse than -11.96 a year ago and worse than 12mo MA at -15.7. Dynamically, 3mo MA through April is at -15.0 which represents worsening in profitability conditions compared to -13.6 average for 3mo through January 2013 and is worse than -13.8 3mo average through April 2012.

Longer-term comparatives: since January 2012 through April 2013, Services profitability index averaged -15.31 - a rate of profit margins decline that is worse than the average rate recorded for 3 years period of January 2009-December 2011.

Profit margins in Manufacturing sectors have also deteriorated in April 2013 at -7.32, but the rate of deterioration was slower than in March 2013 when it stood at -12.04 and much slower than -22.86 rate of decline in profit margins recored in April 2012.

12mo MA is now at -11.1 and 3mo average rate was -15.2 for 3 months through January 2013, while 3mo average for February-April 2013 is at much more benign -9.9. In other words, there is moderation in the rate of margins decreases in recent months.

Longer-term dynamics are shown on the chart below in terms of 3 year averages. Since January 2012 through April 2013, Manufacturing profitability index averaged -13.83 - a rate of profit margins decline that is better than the average rate recorded for 3 years period of January 2009-December 2011 (-14.1). January 2012-April 2013, average rate of deterioration is still the second worst on the record.

An interesting aside: notice significant improvements in profitability in late 2008 - mid 2010 being exhausted in 2011-present in the Services sector and similar, but slightly differently timed changes in Manufacturing? These nicely coincide with the period of most dramatic unit labour costs declines and overall cost-competitiveness gains in the Irish economy. And, just as those gains virtually stopped in 2011-on, so did profit margins conditions improvements.

4/5/2013: Corporate tax rate Laffer Curve

A very interesting, albeit not too rigorous (econometrically) exercise on the relationship between corporate tax rates and corporate tax revenues (the Laffer Curve):
http://alephblog.com/2013/05/03/on-the-laffer-curve-regarding-marginal-corporate-tax-rates/

Worth a read.

Top of the line conclusion: ex-Norway, "...at a 5% level of significance, the equation is significant, with a prob-value of 1.4%, and all but one of the coefficients are significant, and the coefficient on the squared term has a prob value of 11.6%. The signs all go the right way, and the intercept is near zero."

So: "It looks like there is some validity to the idea that as marginal corporate tax rates rise, so do corporate taxes as a percentage of GDP, until the taxes get too high. I didn’t test anything else.  With both equations we learn two ideas:

• The tax take tops out at a 30% marginal rate
• You don’t give up much if you set the marginal rate at 20%"

3/5/2013: Basel 2.5 can lead to increased liquidity & contagion risks

Banca d'Italia research paper No. 159, "Basel 2.5: potential benefits and unintended consequences" (April 2013) by Giovanni Pepe looks at the Basel III framework from the risk-weighting perspective. Under previous Basel rules, since 1996, "…the Basel risk-weighting regime has been based on the distinction between the trading and the
banking book. For a long time credit items have been weighted less strictly if held in the trading book, on the assumption that they are easy to hedge or sell."

Alas, the assumption of lower liquidity risks associated with assets held on trading book proved to be rather faulty. "The Great Financial Crisis made evident that banks declared a trading intent on positions that proved difficult or impossible to sell quickly. The Basel 2.5 package was developed in 2009 to better align trading and banking books’ capital treatments." Yet, the question remains as to whether the Basel 2.5 response is adequate to properly realign risk pricing for liquidity risk, relating to assets held on trading book.

"Working on a number of hypothetical portfolios [the study shows] that the new rules fell short of reaching their target and instead merely reversed the incentives. A model bank can now achieve a material capital saving by allocating its credit securities to the banking book [as opposed to the trading book], irrespective of its real intention or capability of holding them until maturity. The advantage of doing so is particularly pronounced when the incremental investment increases the concentration profile of the trading book, as usually happens for exposures towards banks’ home government. Moreover, in these cases trading book requirements are exposed to powerful cliff-edge
effects triggered by rating changes."

In the nutshell, Basel 2.5 fails to get the poor quality assets risks properly priced and instead created incentives for the banks to shift such assets to the different section of the balance sheet. The impact of this is to superficially inflate values of sovereign debt (by reducing risk-weighted capital requirements on these assets). Added effect of this is that Basel 2.5 inadvertently increases the risk of sovereign-bank-sovereign contagion cycle.

The paper is available at: http://www.bancaditalia.it/pubblicazioni/econo/quest_ecofin_2/qef159/QEF_159.pdf