Economics 18/12/2009: How fair is that Ireland-Greece comparison?

Our policymakers are quick to point out that Ireland has been unfairly treated by the bond markets, for its CDS and bonds spreads are moving in tandem with those of Greece.

The sop story usually flows along the following lines: “Ireland has a better starting position in terms of lower debt burden and it has taken the pain necessary – through three Budgets effecting significant cuts to spending and imposing new revenue raising measures. Greece, obviously, have not done so. Thus, our bonds spreads should be much closer to Germany than they are to Greece.”

An interesting, if somewhat lopsided proposition.

Here are some comparatives (do keep in mind that our real income is GNP which is now 20% below the GDP figure):
Note: No recap scenario refers to no recapitalization funding for banks post-Nama; Recap 50% scenario assumes that 50% of expected cost of recapitalization of banks post-Nama impacts in 2010.
* Severely unrealistic target.
** Ex-Nama.
*** Nama primary €59bn, higher number also factors in expected post-Nama recapitalization costs.

And consider a couple figures:
Data for all three is from IMF/World Bank/BIS database

So here we go. Is Ireland unfairly singled out to be put next to Greece? You decide, but remember, bond markets do not care about one’s starting position or about the current position – they care about the future positions. When a patient gets a massive stroke, the fact that he was jogging 5 miles a day before is neither here, nor there.

And on a good news front: here. We are saved! Escaping Nama will be just a quick 88-mph blast to the past away.

Economics 17/12/2009: End of recession in Ireland?

Is Ireland technically out of the recession? Well, I don't know. And for several reasons.

First, it takes two consecutive quarters to get into a recession. Should one quarter of positive growth mean you get out of a recession? Me thinks not.

Second, what measure do you go by? In a large diversified economy, GDP does the job. In the case of Ireland - GNP. Just as we should not count transfer prices by multinationals as our income, we should not count GDP as our measure of economic well-being. And here is a sticky point for today's QNA data: Q3 2009 saw GDP rise by 0.3%, but GNP fall by 1.4%. So this economy's income/output is falling still.

Third, consider why the GDP expanded in Q3 2009.

In the case of Q3 2009, every category of domestic expenditure fell on Q2 2009:

• Spending by consumers down by 0.7%qoq;
• Government expenditure down 0.9% qoq (good news given the deficit);
• Investment down some 10%
• Spending on Irish exports down 0.6% relative to Q2 2009.

So how did the economy grow? Imports fell a whooping 4.5%. Fewer BMWs and Mercs and flat screen TVs imported into the country and, magic happens – we are now richer by 0.3% than we were in June 2009. Right… North Korean model of growth indeedanyone?..

GDP expenditure components, % qoq
Now, in comparison, the US – economy on public spending (err stimulus) steroids – grew by 0.7% increase in GDP Q3 2009 and this growth was broadly present across all categories of expenditure.

The only net positive is that GNP contracted only 1.4%, which is much slower rate of collapse than 5.2% decline in Q1 2009 and even slightly slower than Q2 2009 fall of 1.7%. Nonetheless, the fall is still significant.

Thus, overall, GDP/GNP gap grew wider once again as the real domestic economy is still deeply in the recessionary dynamic. The GDP / GNP gap is accounted for by the “Net Factor Income from Abroad” or NFIa. As MNCs export more and more profits from Ireland, driven by increased transfer pricing through our off-shore accounting zone, NFIa rises. NFIa also increases as Government debt financing rises – and we know where that is coming from. And it does so as a proportion of the overall value added in the economy. Aptly, Q3 saw NFIa reaching record levels.

How important is the transfer pricing effect in Ireland? Chart below updates the earlier data on the GDP/GNP gap. But figures for sector activity show that while modern manufacturing sectors (Chemicals, Pharma, ICT – all dominated to the tune of over 90% by the foreign companies) grew in output by 6.5% in 2009, traditional sectors (dominated by domestic firms) collapsed in output by some 15%. Did anyone notice new factories supported by MNCs mushrooming over this year? Not really, So 6.5% ‘output’ increase is the MNCs booking higher value added to their Irish operations, assigning accounting value to the same products they manufactured here last year and booking more profits in Ireland at our 12.5% tax rate.

This is cool – it supports jobs here. But do not confuse this with Irish output. Or with Irish income. Or with the end of Irish recession. Lest you want to be that one-time invitee to a cool party who imagines himself to be the owner of a lavish host’s estate.

Now, let me update some charts.
GDP at constant prices - all components are down. Even those that were showing improvement in Q2 2009 (Agriculture, Forestry & Fishing) or stabilization (e.g Industry) are now turning negative. Except for Other Services & Rents (gotta be Nama offices at the banks renting new facilities).
GDP is down in all measures at constant market prices, and GDP relation to GNP is fairly evident (more on this below).

Now, contributions to GDP:
Again, no improvements on Q2 above.

And GDP/GNP gap visualization:
Yes, an end to a recession indeed. We've breached 20% for the gap - a full 1/5 of the so-called Irish income has absolutely nothing to do with Ireland except for the accounting ledger in MNCs offices. If this is growth - well, set up an imaginary ledger in DofF and start entering zeros to our GDP figure on a monthly basis.

Now on to value added in Irish economy:
Things are now worse than they were in Q2 2009 in all sectors, save 'Other' and Agriculture.

This not an end to a recession. It is a recession running at pretty much the same rate as in Q2 2009.

QED

Economics 17/12/2009: The latest on our Knowledge Economy

I will be blogging on the latest story from the 'emerging' economy of Ireland - emerging, allegedly from the recession - in a few hours time, so stay tuned. But for now, while cooking the dinner for my 3-year old let me bring to you the latest news from the 'Knowledge' economy Ireland.

Now, as a researcher I must admit, I know first hand that electronic editions of scientific journals are the sole source of published refereed research material I consult on a daily basis. Physical copies are too hard to use in modern research and archiving. And they arrive with a significant delay. And are environmentally less sustainable than e-versions.

Thus, electronic journals access is a must for any modern research in any field.

And here comes a bomb: Access to e-journals might be dropped by Irish Universities in 2010. Courtesy of the Science and Research strategy from the Government that just a week ago was science and research as the main strategy for our economic revival.

Here are the details from a leaked memorandum... I suppress personal names...

"Dear Fellows and Fellows Emeriti,

This note has been prepared by Dr F.B. of ... (Academic Department).

...alerting all interested parties including students that the Irish Government is about to burn the books. The universities of a knowledge based society must have access to electronic journals.

signed DMcC
Chairman of ... (academic body)


Dear All

Last night the Librarian ...briefed the Fellows on the current state of play with regard to the IREL/ on-line journal access service.

The position is not good and could have serious implications for staff and students at all Irish universities.

Briefly and from memory, the facts are as follows.

The service costs about €8-€8.5 million a year. Up to now, about €4.5m of this has been paid by SFI for science technology and medicine titles, but SFI have always said that their commitment was in the form of seed money and are now withdrawing their support. The HEA, which paid €4 million for humanities and social sciences titles are also stretched. But they may come up with some money. The worst case scenario may be €2 million, the best €3.5 million all from the HEA.

The IUA have been approached about bridging the gap, but either cannot or will not provide the ~€5+ million needed.

...In the short end of the medium term it will cripple research activity and undermine teaching in most areas throughout the universities...

Signed: FB"

Let me give you my quick 5-cents on this. E-journals access in Ireland is already relatively restricted compared to the US & UK universities. Cutting what we do have access to will simply mean plunging our science into the dark age of physical print, slow mail and distant archiving. In the age when Google and Microsoft are racing each other to put libraries on line, and IDA is promoting Ireland as a knowledge and innovation campus for global business, the savings of some €5-6 million at the cost of disconnecting Irish science and students from the rest of the world is just mad.

Economics 16/12/2009: Budget 2010 Analysis

As promised - here is my more in-depth view of the Budget 2010. This is an un-edited version of the Sunday Times (13/12/2009 issue) article.

After weeks of leaks, speculations and over-dramatized Partnership talks, this week Brian Lenihan has delivered the final move in the Government v Economy chess game. Lisbon, Nama and the Budget 2010, we were promised, were all that the Cabinet had to do in 2009 in order to manage the nation through the worst economic storm in its history.

In its last stance of 2009 the Government has reluctantly and belatedly recognised the reality of the crisis we face. Thus, the Budget has done just about enough to delay our descent into the nightmarish company of Greece. For this Brian Lenihan deserves praise.

A Chance at Reforms - Missed

But the net outcome of the Budget 2010 is that we are now entering the third year of recession with virtually no reforms that can support future growth.

There is no real stimulus to the rapidly contracting private sector. Cost efficient and much needed export credits are not in and neither are foreign exchange risk supports – the two cornerstone policies for sustaining exports, especially for indigenous companies.

Taxes remain regressively skewed toward ‘soaking the rich’, by which the Government means the middle class. As in 2009, the burden of taxation in 2010 will be borne squarely by those in the most productive employment with above average skills and aptitude. If a combination of consumption and income taxes accounted for under 68.9% of total tax revenues in 2009, by the end of the next year these taxes will account for 70.3% of total tax take.

Today, some 40% of Irish households deliver 90% of non-corporate dosh for the Exchequer. By the end of 2010, given current trends in unemployment and wages, this ‘honor’ will befall just 37% of households. This is hardly a sign of resilience in the economy.

In 2009, 4% of top earners – many of whom are wealth and jobs creating entrepreneurs and business owners – pay 50% of total income tax. Next year, we are risking to hike this share to 55%. This is hardly a sign of the economy promoting jobs growth.

Should Ireland-based multinationals reduce their transfer pricing activities in 2010 – a prospect consistent with a possibility of a restart of new investment cycle in Asia and the US – an even greater share of the burden of paying for public sector expenditure will be falling onto the shoulders of rapidly thinning minority who still have higher value-adding jobs.

Cuts to unemployment benefits in excess of reductions to social welfare imply that Budget 2010 only strengthened the incentives to transfer from unemployment benefits roster onto social welfare for anyone in long-term unemployment. This will lead a decline in labour force participation rates throughout 2010. Paradoxically this will result in lower official unemployment but a higher cost to the taxpayers.

Uncompetitive Costs Base - Remains Intact

The Budget has done nothing to address the issue of uncompetitive costs imposed onto businesses by our state-owned utilities and suppliers of services. It also did nothing to address excessively high local authorities’ charges and rates.

A net positive of the Budget was honorable mentioning of the internationally trading financial services. However, it remains to be seen what exactly will be done on this front.

Brian Lenihan missed another chance of reforming our business-crippling quangoes. In doing so, the Budget failed to recognize the real damages state and local authorities’ costs inflation poses to the survival of both domestic and exporting companies. If anything, the Budget further expanded the Fas empire – an unchecked state behemoth that yields dubious benefits and wastes hard cash in truckloads. The policy, it seems, is to shove more unemployed into perpetual training programmes with little hope of gainful employment in the foreseeable future.

A failure to introduce university fees means that our education system will spend another year mired in funding uncertainty. It will also mean that many graduating students will desperately cling to education for another 1-2 years. For some, this is a productive opportunity to invest further into their future skills. For many, however, it is an unnecessary extension of studies that will not lead to any meaningful skills augmentation but will consume precious resources. Classroom sizes will rise, international rankings will be threatened, but we will increase output of devalued in quality degrees, certificates and diplomas.

Retaining prohibitively high rates on PRSI, health and income will undoubtedly keep jobs growth on ice. Other, so-called soft labour costs, could have been tackled through simple measures, such as for example abolishing risk equalization scheme in health insurance to lower the costs of employees benefits. These opportunities were missed.

Banking Sector Costs - Unpriced

There are no provisions whatsoever for the banking sector in the Budget. Yet, two future developments with respect to the sector are now virtually assured for 2010.

First, we are likely to see significant demands from the banks for new capital. My estimates suggest that our six banking institutions will need €9.7-12.4 billion in capital post-Nama. If even a half of this falls in 2010, Budget deficit risks reaching 14.5% of GDP. The only way to avoid such a debacle will be to use Nama as a vehicle for issuing even more State-guaranteed bonds. This will make Ireland even more dependent on ECB’s good will.

Second, the Minister has introduced a set of new conceptual frameworks for using Nama to apply pressure on lenders to increase funding for SMEs and distressed households. All are ambivalent, although well-meaning, and all are regressive when it comes to securing stable future for our banking system. None will actually expand real lending.

Structural Deficit - Unaddressed

The Budget has failed to significantly tackle our structural deficit. The pre-Budget projections suggested that Brian Lenihan was facing €14-16 billion worth of structural deficit. The Budget promises to reduce this number to €10-12 billion. Even if this comes to pass the Government is now facing two stark choices. One – hope for a spectacular recovery from the crisis with an average rate of growth in the economy of over 5% per annum over the next 5 years. In this case, the Government will need to cut some €4-6 billion more in 2011 and 2012. Two – take the medicine and cut at least €8 billion in 2011. We have clearly opted for the first option to the detriment of the future growth.

Carbon Tax - More of the Same

Carbon tax introduction is a purely revenue raising and economically distortionary measure. In theory, carbon tax should alter environmentally harmful behavior of consumers and producers, pushing them to adopt cleaner technologies and habits, thus gradually reducing carbon tax revenue. Alas, in the case of Ireland, years of poor planning and zoning, successions of absurd spatial development plans and politically motivated capital investment programmes have resulted in a situation where many Irish consumers and producers have no room for altering their choices. Living and working in the Greater Dublin area often means no alternative but to use a car to commute to work, or even to visit grocery stores. The same can be said about all other parts of the country. Our family structures – with high fertility and dispersed households – mean that many of us have no choice but to do school runs in a car, to undertake international air travel and to deal with employment patterns that do not favor efficient time management that can be conducive to reducing emissions. Ireland’s shambolic (in quality and scope) public transport system simply compounds the lack of choices.

Hence, despite its ‘Green Policy’ label, carbon tax is nothing more than an extension of an income tax with all the associated disincentives when it comes to higher value-added jobs creation in Ireland. Irony has it, transforming this economy into more human capital intensive and thus environmentally cleaner ‘knowledge’-based one is an objective poorly served by the carbon tax introduction.


On the net, Budget 2010 turned out to be more a whimper than a bang. Whether or not it will pave the way for economically more constructive policies in 2010 remains to be seen. But the task left unfinished is daunting – Ireland will need to cut some €10-12 billion more off the Exchequer annual bill in 2011 through 2012. So far, we’ve only made a first step in a longer journey.


Box out:
In light of this week’s events, it worth quickly revisiting one aspect of our budgetary trends – their frightening stickiness to historic targets that runs contrary to any change in the underlying economic realities. Looking at Budget 2007 estimates, one gets a sense of history playing a cruel trick on Department of Finance forecasting section. Back then, the Department projected a steady rise in spending from ca €45.5 billion to ca €58 billion in 2009. In line with this, the revenue was expected to rise from ca €47 billion in 2006 to roughly €58 billion in 2009. What actually happened between then and now is that the expenditure has shot up, settling at above €60 billion in 2009, while revenue has fallen to below €35 billion. Thus, Department for Finance forecasters were almost 97% right on the expenditure forecast side, but some 60% wrong on their revenue predictions. This implies an error swing of some160 points for the Department of Finance. A random error would be consistent with a 50-point range between two calls. In household economics such accuracy of forecasting could earn one a trip to a debt court. In public sector it guarantees the job for life and a nice tidy pension at the end of an errors-prone journey. Accountability is not really a strong point of Ireland Inc.

economics 16/12/2009: Unemployment and Jobs Destruction in Ireland

QNHS data is out for Q3 2009 and guess what... well, nothing new, really. Official unemployment rate is now 12.4% - just 10bps away from the Live Register-based Q3 average estimate of 12.5%. The cheerleaders are shouting 'A slowdown in the rate of growth in unemployment! Happy times ahead!'

But the real world data shows much darker picture. The biggest problem with unemployment is how you define it. If a person would like to have a job but is so discouraged by the labor market that he or she decide to stop looking for one, then they are not in the labor force and thus are not unemployed. Similarly, if a person had a job and upon losing it moves out of the country is search of better prospects elsewhere, then they are no longer unemployed. And if a person, disheartened by the prospect of long-term unemployment simply stops answering CSO phone calls, then she is also not unemployed.

But in the real world, all of these people are unemployed. All of these people's lives are lost in the economy even if they are not measured by the CSO.

This is not to criticise the ways in which CSO collects data. That is not the point. The point is that we need to understand just how many jobs were lost and not regained during the current crisis. And this we can glimpse from the QNHS data.

In Q3 2009 total employment fell 40,200 on Q2 2009. In 12 months to the end of Q3 2009, Irish economy shed net of 183,400 jobs - the rate of loss of 8.8% or the highest rate of jobs destruction on the record. In the course of this recession, we have now lost some 236,300 jobs.

Let's do the maths. The above losses imply:

• €13, 450 million in lost economic activity in Ireland
• €1,500 million in lost income tax to the Exchequer (using lower rate and no income levies)
• €3,750 million in lost consumption
• €675 million in lost VAT receipts, and so on

Notice that all of these jobs came out of the private sector and a number of contractors to the public sector and thus these losses cannot be offset even partially through reduced Exchequer wage bills.

And the problem of falling labor force is a sticky one. The overall participation rate has contracted from 64.2% in Q3 2008 to 62.5% in Q3 2009.

Much of the fall in the labor force is being driven by:

• long term unemployment pushing people into permanent welfare traps;
• exits from the workforce by students who are at a risk of completing new education and not finding new jobs afterward (for 15-19 yo participation rate has fallen to 22.7% from 30.8% a year ago, while for 20-24 yo group it stands at 72.9% as opposed to 77.4% a year ago), and
• emigration.
  

Last year, some 45,000 non-Irish nationals left the country, as in left their gainful productive employment in this state and moved on to be productive elsewhere. That's not so good for our economy. Many worked in the construction and domestic services sector and had skills beyond their jobs. Ireland is losing on their productive potential. But many worked in traded services and here the losses are even greater. The future of Irish economy is in traded services first and foremost - that is the elusive 'knowledge' economy we've been pursuing (even though our policymakers have no idea that this what it is). This economy requires more people with cultural, linguistic and skills sets that are distinct from our average 'national' skill-set. Ireland is losing now on our future productive capacity as well as on the immediate one.

And so on the net, CSO data shows that while unemployment climbed by roughly 120,000 over the last 12 months, the actual fall in employment was 185,000 or 65,000 greater. It is the net loss of jobs figure that is more telling of the realities of Irish unemployment than the headline unemployment rate.

Finally, courtesy of Ulster Bank - a table showing that unlike in earlier QNHS releases, Q3 saw industry displacing construction sector as the main source of jobs destruction:
This is another batch of bad news for anyone who, like our Minister for Finance, believes that things are past their worst. In addition, notice that wholesale & retail trade is about to take over construction as the second greatest contributor to unemployment. Wait until Christmas sales are over for that...

Economics 15/12/2009: Denmark cuts 2010 deficit by almost 50%

An interesting way of dealing with deficits: Denmark shows the way to lower taxes and deferred tax liabilities, while restructuring public expenditure away from direct spending to more pro-business, growth oriented spending. Read the details here.

Another interesting key fact: "The general government budget balance is estimated to decrease by DKK 154bn from 2008 to 2010. This corresponds to a reduction of 8.9 per cent of GDP of which one third reflects the loosening of fiscal policy... Measured by the fiscal effect fiscal policy is estimated to stimulate economic activity by 1.0 per cent of GDP in 2009."

So run this by me again? Cut balance by 8.9%, of which roughly 3% of GDP goes to fiscal spending to generate growth of ca 1%. suggested multiplier? Lowly 30cents on the euro... or rather DKK... not exactly a big bang for a buck, given that over 5 years interest alone would eat up some 15.8 cents out of this amount.

Another crucial bit: "The deficit on the central government net balance, which is essential for the central government debt, is estimated at DKK 141½bn in 2009 and 74½bn in 2010." Implied cut in deficit 2009 to 2010 is 49.6%. Irish Government approach to the cuts (see my estimates here) is to cut 15.2% of the deficit (if no banks recapitalization is taken into the account) or under 1% reduction (if banks recapitalization is factored in at €4 billion in 2010). DofF own rosy projections imply a cut in the deficit of 29.7%, which is still shallower than Denmark's.

So, the Siptunomics is not what Denmark subscribes to when it comes to fiscal discipline.