Economics 05/01/2010: Exchequer tale of excesses amidst the hardship

New Exchequer figures clearly show that the crisis is not over!

Before the updated charts, from the first reading of the figures, it is patently obvious that

• while the expenditure side of the Exchequer balance remains barely on target - only 0.5% below the supplementary Budget 2009 estimates (with current expenditure running 0.6% below April 2009 budgeted levels, while capital spending running 0.3% ahead);
• the receipts side continues downward trend: despite an improvement in the shortfall registered in November 2009, December figures still represent the second worst month in 2009.

Further per more detailed breakdown, on the current expenditure side, Community, Rural & Gaeltacht (+0.3% relative to target), Finance (+3.3% on target), and Justice (+1.5% on target) were the three non-social welfare or health-related departments that managed to overspend their targets.

Now, charts to illustrate:
Relative to April 2009 targets, the chart above shows the shortfalls for receipts by main headings. Corporation tax is ahead the forecast - say thank you to MNCs booking more transfer pricing through Ireland this year to reduce their tax liabilities - but this position is still below 5% at the year end.

CGT is shorting the target again after improvement in November. Capital acquisition tax is down for the second month running. Customs show very shallow upturn - most likely due to motor imports flowing to restock for New Year and some replenishment of supplies on alcohol, tobacco and food for Christmas season end.

Year-on-year changes: corpo tax has fallen precipitously and is staying relatively flat now. Total tax is barely up relative to 2008 dynamics, but still below 2008 levels by double digit percentage - it was down 20.8% in November and now improved to down to 19% in December - in yoy terms - the second worst performance in the H2 2009 (it was down massive 21% in May).
In addition to the above trends, VAT down 20.60% yoy in December - an improvement on -20.80% performance in November and the sixth consecutive month of improvements , Income tax flat relative to November - the latter reflecting the lack of end-of-year bonuses. The former shows extremely weak retail sales dynamic. Stamps & CGT - two investment related taxes are obviously improved. After a 26-30% rallies in S&P, European, UK and Irish stock markets - any wonder?


Next, Exchequer deficit - still wider than annual average, though slightly better than in November. The gap between end-2008 borrowing position and today is €6bn - more Bonds! and Pints! for Q1 2010, then.
Deficit in 2009 relative to 2008:Not a pretty sight - December marks second worst month of 2009 in terms of deficit performance compared to 2008. The big question in this picture is whether this does mark some sort of a return to falling deficits? Well, not really - look at the picture above the last one. There was a seasonal improvement in November - due to the inflow of self-employment receipts for 2008 and estimates for 2009, but it was much weaker in 2009 than in 2008 in part due to the exhaustion of the severance packages, in part due to further jobs destruction for contractors. Apart from this, in October 2009 cumulative deficit was €11.7 billion greater than that registered in October 2008. In December 2009, the same figure was €11.9 billion. I wouldn't call this an improvement or an upturn.

Now, expenditure v receipts dynamics for 2009 and 2008:Pretty obvious stuff here. Vertical distance between 2 solid lines is deficit in 2009, vertical distance between two dashed lines is 2008 deficit. Any improvement would require for the solid lines to move closer to dashed ones.

Slight catching up with 2008 in terms of spending in the last month of the year is still not enough to bring spending down to 2008 level. All in (capital and current spending added), the Exchequer burned through an impressive €60 billion in 2009 - up from hardly insignificant €55.7 billion in 2008. But on receipts side, no improvement is visible. Actually matters are getting worse, with total 2009 receipts (capital and current) adding to less than €35.3bn while 2008 receipts came in at €43.1 billion.

Total tax receipts are now at €33.4 billion. Now, that is - oh miracle! - bang on with Budget 2010 estimate. DofF also predicted a General Gov Balance of €25.261 billion and it came in at €24.641 billion, or €620 million short of the 'forecast'.

Are we supposed to be impressed? Not really - these 'forecasts' were made less than a month ahead of the Christmas break. When one looks back -

• in April 2009DofF forecast a deficit of €20.35 billion. My forecast was €23.35-24.225 billion (see here)
• in February 2009 (here) DofF projected "budgeted expenditure to be in the region of €49bn and receipts in the region of €37.7bn" and deficit of €17.98bn. My forecast then suggested that exchequer tax receipts will add up to €33.6bn for 2009 for a General Gov deficit of €23bn.

Now, I do not have a massive forecasting department staffed with highly paid civil servants and tea/coffee/biscuits deliveries twice daily. I am not even being paid to do any forecasting at all. Per DofF own staffing review, the forecasting powers unleashed by the department on the economy are costing taxpayers a mint.

Their and my error margins for 2009 Deficit estimates are:

• Dof F: 17.4% miss in April and 27.03% miss in February;
  
• my: 1.69% miss in April and 6.65% miss in February.

But you do not have to be an Einstein to see that things are not improving, folks. The is no pulse and the patient has flat-lined. Full stop. Have April Budget been successful in delivering stabilisation of the budgetary dynamic? Not really. Stabilization would imply that we would trend along with the 2008 dynamics of the deficit starting with May 2009. Chart below shows this not to be the case:
Overall, some observers have argued that there is a substantial improvement on Budget 2010 targets. Well, of course there was. The problem here is that one cannot willingly adopt targets that suit one argument. April 2009 set the benchmarks to deliver and by these benchmarks, 2009 turned out to be worse than projected on revenue side. 3.9% worse or cool €1.357 billion - more than double the net savings announced from public sector pay adjustments in Budget 2010.


PS: Amidst all this talk from banks and brokerage economists about 'improving' Exchequer outlook based on 'too pessimistic DofF projections', my fear is that the Government is being prepped by the DofF (via severe overshooting in the Budget 2010 forecasts) to claw back on some of the cuts planned for 2011. In other words, the DofF might be readying to make a call in the beginning of H2 2010 to cull the cuts if returns shows 'improvements' on its own excessively pessimistic forecast targets. Then again, they might be not pessimistic enough...

Economics 04/01/2010: Daily points

Minister Brian Lenihan's statement today - available here - deserves reading. Irrespective of one's disagreements with his policies, Brian Lenihan deserves our best wishes for speediest and fullest recovery and his family deserve our praise for the way they handled the public aspects of such a very private matter. Minister's statement today only re-enforces the sense of dignity and respect which he has projected to the entire nation at this time of a serious threat to his health. Let us hope that his treatment, that begins this week, will be swift and fully effective and that he will be as comfortable in the process of treatment as possible.


Now, onto few interesting issues I cam across in today's press:


A rather humorous mention of Ireland in a Kenyan newspaper (here).

A quote from the Economist reproduced in the paper:
"If we are to generate the sort of sustained and genuine boom that will deliver Vision 2030, we must move away from outdated practices. We must imagine success beyond beacons and title deeds. We must understand that we live in a world where success now comes from the contents of your head, not the soil on which you stand. We must make banks and financial institutions the handmaidens of development, not the brides. We must invest in knowledge, innovation and science. ...Our future lies in making and doing things better than others, not in building a cheap-credit economy in which property is the key asset. Let us learn that lesson before we find ourselves sharing a bad Irish joke."

Here is an interesting observation: over the weekend, Mr Cowen stated that the Government has no intention to help resolve the problem of negative equity. This is exactly the 'bad Irish joke' that the Business Daily Africa is talking about. Negative equity undermines returns to human capital by locking people in specific locations regardless of whether they can obtain a job suited to their qualifications or not. Thus, negative equity acts to undermine:

• incentives for skills acquisition, upskilling and mobility;
• returns to human capital investments to individuals and the economy at large; and
• the potential rate of growth for our economy.

Sadly, Mr Cowen does not seem to understand that this threat is far more severe and harder to deal with than the threats to our banks. One can replace Irish banks or sell them to the highest bidders. One can replace liquidity from the bond holders with alternative sources of financing. All within 2-3 years if not earlier.

But one cannot reverse long term structural unemployment that will be the outcome of the negative equity - often, even after generations pass.


There is an interesting essay on Seeking Alpha (here) discussing some evidence that the 2000s was a lost decade in the US and that this trend is going to continue into the new decade. The second chart, plotting real S&P500 against payroll population ratio to total population is a telling one.


The EU Observer (here) has a story on the French courts striking down the new Carbon Tax as imposing an arbitrarily unfair burden on consumers, while letting industry off the hook. Is there a case for Ireland's courts to protect consumers? Tall order. In the case of the Irish CO2 tax, we, consumers, will pay the full load through:

1. paying directly at the pump and through VRT, and
2. paying indirectly through energy charges set by regulators for semi-state monopolies running our energy sector,
   
3. through higher charges at the airports and on public transport, also set by unaccountable regulators, and
4. at a later date - through incineration surcharges that will be inevitable given the conditions of the contract between the Poolbeg operators and Dublin City.

Here is a telling quote: "Socialist Party grandee Segolene Royal cheered the ruling, calling the law 'ecologically ineffective and socially unjust.' The Greens for their part back the principle of a carbon tax but welcomed the ruling, believing Mr Sarkozy's version of such a tax inegalitarian."

It wouldn't be the job of the Irish Green Party to make sure that our own carbon tax is effective, egalitarian and socially just. But what about the economic logic? Ireland spent 2009 solidly in pursuit of improved cost competitiveness as businesses and the Government cut employment costs. Now, we just managed to hike up the cost of doing business in this country and reduce our ability to accept lower wages by raising a new tax. Anyone to notice a grand contradiction?

Economics 02/01/2010: Irish Economy 2010

In the spirit of a fellow economist who posted his published views on 2010 prognosis for Ireland Inc, here is my take on the future, as published in the current edition of Business & Finance magazine. Note: this is an unedited version.


With the Budget 2010 behind us, January beacons as the month that will make or break our hopes for seeing a recovery next year.

Despite all Government pronouncements, the real issues faced by this country in 2009 reached much deeper than the three Super Challenges of the year. Neither Lisbon, nor Nama (until it is finalised) and especially not Budget 2010 will have as lasting an impact on this economy as the job never taken up – the nitty-gritty of managing our economic freefall.

Throughout 2009, our leadership has resorted to the management strategy known as the ‘sandwich’ technique. This involves delivering the requisite bad news sandwiched between quasi-plausible platitudes. Thus, throughout 2009 the Government has sought to soften the news with some ‘positive thinking’ sloganeering and move from one blockbuster campaign to another. In the mean time, taxation burden explosion and general sense of uncertainty have weighted heavily on our economic psyche.

The Budget 2010 speech by Minister Lenihan, peppered with pronouncements of the ending of the recession and exhortations that ‘The worst is now over’ continued the trend. With such modus operandi, deep and necessary reforms simply cannot take place. And predictably they did not take place.

Instead of admitting that unemployment is here to stay and that it will be our younger workers who will be on the dole the longest, Brian Cowen and his side-kicks applied selective filters pronouncing the imminent end of the recession back in May 2009. Bottoming out claims stretched into June, followed by a promise of a ‘positive growth’ quarter before Christmas.

What the country needed most – exports credits and currency risk supports, tax cuts to stimulate jobs creation and a reform of the banking sector to allow deleveraging of the households croaking under the mountain of debts – never took place. Not once have we heard of the need to stimulate entrepreneurship. Not once in the entire year have we been offered a vision to attract new start up companies into Ireland.

Instead, the country received a hefty dose of PR-speak on ‘knowledge economy’ while mothballing new investment in ICT, IT and venture capital funding. Money not spent on real economy went right over the heads of tens of thousands unemployed workers straight to the white elephant of Fas training schemes.

The problem is that amidst this marketing blitz from the Government, the real numbers suggest that the country is far from reaching the bottom of a recession and that we are heading into the period of protracted stagnation with growth bouncing along a flat trend line.

Take the Exchequer returns. A year ago, Exchequer revenue stood at €41 billion. This year the figure has fallen to €34.6 billion – down almost 15.5% in 12 months. Next year, things will ‘stabilize’ at around €34.25 billion, which will remain largely intact into 2012.

2009 Exchequer returns were artificially inflated by two major factors: transfer pricing by multinationals and redundancy payments that were made in late 2008-early 2009. These factors are unlikely to replay in 2010, because our MNCs will be heading into a new investment cycle elsewhere, with much lower incentives to push transfer pricing through Ireland, while the redundancy payments for the next wave of layoffs will be much slimmer. This suggests that some €1 billion worth of income tax and circa €110 million worth of corporate tax receipts factored into the latest Department of Finance projections are not going to materialise.

And this is before we account for the expected declines in 2009 self-employment tax revenues. Over 2009 VAT receipts fell to €10,368 million, down 20.5%. But retail sales contracted by 15% in value. This suggests that up to a quarter of the decrease in VAT payments came from somewhere else, namely – from the depressed business activity. Doing a simple back of envelope calculation suggests that VAT-related activity has fallen some €15bn (roughly in line with our GNP declines), implying the associated decline in corporate tax revenue of some €150-200 million into 2010.

Table below shows estimated 2010 balance sheet for the Government post-Budget 2010. Assuming the Government delivers planned €4 billion in cuts, the Exchequer deficit in 2010 is likely to be in the region of 10.4% (by Department of Finance estimates, adjusting for net savings) and 14.5% (using my projections). And my scenario assumes that only €4 billion worth of expected 2010 banks recapitalization funding will come directly from the Exchequer, with some €5.7-8.4 billion in additional funds financed through new Nama bonds. Department of Finance naively assumes no new recapitalization demands from the banks during 2010.
These figures compound the crisis of 2009. In other words, while the Exchequer deficit might be indeed stabilising in size in 2010, new debt burden is growing. Far from being closer to solvency, we are getting deeper into dependency of borrowing to maintain our public spending.

By various estimates, structural deficit was between 8% and 9% of 2009 GDP. Given that raising tax burden on current net contributors to the Exchequer is simply not feasible, correcting for this will require reducing our public expenditure by some €10-12 billion more in 2010-2011. Every year we delay the remaining adjustment will cost us additional €500 million in financing costs, shaving off 0.3% of our annual GDP. None of this is factored into Department of Finance projections.


As bad as things might be on the deficit front, at the very least we have an idea as to what measures must be taken to address the problem. Things are more complicated when it comes to unemployment. The latest data for Live Register shows that the number of those claiming jobless benefits is again on the rise, following a decline in October 2009. The rate of increases is much slower than in Q1 2009, but this is neither here nor there for two reasons.

First, our army of unemployed is growing much faster than the Live Register suggests because at least 3,800 people are currently due to rejoin Live Register from seasonal part time employment, while 30,300 people on Fas’ full-time training and community employment schemes have little chance of getting a real job any time soon. Factor these in and Live Register-implied unemployment rises to 13.5%, or just 42,535 shy of the half a million mark.

Second, the real unemployment, as opposed to the statistical measure, has already reached this level due to the fact that we are seeing increases in long term unemployment translating into social welfare dependency. The more the Government talks about cutting unemployment benefits, the greater will be the incentives for moving off unemployment to welfare.

And our welfare trap is a potent one. In a note published a week before Budget day, Department of Finance provided an estimate of the replacement rates for various types of welfare recipients in Ireland. Under Department assumptions (which covered rent relief, child benefit, main benefit and some additional payments), majority of categories of welfare recipients received benefits in excess of 60% of the average industrial earnings which currently stands at €33,634 per annum. Once costs of child care and health subsidies are added, all but two categories of recipients earned more than 70% of the average industrial earnings and three categories in excess of 100%. If you also recognise that working today requires payment for transport and food – the two costs vastly lower for those on the dole, all categories of social welfare recipients examined by the Department of Finance earn more than 70% of the average industrial earnings.

It is a simple mathematical conclusion that every person moving from Live Register to the generous embrace of social welfare adds to the financial woes of the state. Budget 2010 has done nothing to address this problem in real terms, while it did strengthen the incentives for transitioning to the dole from unemployment benefits by imposing a shallower cut to social welfare than to jobs seekers allowance.

All in, we can expect this process to continue working through the labour markets in 2010 as well, with employment falling toward 1,750,000-1,800,000 mark and unemployment rising officially to 13.5-14% - the rise arrested by outward migration, transitions to welfare and artificial Fas programmes ‘jobs’ supports.

The risks to the economy are to the downside with the biggest threat of another unemployment spike in Q1 2010 coming from the battered retail and business services sectors. From cars showrooms to Christmas sales counters, Irish retail sector is holding on to a hope of a half-decent holiday sales season. Should this fail to materialise, a wave of layoffs is going to take place in early 2010 as businesses shut doors for good unable to withstand another 11 months of decimated revenues.


The prospect of rising interest rates hangs over the services sector as a double edged sword.

On one hand, inversion of the interest rate curve upward will spell rising cost of doing business as higher borrowing costs will outpace any rise in ECB benchmark rate. In addition, margins rebuilding and high demand for capital will also imply rises in rates charged by the banks regardless of what ECB might do in 2010.

But in addition to borrowing costs, the retail and broader services sector will also be witnessing deeper retrenchment of consumers who will face the need to maintain high precautionary savings at the time of rising mortgages costs and real effective tax rates.

Over the last 11 months, retail sales have fallen by 26.5% in volume, excluding price adjustments. Another 10% or so contraction in demand will see wholesale and retail sectors shrinking by roughly half from 140,000 employees in Q4 2008 to ca 70,000 in Q4 2010.

And the yin-and-yang Budget is not helping this either. While excise duties on alcohol have been brought down and Vat increase of 2009 was clawed back, the increases in transport costs due to carbon levy will eat up any stimulus that could have been theoretically delivered by other measures.


All of the major economic indicators are therefore continuing to point South with little real evidence that the economy is going to return to robust growth any time soon. If confirmed, further slowdown in 2010 will mean that Irish economy will be traveling down recessionary curve for some 30-33 months by the time the Minister for Finance gets to the next round of public sector expenditure cuts. Lacking any serious policies aiming to get us out of this mess, this is a bleak prospect we will have to look forward to in 2010.

Yet, as our exporters experience shows Ireland Inc is more than capable of turning around. What such a prospect needs today is exactly what this column has advocated since July 2008. A rapid and significant cut in our deficits by ca €10 billion in 2010, followed by redirecting Nama-bound cash to deleveraging household budgets, re-capitalization of the banks through equity purchase to guarantee a capital investment and deleveraging stimulus to the tune of €40-45 billion in 2010. Redirecting existent targeted tax relief to a general cut in employer PRSI and income tax levies with a revenue-neutral effect completes the picture.

We need real reforms. Power costs, water rates, local authority charges and other state-induced costs must be cut by 25-40% through consolidation of local authorities and forceful changes to the way our power utilities operate. Airports levies and charges must be slashed to stimulate travel and to alleviate pressure on our middle classes who are straining under the weight of the state burden.

Short of getting down and dirty with far-reaching reforms, Government sloganeering about ‘taking the pain’ will be about as effective as showing reruns of the ER to a heart attack patient.

Economics 02/01/2010: Comparing banking systems

Based on the latest available data from ECB (through 2008, unfortunately), the following three tables provide relative performance analysis of Irish banking system against its main peers.

In all three sets of comparisons I have:

• included only countries with some proximity (trade / investment / market structure) to Ireland;
• computed some additional (combined) variables using ECB data (group averages and categories totals etc);
• ranked all countries on subsets of criteria shown in each table, so that increasing scores in each case reflect worsening of the rank position; and
• identified in shaded cells the instances where other countries (and/or group average) show poorer performance than Ireland in specific category.

The first table above shows indicators for profitability & efficiency. Here performance rank is computed by assigning the best performing country the score of 1 and the worst performing one the score of 10. There 11 scoring categories in line with the main parameters.

Irish banking system overall comes out as the fourth worst performing in the sample of countries, with significant gap to the group average in terms of sources of income (less stable in the case of Ireland) and total income as a share of assets. Note a very poor performance in net interest income and net fees / commissions - both of these indicators of income will have to be increased in the near future, leading to higher interest charges and fees for retail and corporate clients.

On expenditure side, Irish banks performed above the average, clearly showing that even in the end of 2008 there was virtually no room for improving the margins through further spending cuts. (One caveat - the expenditure side is measured relative to the assets base, so further writedowns on assets in 2009 would have pushed the expenditure performance metric deeper into negative territory). Apart from some layoffs and wages cuts, the sector in Ireland has no choice but to go after income side of the profit margin equation in order to rebuild margins.

On profitability side, provisions & impairments figure is below the average reflecting a clear lack of realism on behalf of the banks. This, in turn, translated into artificially inflated profits, that fell insignificantly short of the group average. However, the relative underperformance of the Irish banking sector was clearly visible in the distribution of returns on equity with most of our banks performing in the lower tier of the group.

The next table shows balancesheets comparatives:Using the same approach as before, I computed rank scores for the countries (note, I omitted countries with no data observations from the sample). Once again, Irish banks come out as below average performers in the group, ranked fourth from the bottom.

Other interesting features of the data:

• On liabilities side - deposits from CBs - or can we call it dependency on CBs liquidity to prop up deposit base is hefty?
  
• Total equity as share of asset base is low.
• Issued capital was low, while reserves are seemingly ok. Issued capital and reserves combined are below average. Ditto for tangible equity.
• On liquidity side, low dependency on interbank market in 2008 really shows the extent to which Irish banks were not being able to access private liquidity pools. So funding base stability was weak.
  

Last table deals with capital adequacy. Once again, Irish banking sector posted a lackluster performance.

Mid-range solvency ratio and Tier 1 ratio in the environment of artificially depressed / unrealistic writedowns and over-inflated assets base is worrisome as are total own funds. Securitization weighted heavily under standardized approach, but this was not captured under the internal approach. Average risk-weight for credit risk were high and total capital requirements for operational risks were the lowest in the group.

Little insight can be gained from operational exposures, as these are obscured by the non-Irish IFSC operations, but corporate exposure and retail exposures combined to a hefty 105% for risk-weighted assets, compared to 91% for the group average. The last two lines - overall solvency ratios are telling. Group average is 12.36%. For Ireland: 91% of all assets were held by the institutions with less than 12% in terms of solvency ratio.

The main conclusions from the tables are:

• Irish banks were too slow to recognise impairments;
• Irish banks profitability is below par, while efficiency is relative robust (with the risk to the downside due to inflated value of assets);
  
• Risk reserves and equity are poor in comparison to other countries, although this does not appear to be a function of regulatory-set reserves; and
• Margins rebuilding on the banks side will have to take place at the expense of retail and corporate clients.
  

Given the lags in the data and in our banks' willingness to face reality of the risks carried on their books, it will probably take well into 2010 (waiting for Nama to become fully operational) for the banks to start in earnest rebuilding their capital and margins positions. Which means that we will not know the true state of our banking sector fundamentals until mid 2011, when the data will be available to cover 2010.

The risk, of course, is that before then, the banks will squeeze all domestic liquidity out of the Irish economy, while the ECB begins to restrict inflow of external liquidity to the system. If that happens, Nama losses and budget deficits will take the second seat to the wave of insolvencies that will hit our country.

Of course, as usual, we have no road map for addressing such risks. Remember - even despite all banking heads insisting publicly that post-Nama there will be no increase in credit flows to SMEs / corporates / households, our Government continues to claim that Nama will be a 'liquidity event' restoring flow of credit to economy.


I will leave you with the following quote:

"Most of this lending is policy-directed with an implicit government guarantee. Despite ...closed factories in *** resulting from the global financial crisis, and hundreds of empty office buildings, retail centres and hotels that are not meeting their debt service payments, banks are still not foreclosing on these properties nor calling the loans due.

The banks prefer to rollover or extend the loans to avoid having to report an increase in non-performing loans. It is not uncommon for *** banks to extend a loan for as much as one year without interest payments if the lender “believes” the ultimate recovery value of the assets will be greater than the outstanding principal and interest. However, it is nearly impossible for a bank to value an empty office building, in a market with a reported vacancy rate nearing 40 per cent ...and declining rents."

The article goes on to argue that for *** this scenario of banks unwilling to recognize losses is risking a derailment of the country progression to the top of the world economic order. The *** is, of course, China. And the article was published here.

But it might have been written about Ireland, where the banks' belief in the ultimate recovery value is nothing more than a punt on selling the distressed rubbish assets to Nama for the price that even at a 30% haircut will reflect an overpayment on their true value of up to 30-40%.

What will Nama do to these assets and how willing it might be to shut down insolvent operations? More willing than the completely reluctant Irish banks? I doubt it.

So where does this leave us at in the beginning of 2010? A Japanese-styled zombie economy scenario for 2010-2025? I hope I am wrong!

Economics 31/12/2009: Bond markets

Food for thought: rummaging through backlogged papers, I cam across 3 notes from our heroic stockbrokers' bonds desks singing songs about the right timings for investment in bonds. These trace back to June and October 2009.

So I asked myself the following question: should I have listened to your brokers' advice to buy Irish or US bonds in 2009?

Well, here are two tables giving a breakdown on bond price sensitivities to changes in interest rates. The US table:And the Irish table is here:Now, in darker blue I marked the cells corresponding to the reasonably plausible scenario for yields for 2010. In lighter blue - the next best predictions. So go figures - should you have listened to anyone pushing Irish or US bonds onto you?

Think of the following numbers - I don't have the same for the Irish markets - in the US, cash inflows into bond funds markets amounted to some USD313 billion in 2009, as yields kept on dropping to artificially low levels on the back of the US Fed buying up Federal paper. At the same time, as stock markets rallied, just USD2 billion net was added to stocks funds. (Numbers are to November 1, 2009). Some has been fooled.

So a Happy New Year for all and best wishes for the new decade!

My next post will be already in 2010 and will show comparative performance for Irish banking sector relative to other EU states - the latest data - for 2008.

Economics 30/12/2009: Competitiveness - it's a long term thingy

We hear often about the loss of competitiveness in Ireland over time. Can we illustrate it? And if so, what can we learn from it?

Here are the charts. Do keep in mind - higher values reflect lower competitiveness.
In terms of unit labour costs, Ireland has not been competitive relative to its peers within the EU15 since Q2 2004 when we crossed over the Netherlands. I ignore Luxembourg here as it is a statistical aberration. We've managed to lose all competitiveness gains incurred since Q1 1999 by Q1 2003. Majority of our peers have done so only 5 years later. while our competitiveness has deteriorated by a massive 22% since 1999 (and this is reflective of the significant gains in competitiveness over the course of 2008-2009), the average for peer countries was 6.2% and absent Ireland and Lux from the sample the rise was just 3%.

Oh, and by the way - there is no evidence that we were competitive in 1995-1999 either...

Chart above also shows that we have not posted a stellar performance against the latest additions to the Euro area. While Slovakia beats us hands down in terms of decline in competitiveness, remember - these are normalised series, so having started from a much lower cost basis than Ireland in 1999, they have been gaining significantly faster in terms of unit labour costs. Of course, notice that before 1999, Ireland was starting from a higher cost point in 1995 than Slovakia.

Is the cost of labour all there is to competitiveness? Well, no.
Consumer prices draw another comparative. But strangely enough, the picture is virtually identical. Except, here pre-1999, more specifically in 1993-1995 - we were performing really pretty well. Having gone off the rails slightly during the mad days of the IT bubble - end of 1996- end of 1998, we then again performed rather well in terms of CPI until things gone out of control for us in the end of 2002.

And just for completeness - a chart on the new entries into the Euro zone:
So what can we really learn from these four charts?

1. Ireland's loss of competitiveness is dramatic and at this stage, seemingly irreversible;
2. Ireland's loss of competitiveness is concentrated in the labour costs/productivity area where deterioration in competitiveness was much more pronounced compared to the Euro area average than in the CPI component;
3. Ireland's loss of competitiveness is not a new phenomena - it has been accelerating since around 2002 and it was firmly in sight of our policymakers at the time;
4. Ireland's loss of competitiveness is a long-term problem and requires long-term solutions - not a one-off cut in wages.

On a different train of thought: an interesting idea that can be explored in 2010. Can we use the proceeds from our carbon tax to supply a long-term economic stimulus to the private sector economy? Here is a thought going in the right direction.

Carbon tax in theory should be behavior-altering, so as consumers and producers reduce their emissions, the tax revenue should decline. To incentivise such behavior, carbon tax induces higher costs on energy use from non-renewable resources. But the revenue raised from the tax can be used to further enhance the incentives - if it is rebated back on the basis of lower emissions. This can also be done within a Cap-and-Trade system.

In the case of Ireland, such a system would involve the following:

• Using revenue from carbon tax to provide direct income tax credits to households proportional to their annual per-capita heating, electricity and gas bills shortfall on the average. Having put into place a system for capturing data on such transactions, a rebate allowance can be estimated for each household at the end the year and this can be credited against the annual income tax.
• The system will provide net subsidy to those who use less CO2 emitting resources.

The main advantage of the system is that it will allow to offset some of the regressive effects of the carbon tax:

• Younger households with children can obtain a rebate that is reflective of the larger size of the household;
• One-off housing and remotely located households will benefit from all and any renewable energy production they can generate on their properties;
• Urban households - who actually do have an option of altering their behavior significantly - will be rewarded for doing so - incentivising more growth in the higher value-adding urban economies;
  
• Businesses will also be allowed to obtain a rebate, implying lower cost for doing business and investing in new technologies precisely for companies in the more productive services exports and modern manufacturing sectors.

Best of all - the Exchequer will not get to treat carbon tax as just another regressive tax revenue raising measures that will simply increase the cost of living and working in Ireland. Of course, those not in the tax net should also receive the deductions, implying that some of them will become net earners from the tax system. As long as they are not enjoying lower cost of overall energy-related expenditure courtesy of state subsidies.