Economics 24/01/2010: A Mexican stand-off: Eurozone v Greeks

It is nice to note that the theme picked up by the post below has been followed upon by the continued media debate today:

According Der Spiegel today: the European Commission warned that the euro area’s chances of survival would depend on adjusting the internal imbalances. DG Ecfin apparently claims in a new paper that internal imbalances would weaken confidence in the euro and endanger the cohesion of the monetary union. Rising deficits and weakening competitiveness in several countries, notably Ireland, Spain and Greece are singled out by the Commissions as the main causes of the pressure on the euro. DG Ecfin, allegedly says the necessary adjustment in the deficit countries will require wage moderation to address rising unemployment in the above countries.

And another one from today: here.

So what is going on with Greece? Not much, it appears. Just like Ireland did before it, Greece decided to throw some smoke around its fiscal debacle with promises of reaching the 3% SGP limit by 2012 (Ireland is now saying it will be 2014, although ESRI’s presentation last Monday was clearly showing they expect deficit to be well above 3% level then).

And like Ireland, Greece has elected to cut some easy expenditure targets – capital investment and irregular payments and some social services. Ireland has gone slightly further by imposing a modest cut on wages and passing a gratuitous tax on pensions in the public sector. Of course, wage cuts were far from what was necessary, while the pensions tax was not even enough to cover the expected future increases in pensions liabilities that will arise due to, frankly Marcian in its surreality, practice of indexing future public sector pensions to wage rises in the sector.

And so, like Ireland, Greece has not been reckoning with the reality of its deficits. Unlike Ireland, however, it was not able so far to fool the markets, and it was unable to raise taxes. And unlike Ireland, Greece was a serial offender on the front of deficits (see charts) in recent years, during the boom. Note, this, of course, does not reflect the fact that Greek’s deficit accounts for their banks supports measures (negligible), while ours does not (massive).
And this means, everyone is still wondering – what is going to happen with Greece?

Last week several significant statements were made on the subject. First, Handelsblatt reported that "the EU has put the thumb-screws to the Greeks", noting that "under massive European pressure the Greek government has agreed to have its state finances cleaned up faster than initially planned". Greece has now pledged to reduce its budget deficit from around 12.7% in 2009 to under 3% of GDP by the end of 2012.

Handelsblatt information de facto denied by senior EU figures. In an interview with Il Sole 24 Ore, ECB Executive Board Member Juergen Stark said that the EU would not help bail out Greece, arguing: "Greece is in dire straits: not only has the deficit reached very high levels, but the country has also witnessed a serious loss of competitiveness [haven’t Ireland?]. Such problems are not due to the global crisis, since they are substantially homemade. …Rules... are unequivocal: being part of the Monetary Union doesn't guarantee any right to claim for financial support by other member states."

Of course, if pressure was applied on Greece [per Handelblatt], there must have been some sort of a threat. What can such a threat be?

Could the EU officials told Greek Government ‘Shape up or you are out of the Eurozone’? Nope – no such possibility even in theory.

Could they have told the Greeks ‘If you don’t resolve the problems with you deficit optics, we can’t give you a bailout’? Oh, yes, that could have happened. In fact, the threat of ‘no EU goodies, unless…’ threat is just what EU has used before on other countries –Switzerland and Norway (access to EU markets), and Ireland and Denmark (access to ‘influence’ within the EU).

So let us take it as a possibility, no mat6ter how remote, that the EU folks told the Greeks to get working on some sort of a face-saving formula to allow for their rescue by the EU/ECB.

Last Friday Wall Street Journal reported that the EU Commission spokeswoman outright denied such a rescue plan being worked on, saying she wasn't aware of any financial bailout packages being arranged. But then, in an interview to Die Welt Chief Economist of Deutsche Bank Thomas Mayer (a man whose statements are not to be taken lightly) said: "The situation [in Greece] is more serious than it has ever been since the introduction of the euro. The trouble in Greece plays a key role for future development... If the Greece situation is handled badly, the Euro-zone could break down, or suffer major inflation. Neither the European Central Bank nor the Commission nor any other EU body can force Greece to implement necessary reforms in exchange for help."

What does he mean ‘no body in the EU can force Greece’? He means here not the political infeasibility of the EU actually slapping on the conditions on Greece to implement austerity measures in exchange for funding. That can be done. What cannot be achieved is the enforcement of such conditions.

The problem is really simple and, thus, grave.
The EU can give Greece a loan – via ECB, say, for 10 years at 2-3% per annum, in the amount of 30% of its debt. That would be fine. It will not solve Greece’s problem, but it will alleviate pressures on deficit side, as country interest bill will fall substantially, allowing it some room to reduce structural side of deficit more gradually. But the EU will have to impose severe restrictions on Greek fiscal policy in order to discourage other potential would-be-defaulters today and in the future. They would have to require, as a condition of the loan, a constraint on Greek deficits going forward so severe that other PIGIES (note the renaming of the club – Austria is out, Estonia is in) don’t dare roll their massive deficits into debt into perpetuity in hope of a similar rescue.

That won’t work – the Greeks will take the money and will do nothing to adhere to the conditions, for there is no claw back in such a rescue.

Alternatively, the EU might commit ECB to finance existent Greek debt on an annual basis. This will allow some policing mechanism, in theory. If Greeks default on their deficit obligations, they get no interest repayment by ECB in that year. Sounds fine in theory but what happens if the Greeks for political reasons default on their side of the bargain?

If ECB enforces the agreement and stop repayment of interest, we are back to square one, where Greece is once again insolvent and its insolvency threatens the Euro existence. Who’s holding the trump card here? Why, of course – the Greeks. And, should the ECB play chicken with Greeks on that front, the cost of financing Greek bonds will rise stratospherically, and that will, of course, hit the ECB as the payee of their interest bill.

Thus, in effect, we are now in a Mexican standoff. The Greeks are dancing around the issue and promising to do something about it. The EU is brandishing threats and tough diplomacy. And the problem is still there.

Martin Wolf of Financial Times: "the crisis in the eurozone's periphery is not an accident: it is inherent in the system. …When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters."

Indeed, we are about to find out… hold on to your socks, folks.

Economics 24/01/2010: Consumer side of the economy equation

Before posting my Sunday Times article, couple of interesting links from elsewhere:

Myles Duffy on Revenue's 2009 figures - here. Good and concise view.

Excellent essay on Google v Apple battle and why Google just might be losing it - here.

Now to my article, as usual, unedited version:

The latest retail sales figures show continued weakness in consumer demand through November 2009 with core sales (ex-motors) up a poultry 0.3% in volume and down 0.3% in value on October. In twelve months to December, Irish retail sector has recorded a massive 8.2% drop in the volume of sales, while the value of good and services sold collapsed 12.9%.

This weakness in retail sales is important for three reasons – both overlooked by the analysts. First, this was a month usually characterised by higher spending in anticipation of Christmas holidays. Second, this was the beginning of the Christmas season that concluded the decade and came after extremely poor 2008 holidays shopping. Penned up demand was great, going into November, but consumers opted to stay away from the shops. Third, even November retail sales were out of synch with forward looking consumer confidence indicators.

Combined, these facts suggest that the retail sector is suffering from a structural change that is here to stay, even if the broader economic activity and consumer confidence were to bounces into positive growth.

This observation is far from trivial. Despite all of our hopes for a recovery based on exports, any growth momentum in the economy can be sustained only on the back of improving private consumption and investment. In Q3 2009, the latest for which data is available, personal consumption of goods and services accounted for 63.5% of our GNP and over 50% of GDP. During the crisis, due to a much deeper collapse in investment, the importance of consumer spending has increased. At the peak of the bubble in 2007, consumption spending amounted to 57% of our national output.

Retail sales form a significant component of the overall consumer expenditure and it is also strongly correlated with other components, especially communications and professional services. These links are highlighted by the anaemic revenues generated by mobile and fixed line service providers, and dramatic declines in demand for insurance.

Thus, overall, retail sales offer some insight into what is going on at the aggregate personal consumption level.

Earlier this week, PwC released an in-depth analysis of emerging trends in Irish retail sector that sound a warning for the future of our consumer economy. The report found that in response to the crisis, some 55% consumers are now reporting lower spending on goods and services, while 65% are saying they are spending more time shopping for value.

Over the last year, only aggressive price cuts kept the volume of sales from reaching the levels of 1999-2000 in real terms. 71% of Irish retailers have increased their promotional activities, while 67% have offered aggressive discounts (63% of retailers plan further realignments of costs in 2010).

In other words, the impact of the current economic crisis on consumer behaviour has been deeper than a normal recessionary dynamic would support. PwC survey has found that 53% of all retailers believed the changes in consumer attitudes to shopping we are witnessing today are long term or permanent in nature.

This permanent nature of change is due to what in a 2004 theoretical paper on household consumption I called ‘learning-by-consuming’ effect. While searching aggressively for better value, the households simultaneously improve their expenditure efficiency and discover that buying cheaper does not always mean sacrificing quality. PwC research confirms my theoretical model by showing that 86% of consumers who shopped for value perceived cheaper goods to be of the same quality as higher priced goods.

The permanence of change in consumer behaviour is worrisome. Barring dramatic improvements in consumer willingness to spend, two negative developments will persist in our economy.

First, any return to growth will be short-lived and prone to sudden reversals with the risk of a double-dip recession.

Second, any recovery absent robust growth in private expenditure will imply further widening of our GDP/GNP gap as MNCs tear away from the lagging domestic economy. Over the long run, this gap will have to be closed either through a massive downsizing of the foreign investment sector (as costs bear down on companies operating here), or via a return of another credit bubble. Neither development would be welcomed.

In the nutshell, we can expect retail price deflation to continue in 2010. According to NCB Stockbroker’s economist Brian Devine, further deflation in 2010 can lead to a statistical bounce in overall retail sales. “With prices declining, consumer confidence stabilizing and consumer attitudes shifting towards value expect the volume of retail sales to grow in 2010,” says Devine. But, “job losses and emigration will weigh on overall consumption and as such we can expect consumption to contract marginally in 2010."

In other words, the prognosis for improved consumer confidence carrying sustained recovery in 2010 is not good.
Should the changes in consumer behaviour be permanent, we can expect consumption to grow at 1.5-3% per annum as wages stabilize and the savings rate begins to decline from its 2009 high of over 11%. And even from this low growth scenario, the risks are firmly to the downside.

Given the expected impact of Nama on mortgage interest rates, credit and deposit rates, it is highly likely that our savings will remain elevated well through the first half of this decade. The ESRI forecasts personal savings rates to stay above 10% through 2013 and close to 8% thereafter. In contrast, over 2000-2007 our savings rates averaged just above 6%. Higher savings, of course, will mean lower consumer spending and private investment. Rising cost of borrowing and credit will add to our woes.

Finally, subdued consumer spending means lower Exchequer revenue through VAT and Excise duties. This is likely to lead to higher tax burden in Budget 2011 and a further downward pressure on consumer spending.
In this environment, the Government simply cannot afford inducing more uncertainty and pressure on already over-stretched households’ balance sheets. Restoration of consumer confidence requires an early and committed signal from the Exchequer that Budget 2011 will not see new increases in taxation. From here on through 2014, all and any fiscal adjustments should take the form of permanent cuts to public expenditure and elimination of tax loopholes, not a series of raids on taxpayers’ incomes.

The Government should also reverse its decision to limit Banks Guarantee coverage of ordinary deposits to Euro100,000 that is scheduled to come into force later this year. Lower guarantee protection will act to increase precautionary savings as well as deplete the already razor thin deposits base in Irish banks. The twin effects of such an eventuality will be greater demand for public capital from our financial institutions, plus lower consumer spending. Does Irish economy need another twin shock just as the recession begins to bottom out?


Box-out: It appears that despite all pressures, the Government is staunchly refusing to carry out a public inquiry into the causes of our banking sector crisis. Instead of confronting with decisiveness this matter of overarching public interest, our Taoiseach has resorted to deflecting all queries with his favourite catch phrase: “We are where we are”. One wonders whether the Government would be as willing to use this phrase if the subject of the proposed inquiry was a series of major transport accidents, or a systemic failure in our health sector. Institutions responsible for over 80 percent of the entire banking sector in the country came close to a collapse and have to be rescued by the taxpayers at a total cost (including Nama) of Euro72-89 billion or 46-57 percent of our annual national output. What else but a fully public inquiry with live television coverage of all hearings can one expect in a democratic society? An inquiry into the systemic failure of our financial system must be not only public, but comprehensive. It should cover all the lending institutions in receipt of state assistance as well all policy-setting, regulatory and supervisory bodies – from the Financial Regulator to the Department of Finance – responsible for ensuring stability of our financial system. This inquiry should have powers to fine those who failed in fulfilling their contractual and/or statutory duties. And it must be conducted by people who have no past (since at least the year 2000) or present connections with the any of institutions called in for questioning. Anything less than that will be an affront to all hard working men and women of this country who are expected to pay for the mess caused by the systemic failures in our banking sector.

Economics 24/01/2010: Knowldge Economy and Irish academia

Charles Larkin and Brian Lucey are having a go at the issues clogging up Irish third level policies in Sunday Business Post today.

Here are few takes and my views on them:

“Hardly a week goes by without a government spokesperson discussing an aspect of the "Smart Economy". In the public and perhaps government mind this is equated with technology. We suggest that a truly "Smart Economy" is not based on technology -- the really smart economy is about flexibility, especially mental flexibility. Developing this should be the primary focus of the higher education sector. We suggest that there exist a set of interlinked issues that make the sector as it stands unable to do this.”

Yes – Knowledge Economy is not about quantity of labs / patents / ICT applications etc. It is about our abilities to create new applications and tools, but more importantly – ability to deploy these in profit earning undertakings (I mean, of course, a broader notion of profit that can, should the individual owners of technology and/or skills elect to do so, include pursuit of non-monetary returns).

“Irish higher education suffers from a severe conflict of mission. It is expected to deliver on innovation, education, social enrichment, economic growth, public health, improved lifestyles and put a chicken in every pot. Though research suggests that all of these and more arise from higher education, the effect varies across individuals and disciplines. The context is further complicated by the regional imperative.”

Also spot on – the conflict between objectives of the universities that are political (and this now also includes science policies) and that are academic is best highlighted by the fact that Irish universities are no longer the hot beds of subversive thoughts. Instead, they are staffed and run by bureaucrats with singular mode of thinking – coalescence, assimilation and homogenization of staff to achieve pleasant singularity of view that can then be monetized via Irish and European grants.

Not a single Irish university today would have seen Keynes offering a job to Hayek. Only senior faculty are allowed, and even then – unwillingly – to express dissenting views. Any junior faculty member peeping their head above the grey mass will be thrown out as soon as their contract comes for a renewal. ‘Does not match strategic direction’ on a rejection letter for a job means that the candidate is simply not ‘slottable’ into the Borg collective of some department.

Can anyone expect any sort of creative excellence out of this?

“Academic freedom is perhaps the simplest and yet most profound step. In essence this would involve the granting of "university" (i.e. degree granting) status to all third and fourth level institutions (inclusive of exceptional legal entities, for example the research-orientated facilities, such as the Royal Irish Academy and the Dublin Institute for Advanced Studies). The announcement by Minister O'Keeffe that he is to abolish the NUI is a first, faltering step towards this... Care needs to be taken that we do not replicate the failures of the UK and Australia in similar reforms. Within the IOT sector new programmes go through a very rigorous evaluation. The issue is that existing programmes need root and branch reform to ensure that they are at the same quality and intellectual standard. With freedom comes responsibility, and the most important responsibility will be to offer educational programmes aligned with the fostering of flexible minds.”

I fully agree – which probably means the authors are now at a risk of being branded ‘extreme’ in their views – freedom must be given to universities and all third level institutions, and they must be self-accountable for their actions. If one chooses to pursue EU and Irish academic handouts through so-called ‘collaborative’ piggy-back-riding on other EU researchers grants, so be it. They will sink in the long run, having reduced themselves to the backwater of unoriginality in thinking and output. If other universities chose to take a bolder position and once again become centres for debate, discussion, challenge and search (breaking away from their current tradition of serving as yes-men to the social regime of singular ideological hue) – they will thrive in the long term as their creativity will allow them to command a premium. The same premium the relative start ups of Stanford, UofChicago, University of California campuses, and so on – having arrived to the university game in the US well after the Ivy League institutions – now command over the majority of previously mighty, now completely mediocre Ivy League institutions.

Last night, RTE was showing the documentary about the Bog Bodies discoveries. In the entire lengthy feature, there was not a single point at which the documentary managed to show any disagreements between numerous Irish and international researchers. Instead, it was a saccharine, sonorous and harmonious blandness of: ‘Yes, I agree with my colleague on this point’ and ‘We all agree with our colleagues on all points’. I am certain that there were probably different views discussed by scientists amongst themselves. But the telling feature of the documentary was just how important consensus is to science’s image in the public. And this is frightening. Not a single major breakthrough discovery in science was delivered by consensual group-think of collaborative researchers.

Back to Brian and Charles’ essay:

“Freedom should be extended to faculty wages. At present, within narrow bands, the best are paid the same as the worst, the most active the same as the least. …Evidence from the US indicates that salary freedom can assist in incentivising staff, but this can arise at the cost of over-reliance on casual and adjunct lecturers at the undergraduate level. …we need to ensure that in the newly freed institutions a motto of "every scholar a teacher, every teacher a scholar" is taken just as seriously.”

I am not sure about the ‘over-reliance on casual and adjunct lecturers’. In my view, and a disclosure is due here – I am adjunct myself, adjunct lecturers are usually self-selected individuals with passion for teaching and with different sets of skills from other researchers and academics. If selected on merit, they can add serious diversity of thought and experiences to the universities. They are also key to linking universities to the real world. What is really sad about Irish universities is that casual lecturers are often selected for a single shot teaching, filling in for absent full time faculty. There is neither coherence, nor open-mindedness as to how adjuncts are selected, appointed and contractually hired.

“Freedom must also of course mean freedom to fail. If a university were unable to deliver on the required educational outcomes then it ultimately would be required to fold or to be subsumed by another more successful university and mechanisms need to be put in place to deal with the fall-out if this happens.”

This really needs no qualification. Superb! I lamented on many occasions the lack of consolidation and closure in the process by which universities that thrive can gain market shares.

“We suggested earlier that a truly smart economy involves the production of flexible thinkers. Such an education must be more than purely discipline-focused at the third level. …We can broadly consider three domains of intellectual activity in universities- humanities, letters and the social sciences (arts), life sciences and natural sciences. Mapping degrees to one of these we suggest that a true university education would involve an annual minimum of 15 per cent engagement with each domain.”

Very well put. Again, on many occasions I raised this concern that we are not producing flexible, creative thinkers, but are focused on producing standardized degree-holders. Like a commodity product, these degree holders are then released into the real world where they go on to form a mass of uncreative, unchallenged and unproductive middle managers and functionaries. The future of Ireland Inc rests with people who can deploy creative and innovative thinking in management (not necessarily in the labs alone, but at all stages of production, marketing, delivery, sales etc). This is what I would call a real ‘knowledge-based’ economy. It is good to see that at least two of my colleagues are now publicly in agreement.

“To adequately provide these postgraduate courses all academic staff in the university would be required to be active researchers, which would be achieved by a rolling tenure system. This would involve the granting of tenure for a prospective 5-7 year period, with biannual reviews.”

Spot on!

“Research activity and research quality are only loosely related but quality requires activity as a prerequisite. To ensure quality of teaching we suggest that again there be biannual reviews of teaching based on best modern practice. This would involve some element of student feedback but would also involve reflective portfolios and classroom observation. To oversee this quality issue we suggest a single evaluation unit within the above suggested ministry.”

Sadly, although I agree with the idea of a review, I am not yet ready to place my trust in Ministry bureaucrats to deliver on such an objective. Fas experience shows that our public officials cannot be entrusted to do this job in an impartial, efficient and effective manner. I would rather suggest use of class numbers, relative to faculty averages, as a partial metric for academic wages. Taken, of course, over a period of time and within comparable disciplines. Students tend to vote with their feet.

“A third element relates to funding. …Separating undergraduate from postgraduate education we suggest allows greater clarity to emerge. Persons seeking to take masters or doctoral qualifications in an area do so for one of two reasons -- a desire to seek entry to an area or profession (investment) or from a personal interest (consumption). There is no obvious reason why the government should fund the latter over other consumptions. In any case the operation of the tax/PRSI system should, in most circumstances, offer a return to society partly via the increased taxable earnings that the better qualified persons achieve, thus capturing the public good element of an increase in, for example, dentists, or telecommunication engineers, or doctors of literature.”

I actually disagree. PRSI and income tax place a surplus taxation burden on individual investment. If a person invests their own funds in education, they should be able to deduct the cost of this investment before they pay tax on capital gains. Secondly, if the society at large already benefits from the social good nature of higher education, then a person having invested in it for private benefit must be reimbursed for society benefit accruing not to themselves, but to others. After all, if my money paid for my PhD and I get a return of x% per annum, while the society gets y% per annum and a tax return on my PhD – is this not a case of double taxation?

This means that, while I fully agree that the state should not provide funding – except that based on merit and inability to pay considerations – for post-graduate studies, I disagree that PRSI/income tax should be viewed as fully functional means for capturing individual gains.

Economics 23/01/2010: Knowledge economy infrastructure

Some interesting data from a study "Broadband Infrastructure and Economic Growth" by Nina Czernich, Oliver Falck, Tobias Kretschmer and Ludger Woessmann, CESIfo Working Paper 2861 published in December last year that provides good comparatives for Ireland relative to the peers in terms of what I would call rudimentary 'Knowledge Economy' infrastructure -

• the relationship between physical capital and knowledge-related capital (broadband penetration and education); and
• the relationship between GDP per capita and the above

all taken over a long period of time (1996-2008).

First, broadly, the findings of the study itself: "We estimate the effect of broadband infrastructure, which enables high-speed internet, on economic growth in the panel of OECD countries in 1996-2007. Our instrumental-variable model ... [shows] voice-telephony and cable-TV networks predict maximum broadband penetration. We find that a 10 percentage-point increase in broadband penetration raises annual per-capita growth by 0.9-1.5 percentage points. ...We verify that our instruments predict broadband penetration but not diffusion of contemporaneous technologies like mobile telephony and computers."

Interesting - a 10% increase in broadband penetration ups the growth rate by 0.9-1.5%. In other words, to get a 10% increase in GDP per capita out of a 10% rise in broadband penetration requires 6.4-10.7 years. Not a bad return. The problem here is that, of course, the starting levels from which this effect is measured are low, so the law of diminishing marginal returns has to kick in somewhere.

I took their data and run through some of it in a very crude way to see if I can glimpse other interesting aspects. Here are the results.
Maximal (for the period GDP per capita, PPP-adjusted) with 2 standard-deviation 'candles' around it. Notice two broadly defined groups of countries: Overperformers (including Ireland) and Underperformers. Now, I know - I shouldn't be using GDP here, but I am not about to make a statement about the actual 'wealth' or 'riches' of Ireland, so GDP will do.

Next, take a look at scatter plot relating GDP per capita to two measures of communications sector performance: broadband penetration for 2008 (the end score, if you want) and starting point measure (voice telephony penetration back in 1996).
It looks like GDP per capita in the end is much more responsive to increases in broadband penetration than to the starting position. In other words, economies with low legacy stock of communications seem to be catching up through broadband penetration improvements. Is this suggesting that a country can leapfrog weak communications sector legacy by jumping straight into broadband age? Well, sort of. The problem here is that we do not separate out the twin effects of growth in broadband penetration (much higher for countries doing leapfrogging) and simultaneous growth in voice telephony penetration (also likely to be much higher for countries doing leapfrogging).

A very revealing chart next:
Let us take physical capital as a share of GDP and compare its effects on overall GDP per capita, against the same effect being induced by education. What is unambiguous is that countries with higher physical capital base share of GDP tend to have lower GDP per capita. How come? Because they are physical capital-intensive, i.e their production is stuck in the late industrial age. Countries with higher education are more labour-intensive and especially skilled-labour intensive, and thus have higher GDP per capita.

Note Ireland. It is relatively poor in physical capital per GDP and yet relatively rich in GDP per capita. Why? Because we do have a modern economy - an economy where value is added through human capital side (of course this happens much more on the side of MNCs, where transfer pricing is used to import, artificially, human capital-intensive value-added, but it also happens in services economy, in our IFSC, etc). And yet, our education measure is far from being impressive.

The gap between our unimpressive levels of education and the levels of education consistent with the 'average' OECD pattern of relationship between education and GDP per capita, to me, clearly shows the importance of transfer pricing in our GDP figures. This gap is captured here by, in effect, showing that our capital and human capital stocks cannot support our GDP fully!

Here is more detailed view of our physical capital stock relative to our education (human capital stock).
Ouch. We are an outlier precisely in the direction suggested by the gap identified above. Note that moving to a 'Sweet Spot' of highly productive economies with significant rates of utilization of human capital requires both - more physical capital formation and even more education. Also note just how inefficient is the stock of education in the upper 'bubble' group of countries that includes all Nordics, Japan and France. These countries are simply not being able to derive the same returns to education in terms of GDP per capita as the 'Sweet Spot' nations.

So here is a question no one is asking - is there such a thing too much of education? Is there an inverted U-curve for the relationship between education and income, whereby too smart for its onw good society leads to suboptimal levels of growth? After all, since the 1990s we are seeing an emerging trend in the developed world whereby the new generations of slackers are increasingly composed of highly educated people...

This is not an argument out of the blue - take example of a potentially 'too livable city' concepts discussed in a brilliant article here. Can the same happen to the 'too-knowledgeable-economy'?

Ok, couple more charts on the same point. Broadband penetration is positively correlated with capital formation... Hmmm. This might reflect the fact that higher stock of capital imply better infrastructure through which broadband can be delivered. The relationship is not very strong, though.

And there is an even weaker, and negative, relationship between education and physical capital. This negative coefficient of correlation does suggest, though, that we are in the early stages of the process whereby physical capital takes second seat to human capital in characterising modern economy. If so - good news for 'Knowledge' economists out there - machines do not possess knowledge. People do. But it is also bad news to all social engineers out there who still think technocratic management of economy/society is possible. Knowledge requires heterogeneity and creativity. And these are antitheses of planning and policy-driven controls and incentives.

Far from being dead, the age of Friedmans' Freedom to Choose is only dawning!

And the final point: education and broadband infrastructure are much more strongly (almost 4:1) positively correlated with each other than they are with physical capital.
This, of course, can be interpreted as a warning to the folks interested in restricting the freedom of people to communicate. If China, and other countries that impose controls on internet, want to have a 'Knowledge'-intensive, modern economy, they will have to deliver real (i.e. free of political ideologies and biases) education and meaningful (i.e. free of political 'bottlenecks') knowledge infrastructure (in this case, broadband).

If they don't, the risk is they will end up being physical capital giants - countries where the world does its 'dirty work' of mass manufacturing widgets...

Economics 20/01/2010: Knowledge Economy and Dublin Water woes

It is beyond any doubt that Ireland has had its share of bizarre unlucky events and disasters:

1. Man-made crises: economic recession, banking collapse, fiscal meltdown, construction/property bust and policy/regulatory legitimacy, a schism between the public sector and the ordinary folks trying to make a living (yes, it is back - industrial strife is now clogging our transport and threatening our healthcare system);
   
2. Natural: swine flu, measles pandemic (remember that one?), floods, a snow storm, a freeze, most current - vomiting bug is apparently back;
3. Natural/man-made: water shortages (with parts of the country still covered in floods).

There have been severe costs imposed on people and the economy at large. And there are lessons to be learned and, hopefully this time around - few people responsible for (1) and (3) to be punished.

But one lesson has not been discussed to date. Recall a year ago, the Government came out with a grand plan for creating a 'knowledge' economy in Ireland. This plan is still alive (as plans go), although, of course, nothing has been done to deliver on its promises. Now, the EU is about to come out in February with a comprehensive platform for building a brighter better Union through 2020. I've seen the document. It too aims for 'Knowledge Economy' thingy.

So now to the lesson of our crises: 'Knowledge Economy' needs functional, efficient and excellent services. Public and private. Functional, efficient and excellent services is what our public sector simply cannot deliver.

That was, of course a two part proposition.

Let us take the first part: 'Knowledge Economy requires functional, efficient and excellent services". I hope this is pretty much apparent:

• PhDs and high quality entrepreneurs who will fuel the 'Knowledge Economy' will require good housing (as opposed to substandard shoe-box apartments we built for cheaper laborers during the Celtic Tiger boom), good on-time and on-schedule transport systems (as opposed to completely random travel times at Dublin Bus), cheap and quality air connections to the rest of the world (as opposed to what passes for airport out on the North side of the city), high quality healthcare (as opposed to waiting lists for tests and procedures measurable in light years instead of days), affordable and superior in quality education for their children (as opposed to schools where teachers do not engage in any post-university life-long training and where doors are shut after 3 pm - when the rest of us, mortals - have to be at work) and so on. They will require parks that are safe and pleasant, the sea front that is free of industrial rubble and incinerators. And air that is clean.
  
• PhDs and high quality entrepreneurs who will find these services wanting in Ireland will require either a much higher rate of pay, making their output, no matter how much 'Knowledge'-infused it might be, uncompetitive in the world markets. Alternatively, they will simply move on to build 'Knowledge Economy' somewhere else - in Paris or Singapore or Hong Kong, where such services (also known as inputs into the 'quality of life') are better and more efficiently supplied.

Agree? Ok, second part of proposition needs to be proven. Does it? Really? Anyone still believes that our public sector delivers excellent services? Or that the shambolic quality of these services has nothing to do with knowledge economics?

Instead of proof - an example. We all can agree that our nation's top university is and must be at the centre of the 'Knowledge Economy' activity. It must be its heart. Well, the speed of the body is related directly to the speed of the heart beating. Here is a snapshot:

From today's email to faculty and students (this is a second such notice this week):

"Dear all,

As we are all aware following the severe cold weather...

Within College we use a large amount of water and must during this period make an additional effort to reduce our water consumption. ...The following water saving tips should be considered by all [I omit the measures proposed that actually should be a normal practice for all times, not just at the time emergency]:

· In laboratories reduce water consumption for vacuum pumps and water cooled condensers

· Ensure all water supplies are turned off when experimental work is complete

· Only run dish washer, glass washers and autoclaves when full

· Consider can any experimental work consuming water be stopped during the current water crisis"

Of course, conserving water is a good practice - it is a scarce resource and should not be wasted. But if three days of snow and -3 degrees temperature can stop experimental work and lead to reduced operational capacity of our best University, are we really getting the public services that can support 'Knowledge Economy'?

I personally don't think so. So why on earth have our policymakers - wise enough to set numeric targets for PhDs well into the first half of the century and capable of producing tomes after tomes of white papers on 'Knowledge' economics - have so utterly failed to even mention the need for proper electricity supply (yes, TCD routinely warns staff that the University is teetering on the top edge of its supply capacity and that ESB supply might be disrupted) and decent water supply?

Before science and technology policy proposals, shouldn't we be first served with a decent emergency response system that can make sure flooding is contained when it happens, roads are gritted when the icy conditions advance and water/power/communications/gas/energy are delivered when adverse weather hits? It might be not 'Knowledge'-intensive and not too glamorous of a task, but it would serve a much greater purpose.

Economics 20/01/2010: Banking Inquiry

I have three simple points to contribute to all the discussion concerning the Banking Inquiry proposals:

1. Any Inquiry must be fully public, to the point of live television broadcast of all proceedings. Imagine a case of not one, not two, but six largest hospitals in the nation recording serial acts of systemic malpractice that were to result in some Euro 70 billion worth of damages. Would Mr Cowen call for a closed-doors inquiry?
2. Any Inquiry must be swift and must lead to convictions and severe punishment of anyone found guilty of malpractice or non-fulfillment of duties (including public officials in charge of regulatory and supervisory functions, should they be found guilty). Imagine a total collapse of six largest bridges in the country at the peak traffic - would Mr Cowen sum up the situation as 'We are where we are, now is not the time to deal with the past'?
3. Any Inquiry that does not cover Nama and Banks Guarantee scheme will simply fail to deliver full account of the causes and the full extent of the damages caused by the current crisis. This is why I oppose an idea of the 'wise men'-drafted preliminary report to set terms of reference for the second stage inquiry. Given this Cabinet will be selecting the 'wise men', I have serious doubts as to the integrity of the process or the group put in charge of restricting any direction of the future inquiry.

Ireland needs its own Truth & Reconciliation Commission to deal with the systemic failures of our supervisory, regulatory and banking systems. If public operation of such a Commission results in irreparable damage inflicted on our banks - how can one tell? After all, with Anglo at the helm, these banks have already done enough to damage themselves. The price of keeping them alive on artificial respirator of paucity, opacity and public cash is the collapse of public trust in our institutions and in our financial system - a price that is much higher than the withdrawal of all international bond holders from Ireland Inc can ever be.

After all, am I the only person one noticing the complete and total ethical collapse of our social system that takes ordinary folks' money to pay the cost of the full and unlimited guarantee of the (largely) foreign bondholders in Irish banks, while their own deposits are now under the risk of being covered by a limited guarantee up to Euro100K?