Economics 03/02/2010: Live Register for January

You've heard the numbers on Live Register results by now, no doubt. A summary, courtesy of CSO:
Here are few charts:
Having breached 430,000 marker this time around, the LR is back on the upward trajectory. As predicted. And with it - unemployment rate:
At 12.7%, we are now in December 1994 territory. Officially, all Celtic Tiger gains in terms of reduced unemployment are now gone. Some 14 years worth of hard labour gone within a span of just 21 months.

Oh, and in case you've heard that we are now doing soooo much better than in January 2009:
It is true - in January 2009, unadjusted LR was rising by 7,251 per week, this January it was rising by 'only' 2,668 per week. Yet, three things worth mentioning:

1. In January 2008 the rate of increases in LR was 2,768 per week - just 100 shy of January 2010;
2. This January saw the highest unadjusted increase per week since July 2009; and
3. Remember - the latest increases are ameliorated by two factors not present in previous years - already high unemployment (meaning that the number of jobs to be cut should be really declining) and high rate of workers outflow from the labour force.
   

Economics 03/02/2010: International hype around Ireland's Fiscal Policies

Nouriel Roubini - an economist I would regard extremely highly, writing today in the Financial Times (a paper I would regard extremely highly) clearly illustrates the point that to international observers, Ireland is hardly important enough to actually engage in fact-checking (here).

"The best course would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes and loophole closures that depend on historically weak compliance. ...This approach is working in Ireland – spreads exploded as public debt ballooned to save its banks, but came back in as public spending was cut by 20 per cent."

Really? We haven't noticed. And neither did the Department of Finance.

First off - Irish fiscal adjustment to date is approximately 50:50 split between higher tax burden and spending savings.

Second, there has been no net reduction in public expenditure in Ireland since 2008. None, folks. Let's face the music performed for us by the Department for Finance. No spin from me. In its "Ireland – Stability Programme Update, December 2009" available to all (including Professor Roubini here) DofF provide some stats.

Start from the top: page 14 of SPU:
Clearly, no sign of decreasing expenditure in sight. Of course there are many reasons for this, but hey, where's that 20% cut? Or 1% cut? None through 2009.

But may be Prof Roubini is talking about future cuts of 20%? Ok, page 20 shows future expected expenditure figures per Budget 2010.
So clearly, neither Gross, nor Net current expenditure are set to fall from 2009 through 2014. Not on a single occasion.

On Capital expenditure side, there are severe cuts. So much is true. But a cut between 2009 and 2010 is just 10.7%, not 20%. The cut between 2009 and 2011 is 23.8% but that is only accounting for 3.11% of the total Net expenditure of the state in 2011. Where's that 20% cut in total expenditure coming from, folks?

DofF plans for a 2.8% cut in the General Government Balance in 2010, not a 20% cut either, and that will leave us (per their rosy forecasts on growth and tax revenue) at 11.6% deficit relative to GDP, down a whooping 0.1 percentage point on 11.7% deficit achieved in 2009.

Oh, yes, while Anglo Irish Bank transfers in 2009 (to the tune of €4 billion) enter the DofF estimates for General Government Balance, there are no provisions for the same anywhere in DofF projections for 2010 (see Table 1c, page 38). So pencil that in and you have No Reduction in Deficit in 2010! In fact, with banks supports still required, 2010 is likely to see an increase in deficits.

Take a look for yourselves:Notice that pesky number on borrowing requirement rising in 2010 on 2009? If Prof Roubini is correct, why would the Government that managed to cut its spending by 20% increase its borrowing by 3%? Unless the revenue side is expected to fall by more than 20%! But no, DofF expects total tax revenue to decline by 4.7% in 2010 (Table 1b, page 37).

Finally, Table 1d on page 40 shows that spending adjustments per Budget 2010 amount to the net of €-4,051,059. Of course, since then we have learned that some of the cuts will not be implemented, reducing this number to some €3.3 billion. But even at a higher level, estimated by the DofF, the adjustments add up to only 8.55% of the Net Voted Total Expenditure, or 6.42% of the Gross Total Expenditure in 2009.

Not even a half of Prof Roubini's 20%!

Hmmmm... someone has been fooled by the PR machine statements coming out of Dublin.

Economics 02/02/2010: NTMA and the banks

Per RTE Business (here which so far cannot be confirmed by any official material published on the NTMA website):

The NTMA "will now hold talks on capital needs with the institutions covered by the NAMA legislation. Among the other responsibilities it is assuming, the NTMA will also hold discussions with financial institutions on their realignment or restructuring within the banking sector. It will manage the Minister for Finance's shareholding in the banks, advise on banking matters, and crisis prevention, management and resolution."

Here are the interesting aspects of this change that raise a multitude of questions:

1. How will NTMA manage the conflict of interest between its own objectives per above and Nama objectives?
2. How will the potential conflicts of interest be disclosed to the markets?
3. What does it mean that NTMA will hold discussions with financial institutions? Will these discussions be subject to usual market disclosure rules or will they risk constituting a price fixing behavior?
   
4. How can NTMA's direct interference with the banks be compatible with the rights of other shareholders?
5. How will NTMA advising on banking matters etc play out vis-a-vis the roles of the Financial Regulator and the Central Bank?
6. What does 'crisis prevention, management and resolution' refer to? Systemic banking crises? Specific institutions crisis? Will it also include industrial relations crises? How will this process be carried out while respecting the general rules of disclosure and non-collusion with the market?
7. With massive firepower and own objectives, how NTMA will assure that the rights and interests of minority shareholders in the banks are protected?

In effect - even the mere raising of these questions implies that there is a risk that NTMA will be engaged in interfering with the markets for shares and debt in Irish banks in markets-distorting fashion. Amazingly we have no details as to how the Government and NTMA/Nama plan to avoid these problems.


There is another issue at hand here. If, at least in theory, DofF is a publicly accountable institution, NTMA by its statues is a secret entity (with extremely secretive culture to boot). What transparency can we, banks customers, have and what assurance can we hold that NTMA will not act to undermine or violate our rights, the safety of our deposits or our ability to access these?


Lastly, I am rather surprised at the timing of this change. In my view, this statement coming before Nama begins transfers of loans suggests that the Government is preparing for taking up a majority stake in the banks - a majority stake that will require full state control of these institutions management and activities.

So is this statement a precursor to full nationalization of the banks?

Economics 02/02/2010: Turning the corner

So we've turned the corner... err... our economy it is... only to discover that, behind that corner the same tumbleweeds keep on rolling across the Exchequer accounts.

It was worth a wait, folks, and January figures for Exchequer returns have shown that, as predicted, the deterioration in our public finances will continue despite Minister Lenihan's efforts in the Budget 2010.

A chart is worth a thousand words:
Tax receipts down on January 2009 by almost 18%. They were down 19% in January 2009 relative to January 2008. Spending, meanwhile, is down 7.5% on January 2009, but... there's always 'but': current expenditure is down by a much lower 5.59% and the slack is picked up by a whooping 21.1% decline in voted capital expenditure (the stuff that is supposed to provide stimulus to our economy through strong public investment programmes).
Check out monthly receipts above and spot the odd on - right, there has been an extraordinary increase of ca 50% (or 250 million) in January 2010 capital receipts. This, of course, is thanks to a massive hold-back on public investment programme in 2009.

What's going on?
Receipts side is clearly gone into a deep red - all, without an exception - lines of tax revenue have underperformed January 2009. Corporate tax has decreased to a third. Stamps - already miserable performer in 2009 are now 41% down on that. Capital gains also sunk by almost a quarter. Income tax, down a massive 9.72% is the best performer. This is dire, folks!

But expenditure side is also showing some poor performance:
Ok, I understand Social Welfare spending increasing 15.76% yoy, but agriculture? ETE is a mixed bag. But, get your thinking going. We are in a recession and in a third year of a fiscal crisis. Over the last two years, we have managed to reduce our spending by a miserable 6.9% or less than 3.4% annualized savings. And that was achieved with a Draconian Budget 2010. what will it take to cut our spending by 25-30% off the peak levels consistent with a structurally balanced budget?

Last picture...

But here is a different way of looking at the expenditure side:
Take the entire set of departments and divide them broadly speaking into primary (vital, if you want) and secondary (supportive) in terms of their roles. Guess which group has manged to achieve greater savings (in percentage terms) out of its budget?

Efficiently run Government would require the secondary set of departments to cut by at least 3-4 times the rate of cuts in the essential departments. Under the above, we'd have cuts of up to 60% in the total spending segment of €660million, or effective savings of €392 million more than has been achieved in one month, or roughly €1.8-2 billion in one year.

Not enough to decrease our massive deficit, but...

Economics 02/02/2010: Minimum Wage Blues

For those of you who missed my last Sunday Times article, here is an unedited version.

Last week, this newspaper reported about the successful Competition Authority probe into a price fixing cartel involving a number of car dealers. Of course, price fixing is illegal in Ireland. Illegal, that is, unless the perpetrator of it is the State. For proof, look no further than the price of unskilled labour – the minimum wage rate.

The end result of this law – a product of collusion between the Government and the Unions – is two-fold.

First, like any other collusive arrangement, the minimum wage leads to a long-term deterioration in the employment creation in the economy. Economists commonly link this to the deterioration in our overall competitiveness.

Second, minimum wage distorts incentives and choices of employers and employees. Over time, investment in skills, knowledge and aptitude fall for minimum wage recipients and lower-skilled, marginally more expensive employees, while businesses are incentivized to substitute their hours of work with physical capital. The age-old fear of machines displacing people is, thus, a logical denouement of the minimum wage.


The fact that the minimum wage laws reduce overall country competitiveness in the sectors heavily reliant on unskilled and low-skilled labour is undeniable. Ireland no longer registers meaningful contributions to its economy from mobile low-wage sectors. Only those lower skills activities that are captive by their nature – such as local protection services – remain here. However, the effects of the minimum wage on workers themselves are far less understood.

There is plenty of evidence that minimum wages lead to reduced employment of the lower-skilled and younger workers. Less known is the fact that minimum wage distorts education decisions of the young. Recent research from the Michigan State University shows that states that raised their minimum wage experienced increased unemployment amongst the low-skill teenagers who had previously dropped out of school. Higher-skill teenagers were more likely to get jobs, increasing their early exits from education. In other words, those who were best suited for early employment could not get a job, while those who were best suited for continued education were incentivised to drop out.

In the long run, minimum wage also shifts resources within various sectors of economic activity. Data for Ireland clearly shows that since introduction of the minimum wage here, traditionally labour-intensive sectors have seen their labour share of productivity decline, while capital share of value added has expanded. In some, labour productivity actually fell in absolute terms. These are the sectors, including hotel and restaurant services, construction, traditional manufacturing sectors, retail services and real estate activities and other, where minimum wage covers a larger overall proportion of the workforce. In contrast, other labour-intensive sectors, where wage structure was not dependent on minimum wage constraints, such as modern manufacturing, financial and professional services and wholesale and logistics services, have registered an above-average increase in overall share of value added attributable to skills and labour inputs. This trend, present in the data since introduction of the minimum wage, was not there prior to 2000.

And Ireland is hardly unique here. A study from the University of California recently showed that employers have reduced employment of the less skilled and increased employment of higher skilled workers with an emphasis on formal job training credentials in the wake of increases in minimum wage rates. For anyone concerned with the plight of the disadvantaged youths, these findings should ring the alarm bells.

Often, proponents of minimum wage laws argue that some studies have found little effect of the minimum wages on aggregate level unemployment. The problem, of course, is that such arguments neglect the issue of movement of people in and out of the labour force. While minimum wage hikes lead to higher average wages paid to those in employment, workers who lose their jobs often drop out of the labour force. As such, their numbers simply disappear off the unemployment count.

Hardly a right-wing liberal, Paul Samuelson, winner of the 1970 Nobel prize in economics had the following to say about the proposals to raise minimum wage: "What good does it do a …youth to know that an employer must pay him $2 an hour if the fact that he must be paid that amount is what keeps him from getting a job?"

This is a non-trivial observation, because it reveals one of the most damaging effects of the minimum wage laws in the modern economy. Nobel Prize winner Professor Gary S. Becker, suggested back in the 1970s that minimum wage acts as a dis-incentive for firms to invest in training of its lower-skilled employees. A recent pan-European study confirmed this to be the case across the EU, including Ireland.

The result of this is the creation of a two-tier economy, whereby those with no general and firm-specific skills remain at the very bottom of the economic hierarchy, while those with above-average skills are moving further and further up the skills chain. The companies, over time, respond to this separation by either choosing to invest more into machinery and technologies that can displace lower-skilled workers or by focusing their production processes on accumulating high quality staff.

This process drives the polarization of the overall Irish economy into what is known as ‘Modern’ and ‘Traditional’ sectors. It also drives deeper divisions amongst the lower-skilled and poorer workers by redistributing income within the lower earning segments of population. Some lower skilled get higher wages, others get permanent unemployment. In the US, a study by the National Bureau of Economic Research has shown that the 1997 hike in the federally mandated minimum wage has resulted in a 4.5 percent increase in the number of poor families.

But minimum wages do more damages than that. Generationally, it is the younger workers who tend to possess lower skills and have trouble signaling to the potential employers their latent abilities and aptitude. They also face higher unemployment rates, both at the times of growth and recession. For them, minimum wage laws create insurmountable barriers to escaping the twin trap of unskilled unemployment.

On the one hand, high minimum wage will increase the risk to the employer from hiring a wrong person, thus reducing the incentives to take on younger workers with unproven skills or performance records. On the other hand, the same workers need to gain access to positions which provide extensive on-the-job training in order to progress within the company. Even more importantly for the lower-skilled workers’ future, they need job environment that supports acquisition of generic skills and aptitude that can be transferred to other employers. Both of these investments are severely constrained by the presence of the minimum wage laws. The severity of this constraint is proportional to the gap between the minimum wage level and the average productivity of the workers seeking entry-level employment.

In other words, given the choice between hiring a young unskilled person for €8.65 per hour and a worker with more experience for the same rate, employers will always choose the latter. In times of robust growth, this might matter little, as other employment opportunities are abundant. Today, the picture is different.

Based on a comprehensive survey of minimum wage studies in the US, a 10 percent increase in the minimum wage tends to reduce employment of young workers by 1-2 percent during the times of abundant jobs creation. It is safe to assume that the rate is double in the times of tight labour markets.

Between 2006 and mid 2007, Irish minimum wage rose from €7.65 to €8.65 per hour, implying an associated decrease in employment of the younger workers of 1.3-2.6%, or up to 4,800 individuals amongst those under 25 years of age. Translated into the period of rising unemployment, the elevated rates of minimum wages in Ireland today are likely to be responsible for keeping up to 10,000 younger workers outside gainful employment.


In the end the problem with the minimum wage laws is that they always attempt to influence the supply and demand, just as any price fixing cartel would intend to do. The truth is, in such cases, invariably, the laws of supply and demand win – to the detriment of the most vulnerable and the youngest in our society. For their sake, it is time to rethink our minimum wage laws, before a new permanent class of young, unemployed and unemployable becomes a reality of Ireland’s post-crisis economy.


Box-out:

This week, Standard & Poor's has finally thrown in the towel and cut the ratings of the Irish banks’ bonds. While the news that our banking system stability overall is ranked alongside that of Slovakia and Korea galvanized business news desks attention, two interesting parts of the S&P analysis largely escaped the media. S&P explicitly provides the proof that the Banks Guarantee and Nama jointly underwrite a bailout of the Irish banks’ bondholders. Absent the two measures, AIB bonds would be rated BB/Negative/C+, while Bank of Ireland bonds would be at BB+/Negative/BB-. If not for taxpayers’ cash, bonds of our three largest banks sold to the public would require a health warning, stronger than the one posted on a packet of cigarettes. Only IL&P would stay above the waterline with BBB-/Negative/B absent state intervention. This, of course, would only be achievable assuming that the company’s life insurance business will continue to underwrite its banking branch – an idea that should be alien to anyone with an ounce of sense. In a separate comment, S&P also directly linked the poor prognosis for Irish banking sector to our sick economy. Of course this contrasts Government optimism around Nama. Remember – Nama promises to restore credit flows via ‘repairing’ banks balance sheets. S&P says that the balance sheets will remain sick after Nama as there is no real support for credit quality improvements coming from our weak economy. You decide whom you believe – Government’s contrived ‘supply will restore demand’ argument or S&P’s view that ‘weak demand will drag down supply’.

Economics 31/01/2010: S&P, Gold and forward view on risk

Couple articles worth reading:

1) China bubble - here. In my view - the analyst is spot on - there is a massive bubble in Chinese economy. So large, when it goes, the entire global growth will be derailed. We are, in effect, now treading to closely to the 1932-1934 period of the Great Depression, when the markets forgot fear for a sustained Bear rally before rediscovering that risk mispriced is a disaster waiting to happen.

2) Gold - here. Great chart on 89% loss line.
A very promising direction on gold, of course, which is in line with (1) above.

Prepare for some fun. Take a look at VIX:
All supports are out at this stage and risk appetite is falling since the beginning of the year. Bonds rallying, S&P is taking on water. The only way from here for the likes of Gold is up, for DJA and S&P - down. Back to that 89% rule line in (2) above.