Economics 15/02/2010: Ireland and the Euro

Sunday Times, February 14, 2010.

Like a namesake of Federico Fellini’s 1983 classic, E la nave va (And the ship sails on), the Greek debt saga continues its course toward the increasingly inevitable default. Another week, another impenetrable web of announcements, and no real solutions. At this stage, the EU’s ability to resolve the crisis is no longer a matter of markets trust and the reputational costs for the euro are becoming more than evident.

So much so that conservative and forward-looking ECB is starting to think of contingency planning. A source close to Frankfurt has told me earlier in the week that some ECB economists are contemplating the likely run on the euro leading to a 20-25% devaluation of the currency to bring it virtually to parity with the dollar. If that happens, an interest rates hike of 50 basis points or more will be a strong possibility sometime before the end of Q3 2010. A derailment of the nascent economic recovery in the core euro zone countries will be virtually assured.
The plan, currently under discussion at the EU level, involves a guarantee on Greek debt, plus a package of subsidised loans both underwritten by other euro zone countries (re: Germany). The problem is that this is unlikely to be enough.

Greek problems are not cyclical and will not go away once the markets calm down. Country structural deficit, in line with Ireland’s is around 60-70 percent of the overall exchequer annual shortfall. And unlike Ireland, Greece is facing an acute problem refinancing its gargantuan public debt. Worse than that, the latest revelations concerning the complex derivative contracts used by the Greek authorities to hide a significant share of its deficit over the recent years clearly show that the country will have to be much more aggressive in scaling back its annual deficits in order to be able to issue new bonds. The EU latest plan does not facilitate any of these measures. Neither does it have a credible enforcement mechanism. Should Greece decide at any point in the future to renege on its obligations under the rescue package, the entire crisis will be replayed tenfold. And the threat of this gives the Greeks a trump card against the EU Commission under collective guarantees.

Thus, currently, there are only three economically feasible structural solutions to the ongoing crisis in the euro area.

The best option would be a massive injection of liquidity across the common currency area. Minting a fresh batch of euros worth around €1-1.5 trillion and disbursing the currency to the national Governments on a per-capita basis would allow the PIIGS some breathing room in dealing with their deficit and debt problems. At the same time, countries like Germany, with more fiscally sound public spending habits, would be able to use this money to stimulate domestic demand and savings through tax credits and investment.

The drawback of such a plan is that it can reignite inflationary pressures within the euro area. This risk, in my view, is misplaced. Given structural weakness in consumer demand and continued cyclical weakness in new business investment, it is unlikely that much of the freshly-minted cash will go anywhere other than savings. Incidentally, with most the money flowing back into the banking sector, the ECB can then use this increase in deposits to close down some of the asset-backed lending positions that euro area banks have built up with Frankfurt.

Two other solutions involve introduction of a parallel ‘weak’ euro for PIIGS, or an outright bailout of Greece, Portugal, and possibly Spain and Ireland, through a partial pay-down of these countries debts. Both would have dire consequences for the euro itself.

The logistics of running two parallel currencies within a block of countries under a single-handed management of the ECB will produce more than confusion in the markets. The monetary policy required for the ‘weak’ euro state would entail interest rates at roughly triple those in the ‘strong’ euro countries, with the resultant potential for an explosion of carry trades unfolding within a single monetary union.

In addition, there is no mechanism by which either Greece or any other country can be compelled to switch to a ‘weak’ euro. In Ireland’s case, being forced into a ‘weak’ euro will be a disaster for the longer term prospects of maintaining strong presence of the US and UK multinationals here who rely on out full membership in the common currency club to drive their transfer pricing.

An outright paydown of the PIIGS debts – no matter how tough the EU Commission gets in terms of talking up ‘conditional lending’ and ‘direct supervision’ provisos of such an action – will result in an unenforceable lending from Germany to the PIIGS.


From Ireland’s point of view, however, the inevitable outcome of all possible alternatives for dealing with Greece will be devaluation of the euro close to parity with the US dollar. And here may lie the best news Irish exporting firms have heard since the beginning of this recession.

Given the dynamics of our exports-producing sectors, Ireland desperately needs a shot in the arm to stay alive as economy through 2010.

Per CSO, our MNCs-dominated modern manufacturing – the source of most of our goods exports – has managed to post a spectacular 14.5% seasonally-adjusted drop in production in Q4 2009. Pharmaceuticals output declined a 7.5% in the last quarter, while computer, electronic and optical equipment sector – another pillar of our exporting activities was down 14.9% in December 2009. It all points to growing weakness in exports-driven high value added segment of our manufacturing. In short, Ireland can use a serious devaluation of the euro on the exporting side.

But a silver lining never comes without some cumulus clouds in tow.

A devaluation – while a boom for exporters – will act to reduce consumer spending and, through higher cost of imports, will further reduce income available for domestic savings and investment. Given the already abysmally low levels of personal consumption, it is highly likely that this will trigger more household defaults on debt and mortgages.

Furthermore, a devaluation can trigger rising inflation across the euro area which, once imported into Ireland, will undermine the gains in competitiveness achieved during the current crisis. For comparison, consider the case of Ireland v Greece. In his recent note, NIB’s Chief Economist, Ronnie O’Toole highlighted the fact that between mid 2008 and the end of 2009, Irish consumer prices have fallen some 4.6%. In contrast, Greece saw its prices rise some 2.3% over the same period. Of course, falling price levels imply that it is much easier for companies and governments to cut nominal wages. A new bout of inflation induced by the EU solutions to the Greek crisis can wipe out this advantage.

Alas, no one so far has noticed that in both, Ireland and Greece, a cut in nominal wages in line with inflation will do two things. One – it will leave real wages – the stuff that private sector producers really care about – intact. And it will be a magnitude of 3-4 times too little for repairing the Exchequer balance sheet. With both countries facing a 2010 deficit of 10-11% of GDP, a 5% cut in public sector wages is equivalent to applying Bandaid to a shark bite.

And a rise in euro area inflation will have an adverse impact on Irish exporters. Despite devaluation, many of our MNCs and indigenous exporting companies buy large quantities of raw and intermediate inputs from abroad. The rise in the cost of imports bill will partially cancel out the gains in final prices achieved due to devaluation. This is especially significant for the companies trading in modern higher value-added sectors, where geographically diversified multinationals use Ireland as a later stage production base with intermediate inputs coming from other EU countries and the US.

Lastly, a devaluation of the euro close to the dollar parity is likely to trigger monetary tightening by the ECB, with interest rates rising by 50 basis points in the next six months. Coupled with reduced provision of new liquidity by Frankfurt, the resulting credit crunch on the Irish banks will trigger a massive jump in the burden of mortgages here. Needless to say, even with booming exports, Ireland Inc will be in deep trouble as trade credits, corporate funding and personal loans will be pushed deep into red by rising costs of borrowing.

At this stage, we really are caught between a rock and a hard place.

Economics 13/02/2010: On benefits of marriage to investment

Feeling marital around the Valentine's Day? Well, how about investing in some stocks?

A paper just published in The Review of Financial Studies (2010, 23(1) pages 385-432) titled: “The Effect of Marital Status and Children on Savings and Portfolio Choice" by David A. Love (not kidding there) looked at the impact of marital status on optimal decisions about saving, life insurance, and asset allocation. It turns out, quite predictably I must add, that changes in marital-status and the number of children can have “important effects on optimal household decisions”:

• Widowhood induces sharp reductions in the portfolio shares in stock, and the impact is largest for women and individuals with children.
• Divorce causes men and women to reallocate their portfolios in different directions; men choose much riskier allocations, while women opt for safer ones.
• Children play a fundamental role in the optimal portfolio decisions. Men with children, for example, increase their shares in response to divorce by less than half as much as men without children.

Obviously, this might have something to do with the fall-off in disposable income and wealth, induced by a divorce when long-term child payments are involved. “…Imagine that a couple with two children living at home gets a divorce. Depending on the legal assignment of custody, the mandated level of child support, anticipated earnings, and the division of household wealth, the ratio of wealth to the present value of future income for each spouse will almost surely differ from the level previously observed in marriage. …this ratio is key to understanding optimal asset allocation because it summarizes, at least in part, the exposure of future consumption possibilities to fluctuations in financial markets.”

In addition to wealth-to-income ratio, divorce and portfolio choice are linked through changes in financial background risk as “the former spouses move from living on a combined income to each relying on a potentially more volatile single stream. …Uninsurable background risk, arising, for example, from labor income, business income, and housing, can have a quantitatively large impact on optimal portfolio decisions.”

A final way that the divorce might influence optimal portfolio choice is through its effect on savings “as the former spouses update their desired consumption of housing, food, transportation, and childcare.” Divorcees from a single car household buy a new car. They also increase childcare expenditure in most cases, unless large divorce settlements induce one parent exit from the labour force. Food consumption expenditure and volume rise, as all other consumption of both durables and non-durables.

Contrast the economic implications of divorce for the two-child couple with those of a childless couple. Members of the childless couple will still experience a change in wealth and income in the event of a divorce, “but there will be no additional shock to resources due to child support, college expenses, or differences in scale economies related to the assignment of custody. Given this differential impact on resources, it is reasonable to expect that the childless couple will respond differently to divorce in terms of saving and portfolio choice. In addition, children may also alter households' responses to widowhood. For example, depending on the strength of the bequest motive, surviving spouses with children will tend to have larger amounts of wealth relative to income compared to those without children, leaving them more exposed to market risk.”

All of these conjectures are supported by evidence, but there are some surprises in findings as well: “We find that households with children tend to accumulate substantially less wealth during the working years but that their slower rates of drawdown in retirement leave them with more savings toward the tail end of life.” Does marriage really mean life-long prudence?

“This trajectory of wealth accumulation is mirrored, in part, by the evolution of portfolio shares. Earlier in the life cycle, households with children hold riskier portfolio shares (by about 10 percentage points) than households without children, but the relationship reverses in retirement.” So no, risk aversion is lower for married couples probably because their dual incomes act as hedges against single income volatility.

Instead – it is bequest motive that drives them to become more conservative in older age. “…a riskier allocation for these younger households is optimal because their consumption streams are less dependent on the performance of financial markets. In retirement, however, children provide an incentive to maintain wealth for bequests, and the resulting increase in the wealth-to-income ratio makes households increasingly sensitive to stock market volatility.”

Hmmm, this brings us to taxes, then. A rise in inheritance tax during the wealth accumulation period of household life cycle implies a reduced incentive to save for bequest. This, should then result in lower risk aversion for older age households. And that, in turn, will lead to greater volatility of investment and also to higher cost of borrowing by the sovereigns. How so? Because if older households become less risk averse, their share of government bonds in total investment portfolio will drop. This means lower demand for bonds and higher yields on new issuance. Cost of sovereign borrowing goes up and the benefits of higher taxes to Government revenues are cancelled out, at least in part.

Imagine that – some say there is no such thing as Laffer Curve… not even at 100% marginal tax rate?

Economics 13/02/2010: Inflation targets and What's in a name?

One interesting observation – Oliver Blanchard in yesterday interview with Wall Street Journal suggests (here) that “If I were to choose inflation target today, I’d strongly argue for 4%. But we have started with 2%, so going from 2% to 4% would raise issues of credibility. We should have a discussion about it.”

I have argued for some time now that a combination of

• continued tightness in the credit markets,
  
• long-term stickiness of European unemployment and
  
• massive national deficits and debt issuance since 2008 imply the need for inflationary reductions in debt levels accumulated by the euro area states, especially those members of the APIIGS club

will mean continued need for unprecedented liquidity injections by the ECB through 2010. The three forces mean that the ECB will have no option but to shift away from its current ‘below 2%’ target for inflation and move on to 4% target.

Good to see serious heavy hitter in policy economics, like Oliver Blanchard, also thinking the same.



Now, to more ‘fun’ economics.

Remember Shakespeare’s “What’s in a name? / That which we call a rose by any other name would smell as sweet.” (Romeo and Juliet).

In the world where information moves much faster and where uncertainty is much higher – in other words, in the world we inhabit today – this view is no longer true, for what is in the name does tell us much about what is in the name bearer.

A recent paper by Aura, Saku and Hess, Gregory D., What’s in a Name?, Economic Inquiry, Vol. 48, Issue 1, pp. 214-227, January 2010 (link here) shows exactly this.

“Expectant parents lie awake at night, consult books, and some even hire a consultant to choose their new child’s name. Is it similar to the process that manufacturers undertake when branding a new product? Viagara pretty much speaks for itself, but to what extent does Gregory, Saku or even Jamaal convey information and/or meaning.”

The study attempts to answer two main questions:

1. does a person’s name convey information about their background?
2. does a person’s name have an impact on the person’s long run economic outcomes, such as income, education, fertility, social standing, happiness or prestige?”
   

“In our dataset, this would mean comparing the outcomes of otherwise similar individuals with a name like Mark (exclusively a white name in our data) with Marcus (exclusively a black name in our data) or comparing Alice (white name) with Tanisha (black name)…

…More specifically, we investigate the extent to which a respondent’s first name features affect his or her years of formal education, self reported financial relative position as well as social class, to have a child before 25, and occupational prestige. …we can examine the gender differences between lifetime outcomes and first name features.”

There are broadly speaking three main findings:

1. there is a strong empirical relationship between an individual’s first name and their background;
2. there is a weaker (but still significant) empirical relationship between an individual’s lifetime outcomes and their first names. Taken together, these first two findings imply that names do convey information about an individual’s labor market productivity. A rose is not quite a rose by any other name.
3. both non-black non-whites with ‘blacker’ names as well as blacks with more popular (i.e. predominantly ‘whiter’) names have significantly worse financial outcomes. “This last piece of evidence can be interpreted in light of a subtle form of discrimination: namely, while black names come with discrimination and identity costs and benefits for black individuals, non-black non-whites with ‘blacker’ names face the costs of such names though not the benefits. A similar identity/discrimination channel would also hold for blacks with more popular (i.e. whiter) names, …though it does not provide conclusive proof of discrimination.”
   

First, names indicate a great deal of information on

• gender (and this conclusion is not based on linguistic gender of the name, but on standard phonetic characteristics);
• the year when one was born,
• a respondent’s higher parental education background "can be partially inferred from higher popularity, fewer syllables, more standard spellings, fewer ‘oh’ endings, not starting with a vowel, ending with a consonant and having a lower Blackness Index (the extent to which a given name is race-specific). This latter result …is actually quite large: moving from a purely non-black name to a fully black name is associated with a Father having 2 fewer years of formal education and a Mother having 1 year less.”
• more popular names are associated with better lifetime outcomes: that is, more education, occupational prestige and income, and a reduced likelihood of having a child before
• names with higher values for Blackness Index are “associated with poorer lifetime outcomes: that is, less education, occupational prestige, happiness, social class and income, and an increased likelihood of having a child before 25".
• ‘ah’ and ‘oh’ ending sounds in a name are also related to poorer lifetime outcomes, though popularity is related to better lifetime outcomes.
  

So first names just by themselves convey information about a respondent’s lifetime outcomes. But does "your first name features affect one’s lifetime outcomes after learning information that may be readily available in a job resume".

It turns out that when this is controlled for,

1. Name popularity remains a significant explanatory variable in education outcomes, but not in financial outcomes;
2. Blackness Index is statistically significant again in the class determination, and whether or not a person has higher happiness quotient in the future, as well as in educational attainment: “Higher values for BIND lead to a lower assessment of social class, happiness and an increased chance of having children before 25. However, as with POPULARITY, BIND is now no longer statistically significant in the income responses. Again, the role of education and labor market experience is clearly soaking up the role that POPULARITY and BIND played in the income response” in earlier analysis.
   

“It would thus seem that first names retain a strong role overall in determining lifetime outcomes even after controlling for a respondent’s labor market experience.”

“There is the further possibility that these quasi economic outcomes may also be correlated with labor productivity: simply unhappy workers and those that feel that they are lower class (or even upper class) may have differential labor productivities. Based on the findings… controlling for a myriad of exogenous family background characteristics, a first name’s popularity and/or ‘blackness’ appear to have an impact on intermediate economic outcomes that are likely correlated with labor productivity but not on actual economic outcomes. It would thus appear that …the ‘blackness’ of a name is correlated with factors that can affect labor productivity which could in turn be reflected in discrimination at the resume level [but not at face-to-face level]. As we demonstrate, however, this potential channel of discrimination does not have an impact on pure economic outcomes in our sample.”

In general, this explains why past immigrants to the US – from Europe and elsewhere – tended to automatically adopt most popular local names for their children to ‘assimilate’ into the American mainstream.

It also shows that, for example in the case of Ireland, one would expect past emigrants to be selected on the basis of those with more common names experiencing more favorable in outcomes. Furthermore, currently, within the country, Irish first names might provide for better outcomes - as they serve as more acceptable norms here, while at the same time placing children at relative disadvantage to their peers if they should emigrate out of Ireland.

Lastly, when looking at the trends in names, since the onset of recession, more mainstream names have moved up the popularity chain in Ireland with more Gaelic-derived names becoming less popular. This too might be explained by the findings - when times are tough, implicitly, parents tend to focus more on real economic and social outcomes than on the feeling of being in tune with Eamon O Cuiv's 'national culture'.


Overall, instead of the Shakespeare’s idea that it is the inherent subject characteristic that matters, not the name, is no longer true. Instead, modern relationship between the name and the person is probably better described by a different quote – from Johnny Cash’s (1969), A Boy Named Sue: “So I give ya that name and I said goodbye / I knew you’d have to get tough or die / And it’s that name that helped to make you strong”.

Economics 12/02/2010: Crisis pressures in broader debt markets

And so the Greek saga continues, with yesterday’s announcement that the EU has a worked-out rescue package for the country now turning out to be yet another wishful thinking piece of poorly prepared PR. No package details, and the markets are not impressed.

But forget Greece for a moment. The good news is that just as in Autumn 2008, the last couple of months have been the case of “bad news = good news”. The markets have finally started to turn their attention to the completely reckless ways in which majority of Governments around the world have been managing their finances, both before the crisis and during it.

The new line of fire is now directed at Turkey and Japan.

Japan, pushing for well over 200% of GDP ratio of debt is in a league of its own. And the current Government is hell-bent on raising the debt limits higher with aggressive spending targets and Napoleonic plans for shifting even more public expenditure into largely unproductive investment (for a country with already extensive public capital stock, the diminishing marginal returns on new public investment have set in some time ago). Debt ratio to working age population is now well above USD100,000 and is rising at accelerating pace. Savings rate has fallen to below 4% while the fiscal deficits are now much higher than they were back in the days when the savings rate was around 18%. Current account balance has declined from the peak of 5% in 2007 to under 1.5% today and is set to fall further. With these dynamics in mind, Japan is going to account for roughly 11% of the total global expected issuance of new bonds in 2010.

Turkey is a serious basket case, although it might not appear to be such from the simple debt levels comparisons. Like Ireland, Turkey has low debt to GDP ratio (45% as opposed to Greece with 113%, Portugal with 77%, Spain with 54%), It is in line with Ireland current 46.2% debt levels (although in Ireland’s case, a GNP base would work much better, bringing out true public debt to a much more formidable 57% of GNP). But it is not the level of debt that is worrisome. The awesome rate of debt increase, along with hidden debts that the public sector underwrites are the real concerns here.

An interesting chart from Turkey Data Monitor:
shows just how bad Turkish debt dynamics are. In the environment where it is currently yielding over 8% with an average maturity being around 2 years, the problem for Turkey is the following:

• Can a country with history of past debt problems and rising deficits really roll-over some USD125 billion worth of debt? and
• Can such a country do this in the environment where worldwide, national governments are expected to issue some USD4.5 trillion worth of bonds in 2010 - three times the normal volume of global debt issuance?

Now, think of it this way – Turkey debt is held by domestic banks (roughly 60%) and the remainder – by foreigners. This, normally, presents the point of stability. Alas, if the banks are not operating in the liquidity saturated markets for funding (and they are clearly not doing so) the Turkish Government cannot default on the debt without risking destabilizing its banking system. And if it does destabilize the banks, the Government ‘solution’ to default will imply demand for massive banks rescue package, adding further to the debt mountain. In other words, unlike with other countries that have heavier exposures to international lenders, Turkey simply must refinance the roll-over debt.

So dynamics matter. And they matter for Ireland. Which got me thinking – just how bad is our debt position going to get and what costs will this impose on the economy. Here are few charts:
Start with gross debt as percentage of GDP and GNP. Above chart shows figures for the official debt estimates from Stability Plan Update, December 2009, issued by the Department of Finance. Additional lines show the ratio of debt to GNP and also extension of debt figures to include Nama's €59 billion allocation, plus expected €12 billion in post-Nama capital injections into the banks. Finally, the last line shows the above, accounting for a lower growth rate in GNP scenario than the one forecast by the DofF for 2012-2014 period. The important issue here is that our debt to GNP (the real measure of our economy) is going to breach 100% even under DofF own rosy assumptions.

Next, consider the growth rate in our debt:
Pretty dramatic, especially when you compare the rate of growth in 2009-2012 against the tiny rates of decline predicted for 2013-2014. The rates of decline in fact will be about half the rate of interest we will be paying on this debt.

So expect no respite in terms of the cost of debt financing in sight:
The above are pretty big annual numbers - up to €14 billion going to feed the debt monster annually! Crazy stuff for an economy worth around €130 billion in terms of its GNP. Alternatively, €14 billion is roughly 30% of the total Government expenditure that this country can afford if we were to stay on structurally balanced fiscal path!

And thus, cost of debt financing as percentage of our economy is going to be excruciating - up to 9.5% of the annual economic output at the peak (under the most pessimistic scenario). Which means the total cost of the current fiscal crisis is also going to be astronomical:
By the end of 2014, thus, we are looking to have wasted between €50 billion and €80 billion in total on sustaining that which is simply unsustainable - our gargantuan public sector overspending.


Incidentally, this pretty much explains why I do not believe that marginal reforms of the public sector, such as 'productivity improvements', 'reduced spending on external consultants' and 'staff re-allocations' will be enough to address the issue. In real world we inhabit, we need a massive cut in terms of overall spending on public sector and this can only be achieved by slashing numbers employed in the public sector and cutting pensions and wage expenditure on the remaining staff.


PS 1: given chronic lack of skills, aptitude and capabilities present in many areas of the public sector, an idea of using internal expertise to reduce reliance on external consultants advice and expertise, while hoping for improved efficiency is simply absurd.


PS2: A year ago, myself and Brian Lucey wrote an article for the Irish Times about the massive debt overhang in the Irish economy. Using IMF statistics we established that Irish economy stands out as the second most indebted economy in the world in terms of ratio of debts to GDP, the most indebted economy in the world when it comes to applying our real measure of economic activity - GNP, and one of the most indebted economies in absolute terms.

In response to the article, we were told by the Irish officials that 'total debts do not matter, only public debt does'.

In the real world, total debts of economy do matter because they show structural composition of economy itself, revealing the extent to which economic growth is being financed by reckless borrowing.

This month, Hayman Advisors weighted in on our side:
The above debts cover public debt, plus 5 top banks per country, with Iceland figure showing pre-crisis conditions. Forbes magazine reproduced this chart in their cover story for February 8 edition with a tag line saying "It's the Total Debt, Stupid".

I agree.

Economics 10/02/2010: Can Labour Party lead?

Does a coalition involving any party in partnership with Labour makes sense?

Unfortunately, despite Labour Party having in its ranks some very talented and economically literate senior politicians (Joan Burton and Ruairi Quinn come to mind), there is a legacy of the LP being largely captured by the Trade Unionist movement. In times of economic expansion, this risks the party pre-committing itself to the policy platforms that:

• expand public sector beyond economically efficient levels;
• make the above expansions permanent in nature (i.e. irreversible); and
• commit the state to correcting any potential funding shortfalls out of tax revenue increases.

In this context, it is irrelevant whether or not the Labour Party can or cannot commit to a credible path of public sector productivity reforms. It is simply a party that will find it impossible to impose fiscal discipline on its own constituency.

For example, consider the current situation with public sector wages and non-wage earnings clearly being out of line with private sector and with the reality of economic crisis on the ground. Two past policy dimensions, each one sufficient enough to rule out Labour's ability to impose fiscal discipline on the state, that come to mind:

1. Labour consistently supported increases in the lower tier wages, thus advocating a compression of wage distribution from the left tail. In current environment, Labour could cut upper tier public sector wages, further compressing the distribution, this time from the right tail. But it cannot commit to shifting the entire distribution left. And this means that any savings achieved will be poultry and will not go far enough to address the existent wages gap between public and private workers to the left of the median wage.
2. Labour also persistently advocated minimum wage increases. A cut in a minimum wage, therefore, is not an option for Labour. But absent cuts in minimum wages, what policy can promote jobs creation at the bottom of the skills distribution? A cut in the cost of employing workers - aka a cut in employer PRSI - is also out of question for Labour. Training and state subsidised employment simply cannot deliver sustained jobs for this category of unemployed.

The legacy of traditionalist approach to class politics is tainting Labour party platforms today. Their current proposals for dealing with unemployment virtually invariably require the State to find new funding to expand existent programmes, such as investment in education and training, a jobs fund in the Budget and a new National Development Plan. Funny thing is, Labour party seems that propping up the same programmes that failed to deliver jobs in the times of the boom (aka all mentioned above) will somehow, once expanded, deliver jobs in a recession.

There is also a strange belief, on behalf of Labour party that extending a place in a university to everyone who applies (see here), regardless of their merit or ability, is a jobs-supporting policy as well. In following this, Labour commits two cardinal errors:

• It implicitly beliefs that getting a college degree improves ones ability to gain employment; and
• It explicitly assumes that providing tertiary education for all is necessarily net-additive economic and social activity.

In other words, Labour party fails to recognise that education can yield diminishing social and economic returns and it fails to recognise that the rate at which social and economic returns diminish is unrelated to the quality of graduates.

So there you have it - despite having some very good people in its ranks, Labour party is simply not a credible contender for economic crisis management.

Economics 10/02/2010: Minumum wage and unemployment benefits

Two weeks ago in my Sunday Times article (see here) I wrote about the long-term effects of the minimum wages. Instead of dealing with the losses of economic competitiveness from Irish high minim wage, I elected to focus in the article on the distorted incentives and reduced training for potential and actual minimum wage recipients. Interestingly, these adverse effects are nearly identical for minimum wages and unemployment benefits.

Last week’s research paper from Zafar Nazarov of RAND, academic think tank in the US and Europe, titled The effect of the unemployment insurance wage replacement rate on reemployment wages, showed that higher unemployment benefits lead to lower wages commanded by those who manage to re-enter employment. In addition, higher wage replacement rate under unemployment benefits ‘depresses depresses the prospect of finding full-time work while increasing the prospect of finding part-time work”. To summarize, therefore, higher unemployment benefits paid hurt those unemployed who find a job in the future and lead to lower quality of jobs available to the previously unemployed.

Qui bono, then from higher unemployment payments? Those on permanent welfare, of course. Since they do not face a prospect of gaining a job in the future, they face none of the costs of higher unemployment benefits. But as their own pay is linked to unemployment benefits through social fairness arguments, there is all the upside of higher rates. Oh, the bizarre world of state-controlled wages, unemployment insurance and welfare benefits. Makes banks’ s shenanigans sound pretty banal.