Economics 05/07/2009: EU Report on Euro area... Ireland's Banking obligations

The EU Commission has published its quarterly report on the Euro area economic performance. There is really very little new in the report relative to Q1 report, but some things worth highlighting (available here).

The Commission report providers two tables worth considering in more details. Table 3 below is not new - it has featured in January report by the IMF and then subsequently in other IMF/OECD/EU commission reports since.
But Table 4 is now published alongside Table 3 (if only a handful pages below), which provides for an interesting comparison. Suppose we take as a measure of affordability of banking measures, the projected overall health of the real economy, as reflected in the expected growth rate in real GDP. We compare this against the total level of liabilities assumed by the states in respect to the banking crisis... we plot the two things:
Oh yes, you've got it right - the country that is least able to pick up the tab takes upon itself the greatest level of liabilities... And, in case you wonder who is that lingering in the +/+ quadrant (combining economic growth and no bailouts):Yeps, that low tax export-oriented economy, called Slovakia and Financial Services exporting powerhouse of Luxembourg. Ever wondered if there is any proof that, contrary to Messrs Cowen, Lenihan and Mrs Coughlan's assertions, our failure is neither in our exposure to Global Finance, nor to Low Tax. Our failure is in our policies exposure to the likes of Messrs Cowen, Lenihan and Mrs Coughlan...

Interesting Research: Happiness on Venus is Falling Relative to Mars

Brilliant paper titled The Paradox of Declining Female Happiness by Betsey Stevenson and Justin Wolfers (UofPennsylvania) (see here) is tackling a paradoxical development of the last 35 years, whereby although "objective measures of lives of women in the US have improved... measures of subjective well-being indicate that women's happiness has declined both absolutely and relative to men." If you think this stuff is esoteric (albeit very exciting) research, you are wrong. Remember - academics flash out paradoxes, but politicians devise pork-laden policies aiming at 'addressing' such paradoxes. Hence, authors' claim that: "The paradox of women's declining relative well-being is found across various data sets, measures of subjective well-being, and is pervasive across demographic groups and industrialized countries. Relative declines in female happiness have eroded a gender gap in happiness in which women in the 1970s typically reported higher subjective well-being than did men. These declines have continued and a new gender gap is emerging - one with higher subjective well-being for me." So that will be a new round of subsidies for closing an emerging new gender gap, then? Women are now relatively poor in terms of happiness than men... someone, quick, call the CORI!

Fair Trade: Implicit Ethical Investment Opportunity Space?

I am a skeptic when it comes to the idea of Fair Trade - an idea that on its surface suggests that we should use our preferences biases in the West to determine winners and losers in the trade game vis-a-vis the rest of the world.

However, for some time now, I am hearing various noises about evidence on superior returns to fair trade-affiliated enterprises. Again, taking this with a grain of salt suggests that some of this effect, if true, can be attributed to the artificially increased market share of the fair trade-affiliated producer: I buy Fair Trade, so I discriminate against non-affiliated producer, thereby increasing the market share of a Fair Trade-affiliated one. On the other hand, some theory might suggest that FT-affiliated producers can benefit from higher productivity of better paid and better incentivize employees or coop-members.

Is Fair Trade Honey Sweeter? An Empirical Analysis on the Effect of Affiliation on Productivity is a recent (July 1, 2009) study from Leonardo Becchetti and Stefano Castriota (UofRome II) published by CEIS Tor Vergata, Research paper 141, Vol 7 Issue 1 (available here). The study evaluates the impact of FT affiliation on Chilean honey producers. "Evidence from standard regressions ...shows that affiliated farmers have higher productivity (income from honey per worked hour) than the control sample. Additional results on the effects of affiliation on training, cooperation and advances on payments suggest that affiliation contributed both to, and independently from, the economies of scale effect. Therefore, we show that the productivity effect is partially explained by the superior capacity of affiliated workers to exploit economies of scale."

In other words, what they do find is that FT link to productivity is a mixed bag. One issue - the beggar thy competitor effect of FT (scale) is certainly contributive to 'higher' productivity. As FT spreads over more and more producers, this effect will diminish. The paper controls for this effect.

Another issue is the price effect of FT - members of FT programmes receive higher prices for their products because we, consumers, are willing to pay that premium. This implies that per fixed number of units revenue of FT-affiliated producers is artificially inflated by our preferences. Again, should FT spread, this effect will also be driven down to nil. Interestingly, the authors report that in the case of Chilean honey producers, "The (wholesale) price of honey sold to the FT affiliated cooperative is obviously lower than the retail price, but surprisingly is also lower than the price paid by local, traditional and international intermediaries. Beyond the myth of higher prices, the most valuable services provided by FT organizations are price and demand stabilization, training courses, technical assistance (in this case, lab tests on honey chemical properties) and zero interest advance payments. The local retail price is lower for Apicoop’s members, thus there are no positive externalities of FT affiliation on their bargaining power with local buyers."

But the most interesting issue from my point of view is what is left as a 'residual' once the above two factors are accounted for. Controlling for selection bias, authors estimate the following relationship relating to output productivity:
and obtain the following results:This is really exciting evidence from my point of view (and do recall - I am a skeptic): authors' "analysis on Chilean honey producers in a period of high market prices highlights that, beyond the fair price myth, non price conditions are much more important... More specifically, ...FT affiliation, in spite of an insignificant price differential in times of rising market prices, has helped local farmers to improve their productive skills across years. In this process more favorable financial conditions (advances on payments at 0% interest rate), internalization of Marshallian externalities via interactions among local producers and training courses are the distinguishing features with respect to a control sample of non affiliated producers which seem to have paid an important role."

Great stuff... but... "On the overall, our findings show that affiliation years significantly contribute to increase producers’ productivity by moving farmers above the inverse U-shaped average product curve in the sample. These results, together with those on similar projects lead us to believe that Fair Trade identifies the right path of action to promote inclusion of marginalized farmers in LDCs (even though not all projects have the same degree of effectiveness and depend crucially on management abilities of the local cooperatives). This is because they correctly identify that the problem at stake is not just one of underproduction but,
mainly one of market power, market access and capacity building. FT by definition offers a diversification of marketing channels, aims to address part of the premium to innovation and part to social needs and has the goal to strengthen local producer organizations and their market power in the value chain with respect to local transportation intermediaries."

What the hell does this mean? Well, it means that FTs greatest benefits are real, but some of these are also predatory vis-a-vis non-FT producers because:

• FTs gain from preferential access to finance (so they pocket risk premium);
• FTs gain from preferential access to the markets (so free trade would eliminate their advantage); and
• FTs gain from marketing premium generated by FT retailers.
  

On the net, the picture therefore is mixed. But I find it very interesting...

Wake up calls for Irish Government

My new article in Business&Finance magazine:

Last week two international reports provided an interesting analysis of Irish policies to date and highlighted some scepticism amongst the international analysts as to the ability of our Government to lead the necessary reforms.

First, caught up in the media feeding frenzy, the IMF Article IV Consultation Paper has raised some serious questions about NAMA. Second, much unnoticed by Irish media, the EU Commission report on public finances in the Euro area have provided an in-depth look at Irish fiscal position relative to our peers.

Let us start with the IMF’s analysis, focusing on the major area of the Fund’s oncerns that received little cover in the media. Our policymakers were quick to present the IMF statement that NAMA can be a break-even proposition for the taxpayers as a major endorsement of the Government plan.

Here is what the IMF report actually did say on the topic: “If well managed, the distressed assets acquired by NAMA could, over time, produce a recovery value to compensate for the initial fiscal outlays.” In other words, the IMF is benchmarking NAMA ‘success’ solely against a possibility for earning zero return on initial public investment. The IMF is simply unconcerned here with the associated costs, such as the cost of bonds financing, NAMA management and the cost of post-NAMA recapitalization of the banks. Yet, these costs are non-trivial from the point of view of expected taxpayers’ losses due to NAMA.

Using the balance sheet model for NAMA developed by Professor Brian Lucey and myself, table below provides estimated discount rates that would achieve break-even for the taxpayers on total costs of creating and operating our bad loans bank.
* All in billion 2009 Euro, assumed inflation: 3% pa, 15-year horizon
** ca 33% of the total value of bonds issued, plus the face value of loans purchased into NAMA
*** Ex-operating cost of €20mln pa (rising at 2% pa from 2010)

Even under optimistic scenarios of 10% impairment on loans, and assuming current cost of financing Irish bonds of 5.9% (consistent with last week’s syndicated bond issue) for 2009-2014, and moderate bond finance costs for 2010-2024, the discount on assets purchased by NAMA required to achieve zero loss on NAMA-associated public outlays ranges between 27% and 50%. Higher impairment charges (12-15%) and/or financing costs raise the required break-even discount above 60%.

In other words, there is no reasonably probable scenario whereby NAMA will end up breaking even on total taxpayers outlays in real terms. Perhaps this is precisely the reason as to why the Government has to date produced not a single estimate for expected costs and returns under NAMA, despite making numerous unfounded claims that it will not result in significant taxpayers losses.

In fact, the IMF report was rather clear in its critical assessment of the Irish authorities lack of proper cost-benefit analysis of this undertaking. “The authorities did not formally produce any estimate for aggregate bank losses. …Staff noted that losses are likely to extend beyond the property-development sector as the economy weakens and the design of NAMA should incorporate that possibility.”

Furthermore, “the debt to be incurred to support the financial sector remains uncertain,” says the IMF. “If the losses suffered by banks are about 20 percent of GDP, as estimated by staff, then bank recapitalization needs could be around 12-15 percent of GDP.” These numbers correspond to the two most extreme scenarios presented above. But the IMF Report also states that in such an eventuality “assets would be acquired against this debt...” Injecting €21-25bn in public funds would do the shareholders in Irish banks will be a de facto nationalization – a scenario consistent with IMF staff estimates, yet denied by the Government.

One day before the IMF report, the 300-pages strong EU Commission paper, titled Public Finances in the EMU, 2009 put forward the picture of Irish Exchequer presiding over the worst performing (fiscally) economy in the entire EU.

The diplomatic Commission said in its report that the scale of the downturn was unexpected by the Irish authorities, “with the end-2007 update of the [Government] stability programme expecting real GDP growth of +3% in 2008, while the Commission services’ interim …forecast estimated growth at -2% in 2008”. Irish “deficit was not considered temporary”, suggesting that the EU Commission disagrees with the Government view that most of our troubles are cyclical.

As per credibility of our Exchequer plans to bring the deficits under control by 2013, Commission said that “the January 2009 addendum to the [Government] stability programme targeted a deficit …below 3% of GDP in 2013, based on yet to be specified consolidation measures. In view of the above, the Commission concluded that the deficit criterion in the Treaty was not fulfilled.” In other words, Brussels does not believe that our plans to reduce the deficit in line with the EU rules by 2013 are credible and, therefore, we are now in a full breach of the EU Treaties.

Just to make it more clear the Commission provides a graphic illustration as to how far off we really are in delivering on the 2013 targets. Like IMF in its report last week, the Commission data shows that whilst the Government has proposed a ca 2.75% of GDP contraction in its deficit in 2009-2010, the required rate of reductions should be more than 3 times greater – at ca 8.5% of GDP.

Using the change in the current level of the structural deficit required to make sure that the discounted value of future structural balances covers the current level of debt as the indicator for long-term sustainability of current Government policies, the Commission puts Ireland in the highest category of fiscal instability risk – one of only two Euro-zone countries (alongside Spain) in the group. At the same time, we came out as the most impaired country in the Euro area in overall assessment of our fiscal position.

The IMF and EU Commission papers do agree on another point. Both state that the start of the fiscal crisis we experience today predates the current crisis by at least 4 years. At the same time, clear downward trend in our fiscal stability was visible, according to the EU Commission back in 2003.

There are some serious discrepancies between the Commission and the Government assessments of the ongoing budgetary consolidation process. According to the Commission spring 2009 forecast, “the deficit is projected to widen further to 12% of GDP in 2009, the highest in the euro area.” The deficit target set out by the Government in April 2009 is 10.75% (up from 6.5% in budgeted for in October 2008). “The projected deterioration of the deficit would take place despite successive consolidation efforts since mid-2008, …with an estimated overall net deficit reducing effect of around 4% of GDP in 2009.” Thus, the EU does not buy into the Department of Finance estimate that the total consolidation to date yields 5% of GDP reduction in the deficit, as table below illustrates.

And in contrast with the Government’s rosy projections of 9% deficit for 2010, the Commission projects the deficit to widen to 15.6% of GDP on a no-policy-change basis. “The difference to the authorities’ target …is mainly due to different projections for the 2009 budgetary outcome and ...the non-inclusion of the indications for the budgetary measures for 2010 presented in the April supplementary budget.” Once again the Commission appears to be sceptical about the willingness of this Government to actually follow through with the targets set out in April.
Thus, in major reports published in one week, two international bodies gave a rather forceful negative assessment of the current Government plans for dealing with the banking and fiscal crises. And yet, the Fitzgaraldo of self-congratulatory remarks from Irish public officials pushes on – ever deeper into the denial of our bleak fiscal reality.


Box-Out:
All last week we have been hearing about the IMF endorsing Irish Government ‘austerity measures’ aimed at bringing under control our runaway train of public spending. Rhetoric aside, real numbers suggest that at least in one area – that of public sector employment – months after setting itself some modest targets for public workforce reductions, the Government is nowhere near delivering the real progress. Chart below, taken from the latest Quarterly Household National Survey data released last week, clearly illustrates the prevalence of past trends in overall employment.
While private economy employment shows catastrophic collapse in total numbers working in industry, construction, wholesale and retail services, basic repairs, accommodation and food services, administrative and support services and professional and technical support services, the same data shows precipitous rise in employment numbers across all three broadly defined public sectors.

Subsequently, the chart below shows an even more disconcerting trend.
In addition to by-now customary steady and precipitous rise in unemployment, we are also experiencing rapid withdrawals from the labour force participation as more and more people are falling into our deep welfare trap or undertake an emigration option. This trend – of collapsing employment and rising unemployment – now poised to threaten our long-term demographic dividend, or the expected higher returns to younger labour force that many of Irish policy makers and analysts close to the Government circles are so keen on referring to in their rosy forecasts.

Well, of course the public sector is rolling in the dough as we are taking a pay cut: