Monthly Archives: June 2012

Euro deal saves Ireland? Maybe…

It’s not clear that it does. I’m not sure it’s a seismic (Enda Kenny) or massive (Eamonn Gilmore) deal. And it happened because of Spanish and Italian pressure.

So far as we can see at present there are three parts to this. The Spanish banks will be recapped directly from the EFSF and later the ESM (assuming there is one…) which will not have formal super senior status but will be more like the IMF and have quasi senior status. The ECB will get an enhanced supervisory role. Crucially for Ireland the deal also suggests that similar cases will be treated similarly. But there is no explicit retrospection.

We have spent, in very rough terms, 30b on Anglo promissory notes, 20b from the then National Pension Reserve Fund in direct bank recaps and about 12-14b more in other recaps, bailouts etc which forms part of the explicit borrowing now subsumed under the troika bailout..

We will not get that 20b back. It’s gone. We might, but it’s not clear, get a deal on the prom notes, but the mood music is that at best this quasi state debt will be converted to very much state debt albeit repayable in a manner that costs less per annum than the 3b cost of prom note redemption. We might or might not get a deal on the 12b, but there is no “Irish state bond for recapping banks” out that can be redeemed. So this would have to be dealt with as part of a general state debt not bank debt deal, which seems not to be o n the cards.

It’s a soda stream not a champagne moment.

Insolvent country in IMF bailout programme to pay 1% of its national income this week to unsecured, unguaranteed bondholders in world’s most bust bank

As NWL says…Lunacy

NAMA Wine Lake

“I put my cards face up on the table, saying, ‘Look, it’s no longer a bank. Anglo is now merged with Irish Nationwide. It’s a warehouse for impaired assets. Its deposit base has been moved out into the pillar banks. And it doesn’t work as a bank anymore. You can’t put your money on deposit in Anglo Irish. You can’t get a loan from Anglo Irish. So the only thing that gives it the name of a bank is because it has a banking license. It needs the banking license to access the monies from the Central Bank. So I said that as far as I am concerned, this is not a real bank. This is a warehouse, and we need your assistance in dealing with the senior bond holders because we don’t think the Irish taxpayer should have to redeem what has become speculative investment. I don’t think it…

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This is an expanded and linked version of my column in the Irish Examiner of Saturday 23 June 2012.

One of the striking elements of the last half decade has been the way in which the public dialog has become suffused with the language, if not completely the understanding of economics. We are all now experts on bond spreads, credit default swaps, the ECB, IMF and the troika. Yet, it remains the case that there is a persistent impression, at least in this writers mind, that the basic structure of the economy remains rather a mystery. Perhaps it is that to the majority of people the magnitude of the aggregate economy and its associated stocks and flows is simply too large. Compounding this is the fact that there are at least four measures of the economy. Three of these are in principle, and in measurement to the extent of human accuracy, equal but give a very different picture of the economy.

We can measure the economy in one of three ways: given that my spending is your income, we can measure the expenditure of various sectors , we can measure the income received by various sectors (rents, wages, profits and income from self employment) or we can measure the output of the various sectors of the economy. The first is the most common and gives a basic accounting measure : income is equal to consumption plus investment plus net government spending plus net exports (Y=C+I+G+(X-M)). This gives us Gross Domestic Product. We can also take into account net income from abroad, which when taken away gives gross national product. In the Irish context we have significant negative flows ,these mainly being the outflows of multinational companies domes filed here making our GNP less than our GDP by some 20%. In most countries these two aggregates are nearly equal, and the Irish situation is unusual. These measures are not ideological or theoretical but are basic accounting identities. An understanding of these is essential to anyone who wants to fully understand the rise and fall of the economy. The CSO databank provides a clear and simple way to drill into these aggregates. The site is well worth investigating.

So how have things evolved since 2000? One popular meme is that we have seen a massive expansion of government expenditure. Well, we have seen an increase but perhaps not to the extent that many consider. Government expenditure has risen by 97% over the period. While that headline figure seems very stark, it is perhaps more instructive to examine the share of government. Measured this way the government has increased its share of GDP from just over 12% in 2000 to 16% now, a significant fall from a 19% share at peak. The largest changes have been in investment. The decline in quarterly GDP since the peak in end 2007 has been just over 10b. This equates almost exactly to the fall in investment, which in turn is largely driven by the unwinding of the credit driven housing bubble and its consequences. Quarterly consumption has fallen by 3b while both exports and imports have risen. It is worth noting that, as it should be when acting as a stabiliser, government spending is much less volatile than that of many other aggregates.

It is in the interrelationships between these components, and in particular the relation of net government expenditure that the theoretical and policy battle between economic doctrines is being played out. At one pole we have Keynesians of various stripes, who suggest that increasing net government spending increases the size of national income. The most notable here is Krugman of course. Countervailing this is the argument from austerians, the newest incarnation of what is also known as classical economists, who assert that increasing government spending crowds out private spending. This debate was first formulated in the mid C19 by David Ricardo, the MP at the time for Portarlington, and in its modern form suggests that increases in economic activity via debt financed government expenditure will be off set by increased savings as economic agents know they will have to pay increased interest charges on this debt . It was revitilized and reinvigorated in the 1980s by Robert Barro. We might note in passing that it is in the view if many indicative of a rather unhealthy state for a aoi-disant scientific discipline to remain mired in what is essentially a two centuries old argument. macroeconomic theory in particular has, many would argue, become sterile and proved itself unable to cope with the political economy aspects of the EU crisis or the massive rise in financial complexity preceding. Economics, macro especially, needs to undergo what Kuhn called a paradigm shift and to incorporate much more explicitly finance and behavioural aspects of human behaviour if it is to move forward. A key aspect of the argument about the role of government revolves the estimation in practice of what is called the multiplier, which is the extent to which the data show whether government spending does lead to long-term increases in economic output.

The news for Ireland is not great for those such as I whose natural inclination would be to wish for a government led stimulus. Ideally we want the multipler to be greater than one, so that increasing government spending by one euro wwill result in national income going up by a greater amount. Irish estimates (see p 48) of the aggregate multiplier tend to be at or below 0.5. Ireland faces an additional problem in that it is an extremely open economy. While much of the imported goods go to manufacturing and services for reexports, we also consume large quantitites of imported goods. And we face the problem that there is no one multiplier (are we stimulating by capital spending or current spending), it varies across the business cycle (with some evidence that it is higher in recessions, exacerbating the effects on national income of cutting government spending) and that it is closer to zero than one for highly indebted countries and open economies (we being both) . A further problem is that the evidence indicates that multipliers tend to be higher for countries in fixed rather than floating exchange regimes, suggesting that the cheery panacea of “ditching the euro” would in all probability result in further reduction of the ability of a government to gain economic traction Add to this the emerging evidence on how sovereign risk leads to a squeezing out of investment and we see that we face a most unpleasant short-term future. Cutting expenditure on government, capital or current, is appalling economics in a recession the more so when it is in a European environment of coordinated austerity. It is however, unavoidable given that we cannot borrow, but the indications are that this will exacerbate and deepen the recession. In the short term that might be balm to the legions that seem to consider all government spending bad but in the long-term a shrinking economy hurts all. Kneejerk cries for “ditching croke park”, slashing public sector wages, are never accompanied by a sober analysis of the downstream economic consequences of same but are instead trotted out liturgically and with the fervour of cargo cultists worshipping a bamboo and coconut mockup of a DC3. But increasing expenditure, even if we were able to, would not in itself refloat the ship of state, as much of the stimulus would be lost. Ireland in other words needs to rely on both exports (in a world and a Europe of competitive austerity) and domestic demand and investment in an environment of broken banks and stagnant consumer sentiment. Which means that we face years of stagnancy, regardless of what way we proceed.


Ok..this is going to annoy everyone I suspect…

One of the things that strikes me about the debate in Ireland is the fundamental misunderstanding that exists about the public sector.

There is a large constituency of people who exhibit tendencies in their discourse that suggests that any wage over zero is too high – these are the die-hards whose discourse is a toxic mixture of ideology jealousy and half remembered catchphrases gleaned from too much Fox News. Small government via starving society of essential services or else making the workers therein so impoverished that they are amenable to bribery works so well in so many places…

There is another large, overlapping but discrete, group who suggest that while of course the government should have a role in the economy it should confine itself to capital and not current spending – far be it from me to suggest that many of these are private sector rent seekers who will cheerfully take the government (taxpayer) cash and spend it on whatever madcap idea has come to mind by a an unholy combination of bureaucrats chasing what they think is going to make ireland rich and vested interests seeking warmer vests, regardless of how low the total ROI will be

Then there is a group, again discrete, who urge us to “scrap croke park” (a football stadium cum conference center and also a totemic 2009 agreement between the government and public sector unions to keep nominal wages uncut in exchange for productivity and other gains), regardless of the fact that such cuts a) will, given higher fiscal multipliers in recessions, exacerbate an already bad domestic demand position, b) will in any case be utterly incapable, the downstream effects of a) ignored, of making a massive dent in the deficit and c) will result in a massive industrial relations mess.

Finally, we have the public sector unions, now moderatly cowed but who have over the years taken advantage of the supine and spineless political system to extract massive rent. Most public sector union leaders in Ireland have beards, for some reason.

I spoke recently to a representative of the first/third group, who urged me to brace for a 40% pay cut “like the private sector has had” via the immenent (wished for?) scrapping of the agreement. Hmmmm. Not quite true… Here is a graph of public/private sector average hourly wages and total employment over the last while. One of the things we want, those of us who dont deem all public servants inherent spongers (or is that the people on welfare? cant ever remember) is that government act to stabilize and smooth out the economic cycle. You dont have to be an unreconstructed keynesian (or even Paul Krugman) to think that smoother cycles are perhaps preferable to more jagged ones.

Both Public and Private wages have remained remarkably constant, or it would be remarkable if we didnt recognize that nominal wage rigidity (the empirical fact that people usually dont get/take/accept reductions in nominal wage packets) is the norm even in distressed sectors.   We also see that the government employment total has declined slowly – taken together this is what we would WANT to see, that government act to keep its injection into the economy smooth. Of course this is not, for the more thinking and conscious, a problem (for the reflexive “small government is good and therefore smaller is better so zero must be optimal” merchants this is a heresy) and acts to ensure that the government is doing its job.  The adjustment in ireland has been in the fall in private sector employment. But it has not been in private sector wages.

The problem in Ireland lies in the fact that there is a significant wedge beween public and private wages. Normal economics would suggest that , all other things being equal, having a permanent defined benefit pensionable job would allow people to take lower wages than those in comparable employment who have less security of tenure and less certain pension. But the opposite is the case here, as over decades governments bought industrial peace and election by generous wage increases.

A significant part of the wedge in pay (lets table the pension issue and how much that would cost to fund) can be explained by on average higher qualifications and greater experience in the public sector. While the government have announced new lower pay scales and less generous pensions for new public sector entrants , it is not clear that they can or should or will do anything for those (like me) who are already in the system. Amongst other things while there has been significant forbearance in relation to industrial relations cutting nominal pay would result in this evaporating. There would be legal difficulty and the certainty of challenges in moving existing pensioners or even those with a reasonable expectation of their pension entitlements to a less generous system, and at least in the university and internationally tradable sectors of the public sector we would face an accelerated brain drain.  And yes, there is one of those – right now it is hard to hire lecturers in Ireland, paying at the bottom of the scale which overlaps with the UK pay scales. It might come as a shock to UK academics but their prospects are positively rosy in comparison to here.  And of course removing several billions at one fell swoop from the pay bill will not magic jobs up for the unemployed but will instead add to their numbers (larger negative shock multipliers are so nasty), while also adding to the hole in the (state owned, supported and money absorbing ) banks from foolish mortgage lending.

Its a mess – there are no simple solutions and no lack of simplistic ones.

only 18% of NAMA loans are performing…

remember, this rate was 21% as late as late 2011…..

NAMA Wine Lake

Ah remember the innocent old days of 2009 when NAMA was just a glint in Peter Bacon’s eye? The assumption was that loans extracted by NAMA from the banks would see the banks crystallising losses of €23bn, after an average 30% haircut – we were so innocent in those days that even the term “haircut” meant something different. And you might also recall the assumption in the draft business plan published in September 2009 that 40% of the loans acquired by NAMA would be performing. Since then, NAMA has actually forced €42bn of losses on banks and we have been constantly disappointed with NAMA reporting fewer and fewer loans performing, and in its most recent report and accounts for Q4, 2011, the Agency said that only 20% were performing, down from 21% the previous quarter. Alas it seems that even this was an overstatement.

In the Dail this week, the…

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Richard Tol, academic freedom and the ESRI.

The ESRI-Richard Tol brouhaha has been strangely ignored by many academic blogs. I guess its because we are all on holidays…

To summarize; in May 2012 Richard, who had left the ESRI under rather strained circumstances earlier this year uploaded a working paper on the welfare-work wedge, whether and under what circumstances it is “better” to be on the welfare than to work. A part of the findings were that for some cohorts there was a significant wedge.

The paper was, according to the details on IDEAS (along with SSRN one of the larger repositories of working papers) uploaded in May.

It appears to me, but maybe I misunderstood, from the various statements that staff in the ESRI may be able to upload papers without any formal checking, but then again they are seasoned academics and researchers who will not generally issue working papers that are manifestly flawed as that will rebound on their reputation.

In any case, the newspapers picked up the findings, and it was widely reported. Here we must note that it was generally reported as “ESRI report” finding something. It was not. To describe it as such is to misunderstand the nature of the research process and to disregard the clear statement on each ESRI working paper that it is not official and should not be treated as such. Why the newspapers and other media choose to so mislead is a source of concern for another day.

In any case, yesterday the ESRI took what it described as the unprecedented step of withdrawing the (unofficial) working paper, declaring it to be in effect shoddy and error prone. It is now no longer on the ESRI working paper site, but the ever reliable Michael Taft has an extensive summary of it here and the entire paper can be downloaded here. Why it felt the need to create a precedent where none existed is unclear. This is worrying for those of us concerned with academic freedom. The ESRI press release states the ostensible reason for withdrawal as

“it has emerged that the underlying analysis requires major revision and that the paper’s estimates overstate the numbers of people who would be better off on the dole than in work.”

This seems to me to fly in the face of how research works. The ESRI working paper series is like any other. Papers start as ideas, then go to drafts then to working papers and then after informal and formal critiquing at seminars and conferences may be submitted for publication where extensive peer review suggests major revisions and then perhaps eventual publication. If the ESRI are now to require all working papers to be error free then they should set up a journal. As a journal editor the only time I would countenance the withdrawal of a paper from any series or publication is if it becomes clear that there is plagiarism, fraud or unethical behavior. None are alleged here. What is clear is that the public debate spooked the ESRI.

When the ESRI next publish a working paper on any area of controversy (and as a social science research institute that is going to happen on a regular basis) we now can no longer be sure that the publication is the thoughts of the author pure and unsullied, but is instead the outcome of internal editing. Nat O’Connor notes that the whole point of working papers is to gain comments from a wide range of people prior to further work ongoing. Editing, as we now seem to see will be the norm at the ESRI, implies control, and control is manifested in a power relationship. The role of an editor or a research institute director, in my view, is not and should not be to ensure that material which might confuse the public is not published. The role should be to ensure that the abstract and press release make clear the main finding, the strengths and weaknesses of the paper, and its role as merely one stage in academic research.

A more reasoned response from the ESRI might have been to note the unofficial, working paper nature, stress that it was part of an ongoing process, and to suggest that (as is always the case in social science) we cannot be sure and must weigh countervailing evidence. What has happened now is frank censorship – and that is not a good outcome. Nor is it feasible in the wired world.

I am neither a labour or tax economist, and so have no clue about the academic quality of the work. It seems methodologically sound, but the data are weak, and that is acknowledged in the paper. Do we wait for perfect data to investigate social phenomena, or press on, carefully, with poor data and the inevitable extra hedging of our conclusions that that will bring? I do know that Tol is a most prolific researcher who well understands the nature of the research process and who is imho unlikely to have put out knowingly flawed work. Although best known as an economist, he has published in many areas, including tax policy. The ESRI director, Frances Ruane, is also a seasoned, well regarded researcher . When the paper, as it almost certainly will, appears in a peer reviewed academic journal with the main thrust of its findings unaltered as seems to be the case, the ESRI will stand as having for publicity or politic reasons withdrawn a working paper. That mars its reputation and the reputation of Irish academia.

Will the Irish banks require billions more?

NAMA Wine Lake

So far Ireland has spent €67.8bn bailing out the banks, comprising €62.8bn in cash and promissory notes directly injected into the banks, and a further €5bn gifted to the banks by NAMA in state-aid and for which we are now on the hook if property prices don’t recover. In a country whose GDP was €156bn in 2011, this represents 43% of GDP. I wonder how the Spanish would feel if they were told now that this was the type of debt they will need shoulder to rescue their banks, rather than the tiddly 10% of GDP implied by the €100bn bailout announced over the weekend? But as bad as Ireland’s bailout costs are so far, they could be set to grow even more. We know about the extra €4bn which the deputy governor the Central Bank of Ireland announced a fortnight ago, which will be required in a couple…

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Ireland needs an industrial policy..

NAMA Wine Lake

Here is a car. In fact, it’s quite a special car. It’s the Duesenberg Simone, a one-off car produced in 1938/9 by the American car manufacturer Duesenberg. Duesenberg was like the American Rolls Royce in the 1920s and 1930s, producing luxury cars that would cost over €1m in today’s money, but has since disappeared as a manufacturer. In 1938 it was commissioned by the French cosmetics and perfume magnate Guy De La Roche to design a car for his lover, Simone. And in 1939 the one-off car was finished and delivered toFranceon the eve of the Nazi invasion of that country. The fate of the car and the two Americans who delivered it is not known. There is a film in there someplace.

Ireland never had a totally indigenous car industry but we did have a substantial Ford plant in Cork for decades in the last century until it was…

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How much money will spain actually need?

As I write there are suggestions that spain will seek a banking only assistance of some €100b.

Is that going to be enough? Look at the following graphs… Bear in mind

a) Ireland is approx 1/8 the size of spain

b) Ireland has to date spent €63b on its banking bailout.

Spanish Private Sector growth (from the Eurostat macro instability website) . total accumulation is not massively different for the banks.

Second comparative house prices (from Ecowin) , rebased to 2000. Again, note that the trajectories are similar, with however the crucial element that spain has not begun the steep declines that have been the cause of the irish banks going pop.

Will 100b, or some 8% of Spanish GDP be enough given the similar trajectories to a country which has seen some 30%+ of GDP vaporised?

Europe needs leadership but from where?

This is an expanded and updated version of a column published in the Irish Examiner
With the passing of the fiscal compact the government now find themselves in a position t once easy and difficult. It is easy in that the parameters of fiscal policy for the next number of years are set out, if not for the next decade. It is hard in that the implementation of these policies is going to result in wrenching adjustments to all aspects of irish life. In 2013-15 expenditure will fall by €2.25b, €2.0b and €1.0b, while tax increases (and these will be coming from an anemic economy) will 1.25b, 1,1b and 0.7b. Despite the ULA and related calling the referendum an austerity referendum, such terminology disguises the fact that there are at least in principle two different kind of adjustments to be made. First, we are still running a primary deficit, defined as government spending less interest payments still being more than government income. Bringing this into broad balance is going to be a sine qua non for accessing regular market bond financing. Second, and only then, we need to consider the issues facing us from the fiscal compact. As has been explained in great detail over the last number of months so long as any nominal growth emerges and so long as government net spending does not run out of control the parameters of the compact can be met

In recent months there has been a slight glimmer of good news for the government in terms of taxation. Income tax has shown strong growth, up 12% over the year (although that figure is somewhat distorted by changes in the way various taxes are allocated to headings). What is problematic is that expenditure is still rising, but this is largely driven by health and social welfare. In a deep recession it is unrealistic to expect these government functions to shrink. Nor might we want to cut too deep. We are not good in this country at realising the essential nonlinearity of much of the relationship between government expenditure and output. Put simply we have a pretty decent health and education system. Small, or even medium increases in expenditure are inherently unlikely to result in a proportional increase in output. The same cannot necessarily be said on the downside – a quality system requires constant high levels of quality inputs, and it is easy for the system to begin to fail with slight reductions in the quality or quantity of inputs. And the pressure will be to shrink. Despite the tax take rising unemployment remains stubbornly high, and the domestic economy has flatlined, as is evident from retail sales and the labour force both shrinking. Any measured growth in the economy for the next few years will only come from the high-tech low-job export sector.

The future of Ireland therefore is crucially dependent on the future of the European economy, both the eurozone and others. this future is now clearly resting on the shoulders of the ECB, shoulders that are being shrugged as if the crisis was nothing to do with it. Right now the epicentre of the crisis has moved to spain. Although spain has a reasonable debt-gdp level of about 80%, there are concerns about its banking system. In particular, there is grave uncertainty about the level of losses in its banks. It is the uncertainty about the level combined with the near certainty that the Spanish taxpayer will end up footing the bill that has spooked the markets. Spanish banks may be broke, but the ECB will not allow them to fail. Nor will they allow bondholders to be burned. A promissory note a la Anglo solution would allow Spanish banks to ease their liquidity problems, as might any euro area lending solution. It would not solve their solvency. So long as the ECB continues to (even with euro inflation low) to obsess about inflation it will not allow monetization via promissory notes. The ECB’s most recent meeting showed how it is now paralyzed by irrational fears of inflation, where they refused to cut interest rates. Paul Krugman has recently echoed the fears of many, that the ECB are repeating the mistakes of the 1930’s. History we are told repeats itself twice : it is our misfortune to be in the first such repetition, which we recall is tragedy.

To solve the euro crisis and the irish crisis will require coordinated movements. Banks must be allowed to fail, and senior bondholders must be forced to take losses. The disruption to financial markets that that will cause is less than will be caused if the euro breaks and in any case the ECB’s insistence on a sovereign-bank linkage has caused untold damage. That will assist in cleaning the Spanish quagmire. Existing bank recapitalisation in Ireland and the bulk of greek debt should be converted to a longterm low interest rate loan, on condition that we adhere to good governance standards. But most of all Europe needs leadership from a patently unwilling germany. Germany is an export led economy, and by definition therefore requires a strong market for its products. The shortterm political win of truculent arrogance will result in a longterm loss of incalculable dimensions. European leaders must make it clear to germany, which is now beginning to show signs of deterioration in its economic state, that mutual adjustment in the eurozone requires both sides to move. This is no longer economics, it is high international politics, a game in which we Irish have little experience or evident competence.