Dissent in the ranks

Slí Eile: Over on irisheconomy.ie (our neighbouring island!) you can read an interesting debate about accountability sparked by a chance remark about deflation which, I think, people are missing in the follow-up comments. There, Kevin O'Rourke writes:

However, the fact that the Government is cutting expenditure and raising taxes as severely as it now has to, thus lowering aggregate demand and worsening unemployment at the worst possible time imaginable (we can argue about the size of this effect, but its sign is in no doubt) is a damning indictment of Fianna Fáil/PD fiscal policy over the past few years.

Banking Reform

Sean O Riain: Once we have banks that have been re-capitalised and apparently stable once more, where does our financial system go? In negative terms, how can we be assured that the financial system will not generate crises on the kind of scale that we are currently living through? In positive terms, how can we increase the chances that finance flows toward productive rather than speculative uses?

These critical questions are largely sidelined in the current debates on nationalization, which have focused largely on the (urgent and very important) questions of how to restore the stability of the banking system and who will end up stuck with the bill. But, even if this is achieved at the least possible cost to the taxpayer (and therefore with the least possible constraint on public investment into the future), this still leaves the questions of stability and productive investment. There is little reason to suppose that an unreconstructed banking system will deliver this on its own – the banking system provided neither stability nor productive investment before this crisis. Reform of banks themselves will be essential, although this has largely disappeared off the agenda in recent months.

There are five areas through which we can influence how banking practices are shaped by the wider system of financial governance (some of these are usefully reviewed in Stiglitz and Uy’s account of the ‘East Asian Miracle’). In each area, the system has left a great deal to be desired and requires reform.

First, we can change investment incentives. When capital gains tax was cut to 20% in 1998, capital flowed into the economy. But as is well known, the vast bulk of that capital went straight into property and, to a lesser extent, financial speculation. Even if capital gains had been reduced selectively, the gains from investment could have been channeled into more productive areas like R&D. As it was, the exceptionally low tax rate combined with various schemes promoting property investments channeled financing away from high tech and other export sectors just when many of them needed that financing most to build international scale operations. There are glimmers of hope in recent government documents of a recognition for the need for a re-design of the incentives for investment, with talk of supports for R&D and education. There are also depressing signs of a strong persistence of business as usual – many millions to go into banking with little reform attached, six million in subsidized pension loans to go into construction, while a one billion euro plan to protect jobs and boost skills proves difficult to approve.

Second, we can regulate the provision of private sector credit. Government plays a crucial role in providing a framework that promotes liquidity in credit markets. However, it is also clear that government must be involved in ensuring that this liquidity maintains a link to the real economy. This does not require that strict capital controls or similar measures necessarily be imposed but it does require a managing of the openness to the more loosely regulated parts of financial markets. Rules about capital requirements, about particular kinds of financial instruments, about dubious transnational capital flows, and about reporting standards will be necessary components, among others.

This is also a matter of the regulator providing a counter-balance to the ‘social milieu’ and analytical models of financial analysts that produced a massive discounting of the risks of the financialised economy. Regulators must provide the institutionalized prudence that can control the ‘irrational exuberance’ of financial markets.

Third, there is an urgent need for an enhanced role for the state in channeling credit to business. It has already been playing a central role in that respect. The state agencies have been a significant funding agency for high tech firms, have led the building of a venture capital industry and have made effective investments. On the other hand, these investments fall well behind the scale of the investments in promising firms made by other countries – including the apparently ‘non-interventionist’ US where an increasing number of the best technological innovations come from federal labs, federally funded R&D and networks of firms supported through government schemes (Block and Keller, 2008). As Iona Technologies founder Chris Horn argued in the Irish Times recently, these kinds of supports need to be extended significantly (with all the safeguards that are by now well developed in Enterprise Ireland and elsewhere). In short, we don’t have to invent a public industrial development bank – we have one already in place that needs much greater funding and political support.

Fourth, we need to transform the organisational culture and capabilities of banks. One of the most remarkable elements of the banking crisis is what it has revealed to public scrutiny about the internal culture and capabilities of the banks. The banks have simply got a very weak capability as organizations to make productive investments. For many years now, the only serious investment options they offered to private citizens was the savings account or buying property abroad. There may well be some human capital problems with temporary nationalisation – but there is certainly an issue with the skills and practices inside the banks themselves.

A temporary nationalization of the banking system will not in and of itself transform this culture and capabilities but it offers an opportunity to do so. The recent ‘swap’ of expertise between Enterprise Ireland and the banks suggests precisely such an effort – but the resistance by government to nationalization suggests a lack of a broader willingness to take on this issue. Indeed, it will most likely take a sustained effort to do so since the partial zombification of the banks at present is hardly conducive to organizational re-invigoration. A period of nationalization should result in organizational restructuring as well as financial stabilization.

The fifth area of reform is the area of regulation itself. If the state must play an enhanced role in governing finance, then the question of how the regulatory system itself is organized is crucial. The model of regulatory independence has been shown to be flawed. Many serious questions have been raised about the Financial Regulator and many of the solutions proposed have focused on the kinds of people to be recruited to lead the agency. However, more serious changes are required. The insulation of the ‘independent’ regulator from the broader democratic system appears only to have encouraged ‘regulatory capture’ by industry interests as the regulator operated outside the view of the democratic system.

The regulator needs to be able to engage with the industry and MIT research has shown that conversations between industry and regulators has been an important source of learning for technology firms in the US (Lester and Piore, 2004). But there needs to be a counter-weight against the pressures of capture that are generated through these dialogues between regulator and regulated. Putting increased pressures of external accountability on the Financial Regulator would guard against the kind of apparent ‘capture’ that have occurred in recent years.

A much stronger role for the committees of Dáil Éireann in reviewing the financial sector on an ongoing basis would provide such a forum. Protection for auditors and whistleblowers would also seem essential, given the pressures that were evidently put on auditors in the recent past. Ironically, they would therefore allow the Regulator to engage in properly advising the banks, knowing that these stronger structures of external accountability were in place. Greater democratic accountability will only strengthen the capacities of the regulator to monitor developments in the sector.

One of the effects of the current crisis has been to push issues of economic governance and policy into the public sphere. Much more complex public discussions regarding the economy and financial sectors have taken place in recent months than over the past decades. This serves to show up the weakness of our ‘economic democracy’ in normal times. Governing our financial system to provide stability and productive investment and democratizing our structures of regulation will be essential elements in enhancing both our economic and political life. We should not let debates over NAMA, important though they are, distract us from these vital regulatory issues.

TASC has moved

TASC has moved to 13 - 17 Dawson Street, Dublin 2. The phone number remains the same (01-6169050). However, incoming calls may be restricted today (Thursday, May 28th) and tomorrow (Friday, May 29th). If you have difficulty contacting us, please call 086-7272626.

Surely we can do better than this?

Sli Eile: Writing in the Irish Times, Michael Casey a former chief economist with the Central Bank argues that a ‘Change of Government will not solve our economic woes’. He goes on to list seven reasons why there is little an alternative Government can do:

We lack the power to devalue currency or change interest rates (just as well?)

Public finances are stuck between a hard rock and a hard place (cut and be damned or reflate and be damned, it is said)

Social partnership will not, cannot, deliver an ‘appropriate incomes policy’ (what would that look like if it included all incomes?)

Public Sector reform will take years (if not decades?) to deliver

Toxic Banking is a poisoned chalice and nobody wants to drink from it (before, during or after NAMA has run its course in 20 something)

‘No political party has formulated an alternative industrial policy’ (not entirely true actually)

‘Most important economic decisions are made in Brussels, Frankfurt and Washington’ (it used to be London, and that was a key argument for joining the Common Market’)

And there the article ends. Is that all that there is to say? One may argue with many of the above claims, but there is an underlying truth – business as usual is gone and in a post-recession world we are left standing on our own two feet. I contest that these two feet should be:

- A new economic policy based on internationally traded services and products with completely new indigenous public, private and community enterprises;

- A new social and democratic contract that will replace the existing model of partnership and ensure the provision of a basic income for all and a 21st century European level of public services.

But how will this be paid for? And how will we dig ourselves out of the present financial hole? And where will be the political momentum come from?

What has progressive economics to offer? What could contributors to this blog suggest? What have non-readers who prefer to read irisheconomy.ie to say?

What is the minimum that a progressive coalition of economists, thinkers, politicians and social commentators and activists could agree on? Let's see. How about a set of ‘contestable’ statements to start a debate:

1 Banking – get this right as a top priority. It is a complex area but you don’t need to be a financial whiz kid to arrive at an obvious conclusion – only full ownership and control of Banking by the State can save this sector and the rest of the economy. Why wait for it to happen, and then say it is our only option. I appreciate that not everyone agrees with this …..

2 Fiscal policy – public finances are in dire straits and nobody denies this (at least since the start of this year). So, let's raid the rich (and not so rich) with much higher capital, new property, local residential and high-income taxes, while closing as many of the tax loopholes and reliefs which have long outlived their economic usefulness (if they every really had any). At the same time increase (yes!) public spending in a planned and strategic way to improve public services, capital infrastructure and job-retention and training while increasing public borrowing through a brokered ‘off-balance’ approach.

3 Jobs – a fiscal stimulus carefully targeted and forensically tested could arrest at least some of the jobs haemorrhage. Although there are no magic solutions, let's accelerate a programme of investment in select areas of research and development and link these to new enterprises – temporarily nationalising those firms that still have a viable future but are about to close, aiding firms in trouble through a new credit agency, converting unused land banks into productive social use and identifying potentially new growth areas for international services such as education, health and green technology. Fine Gael have made some valuable proposals in regard to a slate of new State companies and green technology (Rebuilding Ireland - a New Era for the Irish Economy)

4 Public Services - we need more, and not less, by way of health, education and protection against poverty. We are still among the most prosperous countries in the world but we need to move from being a society of nouveau riche and haves and have nots to a society where citizens and communities share the cost of providing an acceptable level of income, nurture, care and protection.

5 Reform of Corporations and Public Services
Linked to a reformed and enhanced public service is the need to democratise institutions (as well as reform public sector institutions, work practices and responsiveness). Our education and health sectors (to take just two examples) remain profoundly undemocratic and exclusionist in spite of all the talk about customers and inclusion. Likewise, the workplace needs to become a place where skills, team-working and decision-making are not the preserve of the shareholders or the managerial elite. Openness, transparency and accountability must reach into every public, private and voluntary organisations (but especially those in receipt of State subsidies or in charge of delivering some part of public or social services).

A new deal for a new Ireland. Five principles to start a national and international/EU debate. Who is up for it? Comments, disagreements, suggestions?

Or should we resign ourselves to waiting out the storm and someone else (IMF, ECB, EIB, ECion, London, Washington) will bail us out eventually ….? Surely we can do better than this.

Post-Celtic-Tiger errata

John Barry: Have just read Showcasing Globalisation?: The Political Economy of the Irish Republic by Nicola Jo-Anne Smith. It’s a good source of empirical data and debates about the Irish economy in terms of whether it really is 'globalised' or merely 'internationalised' and actually concentrated in terms of trade to a couple of countries - US and the UK in particular. It’s also a rather infuriating read - lots of 'on the one hand...but on the other...' and frustratingly fails to come down with any analytically insightful or normatively interesting positions.

She contests that Ireland is a 'competition state' (Irish-style), as maintained by critics of the neo-liberal Celtic Tiger model such as Peadar Kirby or Denis O'Hearn, yet does not outline what a 'competition state' is and how it differs from a 'welfare' or 'developmental' one. The book also offers the most torturous account of the persistence of inequality in Ireland, while maintaining this is not a major issue given the rise in absolute wages for most and the provision of a (bare and increasingly thread-bare) social safety net. But perhaps most frustrating of all, and which to my mind, really undermines the book's contribution, there is no discussion of the dynamics of globalised capitalism or indeed the character of Irish capitalism. It is as if one can blithely discuss 'globalisation' without mentioning capitalism!

Nevertheless, despite these criticisms, it is a good start to the debate about the Celtic Tiger, and more importantly the post-Celtic Tiger situation, not least in Smith's argument that both the 'Whittaker moment' in the 1950s (which heralded the end of De Valera-style protectionism) and the social partnership model of the late 1980s (of the commonly held features which explains the Celtic Tiger 'take off') were borne out of crisis.

Where is our 'green Whittaker now' and is there a green version of social partnership and the need to respond to the current economic (and growing political) crisis by restructuring the state, economy and civil society in Ireland?

James Galbraith: "No return to normal"

Professor James Galbraith will be speaking at the TASC Annual Lecture on June 4th, at 6.30 p.m. in the Royal Irish Academy. Meanwhile, here are some extracts from No Return to Normal, a recent piece he wrote for the Washington Monthly, subtitled "Why the economic crisis, and its solution, are bigger than you think". Enjoy - and click here to read the whole article.

"The first thing we need, in the wake of the recovery bill, is more recovery bills. The next efforts should be larger, reflecting the true scale of the emergency. There should be open-ended support for state and "local governments, public utilities, transit authorities, public hospitals, schools, and universities for the duration, and generous support for public capital investment in the short and long term. To the extent possible, all the resources being released from the private residential and commercial construction industries should be absorbed into public building projects. There should be comprehensive foreclosure relief, through a moratorium followed by restructuring or by conversion-to-rental, except in cases of speculative investment and borrower fraud. The president’s foreclosure-prevention plan is a useful step to relieve mortgage burdens on at-risk households, but it will not stop the downward spiral of home prices and correct the chronic oversupply of housing that is the cause of that." […]

"The entitlement reformers have it backward: instead of cutting Social Security benefits, we should increase them, especially for those at the bottom of the benefit scale. Indeed, in this crisis, precisely because it is universal and efficient, Social Security is an economic recovery ace in the hole. Increasing benefits is a simple, direct, progressive, and highly efficient way to prevent poverty and sustain purchasing power for this vulnerable population. I would also argue for lowering the age of eligibility for Medicare to (say) fifty-five, to permit workers to retire earlier and to free firms from the burden of managing health plans for older workers". […]

"We will soon need a jobs program to put the unemployed to work quickly. Infrastructure spending can help, but major building projects can take years to gear up, and they can, for the most part, provide jobs only for those who have the requisite skills. So the federal government should sponsor projects that employ people to do what they do best, including art, letters, drama, dance, music, scientific research, teaching, conservation, and the nonprofit sector, including community organizing—why not?" […]

"A paradox of the long view is that the time to embrace it is right now. We need to start down that path before disastrous policy errors, including fatal banker bailouts and cuts in Social Security and Medicare, are put into effect. It is therefore especially important that thought and learning move quickly."

NAMA or nationalisation unlikely to achieve objectives

Jim Stewart: Banks are a vital part of any modern economy. They perform a number of key functions (1) a repository and access to liquid assets; (2) transferring funds; (3) provision of short term credit and lending; (4) provision of financial services and retention of records. Policy actions to date has ensured banks continue to survive and can perform three of the four functions, but expecting banks to start lending is unrealistic. This has not happened in other countries nor is it likely to happen here. Rather than lending to enterprises, eurozone banks have increased their purchase of government bonds. One estimate is that banks bought 75% of the total of €77 billion of eurozone Government bonds issued in January (F.T. 4/3/09). The implications for Ireland is that is that a substantial proportion of recent issues of Irish Government debt was bought by banks and in particular Irish banks. The ECB cannot lend directly to governments but can lend to banks at low interest rates in exchange for many types of collateral including government debt. Banks are then in a position in turn to purchase government debt. This is how the government deficit can be financed. The ECB has recently announced further measures to in crease liquidity which will again support both the banking sector and large borrowers such as Governments.

It is most unlikely that the NAMA will succeed in its stated objective of ensuring households can access credit and that funding will be provided to small and medium sized enterprises (Budget statement April, 2009). This is a similar objective to those stated in the plan to guarantee all the debts of banks last September (the stated aim was to ensure financial stability and “protect the real economy” (Minister for Finance 22nd October, 2008). In the announcement of the government recapitalization plan (11th February, 2009) it was stated that the “recapitalisation package will “reinforce the stability of our financial system, increase confidence in the banking system here, and facilitate the banks involved in lending to the economy”.

The reason this stated aim will be unsuccessful is that it is irrational to expect banks to provide funds to firms or individuals in the context of falling personal incomes, rising unemployment and a rising level of insolvencies in the corporate sector. This is a feature not just of the Irish economy but of all the Eurozone economies. Table 1 below shows that the annual rate of increase in loans to the private sector and in particular the two targeted sectors, Households and Non-financial corporations, have fallen consistently every month since May 2008. This in spite of all the State guarantees, arranged mergers, equity injections, and nationalisations. Much of the increase in lending could be ‘rolled up’ interest as in the case of the Irish Nationwide Building Society.

This is particularly serious for small and medium sized enterprise because bank lending is the main source of finance in the euro zone area.

The most recent bank Lending survey, 2009, reported higher loan margins and more restrictive collateral requirements for five Irish banks participating in the survey. The same survey also reports a decline in demand for loans due to a “reduction in the financing needs of enterprises”.

Current policies have been successful in ensuring banks have survived and continue to perform many valuable services. But it is unlikely that either NAMA or nationalization of the banks would result in additional lending to small business because it is irrational for them to do so, given the overall objective of behaving in a commercial (for profit way). NAMA or nationalization will be extremely costly. Changing ownership does not change the size of the deficit between the value of assets financed by borrowing and the amount borrowed and the likely required State contribution. It is doubtful that changing ownership would result in efficiency gains, for example in realising higher values for assets that are sold. It is also unlikely that a change in ownership would result in losses (transfers in value), other than those already incurred, to bondholders or preference share owners. This did not happen in the Anglo-Irish case (see statement issued by the Government on 30th January, 2009, to the effect that nationalisation would have no effect on Tier 1 hybrid instruments (See: http://www.angloirishbank.ie). It is better to proceed cautiously now than pursue policies that pre-empt all other options because of their cost and size. An early example of delay being the best option was the proposal to seek mergers amongst banks. It was clear to some then but to all now that any bank that merged with either Anglo-Irish Bank or the Irish Nationwide Building Society would reduce the chances of the merged entity remaining viable.

But there is one area in which it is vital that immediate action is taken, and that is to ensure that credit and loans flow to small and medium sized enterprises and not just those involved in exporting. Large corporate entities and the multinational corporate sector have other sources of finance. Some large firms have no need for additional borrowing. What is needed is a new entity designed to lend funds to the SME sector. Such an entity cannot be “for profit”. It cannot be run on strictly commercial lines, because in the current crisis lending to SMEs is certain to result in losses. This new entity could be funded on the basis that 20% of loans would fail. Lending is thus made with the knowledge that there is an explicit subsidy. The return to the State (and the economy) is indirect in terms of job preservation, so that when the economy recovers there is an existing base which is a potential source of growth and job creation. Such a policy could also act as a certification device to other banks. It would reduce risk to other banks provided claims on collateral were ranked below that of additional funding from other banks.

Fortune Magazine's analysis of Ireland's 'new troubles'

Paul Sweeney: Fortune magazine takes a look at Ireland’s “New Troubles” in the current issue, 1st June 2009. It is a particularly shallow and a very ideological analysis. But it is one which will sit well in the boardrooms and with the business “wanna be’s”. Carefully selected interviewees who are all right wing business people and commentators deliver a very superficial analysis of what went wrong and what the prescription is. Fortune’s Shawn Tully ensures that the ill-informed will be no wiser internationally by his crafted ideological piece.

Starting and ending the article with the profound thoughts of leading intellectual, Michael O Leary, “the blarney filled promoter” begins by saying his bikini-clad calendar girls “really do work here.” He ends with a cry to save Ireland’s key weapon of competitive advantage, the low tax on corporations, such as Ryanair. With the penny dropping on how vulnerable this advantage is, Tully and O’Leary are worried that the price of bail-out of Ireland by Europe will be the termination of the race to the bottom in corporate tax competition in a European Single Market. This point was made recently made by James Wickham on Progressive Economy.

Fortune asserts that if the low Corporation Tax rate goes then it will “undermine Ireland’s crucial campaign for lower wages. ‘If taxes rise, employees will demand higher pay,” says Alan Barrett” of the ESRI. “That would go in the opposite direction from our attempts to restore competitiveness,“ he asserts.

Barrett’s is an incrediblely narrow understanding of the issue of competitiveness. In fairness, we hope he was selectively quoted by Tully in order to build his view of Ireland. What about the impact of the 25% drop in Stirling and the fall in the dollar on overall costs on cost competiveness? And the barely functioning banking system? And the poor infrastructure and public transport?

Another quote is from a businessman whose name is always linked to the word “entrepreneur.” Is an entrepreneur a person who make his fortune when the state hands him a very valuable public asset in the form of a telephone licence - which should have been auctioned to the highest bidder? Denis O’Brien warns against union and labour regulation in the piece. “I’d be extremely reluctant to invest in France or Germany because of the labour laws. You have too many rules and negotiations. In Ireland we can cut labour costs very quickly,” he boasts.

In one section, Tully asserts that unions are weak in Ireland (yet the density is 37%here compared to 8% in France) but moans that the government often bends to the will of public sector unions. He asserts that “multinationals are rarely constrained by union contracts”, but yet they are in several of the firms he mentions by name - eg J&J and Schering Plough! And in many others too, especially in pharma. He seems unaware of the Social Partnership process, which largely influences pay and conditions in every sector, unionised or not.

Instructively, he quotes Willie Slattery of State Street who complains that he could not compete with well paid public sector workers for staff. Willie, who wants a pay freeze for no less than three to four years, is a member of An Bord Snip Nua.

The article focuses on “years of reckless spending”, but neglects to point out the crisis was largely created by tax cutting and tax shifting from incomes and profits to spending taxes, which were unstable, especially around property. It was the pro-cyclical policies in the boom, enhanced with tax subsidies for property investors which led to the Irish crisis, combined with reckless lending by the banks, unsupervised by a state “captured” by efficient market theory. The issue is not to deflate the economy further as this piece asserts.

On a positive note, Fortune does point out the there are many excellent sectors and firms in Ireland – “its fundamental economy still packs vast potential for exports and could rebound strongly.” However, if we were to follow the prescriptions of the eminent people quoted by this business magazine, we would be in even deeper trouble.

Guest Post: Response to Richard Tol on 'Green New Deal'

John Barry: Richard Tol, over at Irish Economy, has an ‘interesting’ take on one of the components of a Green New Deal for Ireland.

Focusing on the conventional economics for recycling he (and others who have responded to his post) use this one aspect of a ‘Green economy’, or the Green New Deal now promoted, to dismiss not only the Greens in government but the idea that somehow the greening of the economy as outlined in a Green New deal is ‘not economic’. Only by conveniently (and standardly in neo-classical economic thinking) excluding both the social and ecological ‘bottom lines’ does this even begin to stack up. With thousands losing jobs in Ireland and a long established (though largely localised) ‘social economy’ recycling industry, are we to simply dismiss the prospect of creating ‘green collar’ jobs here in the recycling industry? Especially if we limit or eradicate the market distorting effects of a rush towards incineration (few jobs, high capital cost and environmental/health costs) there are jobs to be created in an indigenous recycling industry. Why does Richard assume recycling in Ireland has to be capital and energy intensive?

How do Richard and his buddies explain the fact that according to a recent report - HSBC’s Climate Change research ‘A Climate for recovery’ - China, India, South Korea as well as the US are spending so much of their stimulus packages on the environmental goods and services sector? South Korea is spending almost 80% of its entire package on the green economy and climate change sector, while China is spending around 33%. And guess what, they are not all ramping themselves up for the deluge of recylates from Ireland and Europe – but a serious bid for first mover status in an emerging market and the next industrial revolution of the inevitable shift to a sustainable, low carbon economy. According to HSBC, Europe is seriously lagging behind.

But then, trapped in the neoclassical, ‘business as usual’ economic logic, what could one expect from Richard and fellow-travellers? The real ambition for a green economy is to get rid of the notion of waste completely from the production and consumption process, as promoted by the ‘zero waste’ strategy now endorsed by New Zealand and long championed by ecological economists such as Robin Murray (Creating Wealth from Waste).

I particularly enjoyed the exchange between Richard Tol and Brian Lucey to the effect that the greening of the economy is driven by ideological concerns (i.e. the Greens in coalition) and not by ‘economics’ – as if the neo-classical economic position espoused by both Richard and Brian is not itself ideological! Precious! Perhaps both would like to contribute to the recently launched campaign to remove ‘toxic economic textbooks’ from undergraduate economics courses - that is, remove the dominance of the neo-clasical model and allow some genuine debate and pluralism within economics.

The current economic meltdown is not the result of natural causes or human conspiracy, but because society at all levels became infected with false beliefs regarding the nature of economic reality. And the primary sources of this infection are the “neoclassical” or “mainstream” textbooks long used in introductory economics courses in universities throughout the world”

The Greens, just like Richard and Brian, are engaged in political economy – economics driven by underlying political values – to think that a neo-classical economic position is somehow ‘value free’, ‘objective’ or ‘neutral’ is not only just plain wrong but disingenuous. ALL economic proposals are ideological, period. So let’s have a grown-up debate about political economy - not this nonsense that somehow there is a ‘scientific’ and objective position from which we can analyse and make proposals about the economy.

And, as an afterthought, have any of these neo-classical economists thought of the impact of the massive carbon subsidies (vastly greater than the 13 million euro being talked about here for the stimulation of an indigenous recycling industry) which have locked us into a carbon dependent infrastructure for decades to come? A Green New Deal and the creation of a green, low carbon economy is not simply about government investment, but also the removal of perverse carbon subsidies in order to incentivise and encourage public and market actors. But then why let a good argument get in the way of cheap political and ideological-based point scoring?

Keep cutting and hoping?

Slí Eile: If anything the atmosphere at today's 2nd 'Economic Crisis' conference in Dublin was gloomier than the first one last January. It was a more serene gloom as people are becoming more accustomed to recession psychology. One recalls audible gasps in the audience at the January conference when the more rash were predicting a 15% unemployment rate later this year and a 10% fall in national income. Some of the papers for the conference can already be downloaded at irisheconomy.ie But don't expect any huge surprises or variations in view. The chorus can be distilled down to:

• we got to price ourselves back into world markets

• nominal wages must be cut - especially those of the public sector

• fiscal balance must be restored quickly – primarily through continuing expenditure cuts and targetted tax hikes

• everything else must be driven by the above or wait on the above.
  
  

Economist Philip Lane commended 'all political parties are showing a responsible approach to fiscal policy … none have espoused extreme views such as repudiation of debt' Hmmm

The overwhelming consensus and underlying assumption from the podium of 6 speakers and virtually all persons who asked questions from the floor is that 'there is no other way' than austerity and severe fiscal adjustment to right the economy over a number of years. The media lapped it up and the experts qua economists are revered as people with special knowledge and insight to whom lesser mortals look up for wisdom. John Fitzgerald suggested that we will know when the recovery has arrived when such conferences are not packed out (this one was full for about 4 weeks due to pre-booking). Irisheconomy.ie was referred to by more than one commentator in such reverential terms as to suggest a required daily meditation.

The consensus is overwhelming.

On the 'what to do' (economists unlike others are not shy about policy recommendations – but these are of course value-neutral):

• move very quickly towards fiscal balance – front-load nominal pay cuts (and another sizeable pay cut in the public sector except this time a proper plain vanilla one and not one dressed up as a pension levy)

• raise taxes and prioritise those on property and carbon emission (by now an ESRI favourite)

• encourage more competition (move parts of state-holdings into direct competition)

• adjust social welfare payments and the minimum wage (downward of course)

• use supply-side measures to activate the unemployed and re-skill or up-skill the long-term unemployed.

Inequality got a mention in one paper (Brian Nolan) suggesting that inequality in household income (after tax and transfers) has been fairly static over time in Ireland but that we are towards the high end of inequality in OECD. Without any data it was alleged by more than one speaker that the recent Supplementary budget was strongly ('remarkably' was the term used by Brian Nolan) redistributive (in favour of those on low incomes or welfare).

One journalist gave John Fitzgerald a grilling on whether he supported pay cuts in the public sector to remove the '20% premium' to the latter over the private sector (where does that figure come from?). Fitzgerald said politely 'it would be nice …' Another journalist asked a question about some website ('progressive economy – ever heard of it?) claiming that Irish wages are about average. Oddly enough throughout the proceedings there was scant reference to profits and their role in driving inflation (in parts of the non-traded services sector). Karl Whelan concluded that the structural-cyclical deficit distinction is not so useful after all – a view not shared by Philip Lane.

Lane's key argument for pro-cyclical deflation now was based on the fact that our initial state is so bad (in other words so pro-cyclical during the boom times) that a fiscal stimulus is neither affordable or desirable now. In chilling tones he spoke of the 'unallocated corrections' in 2011 and beyond not to mention the harsh medicine in store this coming December (that is if an earlier budget is not forced by some new international meltdown). Along with others, Lane is very explicit: 'significant reductions' are needed in public spending this coming 2010 budget and beyond.

Colm McCarthy's (of Bord Snip fame) paper discussed the pension crises. With ageing populations, people living longer and the meltdown in private equity and Defined Benefit schemes (including the large private sector employers) McCarthy believes that the retirement age needs to be raised and more encouragement for private savings. In direct response to a question about tax relief for pensions (at the higher marginal tax rate) he said that he had problems with the line of argument that such tax concessions were 'reliefs' and he seemed to favour keeping many of these be kept in place (lets see what the Commission on Taxation says line). He said that he had 'less faith in capitalism when it came to DB schemes' than many in the Trade Unions.

Banking received attention with Patrick Honohan's paper. NAMA in its current incarnated proposal got mixed support signals. The view is that a refined version of NAMA would eventually take shape. While the risk to taxpayers was acknowledged (by Honohan) he is not for nationalisation.

All in all it was not an encouraging event – more cuts, no end in sight and a very cold and calculating 'markets must clear' as we hope for an international recovery – eventually.

Nobody was asking the question – by how much does unemployment need to increase and how much do wages need to fall to price us back into international markets?

Will a Domestic Stimulus work in a Small Open Economy like Ireland?

Sli Eile: Taoiseach Brian Cowen commented over the last weekend that the main opposition parties wants the Government to cut more while the other (minor) opposition party wants the Government to cut less. Hard to disagree with this observation. Draw your own conclusions. But, who is for not cutting at all and instead spending more? Yes, spend more but very differently and under very different arrangements with regard to how banking, public finances and corporations are run in Ireland and Europe.

Turning to political economy, the trouble with many economists is that they can only look back – to old theories, old evidence and old empirical models based on what is measurable and what was given in terms of the external environment. On the other hand, it is hard to look into the future without regard to what has happened in the past and why it happened. The 1960s were the heyday of econometric modelling as economists discovered new data sources and put all their quantitative prowess on display through the science of multi-variate statistical modelling. This was, also, the time of ‘manpower planning’ and Economic Programmes (Whitaker closer to home). The first ‘Oil Shock’ of 1973, and following it the slowdown in economic growth in the early 1980s, disturbed many of the stable empirical relationships.

The new orthodoxy was monetarism – strong medicine for a new world – allied to ever more complex modelling of micro-economic behaviour and macro-economic impacts.

We are in a muddle again as the old world dissolved in 2008. In particular, the emergence of a very different profile of industrial output, labour market structure and public-private balance emerged in Ireland in the 1990s and the present decade.

The bottom line is that it is hard to model an economic ‘readjustment’, let alone a recovery, when you in the midst of an economic tsunami. The ‘old reliables’ are gone in more ways than one.

A future blog will comment on the latest ESRI publication Recovery Scenarios for Ireland (published last week). This blog goes back to an earlier, less publicised, document that sought to quantify the impact of various policy shifts in regard to expenditure, taxation, employment as well as ‘exogenous’ shifts in competitiveness and world trade.

In a heroic attempt to model the impact of various (simplistic) adjustments to taxes, public spending and nominal wages, the authors of the ESRI paper entitled ‘The Behaviour of the Irish Economy: Insights from the HERMES macro-economic model’, (Adele Bergin, Thomas Conefrey, John Fitzgerald and Ide Kearney) have done some service in assessing the impacts of various changes on key economic outcomes such as GNP, GDP, Unemployment, Government Borrowing and price inflation. Using historical data and based on a complex forecasting model (HERMES) drawing data from another global era, they have modelled forward the projected or estimated impacts of a number of ‘shocks’ or adjustments including the following:

• 5% cut in nominal wages

• Cuts in public spending

• 1% Increases in world growth

• 1% Improvements in competitiveness

A number of salient points are in order:

• Economics is not a perfect science – the questions you choose to ask and explore empirically are a function of your values and those underlying assumptions and interests that you hold dear;

• Instability, uncertainty, conditionality and the impact of ‘exogenous’ variables renders standardised econometrics in the league of heroic simplicity, in spite of all its finesse and seeming complexity;

• The past is a different place and not necessarily a sound guide to the future or present; and

• No policy response is ideologically, politically or morally neutral.

That said, fair play to the ESRI for using the only empirical data available to assess various possible outcomes. But, empirics can never tell the full story, neither can they tell you what to do. The ESRI authors fully acknowledge the limitations (‘expectations in the model are backward looking’, p7 and ‘the unquantifiable effect on confidence’ is omitted).

The doctrine of ‘expansionary fiscal contraction’ (public spending cuts fuelling recovery of private consumption and investment) is firmly rebuked in the paper, as it had been already by Bradley and Whelan in a 1997 paper. The problem identified in many ‘growth studies’ over recent decades is that it is fiercely difficult to account for factors such as new technologies, the impact of political changes and swings in business mood. Some economists such as Harberger (1998) have distinguished between “yeast” and “mushroom” effects in explaining economic growth.

Factors such as knowledge and human capital act like yeast to increase productivity relatively evenly across the economy, while other factors such as a technological breakthrough or discovery suddenly mushroom to increase productivity more dramatically in some sectors than others. The ‘X’ factor is a lot bigger than people imagine. During the heady days of the Celtic Tiger, some growth studies identified a very large ‘unexplained’ residual in the case of Ireland, suggesting productivity increases well above what could be accounted for by standard input measures. Buried in the plot was, no doubt, the impact of temporary foreign direct investment, price transferring and international spillover effects.

The number-crunching (based on ceteris paribus on the explanatory side – all else constant while one variable is shifted but allowing for interactions in all the outcome variables) on various scenarios is summarised in the ESRI paper as follows:

Gross National Product and Gross Domestic Product would fall initially but recover in the medium- to long-term as a result of a 5% cut in nominal wages (details are summarised on page 3 of the paper).

GNP/GDP would fall initially as well as in the medium-term (to 2013) as a result of a one-off hike of €1billion in any of the following: income tax, property tax, public sector pay cuts, employment cuts and Government investment reductions. The extent of the impact varies with larger negative impacts in the case of cuts in employment, public sector pay and income tax. Carbon taxes would be mildly expansionary in the case of the GNP measure due to a reduction in profit repatriations by the manufacturing sector (but not GDP).

GNP/GDP would be higher in the medium-term as a result of either a 1% increase in world growth or a 1% improvement in competitiveness.

One of the major sources of instability is migration. Unemployment peaked at 17% in the late 1980s but would have gone much higher were it not for the huge level of outward migration at the time reflecting job opportunities in the UK and other destinations. Clearly, the same does not hold now. A safe bet is that labour supply will remain fairly ‘inelastic’, at least until green shoots of recovery appear in the UK labour market. The implications of this – not spelt out in the ESRI paper – is that any deflationary shock (recall that the ESRI scenarios entailed a €1billion shock, which is a small compared to what Government is promising us for the next 4 years) will have large and difficult-to-predict impacts on unemployment. Although the ESRI didn’t model the impacts on poverty, health and well-being it is safe to assume that these will be substantial – in the absence of any reversal of current economic policy.

Still, while modelling for a fall in employment in the education and health sectors (p20) the authors bank on ‘extensive emigration’ so that the unemployment rate would initially rise by 0.9 per cent points and fall back to 0.2 by 2015 (for a reduction of around 17,000 in the numbers employed in health and education in 2009). They acknowledge the uncertainty in the labour market situation internationally. Nobody has provided solid evidence, yet, that we are looking at return to net outward migration, and certainly nothing of the order last seen in the late-1980s (when unemployment peaked at 17% and net outward migration at 44,000 in 1989). Put another way, it is not obvious that unemployed teacher graduates or nurses can readily find employment in the UK and further afield. But, it may come to that if labour markets pick up elsewhere before the Irish labour market. And, it would seem that domestic policy is, implicitly aiming for this outcome.

Instructively, the ESRI conclude that pay cuts in the public sector have bigger bucks than employment cuts. Hence, a cut of 17,000 jobs in 2009 would save ‘only’ €500 – much less than half of what could be saved from a cut of 5% in public sector pay. The lesson they seem to be strongly hinting at is cut pay before you cut jobs.

Very crudely, if Government is promising an ‘adjustment’ of some €4 billion for each of the coming 3 years on top of the full-year adjustment of €5 billion, this year then we are looking at (very crudely) something possibly like €17 billion in total cumulative terms. In other words, a one-off impact of a €1 billion multiplied 17 times gives a downward long-run adjustment of 7 % in GNP – other things equal. Who is to know the dynamic effect of such an adjustment if it further depresses demand and undermine confidence?

Perhaps the one of the most intriguing aspects of this paper is the estimated impact of cuts in Government investment (p22). They write:

we consider the impact of a €1 billion reduction in expenditure on public investment under the National Development Plan. These results only take account of the demand side impact of the change in investment. They take no account of the longer-term supply side impact reducing national output and productivity as a result of the reduced stock of infrastructure.

Then they spell this out:

Thus the longer-term impact of this cut on output and employment would be substantially greater than shown here.

The impact on public finances is large (reducing borrowing) for a cut of €1billion in the public capital programme. The net impact on national output is very small in the medium-term (to 2015) allowing for some positive impact on private manufacturing and services in the ESRI model. However, the long-term impact on the ‘supply-side’ is unknown and unquantifiable. Put another way, cuts in the PCP (like in the Ireland of the 1950s), along with cuts in public services such as health and education, will have lasting effects and these effects will interact with the rest of the economy and society. Have we not learned the lessons from the lasting impact of health cuts in the late-1980s?

The ESRI paper standardises all the impacts into a monetary-based multiplier Table 9 (p25). The biggest long-term negative impact is -1.35 in respect of a €1b value cut in public sector employment and the strongest positive impact is 0.15 from a carbon tax hike of €1b. Underlying the ESRI analysis is:

• An inherent assumption that deflation is a necessary part of the medicine to get back on track – (real) pay cuts, a mix of tax increases and some pruning of public investment is assumed appropriate in the circumstances; and

• A hope that improved trade conditions in conjunction with a moderately conservative domestic fiscal stance will lift the Irish boat – in 2011 if thing go well and later if not – eventually the storm will subside and how quickly we bounce back depends on things outside our control and things inside our control.

The Paper does not deal with issues around supply-side initiatives such as training and labour market flexibility – but this can be factored into a package as well.

A problem with the ESRI one-off ‘ceteris paribus’ shocks is that in the real world everything is changing and interacting and a policy stimulus to lower unemployment and improve competitiveness and reduce borrowing in the medium-term and raise national output needs to combine a range of measures into a coherent package. However, the ESRI exercise is useful at least analytically in quantifying the separate effects of one-off shocks on the assumption that everything else on the ‘policy instrument’ side is held constant.

In conclusion one could ask why the ESRI authors chose to try some particular set of scenarios and not others. They probed the impact of cutting expenditure and wages as well as raising taxes. And, they probed the impact of improved international trade and Irish competitiveness on global markets. But, they did not probe the impact of a fiscal stimulus and still less a forensic one targeted at particular sectors and spenders within the economy. Moreover, nobody can quite model the impact of a political stimulus based on a new leadership, new hope and reform of democracy and governance in the corporate and political worlds. It could surprise everyone – even for a small open economy like Ireland with some leverage in Europe and the wider world.

As always, comments, corrections, disagreements, suggestions from the blogosphere on the above welcome.

Political lessons from Iceland

Peadar Kirby: With the forthcoming local and European elections opening the first opportunity for the political impact of the economic crisis to find expression, a look at Iceland offers salutary lessons.

Speaking at a seminar at the University of Iceland last week on the Irish and Icelandic crises allowed me to learn about the similarities in the depth of the economic recession in both countries. Iceland has a budget deficit of about 14% of GDP, a little greater than that of Ireland, GDP is expected to fall by 10% this year and bottom out next year, its unemployment rate is around 9% and though its inflation rate is falling fast it is still around 12%.

The big difference, of course, is that Iceland now has a currency which economists expect can never be traded feely again. To gain foreign exchange, Icelanders have to present an airline ticket out of the country, and Icelandic companies are suspected of keeping as much of their capital as possible abroad in order not to have to exchange it for krona. Discussion therefore centres on what currency to adopt with the Norwegian and Swedish krona being mentioned and the Canadian dollar. Most informed observers see no option other than adopting the euro, and for this membership of the EU is necessary. However, suspicions remain widespread that the EU is after Iceland’s natural resources, particularly its fish, and it is by no means certain that the government would win a referendum on EU membership, which is likely to take place in 2011 or 2012.

It is, though, the politics of the present moment that are most interesting to observe and may be an indication of what is likely to happen here. Icelandic politics had been dominated since independence by the Independence Party, a conservative nationalist party which had always been the largest party in the Althingi (the 63-seat parliament). Unlike its Scandinavian neighbours, Iceland had never had a left-wing government. All this has now changed. A general election was forced by sustained popular protest, with angry protesters camped outside the parliament building and effectively forcing the government to resign in February. The general election in April saw the Social Democrats emerging as the largest party for the first time and they have now formed a coalition with the Left-Green party; together these have 36 seats giving them a comfortable majority. Even the new Citizens’ Movement formed by the protesters, won four seats.

The new Althingi met for the first time last week and is showing a determination not only to resolve the economic crisis but to implement fundamental political and economic reforms. While the decision to apply for EU membership has got most attention, equally momentous is the decision to re-write the country’s constitution and a constituent assembly is to be put in place to undertake this task. Negotiations have taken place with employers to raise the wages of the lowest paid so as to ensure they carry less of the burden of the crisis. Industrial development policy is being fundamentally redrawn as the government has decided to move away from dependence on foreign-owned aluminium plants, attracted to Iceland by its low energy costs, and instead to strengthen the indigenous small and medium-sized sector as well as some large Icelandic companies that continue to be very successful abroad. While the country faces some very painful years of increased taxes and budget cutbacks, there is a sense that the general election has taken control from those who were responsible for the crisis and brought a new political direction to the country. It has created the necessary political conditions to move forward and renew a sense of hope and self-confidence.

Neo-liberalism and the EU: A German perspective

The ZAUBER group in the University of Goettingen in Germany has been examining the future of labour relations and employment in Europe. One of the papers presented at a recent ZAUBER conference, by Klaus Busch, Professor of European Studies at the University of Osnabrueck, offers an interesting perspective on how neo-liberalism came to dominate EU thinking. The paper can be downloaded here. Any comments?

Stiglitz Commission

Earlier this year, a Commission of Experts, chaired by Nobel Laureate Joseph Stiglitz, on reforms of the international monetary and financial system was established by the President of the UN General Assembly. According to its terms of reference, "the Commission will seek to identify the broad principles underlying needed institutional reforms required to ensure sustained global economic progress and stability which will be of benefit to all countries, developed and less developed. The Commission will suggest a range of credible and feasible proposals for reforming the international monetary and financial system in the best interest of the international community, identify the merits and limitations of alternatives, and will evaluate in particular those that are at the center of current global discussions."

Among a number of interesting recommendations, No. 37 proposes that:

"A major reform of credit rating agencies and their role in the financial system will have to be undertaken. When financial regulations make use of credit ratings, regulators must have a mechanism to evaluate the quality of ratings provided. They must also consider mechanisms for avoiding conflict of interest in the provision of ratings by the agencies, and may consider the scope for encouraging new actors so as to encourage competition in the business of credit rating. The reforms needed in this field and in the systems of information provision will be addressed in the final report of the Commission"

The Commission's recommendations can downloaded here.

Any comments?

'There was no supervision, no regulation and wild excess'

Slí Eile: “There was no supervision, no regulation and wild excess. Ireland saw the biggest building boom since the pyramids and this is going to be a painful adjustment,” said Prof Buiter, a former member of the Bank of England monetary policy committee and professor of European political economy at the London School of Economics while addressing the sixth Mercer European Investment Forum.

'It is only because of the implicit guarantee of euro zone partners, particularly Germany, that Irish banks and the State itself were likely to emerge from the present crisis.' he is also reported by the Irish Times as saying 'Recovery, in part through recapitalisation and new lending, would only be possible when banks disclosed fully the scale of their bad debts. He was hopeful that, “by the end of the year, we will truly know who has been swimming without trunks”.'

Guest post: Towards a Green New Deal

John Barry: Last summer the influential think and do tank, the new economics foundation, published what turned out to be a prescient report. Called A Green New Deal: Joined-up policies to solve the triple crunch of the credit crisis, climate change and high oil prices, it analysed the interlocking crises of climate change, peak oil and the credit crisis. This report demonstrated that the urgency of making the transition towards a post-carbon economy, i.e. an energy economy not based on declining and volatile fossil fuels, could also promote secure jobs and investment, jobs that cannot be off-shored, but that managing our planned retreat from fossil fuels not only demands clear government leadership but also requires re-regulating and re-structuring the financial sector to ensure it does not undermine the ‘real’ economy. Its predictions have proved not only prescient but prophetic, in that it predicted the current credit and banking crisis and pointed out the reasons in the de-regulated, complex and high-risk strategies that the majority of banking and financial institutions were engaged with.

Then, in October, the United Nations Environment Program, together with the International Labor Organisation and the International Organisation of Employers, launched a major report: Green Jobs: Towards decent work in a sustainable, low-carbon world.

This report pointed out the millions of secure, well-paid jobs available across the world – but especially in the developing world – in the sustainable, green economy, especially renewable energy production and installation, waste management, water management, building construction, food, agriculture, forestry, transport and and other sectors. As the report states, “It now appears that a green economy can generate more and better jobs everywhere and that these can be decent jobs”.

The election of Barack Obama was based, in part, on his promise of a Roosevelt-style ‘new deal’ for America to help its ailing economy and prevent the haemorrhaging of jobs. The stimulus package just agreed by Congress is a ‘Green New Deal’ in that the infrastructural investment focus is on energy conservation, renewable energy projects, jobs and training. Across the media, economic commentators and political parties, there is a growing acceptance that a Green New Deal is what major economies in the world need: forms of Green Keynesianism and greater public investment and management of the economy. A Green New Deal tackles the issues that global and national economies face in relation to rising unemployment, reducing our addiction to and dependence upon fossil fuels, and also dealing with the threat of climate change. However, there are differences within this emerging agreement around a ‘Green New Deal’.

Those, like most governments including the UK, who see this as part of a temporary ‘blip’ in the global economy and believe that ‘normal service will be resumed’ in a couple of years; and those like the European Green Parties who are campaigning on a common platform in the upcoming European Parliamentary elections, based on viewing the current ‘triple crisis’ as an opportunity which should not be wated to re-design global and national economies in the transition to sustainable, green and less inequitable economies focused on quality of life and economic security – rather than orthodox economic growth.

Across the UK there have been meetings and conferences, as well as media and other commentary, on the outlines of a Green New Deal. In Wales, for example, there was a conference on the Green New Deal entitled ‘A Prosperous Way Down?: Exploring Green Economic Futures for Wales’, while in Northern Ireland, Friends of the Earth held a workshop on the Green Economy in late January, followed up with another in March with contributions from the Northern Ireland trades union movement and Northern Ireland employer representatives. An initial meeting around a Green New Deal for the Republic was held at the end of April.

The Green New Deal is, I strongly believe, one that the unions should get fully behind. I also believe that universities, in particular, should explore the possibilities of providing the space, time and support for workshops and think-ins etc about how to design policies and programmes for the inevitable greening of the economy. At the same time, universities have a unique role and opportunity in this time of crisis to provide expert knowledge and advice on a whole range of issues confronting politicians, policy-makers, businesses and communities. Academics (unionised or not) should be urging their universities to ‘do their bit’ in this time of crisis, and to offer their knowledge, expertise, space and support for genuine dialogue and innovative problem-solving to help our societies get out of this current economic and environmental mess.

Dr. John Barry is Policy Advisor to the Northern Ireland Region of the Green Party. He lectures in the School of Politics, International Studies and Philosophy at Queen’s University, Belfast, and is Assistant Director of the Institute for a Sustainable World, QUB

Corporate governance: We cannot afford business as usual

Paul Sweeney: Listening to the anger, frustration and loss of the shareholders of AIB and Irish Nationwide, can anyone believe any more in the bull about the centrality of shareholders in modern capitalism?

The exposure of the failure of the governance system where shareholders “elect” directors to represent them on the boards of the companies they own must lead to a total reform of that system. Yet we are not even having a debate about it. I wrote a previous post on this, as well as a piece in the Irish Times last week.

For a long while now, I have held the view that the supremacy of “shareholder value model” of governance and of the shareholder’s role is a joke. It is welcome, if too late for so many, to see it so exposed here and internationally. But it has happened before. Remember Enron and the other big corporate scandals? It will happen again, but maybe we can try to change the rules to a stakeholder model of governance. In Ireland, a small economy which is so open, I believe that we have to lead and not lag on this reform. Our reputation is already in tatters, thanks to a few enterprise leaders and government inaction on regulation.

In Germany, the stakeholder or Co-Determination model allows workers to elect half of the supervisory board’s members, and the shareholder “elects” the other half. It is the strategic board, which sits above the management board.

Of course, it is not just PLCs which need deep reform. Michael Fingleton’s Irish Nationwide is supposed to be owned by its members, as a “mutual” building society. There is something rotten there with the massive losses due to so much lending to the politically-connected property elite and its staggering pension plan for Fingleton. It was governed by a self-appointed and compliant board of directors, overseen by former chairman, Michael Walsh.

Where are the leading academics on this issue? Has nearly every business and economics academic in Ireland been tipped out of the same mould?

Again, I fear that after this crisis is over, we will revert to business as usual, to our cost.

Do it, Explain it, Avoid it

Sli Eile: “Do it, Explain it and Avoid it” is the advice of Jens Henriksson. He also says that ‘A few powerpoint slides, a report and a good one-liner can have an enormous impact.’ Ten Lessons about Budget Consolidation (which, interestingly, was free for download from the Breugel site in February, but is now offered for sale) became the received economic wisdom earlier this year. Even the Irish Congress of Trade Unions invited Jan Henriksson to speak. The ICTU ten-point plan There is a Better, Fairer Way argued that budgetary consolidation should be designed as a package with fairness its cornerstone. But be careful what you buy. As Jim O’Leary pointed out back in February, Henriksson’s recipe lessons contain some very nasty medicine such as pay and social welfare cuts. In fact, the Henriksson recipe tastes like a very orthodox slice of ‘balance the books’ before you move on to anything else.

A previous post by Peter Connell (The Swedish experience: lessons to be learned) has drawn attention to the 'political’ and not just ‘economic’ nature of the ‘lessons’ contained therein. It also reminded readers that both the international context of the early 1990s, as well as the legacy of the Swedish social model and partnership, made adjustment possible and sustainable.

To what extent is public policy drawing from the Henriksson ‘Ten Lessons’ (they were originally construed as ‘commandments’ but Henriksson wisely toned it down to ‘lessons’ for international consumption)? And is it the only effective medicine available? Lets run through, briefly, the medicine in 10 steps:

Lesson One: Sound public finances are a prerequisite for growth

Henriksson even goes so far as to suggest that ‘risk aversion is king in economic policy’. It certainly was in the first wave of responses to the Great Crash in 1929 with the disastrous consequences that followed. Getting the public finances right is certainly one element of the recipe. The main contention here, is how the burden is shared and adjustments made. A cartoon from the 1930s depicted various members of society on a ladder descending into the sea with those higher up the ladder saying ‘we should all take a cut and move a step down’.

Certainly, the Government, here, has shared the cost by imposing proportionately similar cuts to those on about the average industrial wage as to those much higher up the income ladder. With so many tax reliefs in place it is hard to know the real effect for those outside the PAYEE tax net.

So, it is the way you do it that matters and not just the fact of balancing the books.

2 If you are in debt, you are not free

Mortgage holders would agree. Again, the issue here is not the level of debt at any point in time as much as the relationship of debt to long-term capacity to generate new income to repay debt. Clearly, some level of risk is involved as it is for individuals. Being a member of a currency union is help in this context as is the relatively low level of debt to GDP ratio for Ireland, currently. The lack of freedom arises from the way in which finance markets interfere with the political process by compromising other issues that fall outside narrow measures of credit-worthiness. If the global markets are king along with its weapons of mass destruction = financial derivatives then the way to address this is not for individual nation states to slaughter the weak and the poor but to work together to regulate markets and financiers that ushered in this crisis in the first place.

The way to relative freedom is through investment in Ireland’s ‘smart economy’ supported by a ‘smart society’ founded on protection of the weak and provision of social services through a balance of taxation at local and national level.

3 The one responsible must put her or his job on the line

Point well made. But, there is little culture of responsibility here whether in State, Corporate or Church worlds except when someone is forced out whether by media, backbenchers or other trend-setters. One of the issues that needs to be brought center stage to any analysis of the current economic malaise is the essentially undemocratic nature of markets as they currently operate as well as processes in our national polity. People need clear yardsticks by which to measure Governments and leaders. Governments should contract with the people not just at each General Election (essentially people don’t vote on which Government to have but on a menu of parties which put together Governments depending all sorts of considerations that may not be foreseen in the run up to an election). The Oireachtas needs radical reforming to make Governments more accountable.

4 Set goals and stick to them

Setting goals is not easy especially if there is more than one. The Swedes had to choose between fiscal stability and unemployment. They gave priority to fiscal priority (just as the Irish Government is doing now) and, implicitly, let unemployment float downwards as conditions improved – eventually. It was painful (as was the case in Finland) but, according to Henriksson, it worked. However, the Swedes (and Finns) had the advantage of at least (i) relatively strong levels of internal social cooperation and solidarity and (ii) favourable external circumstances and international trade. Add to this a strong native base of outward indigenous industry and services and the Nordic countries were able to survive and overcome their severe economic problems of the 1990s

5 Consolidation should be designed as a package

Here the advice turns particularly political – even Machiavellian. Henricksson writes (p19):

...there is also empirical work showing that a right-wing government that raises taxes is more likely to succeed in budget consolidation than a rightwing government that only adheres to expenditure cuts. The opposite goes for left-wing governments…..

The problem, in an Irish context, is that up to now we have had a choice of two kinds of political arrangements – both right of centre and both committed in practice to low taxes and by direct implication low spending too. The options for any incoming administration over the next 3-4 gloomy years are stark – unless they really want to break new ground and depart from the Henricksson scipt.

The key point under lesson 5, according to Henricksson, is that Government need to inflict pain as uniformly as possible on the grounds that (p19):

When one strong interest group complains, you are in trouble. But if everybody complains, you are not.

6 Act structurally but be consistent

Only an economist could talk like this! The advice here is that it is better to go for a flat, across-the-board cut of say 10% (or 11% as was actually cut from all items of Government consumption in the Swedish case) rather than target this area or that budget line. The blunt approach sends an extremely strong signal to everyone. The problem with this is immediately obvious though – it is one thing for someone on €500,000 a year to take a cut of 10%; it is another for someone on €200 a week to take a cut of €20 (even if average prices are falling). It is quite unfair, regressive and deflationary to cut spending especially where people are already on the bread line. But, consistency was never part of the vocabulary here and not even during the current economic impasse. You know this when people in the corporate and public sectors walk away with pensions in the high six digits.

7 Do not leave the problems to the Local Authorities

Given Sweden’s history of strong local government with responsibility (and funding from local taxes) to provide education, healthcare and childcare as well as other services, Central Government did shift much of the adjustment to local authorities and this was not a good thing according to Henricksson. But, Ireland is not Sweden when it comes to local taxation or delegation of powers and revenue-collecting.

8 Be honest to citizens and financial markets

Here the advice is to keep to a conservative set of fiscal assumptions and make it clear from the outset how painful things will be. The aim is to get the ‘markets’ (everything comes back to this) to buy-into what Government is saying and to enable the national authorities – eventually – to get into a ‘virtuous circle’. A series of botched budgets and serious macro-economic under-shoots in the Irish case does not help. And Government has a credibility problem where citizens, investors and international capital markets are concerned.

9 Stick to one message

Here Government has been more successful. The ‘One’ message coming through has been to CUT:

Cut (real and nominal) wages and welfare rates;

Cut public expenditure and spread taxes increases to bring in more of the lower paid; and

Thereby inch back into export markets, foreign direct investment and the ‘smart’ economy which, by now, everyone is paying lipservice to.

10 Stick to it

Once a country emerges from the painful adjustment, it must avoid going back to ‘the old system’ and ways.

Summing up

Lets be clear, the Henricksson medicine, if applied comprehensively here, would be brutal medicine politically, economically and socially. Even if it attracted widespread political buy-in (through for example a national Government of all the main political parties) or revamped social partnership, it would involve a winding down of public spending and household consumption at a rate not seen in recent decades. It would imply escalating levels of unemployment, poverty and in all likelihood would set back levels of public health. It may be countered that this will happen anyway and that the Henricksson medicine would enable us to get over it more quickly than muddling through.

It is necessary to question the moral basis on which any society or elected Government can sacrifice the health and well-being of its citizens on the altar of market clearance and fiscal rectitude. There has to be a better way – a fairer way. What would it look like? Moving beyond the immediate crisis and response, what major actions can be taken by Government, here, to help rebuild the economy? Over on www.irishleftreview.org , Michael Taft has provided some interesting ideas under ‘What a Progressive Government Would Do in the First 100 Days (or Start to Do)’

One final point – notwithstanding the rigidity and apocalyptic tone of the Henricksson medicine (which, if progressives actually read it, one would not advocate here as part of some new social solidarity pact…) – Henricksson clearly counsels against cutting too much in the areas of education and research. One wonders why.

Current policies set to exacerbate economic crisis

Jim Stewart: The Government's main stated current economic policies (Budget April, 2009) are (1) to stabilise the public finances and (2) provide finance to banks in order that they will resume lending. Both policies will exacerbate the economic crisis rather than solve it. This is because raising taxes and cutting government expenditure will result in further reductions in demand and incomes, increase unemployment and reduce taxes. The private sector has experienced an enormous fall in wealth (€150 billion according to National Irish Bank, 2009). This fall in wealth has been accompanied by an increase in private sector saving. What is needed is a fiscal stimulus to increase demand. Fiscal stabilisation policies are not enough. Some possible measures to stimulate spending could be vouchers which must be spent within a limited time period, or vouchers which can only be spent in hotels/guesthouses (accredited by Bord Failte). This latter policy has the advantage of minimising leakage, and most likely stimulating spending of a multiple of the value of the voucher.

The second main policy objective is also unlikely to succeed in ensuring “credit flows to businesses and consumers”. Policy should focus on the real economy, not the banking sector. The overall policy emphasis on ensuring the banking sector is commercially viable will not result in credit flows to the real economy. Rather, it damages the real economy because so much of Government borrowing and future tax revenues is used in support of the banking sector. There is a danger that the banking sector will survive but many firms in the real economy will fail. In my next post I will describe what banks should do, why current policy will fail, and what can be done to correct the situation.

Charting progressive routes to recovery

TASC hosted a seminar today at which Maria Rodrigues, special advisor to the Federation for European Progressive Studies (FEPS), made a presentation based on the discussion paper she drafted earlier this year for the PES, entitled A Matter of Urgency: A New Progressive Recovery Plan for the European Union. The paper can be downloaded here.

The Banking Crisis and the Real Economy

Jim Stewart: Recent reported commentary in the media from the ESRI, drawing an analogy between Zimbabwe and Ireland is unhelpful in terms of analysing the current crisis in Ireland and developing solutions. The recent ESRI report (Spring 2009) in describing the impact of current policies in terms of rising unemployment, falling tax revenues, etc. is very valuable However, forecasting growth rates is in general a very inexact science. Even estimating past growth rates in the case of Ireland is problematic given the large impact of transfer pricing, and profit outflows from, multinational companies can have on measured GNP.

Other commentary within Ireland on the financial and economic crisis has also been exaggerated. Some examples:

1) Nationalising Anglo-Irish Bank would double the national debt. Wrong, because Anglo-Irish bank will be treated as a semi-state company whose debt is excluded in measuring Government debt for EU and other purposes;

2) The ratio of bank liabilities to GNP is 900%. Wrong, because bank liabilities of IFSC companies should be excluded. If excluded one estimate for this ratio is 309% of GDP (Davy Research Feb 17, 2009), but the total amount guaranteed by the State is 230% (€436 billion) of GDP (Annex I to supplementary Budget p. 17).

But more fundamentally some commentators are wrong in assuming certainty for what is uncertain. The overall impression is one of dogma rather than analysis.

The '07 Smell Test?

Slí Eile: Over on Irisheconomy.ie Colm McCarthy is warning against nostalgia about going back to 2007. We must agree. But that is about the extent of it. The orthodoxy is, to quote McCarthy's own words:
"(i) Government debt ratios stabilised and sovereign credit spreads back to low levels;
(ii) competing banks strong enough to lend (a little);
(iii) a competitive economy producing more exports, less houses, and
(iv) a smaller and less leveraged balance sheet."
The problem with these four is that they leave out another four points without which a recovery is neither feasible or just:
(v) direct measures to arrest job losses through activation, training, re-skilling and emergency credit;
(vi) measures to shift de-leveraging away from welfare recipients and low to middle-income earners to those in high-income and high-wealth owning groups;
(vii) begin the slow and painful process of reforming political, public service, corporate and social institutions (including what remains of social partnership); and
(viii) nationalise banking once and for all and retain at least one State Retail Bank and one State Industrial Bank to compete on financial markets for deposits and lending.
Says Colm McCarthy:
'All policy wheezes emanating from the commentariat over the next few months should be smell-tested for 07 Nostalgia, and rejected at the merest whiff. We have been there and it did’nt work.'
Can we suggest, rather:
All policy wheezes emanating from the commentariat over the next few months should be smell-tested for 1987 Nostalgia, and rejected at the merest whiff. We have been there and it did’nt work. First we had growth without jobs, then we had growth with jobs but light-touch regulation and primitive public services and rising inequality and missed opportunities, then we have revelations of corruptions, bribery, incompetence and recklessness, then we had a credit boom. Finally we had bust. Would you not agree Colm?