Investment arguments gaining ground

The imperative to increase investment as the mechanism for an economic recovey - and to close the public deficit - is begining to gain ground among influential mainstream economists. A recent article in the Financial Times on that theme by its chief economics commentator Martin Wolf was highlighted here.

A follow-up article has elaborated that argument and suggests that incentives to private sector investment are the key to economic revival currently. PE's Michael Burke says that the FT's influential voice on the side of boosting investment is a welcome one, and Burke goes on to argue that hopes of a private sector-led investment recovery seem misplaced, and that arguments to cut the public deficit to achieve that are reckless, and could lead to disaster.

You can read the full post here.

OECD on Ireland's economic outlook

Paul Sweeney: The OECD is the conservative think tank of the world’s 31 richest states. The latest state to join is Chile, and Ireland has been a member for many years.

This article covers Ireland’s rapid economic success as a poster child held up for developing and Central European countries to emulate. Now, however, we are on our uppers.The article discusses how Ireland declined. It is interesting that it put an big emphasis on the loss of competitiveness (which OECD economists, like their mainstream colleagues here, see largely in terms of short term movements in wages) and much less on the mad tax-cutting policies of Mr McCreevy and Mr Cowan during a raging boom. That view would have nothing to do with their economists’ low tax economic bias? They focus on wages cuts and, disappointingly for a research body, focus on anecdotal rumours of wage falls in the private sector, when the evidence is not there in the CSO data to date.

The article does admit that “there are risks associated with such deflation, particularly as falling incomes will make it harder to ease the burden of outstanding debts.” They are also correct when they conclude that “fostering a new period of strong and sustained growth the coming years will be a challenge.”

Ireland's private debt - is it time to default?

An Saoi: The Central Bank estimates that Irish private debt is €372,000M. The funding of this massive amount is rapidly going to become the key issue in the very near future. Irish resident deposits are just €64,489M from households and €31,024M from Irish business, a total of €95,513M. Even after NAMA, the banks will still be left with loans of more than €300,000M.

Where do they get the money from? Well, I came across the table below on the website of the German magazine Der Spiegel, which explains all. We are drowning in German money.

As can be seen from the graphic, the Germans have lent just over €3,000 per Greek and €2,000 per Italian, compared to about €42,000 for each resident of this State. Now, if I were German I would be dropping one of the “I” in PIIGS, because the Irish position is more akin to that of Iceland than Portugal, Italy Greece or Spain.

Effectively, all future activity in the Irish economy is completely dependent on the view taken by the Treasurers of a handful of German financial institutions. There are huge questions for the Central Bank and their German counterparts as to how these two countries became tied together in this embrace of debt/death.

To put the Irish position into perspective, each Icelander owes approx. €9,000 to the UK arising from the default of their banks, and a further €4,000 to the Netherlands arising out of their State guarantee. The Icelandic people are voting on whether to renege on that deal, and have won the vociferous support of John Kay in his Financial Times column this week to do so. Our debt to the Germans is more than three times greater than that of Iceland to the UK and the Netherlands.

I would suggest that it is time for us to take similar action. Forget about this referendum about children’s rights, we need a referendum to give our children a future. Let us renege on our German debts!

However, this will not happen. The ECB appears to have a friend in the top job in the Central Bank, and the initial investigation into what went wrong will of course be managed by Mr. Regling, who may be predisposed to protect the interests of Germany. You can read his CV here, or you can read a summary in the Oireachtas press release, which states that:

“Mr Regling is a member of the Issing Commission, appointed by Chancellor Merkel in 2008 to advise the German Government on the reform of financial regulation. The Committee completed its work in March 2009.

From 2001 to 2008 he was Director General for Economic and Financial Affairs of the European Commission. Before that, he was a Director General in the German Ministry of Finance where he worked for more than a decade on Economic and Monetary Union in Europe. He also worked in the International Monetary Fund for more than a decade.”

Retail workers - near the bottom of the HEAP

Last year, TASC and ICTU published the HEAP Report on income inequality in Ireland. Now, Mandate has published a report - Milking the Recession - showing just how little retail workers earn, and showing how some employers are 'milking the recession' to further depress retail workers' pay and conditions. Click here to read Eoin O'Broin's take on the report.

Triple Lock - a lifetime of debt

Slí Eile: Writing in today's Irish Independent, economist David McWilliams in his typically lucid way calls a spade a spade (It's time to shout stop - NAMA is grand larceny). First the bank guarantee, then NAMA and now forced nationalisation (on less favourable terms than if the issue was confronted earlier). He writes:

The triple lock would solder the people to the banking system in a suffocating embrace forcing us to borrow from tomorrow to pay for yesterday and, in the process, destroy the opportunities of today.

Alone of the parties in the Oireachtas, the Labour Party got it right in September 2008 on the guarantee. Labour got it right on nationalisation in March 2009. And they were right on NAMA.
Karl Whelan wrote early last year:
A crucial feature of the nationalisation approach is that it dramatically reduces the risk involved in having to value the bad loans.

Let us invest in the future

Michael Burke: In today's Financial Times, chief economics commentator Martin Wolf has an interesting piece on how we can get out of the crisis. He argues that conventional wisdom about the prospects for economic recovery, and the policy adjustents that will be necessary, is completely wrong.

"The conventional wisdom is that it will also be possible to manage a smooth exit. Nothing seems less likely."

The reason for his more sober assessment is the trend in private sector financial balances; that is, the growing surpluses of private sector incomes over private sector expenditures. For the OECD as a whole this surplus is projected to reach 7.4% of GDP this year. Six countries, Ireland is one of them, will run surpluses of more than 10% of GDP. In Ireland's case it is projected that the private sector will earn more than it spends to the equivalent of over 15% of GDP, the third highest of OECD economies behind only Spain and Iceland.

This has been dubbed 'the paradox of debt' by Paul Krugman, following the Keynesian notion of the 'paradox of thrift'. The argument is that, while for each highly-indebted company or individual it makes sense to save, or, in the current climate pay down debt, for the economy as a whole it is disastrous. The aggregate saving reduces final demand, both household spending and business investment and thereby deepens the recession. Incomes for individual and companies fall further, so they repsond by cutting expenditures further, and so on.

There are many criticisms of this notion from what has become orthodoxy over the past several years. The only serious one is that, if the private sector saves in this way but continues to consume and invest in the same proportions all that will then happen is that prices will fall, and goods and services will be cheaper at the new, lower level of spending. However, this ignores two trends that occur in crises and are happening currently, most especially in Ireland.

The first is that investment tends to fall much faster than consumption, for obvious reasons. Of a total decline in Ireland's GNP of €28.9bn, personal consumption has fallen by 15.1% (€14.7bn) and investment has fallen by 52.5% (€30bn). In fact, as the data shows, the fall in investment accounts for more than the entire decline in GNP, with the difference mainly accounted by foreign earnings. This pattern, where investment is the main driver of the recession, is replicated across the OECD although in some other countries it is net exports which have also plunged, not private consumption as in Ireland.

The second reason why this orthodox criticism is invalid is the level of debt. As prices fall, as they have in Ireland, the real level of the debt only increases. The many vociferous calls for 'competitive deflation' ignore this fundamental fact. Not only is (un)competitiveness a misdiagnosis of the current situation, but the 'cure', lower prices in Ireland than the rest of the EU would only increase the debt-servicing burden for all who earn their incomes in Ireland, individuals, companies and the government.

To return to the Martin Wolf article, he argues that, while extremely loose monetary policy has been necessary, by itself it stores up two alternative problems, both of which lead ultimately to disaster. One possibility is that cheap money reignites a boom in consumption, which itself just postpones an even bigger future financial crisis. The other possiility is that there is no recovery in consumption and the fiscal poston deteriorates further, to the point of widespread government defaults.

Happily, there is another option. Or actually two, according to Wolf, one of which is a surge in demand in 'emerging' economies. But for highly indebted countries like Ireland the policy option to avert disaster is clear: "a surge in private and public investment in the deficit countries ....[where] .....higher future income would make today’s borrowing sustainable."

He argues that the hope that the world will go back to as it was before the crisis is forlorn one. As we have already seen, it is the huge investment deficit which is driving the recesson, and only an enormous increase in invesment can restore both prior levels of activity and government finances.

"Let us not repeat past errors. Let us not hope that a credit-fuelled consumption binge will save us. Let us invest in the future, instead."

Deflation, the economy and growth

Michael Taft: Three Sunday articles with some thoughtful comments. First up, the Sunday Tribune and Eamon Quinn’s survey of six economists from across the political spectrum. Though they may differ as to why, none seem to believe the Government will bring the fiscal deficit under control (i.e. Maastricht compliance) by 2014. However, it is Professor Ray Kinsella’s comments that are the most damning:

‘You have to say to yourself, we have had four budgets now and each of those has been deflationary and unemployment will rise to 500,000. We simply can't afford to keep losing that sort of capacity. Firms are failing every day . . Potential is being lost – I can see it in the university students who are leaving the country. I am very clear that continuing the current fiscal policies will destroy the capacity of the Irish economy to recover.’


Second, is Brendan Keenan’s article which argues that leaving the Euro zone to achieve devaluation may not be such an attractive proposition. He concludes:

‘Those countries which think the balance of advantage for them lies with euro membership will have to tailor their policies to achieve growth within the single currency. Ireland has not yet done so. We should worry less about debt and defaults and more about enhancing the economy itself.’

The third observation is by Will Hutton in The Observer who contrasts the 20 economists writing to the Sunday Times, demanding the deficit be cut and be cut now; with the 60 economists writing to the Financial Times who argued for a fiscal policy that promotes growth and recovery. He helpfully links to an IMF paper which studied financial crises in 99 countries. What is the best response for an economy?

‘The best response is increasing capital spending; lift that by 1% of national output and not only are recessions shorter, but there is a permanent boost to economic growth of around a third of 1%.'

So let’s sum up:

• Current polices equals destruction of capacity
• New priority must be about enhancing the economy
• Capital investment has a positive and significant return

It may not be a syllogism in the technical sense. But it is logical.

No laughing matter

Michael Burke: The British Tory Party have expressed open admiration for the policies pursued in Ireland by the Fianna Fail government. While the entire G20 engaged in fiscal reflation in 2009, only Ireland adopted a contractionary fiscal policy.

Partly as a result, there is a growing interest in Britain in those policies. Meanwhile, letters have been exchanged in the leading newspapers by different groups of economists as to the merits of rapidly adopting contractionary policies which, so far, are unique to Ireland. There is therefore a growing interest in Britain in the nature and impact of recent Irish economic policy. This was the explicit reason for a BBC radio interview with Martin Mansergh which was aired on Sunday morning. The interview is here, almost exactly 15 minutes into the broadcast.

There is perhaps a less-than-commanding grasp of ther government's actual measures, and the degree of levity displayed may disappoint some. But perhaps the most interesting aspect of the interview was the claim that we were fortunate in the timing of the crisis, which gave us until 2012 to face the electorate. Fortune is clearly a relative term.

EU calls on Greek population to tighten belts to support wealthy Greek tax dodgers

Michael Burke: Tactical manoeuvring is continuing among European governments to decide exactly how much of the bill will be picked up by who for the financial debacle in Greece. The one thing they all agree is that Greek workers will not be enjoying a bailout of any kind.

Along with the lowest paid and those dependent on public services, Greek workers will bear the brunt of the 'adjustment process', through wage and welfare cuts, pension reductions, an increased retirement age and other austerity measures. The tactical squabbling is that Greece is being pressed by the European Central Bank and leading EU to go even further in the austerity measures it has already announced.At the same time the Greek PASOK government is facing mass demonstrations and strikes, which have encouraged resistance to further austerity measures.

It is noteworthy who will not be targeted. Greece has one of the lowest tax takes in the Euro Area. In the 15 years to 2006, Greek total general government revenues, as a percentage of GDP, were 37.9% compared to an average rate across the Euro Area of 45.3%.[1] This low level of taxation was, in the Greek case, the source of long-standing budget deficits which were hidden from a gullible or complicit EU (or Eurostat) inspectorate over a number of years.

Greek absence of taxation is also a long-standing burden borne by the poor in the country. The Financial Times reports that, according to the official tax returns, there are literally only a handful of Greek citizens who earn more than €1mn per annum registered for tax purposes, and that the Greek shipping magnates and the other rich are registered as 'non-domiciles' in Britain, and consequently pay tax nowhere.

Greece is not in the financial firing line because of a particularly severe recession or an especially blighted banking sector. The latest estimates from Eurostat show that Greece's GDP fell 2% in 2009, but this compares to -4% for the Euro Area and -4.1% for the EU as a whole. This is shown in Figure 1. At the same time, Greece has committed funds to its banking sector equivalent to 11.4% of GDP - far less than the 31.2% EU average (and 232% for Ireland).[2]

Figure 1

The cause of the turmoil in Greece is its high level of government debt, which existed long before the current crisis, combined with a sharply rising budget deficit. Greek government debt as a percentage of GDP has been hovering close to 100% of GDP in all years this century, and is forecast by the EU to rise to 125% of GDP. Greek bond yields were already rising, but were pushed sharply higher by the decision of the European Central Bank, in effect, to remove Greek government bonds from the list of assets it would hold at the end of this year. A reversal of that announcement alone would transform the attitude to Greek government debt, but has not been forthcoming. Likewise, a genuine transformation of the tax system in Greece, as well as rigorous clampdown on tax evasion by the wealthy, would have a dramatic impact on the deficit.

Instead, it seems as the European institutions are trying to get their act together to act as a quasi-IMF, with any support conditional on a deepening of current austerity measures. This is no more likely to be successful in Greece than it has been in Ireland’s case, where deficit projections continue to rise.

As in other countries the rise in the Greek deficit is caused by a slump in taxation receipts, which have fallen by 8.1% in 2009 and which are forecast to fall by over 10% in 2010 [3]. This hole in government finances is itself linked to plummeting levels of investment in the economy. The recession in investment began a year earlier, in 2008, and has already fallen in total by 22.5%, with further falls expected this year [4]. By contrast, the recession-related rise in government spending over the same two years has been just 3.5% [5]. This is shown in the Figure 2 below.

Figure 2

Greece has a narrow tax base, with an unusually wide range of tax-exempt activities. The tax exemptions are revealing as to whose interests are being protected. Among the tax exempt activities:

* Proceeds from the sale of shares that are traded on the Athens Stock Exchange.
* Income from ships and shipping.
* Any dividend received from a Greek company.
* Capital gain from sale of a business between family members.

As a result, any decline in taxable activity leads to a disproportionate decline in tax receipts. This appears to be the case in Greece, where the slump in investment, which is taxable through a variety of levies on goods and services, has led to the decline in aggregate tax receipts and rising public deficits.

Further, the concealment of the actual size of the public deficits appears to have gone unchecked by the EU Commission - as its own 2004 Report into false public accounting in Greece provided no more than a public admonishment, and no programme for change. The new EU investigation however shows that in the years 2000 to 2003, the public deficit was understated by 10.6% of GDP. And, in a tell-tale sign of the unreformed nature of Greek society since the 1970s, more than half of that, 5.5% of GDP, was on military spending.

There is no economic logic behind spending cuts to close the deficit. Higher spending was not the cause of the budget deficit, lower tax receipts are. Worse, since tax evasion is endemic among Greek businesses and the rich, cutting the income of the one section of society that does pay tax, the poor and salaried workers, will reduce taxation revenues further.

The austerity measures now foisted on Greece stand in sharp contrast to the reflationary measures adopted by the major countries across nearly the entire the Euro Area -a policy led by Germany. German has adopted a reflation/stimulus package amounting to 4% of GDP. Germany's measures could have been better targeted. But despite a stagnant 4th quarter of 2009, forecasts for Germany's growth and its deficit are both on an improving trend.

The question is therefore posed, why is a reflationary recipe that clearly works for 'core' Europe deemed unsuitable for Greece? Why can government investment work for Germany, France, Belgium, and so on, but is ruled out in the case of Greece?

The answer may lie elsewhere, in the countries of Eastern Europe. There a number of countries had been hoping to benefit from further EU enlargement, which now seems postponed. Prior to enlargement, the EU demanded continual reform of the Eastern European economies – including further privatisations, liberalisation of the labour markets and a reduction of social spending.

These privatisations facilitated the arrival of Western European and US telecomms, agribusiness and other firms, but above all banks and financial firms. The drive to lower wages and social spending allowed a cheapening of labour, which could be exploited by Western firms, and led to widespread emigration. The removal of local producers in turn expanded the market for Western goods.

This sounds like the package of 'reform measures' to be demanded of Greece in return for any loans. The Greek population is finding that, while all members of the EU are equal, some are more equal than others.



Sources

1.EU Commission, EcoFin, Europea Economic Forecast Autumn 2009, Statistical Annex, Table 36.

2. EU Commission, Euro Area Report, Winter 2009, Table 2.1.

3. Table 36

4. Table 9

5. Table 35

This post has been cross-posted from the Socialist Economic Bulletin.

We need to rethink macroeconomics

Slí Eile: In a paper by staff of the International Monetary Fund (Rethinking Macroeconomic Policy) authors Olivier Blanchard, Giovanni Dell’Ariccia, and Paolo Mauro make the case for smarter macro-economic policy. They openly acknowledge that the economics fraternity had got it wrong on some key issues. They write:

…we thought of monetary policy as having one target, inflation, and one instrument, the policy rate. So long as inflation was stable, the output gap was likely to be small and stable and monetary policy did its job. We thought of fiscal policy as playing a secondary role, with political constraints sharply limiting its de facto usefulness. And we thought of financial regulation as mostly outside the macroeconomic policy framework…

The single-minded focus on particular problems sounds very familiar, I think, to an Irish audience. Before the current crisis, the role of the Central Bank and the Financial Regulator was passive, facilitating, and entailed non-directive counselling to banks. The model worked, so it was thought, and any lancing of the property bubble would be by way of a soft landing. Essentially, the failure was to ‘join up the dots’. People saw different parallel realities and imagined that any one or two could go pear shape but not the whole lot at the same time and in a way that showed how interconnected everything was in a way not previously realised. People were still working out of the old textbooks from the 1970s and 1980s. A previous blog has discussed this.

Now that the world economic system came crashing down in a matter of months in 2008 economists in general, and macro-economists in particular, have been in a state of shock. The Great Moderation from the mid-1970s gave way to the Great Recession. A partial counter-cyclical response on the part of some big players including USA, UK and Germany (and aided by the boom in demand in China) prevented the world from slipping into a major crash à la 1929.

Now, there are rumblings of the need to cut off the initial fiscal stimulus and to prioritise fiscal balance especially in those jurisdictions where the public sector debt to GDP ratio has risen sharply (notably the UK and the US). Inspiration has been provided, let it be said, by the ‘brave Irish’ who lead the way in fiscal contraction (not having done a stimulus in the first place). However, as in boom times so also in crisis times we should be wary of the advice coming from macro-economy. Blanchard et al. observe that:

….The rejection of discretionary fiscal policy as a countercyclical tool was particularly strong in academia. In practice, as for monetary policy, the rhetoric was stronger than the reality. Discretionary fiscal stimulus measures were generally accepted in the face of severe shocks (such as, for example, during the Japanese crisis of the early 1990s)….

They go on to say that:

…As a result, the focus was primarily on debt sustainability and on fiscal rules designed to achieve such sustainability. To the extent that policymakers took a long-term view, the focus in advanced economies was on prepositioning the fiscal accounts for the looming consequences of aging…

In summary, many economists and some policy-makers forgot about discretionary fiscal policy instruments along with all the other tools available (exchange rate, interest rates, regulation etc). The point is all the more relevant in a small open economy within the European Monetary Union such as Ireland.

The impact of fiscal contraction since October 2008, in the case of Ireland, opens up an interesting case study. Whatever the future holds, levels of debt – personal, corporate and governmental – will remain very high. It is difficult to see any large reduction in these levels any time soon. The second fact is that unemployment will remain very high and may go higher. Should there be a quick recovery in labour markets (especially in English speaking countries) it is possible that outward migration could assume very large numbers here even as the economy here is technically ‘out of recession’ from later on this year.

The multiplier impacts of fiscal contraction are worrying. All the more worrying is the lack of firm empirical work in this domain beyond what can be gleaned from ESRI working papers (documents emanating from the Department of Finance do not provide the technical detail or modelling to show that the full effect over time of recent spending cuts and tax increases have been taken into account)

Blanchard et al. put in succinctly as follows:

Furthermore, the wide variety of approaches in terms of the measures undertaken has made it clear that there is a lot we do not know about the effects of fiscal policy, about the optimal composition of fiscal packages, about the use of spending increases versus tax decreases, and the factors that underlie the sustainability of public debts, topics that had been less active areas of research before the crisis.

However, for the sake of balance it should be pointed out that Blanchard et al. are not calling for the baby to be thrown out with the bathwater (to use their words).

..It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater. Most of the elements of the precrisis consensus, including the major conclusions from macroeconomic theory, still hold...Fiscal sustainability is of the essence, not only for the long term, but also in affecting expectations in the short term’ (P10).

Their paper is highly nuanced and should not be cited as fundamentally at odds with orthodoxy. There is nothing in their line of argument to suggest that the Irish Government is being anything but ‘fiscally responsible’. The details of how they are going about it may be questioned from within and outside the country. But, as Enda Kenny recently said ‘we have no problems with an adjustment of €4bn.

Finally, Blanchard et al write: ‘Identifying the flaws of existing policy is (relatively) easy. Defining a new macroeconomic policy framework is much harder.’ I could not agree more especially in regard to those working in the field of economics and related other disciplines who seek a new baby and not just the old minus the bathwater.

The inequality cascade

Over on Irish Economy, Philip Lane links to this graph from the Economist website, showing the likelihood of a son with a university-educated father going on to get a degree; the graph also correlates earnings with paternal education. Click here to see how Ireland shapes up.

Your Country Your Call

Nat O'Connor: In the spirit of Kennedy, asking us to think of what we can do for our country, President McAleese has launched a national competition: Your Country Your Call.

"Your Country, Your Call gives you the chance to share your creativity to give life to new industry, revitalise or revolutionise an existing market, or even change the way we do business entirely. It's not about creating new products. It's about creating something that will make a long term positive impact on the future of Ireland, its people, and its economy"

Rather aptly, the competition website has a 'ticking clock' with 72 days allowed for entries. The top 20 ideas will be listed and two final winners will receive €500,000 and other support to implement their ideas.

You can read more about it in the Examiner or Irish Times (which also summarised the competition rules).

This competition is an open door to give some progressive ideas a wider hearing...

Latest rental figures

The latest DAFT report is out covering rents, and PE's Michael Taft has written the quarterly commentary. The headline news is that rents have 'stabilised' and have started to rise - though whether this presages a long-term upward trend remains to be seen. However, the commentary goes behind the numbers to examine a

' . . . fragmented, under-capitalised 'cottage' industry lacking the professionalism and modern synergy with a strong regulatory culture that prevails in other EU countries.'

The full report and commentary can be downloaded here.

“…all of the adjustments are being done to impress the rating agencies and international capital markets….”

Slí Eile: So writes Michael Casey, former chief economist with the Central Bank and currently board member of the International Monetary Fund. He then makes the extraordinary claim that (‘The reputations sent up in smoke’)

“..Our Government and the EU Commission have sold out to the rating agencies, none of whom cares about unemployment or emigration.”

Whatever one may think of our Government or parts of the current EU Commission it has to be pointed out that we owe much to the European Union not least because of the excesses and poverty of ambition of our native gombeen classes. (Where would gender equality be, today, were it not for the EU)
Take these statements in conjunction with what another economist, Pat McArdle, wrote recently Irish Times (‘Effective measures are needed to stop the rot from spreading’)

‘With hindsight, we were fortunate to have gone down the road we did. The alternative of job creation schemes or expansionary measures would have been disastrous.’

‘Job creation schemes’ and ‘expansionary measures’. What a terrible vista.
The single-minded focus on correcting Ireland’s fiscal stance, reducing the public sector deficit and competitive devaluation (i.e. cutting wages) is now the only moral narrative in town. Jobs, migration, living standards of the poor – are secondary to the One Policy Target = reduce the fiscal deficit to a much lower level. But, how much lower? At least two interesting facts seem to be emerging in the current debate and debacle over Greece and associated ‘high debt’ countries:

1. The Stability and Growth Pact targets are dead, long live the SGP
2. There is a very widely shared consensus that all roads must lead to fiscal rectitude and all roads to poverty reduction, sustainable growth and full employment (if people care about these things) lead from a balanced or near balanced budget – in the long-run.

But, will this single-minded focus on correcting the fiscal deficit work? I think not. If continuing deflation and wage and price devaluation is the only way then we run into at least two constraints:

• The degree of unemployment and wage reductions needed to ‘clear markets’ and balance the public sector books may be too much for people to take. We still live in a democracy.
• The world recovery may be a lot slower and lot more jobless in a way that offer little solace to a small open economy stuck with a dysfunctional banking system and a low-tax regime.

In other words, cutting wages and cutting public spending may compound the problem not only through reducing domestic consumer demand and investment but also in undermining social cohesion itself – a necessary ingredient to sustainable social and economic progress in the long-run.

But, suddenly, the spin is turning to the following type of meta-narrative:

“…in the year of 2008 the world economy collapsed and plucky Ireland went down fast as output and tax receipts went into free fall…but while other countries in a similar situation dithered the brace Irish and their unpopular Government took brave (and painful – everything must be painful) decisions ….and hey presto from 2011 onwards Ireland was rewarded with a reducing deficit, increased exports and stabilisation in unemployment…too bad many had to emigrate and other indices of social strife, poverty and ill-health went up for a while…that’s life”

Time will tell. However, missing from the debate up to now:

• A comprehensive, progressive, convincing, numbers-backed Alternative Economic Strategy
• A political movement with the backing of more than 40% of the population and with enough electoral backing positioned to implement such a Strategy not in some distant future election but at the next one which has to be within the next 27 months.

Some argue that in the course of the last half-century the left have won many of the cultural wars in Europe but have lost, decisively, the political struggle. However, the time has presented itself for a fundamental re-evaluation of policy because too much is at stake from the very real possibility that unregulated capitalism has wrecked the global eco-system to the unacceptable pain inflicted on the working poor and the unemployed in order to bail out capitalism against itself. If every fiscally troubled country plays competitive devaluation then we are looking at beggar-thy-neighbour.

What can be learned from the fiscal debacle of the noughties?
In a paper presented by Philip Lane at the Statistical and Social Inquiry Society of Ireland, recently (A New Fiscal Framework for Ireland) a case is made for

1. New Fiscal rules
2. A Fiscal Policy Council to monitor and manage fiscal adjustments (the never-again agenda)

There is some merit in these suggestions. However, what rules or what monitoring are needed here to rescue an economy and society from itself? Is our political system so decrepit that existing parliamentary and governmental institutions are not up to the task? Moreover, if such machinery were to be put in place (supported by a research department of economists of course!) who would select the membership and what types of conflicting interests would be brought on the board? Would it resemble Bord Snip Nua or the Commission on Taxation in terms of membership and ideological composition? Lane argues that such a Council or set of rules would be political neutral (it would judge on how much of a deficit or surplus is warranted rather than prescribing a level of taxes or spending). However, this is hardly convincing given the unavoidable interaction between the size of the deficit/surplus on the one hand, and the level of spending and taxes on the other (e.g. a popular claim is that cutting spending is a more effective way to cut deficits than raising taxes – a dubious claim not backed by enough case studies I suggest).

Would such a mechanism assess the wider social and economic benefits and costs of spending and taxes as a necessary corollary to judging the appropriate level of borrowing, spending and taxes taking into account, in so far as data permit, the likely monetary and non-monetary value of adjustments to societal assets and liabilities. Reducing current state liabilities through public sector downsizing as advocated by most mainstream economists may very well corrode valuable public assets not to mention social solidarity and cooperation – which are assets in themselves.

Competitiveness myths ...

"There is a real danger that, encouraged by the economists’ chorus on the need to cut costs as the way to get us out of our current economic troubles, the government will actually undermine Ireland’s long-term competitive position through cutbacks in research and education (in fact, such cutbacks are already being imposed). We desperately need to substitute serious evidence-based analysis for the rote incantation of inherited mantras which currently passes for expert economic advice in the realm of competitiveness policy in this country".

That is the conclusion reached by Proinnsias Breathnach; you can read his full post on Ireland after NAMA here.

George Lee

Slí Eile: In the spirit of playing the ball and not the man...there may be more to George Lee than George Lee. Recent media reports suggest...well...a possibly different approach or emphasis on economic policy and that may explain in part his sudden departure from Fine Gael and political life. If we are to believe the newspapers George was, compared to FG colleagues, less enthusiastic about deflation and more supportive of fiscal stimulus as well as measures to protect the unemployed as well as conserve universal child benefit (a forensic search on the Oireachtas website might be instructive in this regard). Or shall we say deflation with a human face. I wonder if George would have been more at home in mainstream European social democracy? Certainly not in mainstream current-day Irish political economy. I specifically recall him worrying about the scale of deflationary impact in last year's April budget (when he was still a journalist)

With friends like these (once more on Greece)

Michael Burke: There are widespread reports including here, that the meeting of European Finance Ministers will agree to a series of measures aimed at preventing a deepening of the financial crisis as it affects Greece, and threatens to engulf a number of EU countries.

The terms of the bailout and its extent are unclear. But what is clear is that Greek workers will not be enjoying a bailout of any kind. Along with the lowest paid and those dependent on public services, Greek workers will bear the brunt of the 'adjustment process', through wage and welfare cuts, pension reductions, an increased retirement age and other austerity measures.

It is noteworthy who will not be targeted. Greece has one of the lowest tax takes in the Euro Area. In the 15 years to 2006, Greek total general government revenues as a percentage of GDP were 37.9% compared to an average rate across the Euro Area of 45.3% (and 36.3% for Ireland)*. This low level of taxation was, in the Greek case, the source of long-standing deficits which were hidden from a gullible EU (or Eurostat) inspectorate over a number of years. Greece taxation is also a long-standing burden borne by the poor. The FT reports that, according to tax returns, there are only literally a handful of Greek citizens who earn more than €1mn per annum, and that the Greek shipping magnates and others are registered as 'non-domiciles' in Britain, and consequently pay tax nowhere.

Greece has been in the firing line because of its high level of government debt, which existed long before the current crisis. Greek government debt as a percentage of GDP has been hovering close to 100% of GDP in all the years of this century, and is forecast by the EU to rise to 125% of GDP. The bond market fear which has pushed Greek yields higher was exacerbated by the decision of the European Central Bank in effect to remove Greek government bonds from the list of assets it would hold at the end of this year. A reversal of that announcement alone would transform the attitude to Greek government debt, but has not been forthcoming. Likewise, a genuine transformation of the tax system in Greece, as well as rigorous clampdown on tax evasion by the wealthy, would have a dramatic impact on the deficit.

Instead, it seems as if the European institutions are intent on acting as a quasi-IMF, with any support conditional on a deepening of current austerity measures. This is no more likely to be successful in Greece than it has been in Ireland. Greece is actually experiencing a mild recession compared to most industrialised countries. GDP is expected to fall by just 1.4% over 2009/2010. Yet investment is expected to decline by 25.5%, having started to fall a year earlier. It is this investment slump which has caused tax revenue to decline by 8.8%, which in turn is the source of the rise in the deficit. By contrast, the recession-related rise in government spending over the same two years has been just 3.5%.

The austerity measures foisted on Greece stand in sharp contrast to the reflationary measures adopted all across the Euro Area, and led by Germany (with the stark exception of Ireland). German reflation has amounted to 4% of GDP. The measures could have been better-targeted. But despite a stagnant Q4, forecasts for Germany's growth and its deficit are both on an improving trend. The question is therefore posed, why is a reflationary recipe that clearly works for 'core' Europe deemed unsuitable for Greece? Why can government investment work for Germany, France, Belgium, and so on, but is ruled out in the case of Greece?

The answer may lie elsewhere, in the countries of Eastern Europe. There, a number of countries had been hoping to benefit from further EU enlargement, which now seems postponed. Prior to enlargement, the EU demanded continual reform of the Eastern European economies – including further privatisations, liberalisation of the labour markets and a reduction of social spending.

The privatisations facilitated the arrival of Western European and US telecoms, agribusiness and other firms, but above all banks and financial firms. The drive to lower wages and social spending allowed a cheapening of labour, to be exploited by Western firms, and led to widepsread emigration. The removal of local producers expanded the market for Western goods.

This sounds like the package of 'reform measures' to be demanded of Greece in return for any loans. Greece may soon find that, while all members of the EU are equal, some are more equal than others.

* All data from the EU Commission Area Report, Winter 2009, Statistical Anne, unless otherwise stated.

Greek strikes and protests

Michael Burke: The scale of the action by Greek unions is evident even from this short clip. ADEDY is the main public sector trade union which organised the strike. Its General Secrtary has announced that his organisation had decided to support the call of General Confederation of Labour GSEE’s (which operates in the private sector) for a second General Strike on February 24th.

How fortunate to have avoided such disaster

Michael Taft: Pat McArdle celebrates the fact that the Fianna Fail government has taken up the austerity cudgels:

‘With hindsight, we were fortunate to have gone down the road we did. The alternative of job creation schemes or expansionary measures would have been disastrous.’

Let’s run through some comparative data to see just how ‘fortunate’ we have been and how we avoided ‘disaster’. These cover the years 2007-2010 – three years of recession (for Ireland, anyway). The Euro zone data and estimates come from the EU Statistical Annex. Irish data and estimates come from the recent ESRI Quarterly Report (except for Irish domestic demand which comes from the EU estimates).

• Euro zone GDP is estimated to fall by -2.7 percent. Irish GNP is estimated to contract by -13.3 percent.

• Euro zone GDP per capita is estimated to fall by -4 percent. Irish GNP (for the domestic economy) per capita is estimated to fall by -16.1 percent.

• Euro zone domestic demand is expected to fall by -2.3 percent. In Ireland it is expected to fall by -19.3 percent

• Euro zone consumer spending will hardly fall at all: -0.4. In Ireland, consumer spending will fall by -8.8 percent.

• Total investment in the Euro zone is projected to fall by -12.8 percent. In Ireland, the fall is projected to by -51.7 percent.

• Non-property investment is estimated to all by -17.7 percent in the Euro zone. It is estimated to fall by -38.9 percent.

• In the Euro zone, employment is projected to fall by -3 percent. In Ireland it is projected to fall by -12.7 percent.

Pity those other Euro zone countries with their ‘job creation schemes and expansionary measures’. We’re just ‘fortunate’ that Fianna Fail is in power.

A pessimistic Stiglitz

Today's Guardian carries a deeply pessimistic interview with Joseph Stiglitz, who notes that "Plans to re-regulate the financial markets have run into a political quagmire and there has been a resurgence of deficit fetishism", and goes on to express surprise at at how fast the forces in favour of the pre-2007 status quo have re-grouped. "The optimist in me is hopeful we won't need another crisis to finally motivate the political process," he said. "The pessimist in me says it may need to happen."

You can read the full interview here.

Falling prices and low-income households

"Price deflation for low income families will be experienced at the lower rate of 2.2% and will do little to compensate for the real drop in incomes produced by Budget 2010. Indeed for many families household income will reduce further as a consequence of the increased costs of education, energy, health and transport.

In this context any change to either the Minimum Wage or pay rates agreed through Registered Employment Agreements will have the effect increasing hardship for those individuals and families currently living on or below the Governments income poverty line"

You can read the rest of Eoin O'Broin's post on Politico here.

Basel III, pensions and the recapitalisation of Irish banks

An Saoi: Wednesday’s Financial Times had a very interesting article on proposed changes in banking rules under Basel III. Sensibly, the Bank of International Settlements is proposing that pension deficits should be deducted when calculating net Tier One capital. The pension obligations are long-term liabilities and should of course be deducted from core assets, as they are a core liability.

British Banks are up in arms over the proposal as many have huge deficits. What is the position of the Irish banks?

Bank of Ireland had a deficit of €1,478M at 31st March 2009 and Allied Irish Banks admitted to a deficit €1,263M at 30th June 2009. It appears that these two banks will require perhaps a further €3,000M, on top of current estimates, which the Government and the Governor of the Central Bank has glossed over to date. Certainly the failure of Dr. Honohan to bring the BIS’s proposal to the attention of the Irish public in his utterances about recapitalisation raises many questions in relation to his impartiality.

This additional cost to ensure that the pensions of the fat cats who got us into this trouble are secured is surely one step too far?

Spring Alliance ...

Paul Sweeney: In 2009, the Spring Alliance was established with the four key civil society groups within the European Union: the European Environmental Bureau, the European Trade Union Confederation, the Social Platform and CONCORD, the body representing NGOs in Europe.

Spring Alliance has set out an agenda for the next decade, laid down in their Spring Alliance Manifesto. It has already had two debates with President Barroso on the results, and this manifesto formed the background for many contributions to the consultation on the EU-2020 Strategy being debated by the Commission.

The see five major challenges facing Europe:

The first challenge: climate change and loss of biodiversity and natural resources.

The second challenge: global inequalities between North and South are growing, and fundamental rights violations remain widespread.

The third challenge: the EU’s focus on competitiveness and deregulation has failed to serve the public good.

They argue that, since 2005, the EU has made a push to increase the deregulation of its markets, including its labour market, in accordance with its “Lisbon” growth and jobs strategy. This has had a detrimental effect on European society, causing a rise in low-quality work and failing to reduce poverty. The Lisbon strategy, with its strong emphasis on competitiveness, also had an adverse effect in the environmental domain, by halting or slowing down the adoption of legislation, including in the area of climate change.

In addition to these trends, today we’re facing a global economic crisis that has been triggered by the same philosophy of deregulation, which gave rise to irresponsible lending and negligence on the part of weak regulatory bodies. As a consequence, unemployment is now rising, and public debt is increasing.

The fourth challenge: inequalities in wealth distribution are increasing, putting the cohesion of our societies at risk.

The Spring Alliance notes that “79 million people in the EU are living in poverty, affecting one child out of five. Although many of these people have full-time jobs or receive pensions or benefits, their income is still too low to stop them from falling into poverty.”

Finally: the gap is widening between the EU and its citizens

It is stated by Spring Alliance that “The majority of the EU population feels disconnected from EU decision-making processes. National politicians often consider “Brussels” as an external power, and sometimes use it as scapegoat for unpopular decisions. This further undermines the EU’s credibility and its capacity to lead its citizens through difficult times.”

The Spring Alliance suggests ways in which these challenges can be addressed with the EU taking a lead. Further information is available on their website.

A disastrous approach to disaster capitalism

Colm O'Doherty: The captivation of our Fianna Fail-led government by the Milton Friedman /Chicago School policy trinity of privatization, government deregulation and reduced social spending is critically harming our well-being. Our economic crisis has allowed free marketeers to instigate orchestrated raids on the public sphere. The crisis opportunism of disaster capitalism is activated through networks of rule which underpin the governance strategies facilitating our so- called recovery. Economic ideology masquerading as technical and uncontentious adjustments has been engaged to finesse this asymmetrical relationship between power and rationality - power produces rationality and rationality produces power, but power has the upper hand in the dynamic and overlapping relationship between the two.

The hallmark of disaster capitalism - economic shock treatment - is manifested through coercive policies which decouple individual well-being from social well-being, and privilege private gain over common good. The atmosphere of crisis generated by the failed policies of successive Fianna Fail-led administrations has paved the way for an economic settlement which overrules the expressed wishes of citizens and has handed the country over to economic technocrats. As Naomi Klein puts it in the Shock Doctrine (2007,140,) “If an economic crisis hits and is severe enough – a currency meltdown , a market crash, a major recession –it blows everything else out of the water , and leaders are liberated to do whatever is necessary (or said to be necessary) in the name of responding to a national emergency”.

Thus, our recession has provided those economic zealots in thrall to the fundamentalist doctrine (Capitalism and Freedom ,1962) of Milton Friedman with an opportunity to reduce all regulatory obstacles to profitmaking , sell off all public assets , cut back funding of social programmes and keep taxes low. The dominance of this ideological vision is strongly reflected in the competiveness, securitisation and flexibility discourses filling the airwaves.

Fianna Fail and their coalition partners have articulated these political rationalities in a populist idiom - the idiom of frontier politics. Here, politics finds expression through economic sequestration of social citizenship. Abolition of social rights is viewed as a pragmatic “structural adjustment”, and the task of politicians is to follow the money from crisis to crisis. Opposition to frontier politics within the political system is finite, as Fine Gael is also in thrall to economic fundamentalism and Labour lack political muscle. Civil society is the only real opposition, and civil society in Ireland has been shaped and nurtured by the very politicians it now has to challenge and oppose. The capacity of civil society to act as a counterweight to the economic shock therapy now being administered has been undermined by the cut backs and closures imposed on community development/family support projects, and by the tightening of revenue streams for voluntary service providers.

The trade unions are the only remaining force in civil society capable of challenging the Government’s disaster capitalism doctrine, as the Catholic Church’s power has been compromised. However, the trade unions are now engaged in a form of action which is focused on some of the symptoms of our political malaise rather than its root cause. Industrial action which, in the main, impacts on fellow citizens will further weaken civil society and plays into the hands of the Government. What is needed here is a co-ordinated, strategic political campaign organized and directed by the trade union movement targeting Fianna Fail and their coalition partners. Solving our political crisis by confronting a Government who are bent on protecting the wealthy by impoverishing large sections of the population should, logically, be the first step in reforming our ailing economy.

"Soaring jobless, plunging benefits ..."

"Ireland has experienced near-depression conditions over the past 18 months, and the expectation that budget cuts will lead to spontaneous recovery through which the private sector will compensate for the retreat of the public sector is unproved. Indeed, there is a considerable risk that removing spending power from the economy will lead to more companies going bust and deter the survivors from investing more".

You can read the rest of Larry Elliott's take on Irish economic policy in today's Guardian here.

Government policies

Tom O'Connor: The exchequer figures published last week show that government tax revenues have fallen by €700 million from €3.7 billion in January 2009 to €3 billion in January 2010. Also, the CSO published figures this week showing unemployment had risen sharply by 13,341 in one month. We are also now led to believe that NAMA may result in very little lending by the banks, according to media reports on a leaked memo by the IMF to Brian Lenihan at the NAMA instigation stage.

These results and revelations are very bad. However, a new spin has been put on them by government to show the opposite. Brian Lenihan has said that the fall in tax revenues is in line with the government’s expectations, and the sharp rise in unemployment was also what they expected. He assured the public on the media that there isn’t any problem simply because he expected it!

It would seem that the 436, 936 workers signing on the live register at the moment needn’t worry because Brian Lenihan expects them to be there. Because he expected unemployment to rise, he obviously expected tax receipts to be down, which may mean that more cutbacks will be necessary. But that would seem to be o.k. Why? Because Brian Lenihan expected it.

This type of economic reasoning will do nothing to reduce unemployment and will leave poverty-stricken families, many on the verges of having their homes repossessed; exasperated, frustrated, angry and fearful for the future of their families. It sends a clear message to them that the government doesn’t care.

However, there is a very clearly discernible economic policy at work here: Brian Lenihan is content because he knows that the draconian cutbacks for this year may still help stabilise the economy, despite the fall in tax receipts. He has clearly chosen to ignore making any serious efforts to solve unemployment and get tax receipts up, simply because he is implementing enough cutbacks in the coming year.
Why would a government not prioritise reducing unemployment, virtually give up on tax receipts and instead go for a one-dimensional solution of cutting back government expenditure? The answer is well-known in economic models: Lenihan is implementing a classical monetarist, expectations-augmented Phillips Curve solution to the Irish economy.

These fancy words mean that: the government is taking the view that,, with huge unemployment workers expectations will be very modest and they will feel they are lucky to have a job at all. In fact, they will be softened up in to accepting wage cuts.

This softening-up exercise was confirmed last Monday with Colm Mc Carthy stating that his ‘Mc Carthy Report’ was simply a ‘political exercise’. For those whose jobs have been lost due to the government accepting the veracity of Mc Carthy, they now know that it was a political exercise to soften up the population for cuts in all directions.

In order to shock the population in to accepting lower wages, you will need the recession and a huge army of unemployed people to carry this through, with workers expecting pay cuts to stay in a job. The next stage in this reasoning is that, once workers have become more ‘competitive’, than the conditions will be ripe to hire more of them.

In addition, severe cutbacks in public services allow the government to stay in a strong bargaining position by not relying on increased tax receipts due to cutback savings. It further increases the supply of nurses, speech and language therapists and special needs assistants so that they will accept lower wages if they are lucky enough to be re-employed in the future.

Then, with workers wages significantly reduced in both the public and private sectors, sufficient economic incentives will be restored to employers who may then employ some workers to produce increased amounts of goods and services. At this stage, economic growth, employment and tax receipts grow again and this has the knock-on effect of improving the government’s finances.

There are huge problems with this approach: firstly, it is in effect an IMF type structural adjustment programme and has no respect for the social hardship it creates. The fact that speech and language therapists, occupational therapists, nurses, special needs assistants and other personnel are being laid off is seen as a necessary part of the plan, even though thousands of children and sick adults urgently need them. In some cases, it is a matter of life and death.

Secondly, once the plan is complete and some workers are re-hired, they will have to accept wages which may be so low as to force them in to poverty. They may also have to work more hours to make the same wages they made previously, either with their old employer or with an added part-time job just to pay the mortgage. This is exactly what has happened in the USA in the past 20 years, where low-skilled workers have to work two minimum wage jobs to afford the cost of living in a trailer.

The third point is that it is economically unsustainable. This approach is not really about inventing any new, highly productive and highly skilled well paid jobs. It is about making the economy competitive without moving towards the knowledge economy. The problem here is that with 50% of taxpayers earning less than 30,000, and 25% who haven’t completed a leaving cert, the government is trying to force these to accept less by competing for wages in an increasingly low cost environment.

These workers will not be able to compete with low cost countries. Instead, they need to be re-trained and redeployed in high skilled areas where wages can still remain at the level of the economically developed countries of the EU. This requires state investment in both retraining and productive capacity.Wages can be reasonably good if the worker has increased productivity and skills gains to give her a competitive advantage over workers in cheaper, low skilled countries. To achieve this, the government needs to invest in technologically advanced infrastructure, high skilled industries and in high grade services areas. Increased productivity levels for those at the higher end of the income distribution also need to happen in both the public and private sectors.

Fourthly, by leaving unemployment to rise, to achieve, what is in effect, a rather merciless agenda, the government will almost certainly cause unemployment to stay stubbornly high for at least five years after 2010, and will cause the emigration of tens of thousands of workers whom the government itself has spend thousands training. It also continues to ignore 30,000 families whose homes are in danger of being re-possessed, many of whom are out of work.

Fifthly, these policies are the antithesis to investing in the productive and competitive capacity of the economy to stay competitive and allow for decent wages. For example, the government’s huge investment in research, if not mainstreamed, will result in hundreds of incubated companies being bought out by huge global high knowledge companies who will subsequently reap the rewards of billions of state money. They will also take hard earned ideas, technological advances and associated personnel of the Irish universities and Institutes of Technology.

Sixthly, even though social partnership has been pronounced dead, the current policies do little for any of the social partners. Several businesses are closing every day, banks are not lending, the government has reined in its investment in the economy. Businesses are suffering. Workers are suffering. Community groups are suffering. Farmers are suffering from lower prices on the grounds of depressed consumer demand. In addition to the opposition parties, large numbers of FF TDs do not favour the current agenda. We are left with the cabinet and less than a half dozen academic advisors pushing this agenda. So much for democracy Irish style.

In short, Brian Lenihan’s approach is economically and socially retrograde and will serve the economy and society very badly unless changed. To make matters even worse, in the light of noises coming from the banking sector itself in recent months and the news of the IMF memo to Brian Lenihan on NAMA, there is a clear need to reverse the irresponsible policy of structural adjustment and the associated complacency on the part of the government in running down of the economy and accepting continued increases unemployment.

If not, any growth in the second half of the year will be too little, too late to avoid misery for hundreds of thousands of people, and the skills/productivity weaknesses in the economy will persist for many years afterwards. In doing nothing right now, the government is burying its head in the sand.

Usury

Nat O'Connor: One of the interesting minor features of the Finance Bill 2010 is that certain changes were made to Irish law to make it easier for banks following versions of Shari'a/Islamic law to operate here. The need for change is that Shari'a regards charging interest on loans to be a sin: usury.

One commentator in the Irish Independent (Friday 5 Feb 2010, p.11) made a mistake in claiming that: "The Finance Bill contains measures to tax Islamic financial transactions in a similar way to Christian finance."

The mistake is that, clearly, there is no such thing as "Christian finance". The law that governs finance in Ireland is secular, and passed by the Oireachtas. In recent years, the Finance Bill has become a highly complex document filled with references to the annually modified original law. It weighs in at 230 pages this year and makes the Lisbon Treaty look like bedtime reading. These are the rules that hide numerous tax loopholes and special arrangments that successful lobbyists have persuaded successive governments to include. These are also the rules that continue to permit extortionate, exploitative borrowing. For example, legal moneylenders here can charge over 100 per cent on loans.

Theological scholars will also be quick to point out that Christians, including several popes, also outlawed usury over the ages. Plato and Aristotle condemned usury, and Ancient Rome capped interest at 8.33 per cent (see Jonathan Freedland's interesting article on usury in the Guardian).

In Ireland, Section 35 of the Finance Bill 2010 allows certain payments by Islamic banks to be treated as interest for tax purposes. (The explanatory memo gives quite clear details about this). This is welcome, in so far as it allows more international commerce and it is of benefit for Muslims living in Ireland (and others) who would like to avail of alternatives to interest. However, tinkering with the small print of the labyrinthine finance legislation will simply allow these banks to operate in parallel to our existing norms.

We are long way away from reigniting the argument here on how much is reasonable profit from a loan, and at what point does exploitation (usury) begin.

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Any initial thoughts on the Finance Bill 2010?

Nat O'Connor: I'm still reading through the Finance Bill, but I want to put up this post to give readers a space to post any comments over the weekend about their own impressions so far of the Bill, any interesting coverage, any likely implications, etc.

Uno duce, una voce

Nat O'Connor: I cannot allow two recent stories in the papers to go by without comment.

Today's Irish Independent reports (in a story about Enda Kenny) that "Brian Cowen's handlers are issuing instructions to the media about what questions the Taoiseach can be asked."

The report goes on to say:
"Mr Cowen is objecting to being questioned about national issues when he travels around the country.

"In an unprecedented move, the Fianna Fail press office yesterday issued a schedule for Mr Cowen's trip to Cork this afternoon with the instruction 'the Taoiseach will only take questions related to his visit to Cork'.

"Mr Cowen's spokesman said the Taoiseach would rather focus on the topics he is dealing with on the trip."

In a democracy, and not only during an unprecedented national crisis, it is the right of citizens and journalists to ask the Taoiseach any question that they believe to be of public interest.

Meanwhile, a controversy rages between the Minister for the Environment, Heritage and Local Government and the ESRI. In particular, the Minister is quoted as saying:

"I do regret that they have been drawn into what is clearly a public relations campaign on behalf of Dublin City Council and Covanta and it is no coincidence that the report was released today and it is simply to undermine Government waste policy,”, and

“Certainly in my time in public life, I’ve never come across anything like this where ESRI is used in that way and I think they departed from their normal standards in that regard,”

It is welcome that the Minister's consultants (Eunomia) should argue with the ESRI about the method used, the data included, etc. That's healthy. Many people on this blog also argue with the ESRI about methods and data.

But for the Minister to accuse the ESRI of public relations campaigning for Dublin City Council and "departure from professional standards" undermines the role of evidence in informing policy-making. That doesn't just undermine the ESRI, it undermines any organisation that presents evidence and reasoned arguments for or against policy, particularly when the issues are complex, and different theories and models can be used.

If the Taoiseach is not to be questionned and the Minister for the Environment is not to be disagreed with, what next? Uno duce, una voce?

Finance Bill 2010

The Finance Bill 2010 is now available for download here, and the explanatory memorandum is available here.

Finance, NTMA and FOI

Nat O'Connor: The Story (freedom of information blog) offer an insight into why the Minster for Finance transfered powers to the NTMA yesterday:

"One thing that stands out like a sore thumb is the fact that unlike the Department of Finance, the NTMA is not subject to the Freedom of Information Act. Indeed the Department have said to me several times of the past few months that my requests for information were being delayed because the Department was so busy with NAMA, and with other FOIs. Now, it seems, much of the decision making will be made in secret anyway."

You can read the original here.

Lies, damned lies and statistics: car scrappage scheme

An Saoi: On Tuesday morning Alan Nolan of the Society of the Irish Motor Industry was on Morning Ireland and made reference to the increase in car sales in January of approx. 5%. He uttered some of the same phrases that were mentioned about shopping in the run up to Christmas, which as the January VAT returns showed did not conform to the facts. He said that there was “great footfall in dealerships and great interest”.

Car sales are a serious source of tax revenue and in the interest of commenting accurately on tax issues, I decided I had better have a look at the SIMI National Vehicle Statistics, which are provided from figures prepared by the Revenue Commissioners.

Right enough, there was a 5.04% increase in new car sales but a 9% decrease in new car registrations because the number of used imports had fallen by nearly 46%. Now when a used car is imported VRT and Vat must be paid, just as with a new car. SIMI have helpfully provided the number of new cars sold by marque and it is clear that sales of larger cars, Mercedes, Audi, BMW etc. have been particularly badly hit. It appears that most of the cars sold fall into the less polluting group, with much reduced VRT and possibly the scrappage grant payable also.

As all cars are imported, it makes little difference to the State whether the car a person buys is used or new when it is imported. The tax yield may be slightly higher on a new car - that is all. There seems to be little if any benefit to the country from the scrappage scheme, or am I missing something? It looks like a serious waste of money.

Where have all the taxes gone?

An Saoi: Today’s tax figures were a shock, even to me. Perhaps I shouldn’t have been so surprised as the Central Bank’s report for December had already told us that spending on credit cards was over 14% below the 2008 level. This is reflected in the nearly 18% decline in VAT. As taxes are paid in arrears, these figures give us a snapshot of the economy to December and do not reflect activity in January.

All through December we were fed a bunch of misrepresentations by the Irish media, which was so succinctly described by David McWilliams in last Sunday’s Business Post. Newspapers & RTÉ happily talked up an economy, which we now see is still in tatters.

Looking at the detailed figures, we see a consistent pattern of decline. On the consumption side, Customs duties down 17%, Excise down 16% & VAT down 18%. On the taxes on income side, the year on year decline in Income Tax of just 10% was helped by the Income Levy. The cuts in Public Sector pay will feed into considerably lower tax payments from next month. The 66% decline in Corporation Tax may be down to pre Christmas refunds and it is hard to draw any conclusions from it. Next month’s figures are far more important. The fall away of CAT is not surprising given the state of the housing market. The declines in Stamp Duties and CGT are slightly surprising as they had been quite good in December. I mentioned last month that the introduction in E-Stamping by the Revenue had perhaps energised many solicitors into getting their affairs in order.

However there remain two imponderables, which may have made a material difference to this month’s figures.

1. We have no idea as to the levels of unpaid taxes and by how much they are increasing each month.
2. There is no summary of outstanding repayments. Delaying or expediting large repayments from month may affect the monthly outcome. This is particularly true for VAT return months such as January.

Delaying repayments may partially explain the better than expected figures in December. However this is a very dangerous game as anyone who has juggled paying their bills and credit cards knows.

The figures suggest that the Government will struggle to achieve their very modest targets, which it should be noted are below those of 2003. February will tell us far more about the state of the economy. The Government published their 2010 Tax Profile today and are expecting February 2010 to come in at €1,726M, €298M below Feb. 2009.

Within the global figure, they are expecting Income Tax to come in close to 2009 figure, €891M against €915M, which seems very optimistic. Corporation Tax is expected to come in at just €90M against €290M last year. This is partly down to the change in preliminary tax rules, but there must be some big losses also expected from companies with a 31st March accounts year. It is not a VAT return month with just VAT collected by Direct Debit and on imports due. A bounce is expected in Excise, which includes VRT increasing from €310M in 2009 to €344M this month. Time will only tell. I will make my estimate of the end of year outturn after the March figures, but it is hard at this stage seeing the figures break €30,000M by year-end.

McCarthy on fiscal correction - advice to Scotland

Slí Eile: Never shy to expound, economist Colm McCarthy, of Bord Snip fame imparted wit and neo-liberal orthodoxy last week in Edinburgh. See an account of his address here. (Does anyone have the full text somewhere?) He declared:

It’s getting public opinion and the opposition parties and the broadsheet media on board and getting them to accept and understand that we’re not doing this for fun, that we’re in a hole and that the quicker we start dealing with it the better and that there has to be a fiscal consolidation and all this kind of stuff.

Looks as if this approach had a large measure of success in 2009 - except that the fiscal deficit is still hanging where it is and the prospect of more deflation, more unemployment and more spending cuts will see to a continuing debt trap.

Greek Tragedy II - and the tax dimension

Michael Burke: In today's Financial Times, two economists from the Breugel think-tank in Brussels argue that the best course for Greece is to call in the IMF.

The Greek economy and financial markets are bearing the brunt of concerted pressure in the Euro Area, and there are fears that a collapse there could lead to renewed speculative pressure on a number of countries including Ireland.

The possibility of an IMF intervention ought to be shameful for the architects of Europe's fiscal and monetary arrangements, since the Euro was touted as an instrument that would protect the economies of Europe from speculative pressures. 'European Solidarity' has proved a mirage. Worse, leading EU institutions have played their part in Greece's difficulties. As the authors of the FT piece note,

"One reason why things have sharply worsened is that the ECB has said that by the end of 2010 it will tighten quality requirements for bonds pledged as collateral – which risks excluding Greek bonds from repurchase agreement operations. This, and Greece’s inability so far to present a credible fiscal plan, explains the alarm in financial markets."

This unilateral move by the ECB seems wholly misplaced. If the ECB is concerned about the deterioration of asset quality in a tiny part of its portfolio, it should make its own determination about which assets can be pledged. Outsourcing this to the largely discredited ratings agencies seems like a wholly unwarranted measure, designed to increase the pressures on a Greek government which has inherited a crisis not of its own making.

Nor is the Commission blameless, having been apparently hoodwinked over a number of years by the previous Greek governmet about the size of the deficits (and debt!) in a manner that would make a primary schoolteacher blush.

The new government has bemoaned the endemic corruption in Greek society, includig government bodies, and its effect on reducing tax revenues. Perhaps the Commission could provide greater assistance as tax collectors than as macroeconomic advisers, or even auditors. In the period 1997-2006, Greek tax revenues as a proportion of GDP were 5.5% below the Euro Area average. Even in 2008, they were 4% below the average. Closing in on the average level would make a major dent in the deficit and, once the economy recovers, the debt stock too.

This low taxation is a common feature of those Euro Area countries currently in the cross hairs of the financial markets. In 2008, Spain's tax revenues were 37% of GDP, 7.8% below the Euro Area average. By contrast, in Germany they were 43.7% and in France they were 49.3%.

Of course, in 2008, Ireland's tax revenue GDP ratio was the lowest of all in the Euro Area, at 34.9%, and fully 10% below the average (Table 36). Closing in on the Euro Area average would see Ireland's deficit melt away to nothing.

Taxbreak hotels

Sinéad Pentony: The report by Peter Bacon on the Irish Hotel Industry highlights the sorry state of the industry, which has been insolvent since 2008. By the end of that year, there were a total of 59,000 hotel rooms in the country – and according to the Report, a quarter (15,000) of these rooms need to be closed down urgently. The Report also estimates that €1bn of debt in the hotel industry is not covered by assets. Peter Bacon makes a large number of recommendations in the Report that, if implemented, would effectively restructure the industry. However, it is worth taking a closer look at his recommendations in relation to the accelerated capital allowances for hotels (tax breaks), because it would result in a significant bailout of developers if implemented.

The Report on the hotel industry identifies a number of factors that have contributed to the virtual collapse of the industry. In the first instance, it points the finger at hotel tax breaks and the damage they have caused by distorting the market. The tax breaks resulted in the creation of a huge over-supply of hotels whose viability was questionable from the outset. Bacon concludes that the stock of new hotels has been seriously insolvent since 2005, and the analysis shows that in every year since 2002, new hotels on average have been insolvent from the year of their construction. The economic crisis has compounded the situation and has brought the industry to the brink of collapse.

Secondly, the Report highlights the practices of financial institutions and banks in contributing to the problems in the industry. It would appear that the banks and financial institutions are supporting a large number of insolvent hotels to remain in business. Bacon identifies a number of reasons for this in the Report, including “... the need of hotels to remain open for seven years to allow investors to avail of capital allowances and to avoid the creation of a tax liability due to a clawback of allowances that have been claimed already; the reluctance of banks to realise losses and write off loans granted to hotels with no prospect of recovery because of the additional pressure this would place on the capital adequacy of their own balance sheets; and the reluctance to act in advance of the introduction of NAMA.”

The result of these factors is that the insolvency problem is being spread through the industry, and solvent hoteliers now find themselves having to compete against ‘zombie’ hotels, many of which were created specifically to take advantage of tax breaks, and this is threatening to destroy fundamentally sound businesses. At the same time, the reluctance of banks to provide sufficient working capital is leading to liquidity problems that further undermine the businesses of solvent hotels. Peter Bacon points to the possibility that the banks have less incentive to keep viable hotels with relatively low levels of debt open, than is the case for hotels with high levels of debt, for the reasons stated above – having to realise losses and write off loans.

So how do we solve this problem? The recommendations contained in the Report outline the restructuring that needs to take place within the industry, to put it back on the road to solvency and viability. One of the key recommendations relates to the issue of over-supply and removing 15,000 rooms from the market – it goes on to specify that the reduction of excess capacity should be facilitated by the adjustment of tax regulations concerning tax allowances for new hotels.

Incredibly, the Report recommends “...that a special provision be introduced in the Finance Act 2010 to allow relevant hotels to exit the industry without disadvantaging the initial investors in terms of capital allowance. It is further recommended that an accompanying provision be introduced to the effect that capital allowances that have already been claimed in respect of any hotel should not be subject to any claw back by the Revenue should that hotel exit the industry within seven years”.

Essentially, the Report is recommending that developers who took advantage of tax breaks to build hotels that were never going to be viable should not be subject to the clawback of those capital allowances - because they won’t have an incentive to close these hotels but rather, keep them open for the seven years, which will further undermine the hotel industry. There are two questions that arise here: the first is an economic question, and the second relates to how insolvent hotels continue to be financed.

We live in a market economy and the Report clearly demonstrates the detrimental consequences of market-distorting tax breaks. The economic logic would see the removal of the tax breaks and, if the hotel ceases trading within seven years, tax allowances would be clawed back. The tax breaks for hotels have been discontinued along with other property-based tax incentive schemes. However, the Commission on Taxation Report 2009 notes that many live on for existing projects and “for pipeline projects”, as in the case of hotel accelerated capital allowances (tax breaks).

The recommendation contained in the Report in relation to the treatment of the claw back can only be described as a further market distortion and raises serious questions in relation to ‘moral hazard’, whereby failed investors are in fact freed from the consequences of their actions. If implemented, this recommendation can only be described as a bailout for hotel developers, when they should, in fact, be subject to the same rules as everyone else who operates in a market economy. This leads us to the second question.

How can struggling developers and investors afford to keep insolvent hotels open? The answer is - the banks. The Report identified the actions of banks as being “particularly damaging” because they are avoiding the need to realise losses due to bad loans on hotels that are not viable by providing a “drip feed of working capital”. Meanwhile, hotels with low debt levels and viable businesses are experiencing liquidity problems because they are having difficulty in accessing sufficient working capital. The Report recommends that the banks need to fully recognise bad loans within the hotel sector and face any capital adequacy issues which might follow.

John Power, CEO of the Irish Hotels Federation, in an interview on Drivetime on the 5th January clearly articulated the problem with the banks keeping insolvent hotels open and the detrimental effect this is having on the industry as a whole. But how can the banks, which have such serious liquidity problems afford to keep these insolvent hotels open – when we hear countless stories of viable businesses going into liquidation because of credit restrictions?

We can only assume that part of the capital that has been injected into the banks from the State (€11bn to date) is being used to keep insolvent hotels open, so that they can be transferred to NAMA and/or to prevent the developers from incurring tax clawback liabilities, should the hotel be forced to close within 7 years of being built.

The Report puts the costs to the Exchequer of removing this barrier to exit the industry at zero. Hotel-related capital allowances which remain to be claimed have an estimated value of €527 million to investors. More importantly, allowances already claimed, which potentially could be clawed back by the Revenue, have a value estimated at €1bn. The total potential loss to the Exchequer adds up to over €1.5bn.
The Finance Bill is due to be published in the coming days, so we will have to wait and see if hotel developers are next in line to be bailed out by the taxpayer. Hotel developers would not be able to keep these hotels open were it not for the support of the banks, who in turn, have questions to answer - in relation to continuing to finance insolvent hotels and the extent to which capital injected by the State is being used to support this activity. It would appear that the taxpayer is being used to prop up the whole system and is keeping the banks, speculative developers and other vested interests afloat.

But who is propping up the tax payer?
Sinéad Pentony is Head of Policy at TASC

AIB makes case for increased public spending

Peter Connell: Encouraging news from AIB. In its Economic Outlook for 2010 published last month the bank agrees with many of those writing on PE on the issue of Ireland’s sovereign debt.The report points out that ‘Ireland has one of the lowest debt ratios in the EU: 51% at the end of 2009, allowing for cash balances’ – which it states amounts to €22 billion (slide 12 in the presentation linked above). Like many on this blog, the bank argues that this relatively positive picture provides the State with options regarding investment and public spending.

Virtually all mainstream commentators argue that there is no alternative to fiscal consolidation, so this is important information as it is emanating from an unexpected source and certainly one not naturally sympathetic to the kind of analysis you’ll read on this blog. But, it’s there in black and white. AIB says it’s OK for the State to increase public spending. Let me see, how exactly does the report put it? Ah yes, ‘low public debt gives the State the capacity to support the banking sector’ (see slide 12)….