Effects of the minimum wage on the jobs market

Tom McDonnell: TASC made a short submission last week to the Labour Court review of the JLC wage agreement mechanisms. The submission is available here.

The Joint Committee on Jobs, Enterprise and Innovation published a report in February on actions to address youth and long-term unemployment. It can be found here. One of the recommendations (Number 26) states that there should be an investigation into the effects of the minimum wage (both positive and negative) on the jobs market. This is a sensible recommendation. The independent Low Pay Commission (LPC) in the United Kingdom does this every year. What does the evidence suggest?;

The LPC's 2012 Annual Report is here and their discussion of the minimum wage's impact on the UK's labour market begins on page 48 of the pdf. They state that: The general consensus...is that the NMW (i.e, the national minimum wage) has not significantly affected employment . 

Both the theoretical and empirical literature are ambiguous concerning the impacts on employment. While the standard competitive model suggests there should be a negative effect on the jobs market, institutional models and dynamic monopsony models both suggest that the effect is actually much less clear cut. Increased aggregate demand and reduced search costs are just two reasons why the effect on net employment might be minimal or non-existent. Recent empirical work suggests minimum wage have little or no overall effect. See for example this study by Arindajit Dube, William Lester and Michael Reich.

John Schmitt asks why the minimum wage appears to have 'no discernible effect' on the minimum wage here while Barry Hirsch, Bruce Kaufman and Tatyana Zelenska try and explain the lack of effect on employment here through the framework of differing 'channels of adjustment'.

While innovative solutions to the jobs crisis are needed, reduced levels for wage floors are unlikely to be helpful in reducing unemployment. The major effects would likely be to increase financial hardship and vulnerability for low wage workers, and increasing income inequality, without any meaningful impact on overall employment.

The Unhelpful Mister Rehn

Tom McDonnell: Mr. Rehn's recent open letter on fiscal multipliers; the effects of discretionary fiscal consolidation; and the relevance of economic theory and evidence, was a truly dispiriting and perplexing intervention.

It is easy to understand why the handling of the Euro crisis has been such an unmitigated shambles with people like Mr. Rehn running the show. We deserve better.

The Commissioner is taken to task by Jonathan Portes here and by Karl Whelan here. Both contributions are well worth a read.

Confidence indeed.

Promissory Notes: Any old deal won't do

Tom McDonnell: There is a real risk that any old deal in advance of the 31 March payment will be hailed as a victory after the failure to get a deal on the promissory notes last year. No matter how bad the deal actually is.

In that context Nama Wine Lake provides a quick overview here of what would and wouldn't constitute a deal. Just eleven weeks to go.

Open debate on paying the promissory notes - the long countdown

Tom McDonnell: Various official sources (including Ministers) have been making the claim in recent days that the 2012 promissory note to the IBRC went unpaid. Sadly this is untrue.
The ECB insisted all along that it receive its ELA repayment from the IBRC on time on 31 March and this is exactly what happened.  The repaid money was then destroyed/deleted/burned/expunged on time and as scheduled.

It is true that the money promised to the IBRC was initially paid to the zombie bank by the state-owned NAMA (in exchange for a 13 year government bond given to IBRC by the Irish State) rather than by the exchequer. Nevertheless it was paid using 'our' money - we own NAMA after all. Following a series of subsequent exchanges the bond is currently held by Bank of Ireland.

A slightly irritated ECB watching the shenanigans merely acknowledged that it got paid on time as expected and that it had observed certain transactions betwen various Irish state institutions.

That the promissory note was paid (by issuing a sovereign bond) is stated clearly in the Department of Finance's Medium Term Fiscal Statement. Much of the confusion may stem from the media's general failure to accurately report and explain what happened on 31 March - understandable given the byzantine nature of what occurred. Fortunately not everyone in civil society has been taken in by the official line. For example the Debt Justice Action group has a letter in today's Irish Times which draws attention to this issue.

The government's next payment to the IBRC will not be made for 108 days. There needs to be an open and honest public debate about the subsequent promissory note payments to the IBRC. All options have to be on the table.

The Default Option - Cancelling the Odious Debt

Tom McDonnell: We have seen again in the last few days that the troika are a not a monolith. They disagree quite fundamentally on many issues.

It is widely understood that the debt crisis professionals (the IMF) were overruled at an early stage by the debt crisis amateurs (ECB/European Commission). Greece was originally prevented from defaulting and then not allowed to default to a sufficient degree to restore its debt dynamics to a sustainable path. A second default is now certain within the next eighteen months.

According to Der Spiegel the inevitability of the second Greek default is well understood in Brussels and Berlin as indeed it must be to any competent analyst.

Ex-IMFer Ashoka Mody has an excellent piece in today's Irish Times making the case for defaults in the European periphery. Defaults are an entirely normal (even expected) thing when it is clear that debt levels have spun out of control.

Over at the Irish Independent Stephen Kinsella makes the case - articulated repeatedly on this blog and indeed on many other blogs - that the promissory note payment to the IBRC should not be paid on 31 March. I would echo Stephen's reference to this debt as 'odious'. The government failed to get a deal last year. Months of pleading have gotten them nowhere and the working group is missing in action. TASC's position is that the promissory notes should now be immediately suspended pending a full renegotiation. It is time to start rethinking the debt default option. Reducing the debt burden is an essential component of a Greek recovery and failure to strike an acceptable deal on the legacy bank debt will delay Ireland's recovery for years to come.

Internal devaluation in the Eurozone

Tom McDonnell: Ronald Janssen explores the impact of falling wage costs in the Eurozone periphery here. He argues that export revival has not been enough to prevent the collapse in domestic demand that accompanies the cuts in public budgets and real wages and that the net outcome has been recessionary.

A Path out of the Euro Crisis?

Tom McDonnell: Eurozone level policy making has been nothing short of disastrous and there is little sign of any change. Spain is moving closer by the day to a full bailout and faces into a half decade of stagnation and high unemployment.

In this context, INET's Economic Council has released a timely policy document "Breaking the Deadlock: A Path out of the Crisis" intended to chart a way out of the Euro crisis. The council argues that unless decisive action is taken the euro will continue to drift toward a breakdown of incalculable cost. You can read the council's proposals here.

MOU for Spain

Tom McDonnell: The Spanish Memorandum of understanding is here. EL Pais has distilled it down to 32 key points here. Eurointelligence helpfully translates these points here. The average maturity of loans will be 12.5 years.

Spain is required to introduce legislation to apportion losses to several classes of shareholders and subordinated bondholders by late August 2012 and to legislate for a bad bank before the end of Autumn.

Bad news for Ireland as it looks like all the risks will remain with the Spanish sovereign. Spanish 10 year bonds were at the unsustainable rate of 6.91% as of this morning.

Euro Crisis, Causes and Solutions

Tom McDonnell: Despite the developments at last week's EU summit we remain a long, long way from a successful resolution of the Euro crisis. My own thoughts on what should be done are in this TASC discussion paper.

I welcome any comments or feedback.

Ireland and EFSF access

Tom McDonnell: It was pointed out on this blog a few weeks ago that Ireland would be able to obtain access to new funding from the EFSF provided the Government applied for that funding before 1 July 2013. Ireland would also need to negotiate a new Memorandum of Understanding.

It is the position here that Ireland will need to access further official lending beyond the current 'bailout' programme and that the Government should make an application in the first half of 2013.

The Minister for Finance appeared to acknowledge last Tuesday in the Dáil that Ireland would indeed have access to further EFSF funding in the event the Government applied before 1 July 2013. The discontinuation of the original Greek programme, and its replacement with a new programme, suggests that countries in existing programmes do not have to wait until their current programme finishes before beginning a second programme.

European Monetary Union: Doomed to fail or just another stepping stone?

Tom McDonnell: With talk of a Greek exit from the Euro now being treated seriously it can be informative to consider past experiences with monetary union. The normal fate for currency unions has been eventual failure and dissolution, and the history books are full of examples of such failures. By and large having some pre-existing form of centralised political union in place appears to greatly improve the chances of a monetary union succeeding. Classic examples of resilient monetary unions include the USA, the UK and in some respects even the former USSR.

Nineteenth century Europe had the Latin Monetary Union (LMU) based on the French franc and centred on France, Belgium, Switzerland and Italy, as well as the Scandinavian Monetary Union (SMU) between Sweden, Denmark and Norway. Both the LMU and the SMU broke apart because there was no central institution to enforce common monetary policy and because of divergent fiscal policies motivated by domestic concerns.

Perhaps the most famous example of a de facto currency union was the gold standard which developed internationally from 1870 onwards. The gold standard was a system of fixed exchange rates based on convertibility to gold at set prices. The system came under severe pressure following the stock market crash in 1929 and finally came unravelled in the early 1930s when virtually all countries abandoned gold convertibility.

The outlines of a new international monetary system based on the convertibility of certain national currencies into United States dollars was agreed in July 1944 at Bretton Woods. The US dollar was itself backed by convertibility into gold, and this meant all participating currencies were indirectly pegged to gold and therefore to each other. Under the Bretton Woods system countries could devalue their currencies under certain agreed conditions. The Bretton Woods system began to fray in the late 1960s as the United States became increasingly unable and unwilling to sustain the dollar's exchange rate with gold. Eventually dollar convertibility was terminated by the United States in 1971.

The currency instability of the 1970s prompted a series of attempts to stabilise exchange rates in the European Economic Community (EEC). The first of these was the ‘Snake in the Tunnel’ system designed to peg the EEC currencies to one another within narrow bands. The Snake in the Tunnel system had broken down by the mid 1970s. The next major attempt at monetary coordination was made in 1979 with the launch of the European Monetary System (EMS). The EMS was based on a system of narrowly fluctuating exchange rates known as the Exchange Rate Mechanism (ERM). In practice the Deutsche Mark quickly became the anchor currency of the EMS and the system was characterised by repeated devaluations by member states.

Post-reunification expansionary fiscal policy designed to support the rebuilding of the former East Germany, combined with the Bundesbank's ultra-tight monetary policy, forced other countries to keep interest rates at extremely high levels to support their currencies and prevent capital outflow to Germany. A number of European currencies came under speculative attack and Sterling’s membership of the ERM was suspended by the British Government in September 1992. Italy withdrew the following day and the ERM was effectively dismantled in 1993 when the fluctuation band for national currencies was extended to 15 per cent. As with previous failed attempts at fixing exchange rates, the system was undermined by conflicting policy goals in the different countries and by the inability of member countries to harmonise monetary and fiscal policies.

Despite these setbacks, the push for monetary union continued as it was claimed that unpredictable exchange rate fluctuations were incompatible with the EU's fully open and competitive internal market. This perspective drove European Monetary Union (EMU) and policies aimed at convergence between the various EU economies in areas such as inflation and fiscal discipline. These policies were intended to create the conditions for a viable currency union. One lesson drawn from the ERM experience was that systems of fixed exchange rates will eventually buckle under the strain of divergent domestic policies and objectives. Thus, in preference to yet another system of fixed exchange rates, the decision was made to pursue a single currency as well as a single monetary policy under the control of an independent central institution. Eleven national currencies were made convertible to the Euro at established rates in 1998 and the Euro was officially launched the next year, with monetary policy and enforcement falling under the authority of the independent European Central Bank (ECB).

It remains to be seen whether this latest experiment in monetary union will succeed. It is now clear that EMU has major fundamental design flaws and if history is a guide then the odds of success do not look great. On the other hand, Europe's persistence with the idea of monetary union suggests that mistakes will be learned and the attempt renewed.

The real question is whether the mistakes will be learned in time to prevent the currency union from imploding.

The Spanish crisis, thirteen defaults to date

Tom McDonnell: As well as being World and European football champions Spain also currently holds the distinction of having the world record for number of sovereign defaults. Spain defaulted six times on its external debts in the period between 1557 and 1647 and a further seven times between 1809 and 1882. Thirteen in all.

Spain will clearly be the key battleground of the debt crisis. Already things do not look good and the bank recapitalisation process is now set to begin in earnest. The Spanish Government nationalised Bankia yesterday. This may well prove the first of a number of nationalisations. Veteran observers of the Irish bank bailout will watch with great trepidation as this story unfolds and the full scale of the losses in the Spanish banking sector become clear.

According to the European Commission Spain is unlikely to meet its deficit targets this year or the next while yields for Spanish 10 year bonds were 6.171% as of this morning, a level that is unsustainable over the long term. Arguably Spain is now insolvent and it could easily totter into a bad equilibrium whereby it is de facto locked out of private markets and requires rescuing by a bailout fund. Over at the FT Nouriel Roubini and Megan Greene are pessimistic. They argue that:

"The only way for there to be a happy ending in Spain is if action is taken swiftly in Brussels, Frankfurt and other European capitals. But that is not likely to happen. The eurozone periphery and Spanish crisis look like a slow-motion train wreck."

The bailout packages (EFSF, ESM) as designed are inherently fragile in nature and certainly not suitable for a country of Spain's size. Worsening figures in Spain and the threat of a fourteenth external default could be the catalyst for the ESM to get a banking licence. That would completely change the dynamic of the debt crisis.

Euro crisis solutions: An ongoing debate

Tom McDonnell: The Irish body politic and especially its commentariat will no doubt spend the next few weeks obsessing and navel gazing over the fiscal compact and its perceived impact on Ireland. Yet in truth the real debate that matters is the one going on at the Euro zone level. The institutional and policy architecture of the Euro zone is deeply flawed at a structural level. These flaws have been cruelly exposed by the response to the debt crisis and by the failures leading up to the banking and debt crisis. How Europe now decides to respond will decide the future shape of the Euro zone and it is in that intellectual space that Ireland must begin engaging in.

There are a number of useful 'non-official, non-Irish' resources on the Internet for those interested in the debate:

The Eurointelligence feed (newsbriefing@eurointelligence.com) is probably the best free daily resource on the Euro crisis that is out there. It combines news and media reports from around the Euro zone with high quality analysis. See here.

Over at VOX EU there is a lively debate going on about the merits, or otherwise, of austerity. See here.

The Social Europe Journal is another site worth a visit for its analysis of the crisis and for a constructive, albeit damning, critique of current policies.

Well worth a look at from time to time are the CEPS, Project Syndicate and Breugel websites while John McHale helpfully adds a few additional links here. Yanis Varoufakis provides the perspective from Greece here.

Across the atlantic Paul Krugman and the idiosyncratic Brad DeLong regularly provide external and often scathing perspectives on the official response to the Euro crisis.

Finally, the Financial Times and the Guardian usually conduct rolling live blogs whenever the latest Euro zone drama erupts.

This is just a small selection. We are in the midst of a multidimensional crisis with multiple targets. There can be no silver bullet in such a scenario. Nevertheless there are viable solutions out there that can, taken as a package, ensure the viability of the Euro zone over the medium-term. And not just a Euro zone where unemployment and poverty concerns are seemingly always secondary to concerns like narrow price stability.

Some of these solutions will undoubtedly be politically difficult. Ultimately Europe's leaders will need to decide what their vision for the Euro zone is, what is sacrosanct, and what is negotiable. Indeed they should be obliged to articulate their vision. This would bring a degree of much needed clarity to the discussion.

The Fiscal Compact - crisis resolution?

Tom McDonnell: Sebastian Dullien has a useful piece on the Fiscal Compact over at the Social Europe Journal.

Sebastian correctly argues that none of the Fiscal Compact rules will make a direct impact on fiscal policy for at least half a decade. In part this is because most countries are already in an Excessive Deficit Procedure (EDP) agreed with the European Commission. Ireland’s current EDP ends in 2015. The Stability and Growth Pact and the Six Pack, rather than the Fiscal Compact, are driving the current austerity.

And the austerity itself is a major part of the problem. The cumulative effect of each Euro zone country accelerating the austerity drive is a recipe for prolonged stagnation and high unemployment across the continent. Sebastian calls for a longer adjustment period, a reorganisation of public investment financing with the European Investment Bank playing a central role and a move towards euro-bonds or some form of European debt redemption fund.

One hopeful sign is that Francois Hollande is evidently calling for the ESM to be given a banking licence. See here.

Germany will resist. Hollande’s success or failure on that issue will go a long way to determining the outcome of the crisis. With a banking licence the ESM (or indeed the EFSF) could perform real time unlimited Lender of Last Resort functions. Without such an institution in place it is difficult to see how the Euro can survive in the long run.

The Promissory Notes: Deal or No Deal? No Deal

Tom McDonnell: The ECB has informed the Irish Examiner that the Irish Government has submitted no documentation to the bank pertaining to renegotiation of the terms of the promissory notes. The report is here. The quote from the ECB is here:

"Having duly looked into this matter, we would like to inform you that the ECB did not receive any documents from the Irish Government on the renegotiation of the terms of the promissory notes."

It's important to remember no deal was actually done with the ECB leading up to March 31. As the ECB stated in response to the multi institution shenanigans and gymnastics leading up to March 31:

"The ECB is not part of it, as it is the redemption of the promissory notes and a subsequent reduction in emergency liquidity assistance provided by the Central Bank of Ireland.

The ECB also clearly stated how it expected to be paid in full and on time. Unsurprising if it never even received documents from the Irish Government.

Well done to the Examiner on ferreting out this very useful bit of information.

Ireland's financing alternatives - the EFSF

Tom McDonnell and Michael Taft: In our first post, we outlined some of Ireland’s financing alternatives; namely through the IMF and the European Stability Mechanism. There is, however, a more compelling source of institutional funding in the eventuality of a No vote: the European Financial Stability Facility (EFSF).

The EFSF is one of four external sources of funding for the current Irish bail-out (along with the IMF, the European Financial Stabilisation Mechanism, and bi-lateral loan agreements with the UK, Sweden and Denmark). The EFSF remains a source of funding for all Eurozone countries until the middle of next year.

The EFSF stands apart from the ESM and the Fiscal Treaty. Ireland, and all countries who are members of the EFSF, has access to this fund as of right, depending on the following conditions:

• They cannot access funding at reasonable rates on the international markets
• They have negotiated a Memorandum of Understanding with the EU and the IMF

A further stipulation is unanimous consent from the Finance Ministers of the Eurozone (Eurogroup), which would follow on from an agreement with the EU/IMF. Applications for this funding can be made up to the end of June 2013. After that the EFSF will only administer funding that has already been agreed.

According to the recent Eurogroup statement (the Finance Ministers of Eurozone countries):

‘For a transitional period until mid-2013, it (the EFSF) may engage in new programmes in order to ensure a full fresh lending capacity of EUR 500 billion (for the ESM).’

This is confirmed by the EFSF itself which states:

‘ . . . following the Eurogroup meeting held on 30 March, it was decided that the EFSF would remain active until July 2013 . . . For a transitional period until 2013, EFSF may engage in new programmes in order to ensure a full fresh lending capacity of €500 billion . . . after June 2013, EFSF [will] not enter into any new programmes.’

Therefore, were Ireland to apply for a second bail-out prior to July 1st 2013, it would be granted if such an application were accompanied by a Memorandum of Understanding negotiated between Ireland, the EU and the IMF – similar to the first bail-out. This funding is not contingent upon the ratification of the Fiscal Treaty.

In all probability, funding for Ireland’s second bail-out – whether it approves the Fiscal Treaty or not – will be routed through the EFSF. The EFSF (the temporary bailout fund in place up to July 2013) and the ESM (permanent bailout mechanism) are different companies. The EFSF has €440 billion (see page 1 of the EFSF document) of which €192 billion already committed to Ireland, Portugal and Greece (see the diagram on page 20 of the EFSF document). The remaining lending capacity of the EFSF for programmes initiated before July 2013 is therefore €248 billion. The EFSF will remain in place to manage its existing programmes (see diagram on page 20 of the EFSF document) and any other new programmes approved prior to July 2013, until such time as all these programmes are all wound down.

The ESM itself has €500 billion and is scheduled to enter force on 1 July 2012. As stated above, the intention would be to ensure the ESM retains its full lending capacity of €500 billion. This no doubt refers to the prospect of larger countries, in particular Spain, needing a bail-out. The ESM would require full capacity to accommodate new countries’ need for a bail-out.

Ireland’s continuing access to institutional funding beyond the current bail-out programme has been guaranteed not once, but twice, by the Heads of States and Government; first, on July 21st of last year when the establishment of the European Stability Mechanism was agreed, and most recently on January 30th of this year – after the Fiscal Treaty was signed:

‘We welcome the latest positive reviews of the Irish and Portuguese programmes which concluded that quantitative performance criteria and structural benchmarks have been met. We will continue to provide support to countries under a programme until they have regained market access, provided they successfully implement their programmes.’

This is an important and helpful guarantee. There is no condition set on continued support until we return to the markets – except that we implement agreed programmes. If continued support were contingent upon acceptance of the Treaty, we should have expected it to be highlighted in this statement.

This helps explain another issue we highlighted in the first post. The drafters of the European Stability Mechanism Treaty inserted clauses that provide manoeuvrability in negotiations with any Eurozone country in need of financing, regardless of the Fiscal Treaty. In particular, they inserted references to ‘new programmes under the European Stability Mechanism’, a clause which would have been unnecessary if all financing under the ESM were strictly conditional on a yes vote. They have seemingly factored in a situation whereby a second bail-out for Ireland (and potentially Portugal and Greece) would constitute ‘rolled-over’ financing, rather than ‘new’ financing. This buttresses the guarantee given by the Heads of States and Governments – namely that Ireland will continue to be supported until we return to the markets.

This is an important debate as there is a high probability that Ireland will require a second bail-out. We are expected to return to the markets in late 2013 and fully by 2014. However, the IMF is cautious:

‘Debt sustainability remains fragile, especially with respect to medium-term growth prospects . . . In this context, the prospects for regaining the substantial access to market funding that is assumed in 2013 remain uncertain.’

Were a second bail-out required, we estimate that it could be as large as €45 billion and possibly more for the years 2014 and 2015, taking into account the Exchequer balance and bond redemptions. This does not include bank payments. While this is less than the current bail-out provision it is clear that Ireland, without access to either market or institutional funding, would not be able to cope with this fiscally. We would be heading into a default – quite possibly on both sovereign and banking debt. This would have negative spillover effects for other Eurozone countries.

We reiterate the point from our first post: there is no reason to resort to counter-posing ‘appalling scenarios’. Some argue that Ireland will be frozen out of both market and institutional funding if we vote No. Clearly, this would be an appalling scenario. Others argue that it would never come to this because of the impact on the Eurozone (defaults, contagion) – another appalling scenario.

This is not a satisfactory way to debate this issue. This will trap us in a ‘race-to-disaster’ debate which will be particularly uninformative. We have attempted to outline concrete alternative funding scenarios for Ireland. Whether these would become available is a subject for legitimate debate. However, those who claim that Ireland would be denied access to EFSF funding – or any other funding sources – should provide concrete evidence to this effect. Evidence one way or the other would be a valuable contribution.

The debate over the Fiscal Treaty should be just that – a debate about the provisions of the Treaty. In this respect, it is helpful to note wider European developments. Spain has, unsurprisingly, officially re-entered recession putting at risk their deficit targets; the prospect of a Socialist Party victory in the French second-round Presidential vote raises the prospect of some renegotiation of the Fiscal Treaty; the fall of the Dutch government over failure to agree budget cuts highlights the problems posed by the Fiscal Compact in a major core country.
As Ireland prepares for the referendum vote, the ground under the Fiscal Treaty may already be shifting. Resort to ‘appalling scenarios’ will only confuse the issue when the debate should be focused on whether the provisions of the Fiscal Treaty are good, or even sustainable, for Ireland and the Eurozone.

The Baltic Experience

Tom McDonnell: Dan O'Brien recently argued that the Baltic countries provide good examples of the case for front loading austerity. He notes that: "Estonia’s GDP grew by a blistering 7.6 per cent last year, Latvia’s by 5.5 per cent and Lithuania’s by 5.9 per cent. The three were – by a considerable distance – the fastest growing economies in the developed world." He suggests that front loaded austerity and greater competitiveness i.e. internal devaluation, are required to resuscitate the economy.

I would argue that this feel good story needs to be put in context. Unfortunately the recent experience of the Baltic countries has not been a happy one and these countries grew so fast in 2011 in part because they had previously fallen so very far. Table 1 of this paper by Terazi and Sanel shows the scale of the decline in real GDP in 2009 alone. The Baltic countries suffered the largest declines in economic output in the EU despite already being amongst the poorest EU states in terms of GDP per capita.

The Latvian experience has been particularly traumatic. This paper from Weisbrot and Ray of the CEPR provides an overview of the Latvian experience. Latvia's loss of output was 24.1 per cent - even larger than Ireland's (see figure 1 for a comparison with historical downturns).The IMF estimates that Latvia's real GDP will only return to 2007 levels in 2016 (see figure 2). Effectively a lost decade and surely no blue print for 'best practice' in managing downturns. Weisbrot and Ray argue that the data contradicts the notion that Latvia's experience provides an example of successful internal devaluation and they caution that weaker euro zone economies should be wary of becoming locked into pro-cyclical policies.

Unemployment in the three Baltic states also remains above the EU average of 10.2%. Estonia fares best at 11.8% while Latvian unemployment is 14.6% and Lithuanian unemployment is 14.3%. The employment rate in all three countries is also below the EU average. Even these figures don't tell the full story as it is estimated that Latvia's net loss of population in 2009-2011 amounts to as much as 10 per cent of the labour force.

Overall the picture is mixed. Estonia has certainly fared better than Latvia and Lithuania. The IMF country report for Estonia is here. Figure 3 on page 23 of the pdf shows the impact on employment since Q3 2007 with net employment still below 2007 levels. GDP still remains below 2007 levels five years on, although Estonian GDP is forecast by the IMF to pass that threshold in 2012 (see table 1 on page 29 of the pdf).

I guess success is relative.

Ireland's funding options: Time to end the 'race-to-disaster' debate

Tom McDonnell & Michael Taft: Even before the wording has been published and a referendum date named there is one issue that looks set to dominate the debate over the Fiscal Treaty; namely, what future financing options does Ireland have in the eventuality of a ‘No’ vote. While we are not taking a position on the substantive issue in this post, the following is intended to aid the debate by helping to answer that question.

The ‘Indispensable’ Condition

First, regardless of the Treaty vote, Ireland is guaranteed funding under the current programme – as long as it meets its targets. A Yes or No vote will not change this.

In the event of a No vote with Ireland unable to fully return to the markets, what would the situation be?

‘ . . . the granting of assistance in the framework of new programmes under the European Stability Mechanism will be conditional, as of 1 March 2013, on the ratification of this Treaty by the Contracting Party.’

This clearly states that new financing under the European Stability Mechanism is contingent upon ratification of the Treaty. However, we would put the following points that suggest that the issue contains potentially significant ambiguity.

First, the text of the European Stability Mechanism Treaty states that there are two conditions for providing support for ESM members:

‘The purpose of the ESM shall be to mobilise funding and provide stability support under strict conditionality, appropriate to the financial assistance instrument chosen, to the benefit of ESM Members which are experiencing, or are threatened by, severe financing problems, if indispensable to safeguard the financial stability of the euro area as a whole and of its Member States.’

The two conditions for support under the ESM appear to be (a) a member-state requires assistance, and (b) such assistance is ‘indispensable’ to the stability of Euro area. The indispensable clause, not surprisingly, is stated four times in the ESM treaty; unsurprising as this is the purpose of the ESM – to safeguard the Eurozone’s stability.

For argument’s sake, let’s assume Ireland – a member of the ESM but having voted No in the referendum – is in demonstrable need of financial assistance; and further, it can be objectively established that, without such assistance, there is a threat to Eurozone stability (issues of both state and bank default which may arise if assistance isn’t forthcoming). A literalist reading of the Fiscal Treaty would seem to settle the issue – Ireland, if voting No, would be excluded from the fund. But how final is this literalism?

‘Indispensable’ to the financial stability of the Euro area does not become less indispensable merely because Ireland, an ESM member, has not incorporated rules (rules that it has already agreed to) into its constitution through a process unique in the Eurozone – that is, a popular referendum. It is difficult to imagine a situation where the financial stability of the Eurozone (and Eurozone countries from Spain to Germany) is at risk and the resolution of that risk is barred because of a referendum result in a member-state. This would effectively undermine the intent of the ESM and its ability to respond to financial risks in the Eurozone.

What this crisis has shown is the flexibility of the Eurozone and EU institutions to respond to the crisis, whether we agree with the policies or not. For instance, the European Central Bank is legally barred from acting as a lender of last resort to sovereign states. But that did not stop it from, first, participating in the secondary bond markets and, second, from providing over €1 trillion in liquidity to European banks through their Long-Term Refinancing Operations (LTROs). The LTRO was intended to indirectly ease pressure on Spanish and Italian bond yields and was effectively a roundabout method of overcoming the bar to lend to sovereign states. Both of these were innovative and flexible responses. This resort to flexibility has implications for Ireland in the event of a No vote.

The Fiscal Compact refers to ‘new programmes under the European Stability Mechanism’. The ‘new’ may provide some flexibility, especially if Ireland is unable to re-enter the market and seeks a continuation of the current programme. This could be buttressed by the statement by the EU Heads of State or Government in July of last year. This, too, is definitive:

‘We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes.’

Minister Michael Noonan confirmed this after the summit:

'There is a commitment that if countries continue to fulfil the conditions of their programme the European authorities will continue to supply them with money even when the programme is concluded . . . The commitment is now written in that if we are not back in the markets the European authorities will give us money until we get back in the markets.’

That both the EU leaders commitment and the Minister’s statement followed on from agreement to establish the ESM – with the same clause that disbursement of funds is based on the same ‘indispensability’ condition referred to above – suggests that there is considerable room for all sides to manoeuvre, even in the eventuality of a No vote. We are not suggesting that this is a definitive outcome. However, resort to a literal reading could lead us to the conclusion that Ireland, even if voted Yes, could be denied funding under the ESM if it was concluded at EU level that assistance was not indispensable to Eurozone stability. We seriously doubt this scenario which is why literal readings of one section of one treaty can lead us to unjustified conclusions. This holds when discussing the outcomes of either a Yes or No vote.

Alternative Sources of Funding

Regardless of the above, there is a credible argument that Ireland, in the eventuality that it needs a second bailout, has access to funding sources apart from the ESM; namely the IMF. This is the same ‘insurance’ or ‘back-stop’ that all EU countries are entitled to as members of the IMF. More EU countries have accessed IMF support than EU support in the last decade: Latvia, Lithuania, Poland, Bulgaria, Romania, Hungary, and Estonia.

The IMF programmes have recently undergone considerable reform in order to tailor support for the specific need of a country. Further support from the IMF does not necessarily have to come via the Extended Facility that Ireland currently participates in. Some of these programmes may even be more suitable to the Irish economy than an ESM programme modelled on the current one. This is because IMF programmes can provide credit lines on a precautionary basis. In these circumstances, Ireland may be able to enter the market even on a partial basis but have recourse to the IMF if and when further support is needed. A particular strength of some of these programmes is that Ireland may not have to draw down any funds (though it would make a ‘down-payment’ to participate in the particular programme).

There is a range of programmes that Ireland may be able to avail of:

Stand-by Arrangements with high-access precautionary provisions. The IMF describes this as its ‘workhorse lending instrument’.

The Flexible Credit Scheme which does not carry with it any conditions (and which the IMF claims ‘reduces the perceived stigma of borrowing from the IMF’.

The Precautionary and Liquidity Line is another line of support which provides finance and, according to the IMF, ‘is intended to serve as insurance and help resolve crises’.

Rapid Financing Instrument provides a quick response to an outside shock – including economic shocks.

These programmes are separate from the current Extended Facility programme we are in. Some have conditions attached to them; one does not (the Flexible Credit Scheme). They have a range of participating and payback periods, with provision for roll-over. We are not suggesting that Ireland would comply with all of the above; however, it shows the considerable potential sources of funding. There are two issues that might arise in considering these alternatives.

First, will Ireland be eligible for future financing? IMF financing is based on quotas assigned to each country with programmes laying down specific amounts that can be lent. However, all the programmes have exceptional access policy whereby limits are waived – with the exception of the Flexible Credit Line which, in any event, has no cap on funding.

In fact, for many countries there is a natural progression from the type of IMF funding Ireland is currently in (an Extended programme) to the programmes listed above. Poland is an example which started out in an Extended Programme, progressed to a Standby Arrangement and is now in a Flexible Credit Line which has no conditions attached. Ireland could make a similar progression.

Second, it has been suggested that the IMF actually regards Ireland as a high-risk country and may, therefore, refuse to lend further. In the first instance this would certainly be curious. To date, Ireland has abided by the programme that the IMF itself helped design (it’s fairly typical of IMF extended facilities). If the IMF suddenly claimed Ireland was too risky, this would be tantamount to an admission of their own failure. Would Ireland be penalised by the IMF for adhering to a programme that the IMF helped designed?

There is a strong argument that Ireland fulfils all four criteria for an ‘exceptional access’:

(a) The member is experiencing or has the potential to experience pressures resulting in a need for Fund financing that cannot be met within the normal limits.

(b) There is a high probability that the member’s public debt is sustainable in the medium term. However, in instances where there are significant uncertainties that make it difficult to state categorically that there is a high probability that the debt is sustainable over this period, exceptional access would be justified if there is a high risk of international systemic spillovers.

(c) The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.

(d) The policy program of the member provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment.

We would draw attention to the condition in (b); in particular where exceptional access is justified if there is a high risk of international ‘spillovers’. There is a strong argument that Ireland is in such a situation. That the IMF participated in the current bail-out, despite the staff country report in December 2010 stating that Ireland would entail ‘substantial risks’, only confirms their determination to participate in programmes where the risks of spillovers are significant.

Another issue is the scale to which Ireland has already borrowed from the IMF. Currently, Ireland is the third largest debtor to the IMF – behind Greece and Portugal. Poland has a similar level of contingent debt, while Mexico is much higher – though these countries are in the Flexible Credit Line have not drawn down funds. There is a limit to which a country can borrow – even if complying with the provisions of the exceptional access. The IMF has lent a considerable amount to EU countries already and while it still retains considerable reserves, and while further precautionary lending to EU countries would not impact unduly, the possibility of larger countries needing assistance (Spain, Italy) could squeeze available funds to Ireland.

Taking all of the above on board, that the IMF has decided to extend its assistance to Greece in the form of a second bail-out suggests that Ireland would be a credible candidate for further support if it cannot access the international markets. If so, this could be a viable alternative to ESM funding.

Appalling Scenarios and a Legitimate Debate

None of the above can be certain. But that is no reason to resort to counter-posing ‘appalling scenarios’. Some argue that Ireland will be frozen out of both market and institutional funding if we vote No. Clearly, this would be an appalling scenario. Others argue that it would never come to this because of the impact on the Eurozone (defaults, contagion) – another appalling scenario.

This is not a satisfactory way to debate this issue. This will trap us in a ‘race-to-disaster’ debate which will be particularly uninformative. We have attempted to outline concrete scenarios for Ireland apart from the ESM. Whether these would become available is a subject for legitimate debate. The fact that Ireland may have a secure safety net with IMF funding is likely to induce cooperative, if ad hoc, relationships with the EU. Competing disaster scenarios will only undermine our understanding of these difficult issues.

In one respect, debating non-market funding has an air of unreality about it – if we are to heed the Government’s dismissal of a second bail-out as ‘ludicrous’. The fact that this issue is being taken seriously is a testament to the common sense of the debate. While we respect the fact that no Government will intentionally play down the prospect of being able to borrow on the international markets, in our own opinion a second bail-out is a real and probable outcome of current policies.

And this is not in the best interests of the Irish economy, whether that support comes from the IMF, the EU’s ESM , some other ad hoc EU support or any combination of these.

Nama Wine Lake on the Promissory Notes

Tom McDonnell: Here is a timely recap by Nama Wine Lake of the grotesque farce that is the Anglo promissory note debacle.

The Fiscal Compact, or: where will we be in 2018?

Tom McDonnell: The debate about the fiscal compact is likely to continue for some time. Much has been made of the 'one twentieth' rule but in practice it is adherence to the rules around the structural balance which will really matter in terms of the fiscal stance post 2015.

Ireland is currently working its way through an Excessive Deficit Procedure (EDP) which requires the general government deficit to be no worse than 3% of GDP in 2015. At that point Ireland will be expected to improve its structural budget balance by converging to a medium term objective of a deficit no larger than 0.5% of GDP. The Department of Finance estimates that the structural deficit will be 3.7% in 2015. If one generously accepts this figure as accurate then the government will be obliged to adopt a fiscal stance consistent with 'correcting' the remaining gap. This will trigger additional discretionary fiscal consolidation equivalent to circa 3.2% of GDP - about €5 billion in 2012 terms (though not necessarily all in the same year). This suggests that the programme of continuous austerity will continue out to 2017/2018. A bleak prospect.

This continuous fiscal tightening combined with the huge private debt overhang will drag on the economy's capacity to generate increases in real GDP. Debt sustainability in the absence of higher inflation (anathema to the ECB) or low interest rates on government borrowings (perhaps by extending the official programme past 2013) will be challenging. The Treaty does refer to an ability to deviate from the medium term objective under 'exceptional circumstances'. It will be interesting to see how this is interpreted in practice and it is possible there may be scope for wriggle room.

The fiscal compact is certainly no panacea for the current crisis though it might ameliorate the severity of the next one. The answers to the current crisis lie elsewhere.