Tuesday, March 31, 2009

Regime Uncertainty

The vulgar Keynesian does not understand that policy activism itself works against economic prosperity by creating what I call "regime uncertainty," a pervasive uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future. This kind of uncertainty especially discourages investors from putting money into long-term projects. Robert Higgs
Are you waiting for the Budget next week? So am I. So is most everyone I’ve spoken to recently. Nobody knows what to expect: other than it won’t be pleasant. Ireland has been gripped by regime uncertainty since last summer – to use Robert Higgs eloquent concept. The uncertainty continues.

Not everyone is uncertain, of course. Standard & Poors decided not to wait for the Budget, and went ahead and downgraded Ireland's credit rating from AAA ranking to AA+. Perhaps they read yesterday’s OECD report showing that Ireland is unique in embarking upon a tax-increasing, deflationary budget among its member nations (see table - HT Constantin Gurdgiev).

Unfortunately the Budget won’t bring certainty – neither to the Government’s own budgetary situation nor to the outlook for Ireland’s businesses and their employees. The regime uncertainty looks set to continue.

Monday, March 30, 2009

About Time

Monday: only five more days 'til the weekend. I remember suggesting a few years ago to a director in IBEC that instead of negotiating pay rises through social partnership, IBEC should negotiate a four day week instead. I reckoned that if we added 3-4 new bank holidays each year for the next ten years we would effectively end up with a four day week. Sadly they went for benchmarking instead ...

As I've noted before, our notions about the normal flow of the seven day week are changing all the time (see Saturday is the new Sunday). One outcome of the Great Recession we are now living through will be a very different social contract in relation to the working week. Not just because of rising unemployment, but also because of the unilateral introduction of shorter working weeks, salary cuts and compulsory holidays by a growing number of businesses (and, before too long I expect, by the public sector).

As Patrick Collinson noted in Saturday's Guardian, the hard distinction between weekday work and weekend leisure only became predominant during the heyday of American industrialisation under Henry Ford. But we now live in a predominantly services economy. Much office-based work (though not all) could be managed on a four-day basis: it already is every time we have a bank holiday. It would simply represent the further maturation of our civilisation, as we reap the rewards of the free market economy not in more stuff but in more time. Acton Institute's Michael Miller puts it eloquently:
The goal of economic liberty is not a society of producers and consumers in equilibrium. Economic liberty is important because it creates space for people to live out their freedom, take care of their families, and fulfill their responsibilities. Economic freedom is necessary because it allows people to take risks and create material prosperity for a flourishing life. Economic liberty is needed because without it there can be no political liberty. Both require individual virtue and a moral culture for sustenance. Neither an adolescent culture following its whims, nor a soulless culture severed from its historical roots, from the sacrifices and struggles of our fathers whose spirit and dedication to freedom made it possible, is adequate.
Living out our freedom includes being free to use our time to earn more money (through work and/or investment) or to use it for the many other things that we value, especially spending time with our family and friends. Restoring Ireland's economy to health will mean not only getting back on a path of growth and job creation, but will also mean recognising that we are 'free to be free'. One of the more delightful ironies of the free market is that it also frees us (eventually) not to be all that engaged in the marketplace, especially the labour market.

There's something to look forward to ...

Saturday, March 28, 2009

Leave The Lights On

What kind of perverse mentality thinks that switching off lights for an hour is a worthy tribute to this beautiful planet we live on? Two billion people don't even have access to electricity and some self-appointed eco-fundamentalists tell us to switch the lights off 'for the Earth'. Are they serious? We spent untold millennia as a species huddled in the dark, fearful of the unseen - yet these people want us to go back to darkness? We insult our ancestors and our fellow human beings still living in the dark with this ludicrous stunt. It's disgusting.

Electric light must surely rank as one of the most beneficial technological achievements of our species. The tragedy is that too many still do not share in that achievement. But they can and they will if we apply our human ingenuity, passion and ambition to the task. As the poet Frederick Turner (whom I've quoted before) puts it:
In economics, we are recognizing the exponential power of markets to generate wealth. Now that we have a global economy, the wealth of the average individual person on this planet doubles every twenty years or so, and our average life-expectancy is now doubling every century. ... The world is not a zero-sum game, but rather a great cascade of gifts; if we lack for anything it is because of a lack of knowledge, not an unavailability of goods. Our problems are those of cash flow, scheduling, bottlenecks and distribution, so to speak, not of the basic health of the balance sheet. We are threatened not by scarcity but glut. If we did not get in each others’ way by bad and over-controlling governments and ideas, we would all be rich.
Sure we're in a recession. But guess what? It will end - just like they all do. And the glories that we have achieved as one of our planet's most delightful species will still be there, ultimately available to every human being. Let the stories our ancestors told one another in the dark continue to unfold. So Just leave the lights on.

And celebrate Human Achievement Hour instead:

Friday, March 27, 2009

Entering Las Vegas

The latest ESRI/PTSB house price measures points to a significant drop in average prices. Irish house prices - like Irish equities - peaked just over two years ago in February 2007. We've been getting poorer since. House prices are down 18% since their peak, equities are down 80%.

Most people with an interest in the housing sector that I've spoken to (lenders, developers, landlords, buyers) are convinced that prices have fallen even further than the average fall indicated by the ESRI data. I'm sure they're right. Moreover, nobody thinks all the price falls are behind us: most expect more to come (a lot more, if you are UCD's Morgan Kelly).

David McWilliams suggested recently that Ireland's story was like that of Las Vegas: we gambled on a perpetual boom and ended up eating (cement) dust. Though Ireland's housing market hasn't fared quite as badly as Nevada's: average house prices in Las Vegas are about 50% down from their peak, and the number of foreclosure house sales now exceeds 'regular' house sales. Maybe it's just a matter of time ...

There are other Ireland/USA parallels as well. I've just read Peter Schiff's book Crash Proof - How to Profit from the Coming Economic Collapse. Cheery stuff. And a remarkably prescient book published at the end of 2006. He famously predicted the credit crisis and the great deleveraging that has followed. And he is unforgiving about the consequences: let the failed banks fail; avoid government binge borrowing to cure the consequences of private binge borrowing; and be prepared for the pain of adjusting to an economy based on wealth creation rather than wealth consumption. Here's a brilliant, sometimes very funny podcast of Schiff speaking recently on the Lew Rockwell show.

Looking at the US housing sector, he expects a major shift towards renting rather than buying. Something he does himself. As he says in the podcast: "People say: 'why rent, you're throwing away money? I say, I need a roof over my head. Accommodation is a consumable like food: yet nobody says 'why are you throwing away money on food'?!" I think his outlook is right for the United States, and it also applies to Ireland, as I've written about myself. The Irish people will shift away from mortgages to renting not because of house price uncertainty, but because of income uncertainty. And that isn't going to change any time soon.

By the way, to get a flavour of Peter Schiff's powers of prescience check out this YouTube video, seen by nearly 1.3 million people already:


Thursday, March 26, 2009

Debt is a Fact, Wealth is an Opinion

How much is your house worth? Less than this time last year, to be sure, but if pushed you'd come up with a 'guestimate', wouldn't you, give or take ten or twenty thousand? How much is your mortgage? No need for pushing, is there? One thing everyone is beginning to realise: debt is a fact, wealth is an opinion. Your mortgage is a number. The value of your house is, well, a mixture of hope, salesmanship and precedent.

I was speaking yesterday at the Irish Banking Federation's seminar on debt management. I was looking at just how big a problem consumer debt is right now; at new research into who in particular is affected by debt problems; and how the current debt situation is impacting the wider economy. You can see my presentation here. Warning: some of the trends are disturbing ...

Other speakers - from the banks, MABS, askaboutmoney.com and Mason, Hayes & Curran - shared their experiences of dealing with debt issues arising from the binge borrowing of the Celtic Tiger years. Sobering stuff, and the scary thing is that our debt problems as a nation are only beginning. What is unprecedented about our debt problems is not just the scale - horrendous as that is - but rather the location of the problem. This is a middle class recession: it is people in their forties and fifties - people who, in the normal scheme of things, would have built up considerable equity in property, shares and pension funds - who have been 'wiped out' financially. As I noted before, we are experiencing not just an income shock - due to rising unemployment - but also a wealth shock due to the collapse in Irish equities and house prices.

And that's what struck me about several of the presentations yesterday: it is 'people who never had debt problems before' who are now a rapidly growing source of demand for services such as MABS (who have seen inquiries double in just twelve months). And their problems are not your common-or-garden credit card/electricity bill sort of problems: rather you get a complex mix of someone like a part-time landlord who has lost his full-time job just as his tenants have upped stakes and left for Eastern Europe, oh, and whose pension fund has been wiped out within a few years of his retirement. I've talked to people like this in focus groups recently and, well, my heart goes out to them. All they can hope for (like the rest of us) is a recovery that reflates the labour market and house prices. You've got to hope.

But what if recovery is several more years away? That's the scary thought. It's all well and good giving someone in arrears with their mortgage a few months 'grace' on the repayments to get themselves sorted (as most banks will if the borrower is behaving reasonably). The problem is when a few months is not enough because the labour market is shut down and the economy is contracting (as it is at present). The danger is a vicious circle - a debt deflation spiral - whereby the 'hard facts' of debt meet the 'increasingly pessimistic opinion' of property prices. The result is the economic equivalent of cardiac arrest, or as Gregor Macdonald puts it - 'the future is cancelled':

The problem, generally, with collapses is that observers think they are simply more extreme versions of a recession. Standard recessions tend to be disinflationary because spare capacity grows and demand falls but each of these occur outside of a catastrophic framework. Production shuts down more slowly, and more reluctantly. Credit carries onward, and the anchors of the banking system remain intact. Much of the work done in a standard recession is preparation for recovery. Much of that work is intentional.

In a collapse of the kind we are experiencing now, however, the future is cancelled as the system both behaviorally and structurally can no longer make plans for it. Production is closed immediately. Labor is let go at a hyper rate. The collapse has started out in textbook fashion with a demand crash, and the result has been what I call a petite deflation. The petite deflation feels strong, because of the rate of change.

The risk now is that we move next into the heart of this bust, which will be an inflationary depression. In its nastiest form, it won’t matter one whit that entrepreneurs want to raise more cattle when beef prices skyrocket, pump more oil when black-goo goes back up in price, deliver more fruit when juice demand rises, or innovate. When the future’s been canceled there will be no credit for any of these business propositions and lenders will say, “I don’t care that X is rising in price and that your plan to more efficiently deliver X looks profitable now.”

Back to the banks again. The banks are at the centre of the debt hurricane now sweeping through our economy. We are experiencing what Edward Harrison and others have described as the Great Deleveraging, to wit:

In a normal recession, credit becomes tight, but it is not central to the downturn. In fact, 80% of the decline in GDP is due to a de-stocking of inventory. Basically, businesses get ahead of themselves and forecast future demand that turns out not to exist. They are forced to ratchet back production and sell off inventories. In this case, policy makers can step in with fiscal and monetary stimulus and re-kindle domestic demand with a bit of a lag. Bing, presto, we are off to the races again. That’s why recessions are over in 12-18 months tops.

That’s not what happens in a depression - and this is a depression. In a depression, what happens is macro disequilibria build up so much and become so unsustainable that when the break in demand happens, there is no bing, presto from traditional policy responses. The leverage and debt in the system is just too large. The debt cannot be worked off without de-leveraging.

The problem, as I see it, is that even if the government 'rescues' the banks (i.e.: gives them taxpayers' money), many middle-aged, middle-class householders will be stuck with property-related debts that they have no chance of paying off due to falling house prices and income losses. In that scenario, people are going to get (even more) angry with the banks: as Fred Goodwin has just discovered. They will not take to their new impoverishment peacefully, and they won't be long reminding politicians that householders have votes, not banks.

Wednesday, March 25, 2009

In Praise of Failure

I've been a fan of Nassim Nicholas Taleb ever since I heard him in an EconTalk podcast a couple of years ago. I've heard him a lot since, and whenever you hear someone repeatedly it does tend to seem like he's saying the same thing over and over again. So I approached the latest EconTalk interview - a sequel to the previous one in effect - with some trepidation, partly expecting a repeat of much of what he had said before. Fortunately it isn't, and instead we are treated to some interesting discussions about medical discoveries, religious beliefs as insurance against probability, why most universities are poor innovators, and Hayek. With the occasional sideswipe at the 'quants' who brought about the current financial crisis. It's good stuff - well worth listening.

Taleb's core thesis in his books is that historical data (always partial and incomplete) is rarely able to prepare the user for extreme shocks in the future (fat tail events, as he calls them). Failure in human affairs is both inevitable and, often, beneficial. He makes the point in the podcast that capitalism is about failure. Figuring out what doesn't work (or what the market doesn't want) is as important a part of the free market mechanism as is figuring out what works and is successful. Which is why he is angry about the various attempts now being made to rescue failed banks around the world. They should be allowed to fail so that others will succeed, presumably by avoiding the mistakes of the failures. But that doesn't seem to be what is happening in Ireland or elsewhere. As Interfluidity puts it about the US (and similar) bank rescue package:
Of course the whole notion of repairing bank balance sheet is a lie and misdirection. The balance sheets we should want to see repaired are household balance sheets. Banks have failed us profoundly. We want them reorganized, not repaired. A world in which the banks are all fixed but households are still broken is worse than what we have right now. Too-big-to-fail banks restored to health are too-big-to-fail banks restored to power. The idea that fixing legacy banks is prerequisite to fixing the broad economy is a lie perpetrated by legacy bankers.
Taleb's perspective is similar to that of Paul Ormerod, a former colleague, whose book - Why Most Things Fail - anticipates (because it predates) some of what Taleb has to say in The Black Swan. I've just finished reading it and would recommend it. One thing Ormerod points out in his book is that:
More than 10 per cent of all economically active firms in the US become extinct each year. It is a distinctive feature of firms, and any theory of the firm should attempt to explain it. Conventional economic theory can only do so by positing an endless supply of completely unexpected shocks, for otherwise the perfectly informed, rational decision-making firm could never die. It would live forever ...

To repeat a key phrase which needs to be hard-wired into the brain of every decision-maker, whether in the public or private sector, intent is not the same as outcome. Humans, whether acting as individuals or in a collective fashion in a firm or government, face massive inherent uncertainty about the effect of their actions.
Ormerod also has some interesting things to say about the dangers of regulation in light of his analysis (as does Taleb in his interview: it was regulators who insisted on the use of 'value at risk' measures that misled market participants as to the true nature of the risks they were taking, or 'returnless risks' as he sarcastically puts it). Here's Ormerod:
Regulation that serves purely to intensify the internal degree of competition in a dynamic, evolving system can have adverse consequences for the system as a whole. As the degree of this kind of regulation increases, initially the adverse consequences are small, but beyond a critical level their impact grows rapidly. And with a high degree of such regulation, the fitness of the system begins to approach zero, at which level it risks total extinction.
Wise words as we anticipate the handover of billions of taxpayers' euro to Irish banks to ensure their 'survival'. What if we end up ensuring the precise opposite? Fat tail anyone?

Tuesday, March 24, 2009

Northern Exposure

We should be grateful that the Northern Ireland Assembly doesn't have taxation powers. Otherwise the already significant advantages Northern businesses enjoy relative to their Southern counterparts would become an even greater source of competitive advantage. The Department of Finance's report on Cross Border Shopping projects that Southern consumers will spend up to €700 this year in Northern Ireland (see table). From discussions I've been having with Southern consumers in focus groups recently, that projection just might be on the conservative side.

Though retailers in the Republic of Ireland hardly need to be told about the competitive threat posed by the North's tax and cost advantages, other businesses are waking up to it too. On most measures that matter - price levels, wage levels - Northern businesses start with much lower outlays to get going and keep going, even as growth slows. Even social welfare payments in the North are a fraction of their Southern equivalents (hence the incidence of cross-border 'welfare tourism'). As Michael Taft points out (okay, he doesn't - but the data's there): a single person in the North receives little more than half the unemployment benefit of the same person in the South.

Add in the onset of deflation in the UK for the first time in 50 years and the exposure of Southern businesses to the Northern competitive threat just keeps growing. One consolation though: from my conversations with Southern consumers they are rapidly becoming as canny as their Northern counterparts in demanding and getting better deals. That's a piece of North-South convergence we should all welcome.

Monday, March 23, 2009

Immoral Outrage

The demand for limited government has absolutely nothing whatsoever to do with a belief in the essential goodness of human nature. No - all human beings can be, and often are, selfish, destructive, venal, vicious, stupid and desperately wicked. Rather, it is based on an insistence that the political class are made from the same human material. Shuggy's Blog

Poor old Gerry Ryan - I kind of felt sorry for him as he wilted under the gentle prodding of his employer, listeners, colleagues, and other media all telling him to 'take the cut'. As one, fictional RTE presenter (Ross O'Carroll-Kelly's mother) lamented in a recent hilarious instalment: "A pay cut? I’ve never heard the like of it in my life. Do you think if advertising revenue was up, they’d be phoning me saying, ‘This is terribly embarrassing, but we’ve suddenly got lots and lots of money – we’re going to give you a ten percent increase’? Of course they wouldn’t! So I don’t want to hear any more of this paycut nonsense."

Gerry is a victim of the 'visible fist': an apt metaphor for what happens when governments and politicians decide to make pay a policy issue. Just look at the furore over the AIG bonuses in the United States and the dangerous decision to introduce special, retrospective taxes specifically to claw back up to 90% of the same bonuses.

But I tend to find this type of moral outrage more than a little galling. After all, the biggest employer in this country (and most others) is the government itself. And our own government has been AIG-like in its extraordinarily generous remuneration packages (including pensions) for most of its senior employees. Most comparisons of the salaries of senior, Irish public sector employees with their counterparts elsewhere are embarrassing in their largesse relative, indeed, to much larger and richer countries. One such comparison that brought it home to me was that the governor of the Central Bank of Ireland (most of whose work is now done by the ECB) is paid more than twice what Ben Bernanke earns as head of the Federal Reserve.

The immoral outrage that we have been subjected to in recent months fails to address two key questions, namely: 1) what is any employee worth; and 2) why should any employee be paid more than another? Gerry Ryan can point to advertising revenues for his show in relation to the first question, but most of us don't have such direct indicators. As for the second: could anyone do as good a job as Gerry (or better) for considerably less? Perhaps: RTE would take a risk replacing him (assuming they could contractually etc) - would the pay off in cost savings offset any potential advertising reduction? Tricky one that. Same goes for the heads of Irish banks who have had a cap put on their salaries in return for receiving taxpayer support. What should they be paid? Or their new political masters come to think of it?

In a free market, of course, the price of labour is set in much the same way as other prices: through the interaction of willing buyers and willing sellers. When demand exceeds supply the price of labour goes up (as it did, during the boom); when supply exceeds demand then the reverse applies. Or at least it should: but then don't forget we have a panoply of minimum wages, social welfare entitlements, labour market regulations, trade unions and professional bodies, social partnership agreements etc to ensure that demand and supply are more likely to be mis-aligned than aligned much of the time. Add in politicians trying to score points and adopt poses to prove they are more outraged than the next representative and it risks turning quite nasty. Especially when they used the boom years of the Celtic Tiger to pay themselves salaries that would make some premier league footballers blush. I'm with Don Boudreaux when he vents his moral outrage at all this immoral outrage:
The single greatest instance of intellectual foolishness today is the continuing pretense that politicians are serious people worthy of serious consideration. They are scoundrels, each and every one, regardless of party (although some of them, it is true, are more scoundrelly than others). For any scholar to pretend that these people are disinterested servants of the public welfare -- to pretend that the words politicians utter or send out in press releases are meant to promote any goal other than politicians' own glorification and pursuit of power -- is for that scholar to be duped to a degree that should be more embarrassing than would be the discovery that that scholar believes the earth to be flat or that Big Foot was in league with Lee Harvey Oswald to murder JFK.
So we should be very careful about letting politicians use the visible fist to answer questions best left to the invisible hand. I'm sure Gerry would agree.

Sunday, March 22, 2009

Mum About Marriage

A happy Mother's Day to all mums. The latest CSO statistics on births, deaths and marriages (pdf) show that becoming a mother is increasingly popular in Ireland, with our birth rate substantially up on a decade a go. This is good news: many European countries are experiencing a decline in births. Even better news is that marriage is also increasingly popular - as the chart shows. And this despite the poisonous, PC-led attempt to foist the word 'partnership' on us: the Irish people, in their usual wisdom, aren't buying it.

The ongoing debate in the United States about gay marriages has certainly had the effect of forcing those who favour the concept of heterosexual marriage to to justify their preference for the institution itself. Ryan Anderson provides a concise justification when he observes that:
Marriage attaches a father to his children -- and to his children's mother -- and fulfills the societal need for children to have the love and care of both mother and father. This institution is the natural response to human sexual embodiment as male and female, to human longing for bonding and intimacy, and to human dependency and need (especially in view of the fact that human newborns, unlike newborns of many other species, require many years of nurture before reaching self-sufficiency). That is why a well-ordered society protects and encourages marriage in the first place.
That last point about a 'well-ordered society' is vitally important. We give our children the best chance possible by raising them in families with their father and mother present - and marriage tends to maintain that presence better than any other arrangement. Their chances of going on to higher education, to gaining employment and to avoiding crime are vastly higher. Which is good for the children, and good for our society. Again, the Irish people get this: which is why the vast majority (68%) of births are to married women.

Even more encouraging is the greater involvement by fathers in family life. This has always been a bone of contention with most married couples with children. It even figures in this delightful series of Tests for Husbands and Wives from the 1930s (go ahead: rate yourself against your parents'/grandparents' marriage!). Looking ahead, new UK research suggests that family life is going to become more cohesive over the next 20 years - reversing some of the trend in family breakdown of recent decades. All because fathers are becoming more involved in family life: sharing more of the responsibilities that too often fall on mothers. A small silver lining perhaps in a cloudy sky of uncertainty.

All-in-all it looks like a good future for mothers and their families: that's something to celebrate on the day that's in it. Anyway, got to go, my turn to make the dinner ...

Friday, March 20, 2009

Inconspicuous Consumption

The latest Retail Sales Index report from the CSO is - to put it mildly - horrendous. This is economic bungee jumping without the bungee. Total volumes are down -20.4% year-on-year in January 2009. Sure, the motor trade have contributed much of the decline, but every single other category is showing year-on-year declines: up to -34.2% in the case of furniture.

As the table shows (which I created using annual CSO data re-based to the current 2000 base - click on it for a larger version), some categories are showing volumes down at levels last seen in the late 1990s. Some - such as bars - are actually down to levels from before 1995 (earlier data isn't available on the otherwise excellent Database Direct facility). Like I said: horrendous.

It seems as if Irish consumers are conspicuously not spending right now. Indeed, feedback from various focus groups I have been involved in recently would suggest that there is a mindset out there among many people that they should not be seen to be spending. Especially on cars, furniture and other big ticket items. Or else they're taking their fragile earnings and spending them across the border.

Which brings us back the government's challenge of catching the falling knife. With consumer spending this fragile, what will income tax rises and a slew of stealth taxes do to spending? Constantin Gurdgiev is wondering as well.

Guess I'm going to have to get that retail data from the CSO for the early 1990s in order to track how far some volumes will fall in the months ahead.

Tuesday, March 17, 2009

Ní Neart go cur le Chéile

We live not only our own lives but, whether we know it or not, also the life of our time. Laurens van der Post
The 'life of our time' is not an easy one in Ireland right now. But on the day that's in it, let us remember those who have gone before us and endured much, much more than we are called on to endure right now.

Let us also take our cue from St. Patrick: clearing an island this big of snakes was no mean task! And he surely didn't do it alone. As the old Irish saying goes: together we are stronger.

Happy St Patrick's Day!

Monday, March 16, 2009

Deflate the State

The Bank of England Quarterly Bulletin for Q1 2009 has an interesting analysis of the hypothetical impact of deflation. For the UK, the prospect of deflation remains just that, something that might happen since consumer prices there are still rising at 3.0%. Here in Ireland we are already experiencing deflation, the annual Consumer Price Index fell -1.7% in February. Recent forecasts from Ulster Bank project annual deflation of -4.0% for 2009, the first time we will have had a full year of deflation since the Second World War, as illustrated in the chart from their quarterly report.

Though there is much to be said in favour of deflation, the Bank of England analysis reminds us of some of the disadvantages (illustrated with reference to the situation in the UK), particularly in terms of a deflation that follows a credit boom (or debt deflation in the jargon):
The key element to the debt deflation channel is the transfer of wealth from debtors to creditors caused by an unexpected fall in inflation. Since debtors are likely to have a higher propensity to consume than creditors, demand is likely to fall. For this mechanism to matter, the fall in inflation must be unexpected relative to when the debt contract was entered into; so for example, if inflation were to fall unexpectedly by 2% for two years, the real debt burden on existing nominal contracts would necessarily be 4% higher. To the extent that borrowers are committed to fixed interest rate payments on their loans, then the burden of real interest payments will be correspondingly greater too; in the United Kingdom, some 40% of mortgages are on a fixed-rate basis. And real interest payments would also increase if nominal interest rates did not fall in line with inflation either because policy is prevented from doing so ... or because banks increased their lending margins. There is some evidence that this has been happening recently in the United Kingdom.
Here in Ireland we now have a situation whereby many households and businesses with fixed rate borrowings (or slow-to-adjust-downwards borrowings), are caught in a debt deflation trap: their incomes/revenues are contracting but their debt repayments remain fixed and are actually increasing in real terms. Research by my own company for the National Consumer Agency, published yesterday, shows that nearly one in four adults in Ireland are now finding it difficult to meet their loan and/or mortgage repayments (see slide 12).

But it isn't just households and businesses that can get caught in a debt deflation spiral. So also can the state. Colm Keena points out in today's Irish Times that as the economy shrinks the cost of funding the National Debt rises (even at near zero interest rates). With the government under increasing pressure to borrow, the prospects of funding extra debt looks increasingly onerous - especially if the economy shrinks next year as well (as Ulster Bank are forecasting).

So rather than all sink together, we need to put in place something like the Grand Bargain that John McHale describes over at the Irish Economy blog: including a 10% nominal wage cut for the public sector and a freeze on social welfare payments. Not very pleasant for those affected, but a lot less pleasant than the 100% cuts some 1,000 private sector workers are experiencing every day as they lose their jobs. The recent NESC analysis of Ireland's Five-Part Crisis reaches a similar set of conclusions about how to restore sustainability to the public sector's finances, including:
  • The desirability of prioritising services and employment over remuneration in the adjustment period;
  • The key role of the new public expenditure review group in identifying opportunities for improved value for money;
  • Ensuring the immediate retrenchment measures are consistent with desirable structural reform and long term goals;
  • Ensuring that borrowing is kept at a manageable level; and
  • Addressing the long standing challenge of public sector reform to achieve a real improvement in value for money in the use of public resources.
Which I presume is 'Social Partnership speak' for:
  • cut wages, not jobs
  • spend money more efficiently
  • don't cut valuable capital spending
  • keep the ECB/Germans/CDS markets happy
  • increase public sector productivity
All very sensible, and it might work too - so long as the public sector trade unions do not insist on outsourcing the recession to the private sector as they have until now (all in the name of 'fairness' of course).

But getting it right in the forthcoming budget will be a necessary but not sufficient condition for recovery. We still have the appalling overhang of the banking crisis and all that it means for Ireland's reputation abroad as well as for the domestic economy. This was brought home to me by a recent IMF paper on The State of Public Finances: Outlook and Medium-Term Policies after the 2008 Crisis (pdf). Table 1 on page 7 shows the Irish Government's exposure to the financial sector (in terms of support and commitments) equal to 263% of GDP - vastly higher than any other country surveyed, and nearly ten times G-20 average. Boy have we boxed ourselves into a corner ...

And of course the two issues of the budget and the banks are connected. The right budget will send the right signals to the international markets that Ireland means business. This is important because today's FT Alphaville reports a UBS study showing that two thirds of the increase in Ireland's and others' sovereign CDS spread is due to risk aversion rather than fundamental doubts about the economy. A point supported by a separate analysis of the recent increase in the US CDS which notes that:
The most important point to be made here, the same one I make in my AIG post, is that, one shouldn’t look at CDS as a “default” trade. Though their pricing is clearly driven by the likelihood of default and the payout upon default, I can tell you that 99% of people buying CDS do not believe that the entity upon which they are buying protection will actually default. In this, they are similar to investors in stocks. People buy and sell stocks because they think the stock in question will increase or decrease in price. Same goes for CDS.

... I think one thing we can safely dismiss as the driver behind the widening of US CDS spreads, or in fact any sovereign spreads, in the market is any kind of fundamental view of where these spreads should be.
This is good news for Ireland: get the Budget right - including a measured contraction in public sector spending that does not exacerbate the already weak level of demand - and we will likely be rewarded quickly by falling CDS spreads and access to cheaper borrowing. This will even help Ireland's personal and business borrowers - which in turn can help us avoid the debt deflation spiral that threatens to leap from the text books into reality.

Destructive Creation

I was at the Bizcamp Dublin event just over a week ago. Inspiring stuff: scores of entrepreneurs, start ups and new companies saying 'feck the recession' and getting on with business. There's another one next week in Limerick: if you're in the area and your in business it should be worth your while attending.

I especially enjoyed talking to a lot of entrepreneurs because a lot of the day job in Amárach Research is spent researching clients' innovations, inventions and ideas. Including not a few entrepreneurs. We get to do a reality check on their ambitions by road-testing their concepts with consumers. Reporting on the ones that are successful is fun. Reporting on the ones that are unsuccessful is a tad more difficult. But the story is usually always the same: no matter how 'brilliant' the innovation if consumers aren't interested then it's dead in the water. They just don't get past the Inception stage in the graphic. One of the speakers at Bizcamp - Caelen King - made a similar point: don't over-invest in the concept or application until you've established there's a real market for it.

Some of the lessons from our experience and others involved in researching innovation are captured well by Chris Lawer who reminds innovators to ask the following questions:
  1. Do you know exactly who will be the likely target customer or target segment of your concept / product?

  2. Do you know the market size of the target buyer / segment?

  3. How will this market size change at the time of launch?

  4. Will the concept / project address known, quantified important unmet customer needs?

  5. Do you know what these unmet needs are without ambiguity?

  6. What improvement in satisfaction in needs will the project / concept achieve?

  7. Do you have the optimum number of features and functions on the platform matched to unmet needs?

  8. Have you defined a clear value proposition for the concept based on unmet needs?


And he didn't even mention patents ... But there is a bigger point here than just the obvious need to understand your potential customers better. It is that the current emphasis on innovation in Ireland - especially via the medium of an expensive expansion of 4th level education - may be seriously flawed. Take the recent announcement that UCD and TCD are creating a new joint enterprise development unit to capture knowledge and seek opportunities for ideas and inventions. To be achieved by "establishing a fourth level innovation academy to plan and ensure the quality of research across the two campuses, with a view to doubling the number of PhD students in science, engineering and technology to 1,000 per year". This in turn will apparently created 30,000 sustainable jobs over the next 10 years. A case of 'think of a number and raise it to the power of n' for the press release methinks. Still - I wish them well: I hope it is a precursor to a far more radical rationalisation of Ireland's wasteful and ineffective third level sector.

But I think it is worth exploring the assumptions behind this initiative in relation to innovation and its exploitation via commercialisation. There appear to be two key assumptions, namely:

1. The primary channel for government policy to stimulate innovations that can support economic development in Ireland is via the third/fourth level.

2. People with PhDs and post-doctoral experience in third/fourth level institutions are optimally equipped to support the commercialisation of their inventions/innovations.

I beg to differ on both counts. Firstly, we are seriously mistaken if we assume that invention and research (especially at the pure science end of the spectrum) is the best way to deliver innovation-led economic growth. It isn't. As I noted before, Ireland is more likely to gain from other people's inventions in other countries than from any inventions of our own. Amar Bhidé has done an excellent job of deconstructing this absurd 'only-invented-here' attitudes toward innovation that seems to grip governments in most developed countries. As he observes:

Techno-nationalists and techno-fetishists oversimplify innovation by equating it with discoveries announced in scientific journals and with patents for cutting-edge technologies developed in university or commercial research labs. Since they rarely distinguish between the different levels and kinds of know-how, they ignore the contributions of the other players—contributions that don’t generate publications or patents.

They oversimplify globalization as well—for example, by assuming that high-level ideas and know-how rarely if ever cross national borders and that only the final products made with it are traded. Actually, ideas and technologies move from country to country quite easily, but much final output, especially in the service sector, does not. The findings of science are available—for the price of learned books and journals—to any country that can use them. Advanced technology, by contrast, does have commercial value because it can be patented, but patent owners generally don’t charge higher fees to foreigners. In the early 1950s, what was then a tiny Japanese company called Sony was among the first licensors of Bell Labs’ transistor patent, for $50,000.

In a world where breakthroughs travel easily, their national origins are fundamentally unimportant.
Well worth reading the entire piece - including the accompanying discussions over at McKinsey's What Matters section on Innovation. It seems to me a lot of the current obsession with innovation via universities is to do more with the old idea of government picking winners. I'm inclined to agree with Will Wilkinson that government involvement in pure science research is inevitable and mostly desirable, but the further you get away from pure research then the less obvious is the case for involvement.

But even if somehow our expanded fourth level does deliver the goods in terms of inventions and scientific discoveries with commercial/patentable potential can they then exploit them? Hence my second concern about the current strategy: acquiring a PhD doesn't necessarily qualify you for entrepreneurship or equip you with the necessary commercial skills. Not at all in fact. As the Economist notes this week in an excellent supplement on Entrepreneurship, there are five myths about entrepreneurs that need exploding:
  1. Entrepreneurs are lone heroes: actually no - they all need an established network of advisors, mentors, friends and colleagues to succeed.
  2. Entrepreneurs are relatively young: again no - in the US there are twice as many businesses founded by over 50s as by under 25s (though there is some evidence of creativity following a 'hump-shape' distribution by age pdf).
  3. Entrepreneurs depend on venture capital: another myth - mostly it's a mix of loans from banks, relatives, and the occasional investment by a business angel.
  4. Entrepreneurs have to be inventors: a few are, but many more innovate around processes rather than products.
  5. Entrepreneurs must be in start up businesses: many do, of course, but many large businesses encourage their own subsidiaries and divisions to be entrepreneurial, with considerable success in some instances.
No mention there of the 'smart economy'. Though entrepreneurs do need smarts - as well as guts and, most especially in my experience, luck. The bottom line is that I expect most of the PhDs emerging from the 'innovation academy' will want to be, well, academics. There's nothing wrong with that per se - I'd personally like to see Irish academics rating higher globally in disciplines such as economics and others that I am interested in. I suspect several will in due course.

But I'm just not sold on the idea of their being the front line of developing a 'smart economy' - whatever that is. Especially when I have learned at first hand of two innovative Irish companies that have either had second round financing by Enterprise Ireland cancelled (the company was planning to hire software engineers), or first round financing put on hold both 'because the Department of Finance are pulling in budgets'.

Maybe a new fourth level centre on 'joined-up-thinking' might deliver real value come to think of it.

Saturday, March 14, 2009

Cent Wise, Euro Foolish

Imagine you run an investment fund in Germany and you are looking around for places to invest your money (what's left of it). How likely are you to invest in an Irish bank right now? Unlikely, I'm sure you'll agree. Very. Which brings us to the problem facing the Irish government and its plan to divert rapidly declining tax revenues in order to invest in AIB and Bank of Ireland in the coming weeks. The plan is contingent on the likes of our hypothetical German fund manager coming up with the goodies as well. There's the problem.

Which must eventually mean the government will have to come up with a Plan B. Such as the Plan A advocated by Willem Buiter to separate out good banks from bad banks. Moreover, as he explains today, such a plan is a) better for the taxpayer and b) fairer as well:
The Good Bank solution favours the tax payer. The Bad Bank solution favours the unsecured and non-guaranteed creditors of the zombie banks. ‘Tax payer’ includes those beneficiaries of public spending programmes that may have to be cut to meet the fiscal cost of purchasing or guaranteeing the toxic assets under the Bad Bank solution. It also includes those who lose as a result of future inflation or sovereign default, should either of these two solutions to dealing with the public debt created as a result of the Bad Bank solution eventually be adopted.

... There can be no doubt that, from a distributional fairness perspective, the Good Bank solution beats the Bad Bank solution hands down.

The Bad Bank solution creates moral hazard, because it rewards past reckless investment and lending. It also represents an inefficient use of public funds in stimulating new lending by the banks. To stimulate new lending, a subsidy to or guarantee of new lending is more cost efficient than the ex-post insurance of losses that have already been made on old lending, even though their true magnitude is not yet known. The Good Bank solution leaves the toxic waste with those who invested in it and with those who funded these activities, freeing government funds for reducing the marginal cost of new lending or increasing the expected return to new lending.

We also need to recognise that Ireland shares many of the same banking and economic problems as other countries. As John Redwood MP notes in another one of his excellent blog posts (is there a single Irish TD capable of similar clarity and insight?):
The UK, the US, Spain, Ireland, the Eastern Europeans and a few others borrowed too much. Banks got over extended, and then the authorities called abrupt time on the party leading to a huge hangover. Meanwhile China, Germany, Japan, and some others worked hard and saved hard, building up large surplsues which they lent back to the overborrowed.

The different countries need different solutions to help resolve the crisis. The saving and exporting countries could afford to spend more and create more demand at home. That would be very helpful. The countries that have borrowed too much need to control their borrowings and learn to live closer to their means. They need to save and export more, not reflate by borrowing too much.

The bad banks should not be bolstered and subsidised on the collosal scale this government favours. They should be made to own up to their losses, cut their costs, and get their businesses into shape. Far from lending more, they should be getting their risks into line with their capital. If the government must see more lending to UK businesses and individuals it should be done through good banks and new banks, not through the costly and distorting mechanisms of the bad banks. The government should learn that business does not need more loans, but more orders, not more bank debt but more revenue.

The approach our own government is taking risks burdening a generation of tax payers with a 'solution' that will only exacerbate the economic difficulties we now face. And pathetic acts of stunt politics - such as capping the salaries of senior bank officials - won't make a blind bit of difference to the outcome. A classic case of 'cent wise, euro foolish'.

Friday, March 13, 2009

Catch the Falling Knife

Another Americanism: 'catch a falling knife' refers to an investor strategy of buying falling stocks as they are about to stop falling and start heading back up. The 'falling knife' bit refers to the obvious challenge of timing the purchase so stocks really are at the bottom - otherwise your purchase will keep falling and 'cut' you in the process. Ouch.

By analogy it seems to me that the government is facing a similar 'timing' problem right now. They want to increase taxes without turning the current consumer spending retrenchment into a rout; and they want to maintain a high level of public spending without blowing the targeted 10% budget deficit to GDP ratio and frightening international markets. Come to think of it they're trying to catch falling knives ... tricky.

As I note in a comment on a post over at Progressive-Economy@Tasc, my worry frankly is that we are nowhere near the bottom of the economic cycle (or cliff dive if you prefer more literal descriptions) and that borrowing-fuelled spending now will leave us in an even deeper hole as we face into a continuing economic contraction in 2010. It might work in the United States (a big 'might'), or Switzerland or Canada or Norway: but in Ireland's case we are severely stymied by the absence of a currency depreciation option and the disastrous situation in our banking sector.

To make matters worse, the income shock we are experiencing as GDP contracts is but a temporary glitch relative to the wealth shock that will reverberate for decades to come. With Irish equities down by more that the Dow Jones following the 1929 Wall Street Crash at the same point after the fall started, and house prices probably only half-way to their ultimate contraction of 40% or more, the last thing we need is a huge surge in government debt to add to our long term liabilities.

I wonder what is the economic equivalent of chain mail gloves?

Thursday, March 12, 2009

After America

It's a sign of the times: Devo are releasing a new album. Who? Okay, they're a minority taste (they were back in the 1980s come to think of it), but their cover of the Rolling Stone's (I Can't Get No) Satisfaction is still, in my humble opinion, waaayy better than the original. Though I hasten to add I like the original too ...

Devo stands for 'de-evolution': the idea that societies can go backwards was well as forwards (the evolution bit). Back in the 1980s, the idea that things could get worse rather than better wasn't too hard a sell it has to be admitted. The band hails from Akron, Ohio - one of those rust-belt cities left behind in the 1980s and 1990s. So is 'de-evolution' back on the menu of possible futures for America?

I don't know, but truth is I worry about America. Partly for Americans themeselves (a very likeable people in my experience: they could teach the rest of us much in the way of civility and good service); but also for the rest of us - where America goes ...

Looking at the challenges facing Obama I am inclined to hope (sincerely) that he succeeds, but fear, frankly, that he will fail. The size of the gamble he is taking with the massive reflationary measures that have been proposed (and the budget deficit they imply as shown in the chart), is one of those double-or-quits kind of measures that don't tend to give unlucky participants a second chance.

I noted before when I was last in the United States the extent to which America is a land of contradictions. A land that purports to value freedom above all else and yet seems to be in state of semi-permanent 'lockdown', to borrow one of their ubiquitous additions to the English language. Indeed, as this powerful essay by Glenn Loury points out: the United States has become a nation of jailers. The statistics are quite horrific:
We imprison at a far higher rate than the other industrial democracies — higher, indeed, than either Russia or China, and vastly higher than any of the countries of Western Europe. According to the International Centre for Prison Studies in London, there were in 2005 some 9 million prisoners in the world; more than 2 million were being held in the United States. With approximately one twentieth of the world’s population, America had nearly one fourth of the world’s inmates. At more than 700 per 100,000 residents, the U.S. incarceration rate was far greater than our nearest competitors (the Bahamas, Belarus, and Russia, which each have a rate of about 500 per 100,000.) Other industrial societies, some of them with big crime problems of their own, were less punitive than we by an order of magnitude: the United States incarcerated at 6.2 times the rate of Canada, 7.8 times the rate of France, and 12.3 times the rate of Japan.
Perhaps this extraordinary culture of punishment is an inevitable corollary of America's extraordinary religiosity? It's a factor, alongside the gruesome legacy of endemic racism, social disadvantage and the absence of the social binds of collective welfare provision that Europeans and others have adopted (with all their own unique faults).

The prison statistics are just one indicator of the seismic tensions underlying America's society and economy. But what if Obama fails? What then of the tensions that threaten to erupt? I'm inclined towards a view of America's future similar to that described by Bruce Sterling in his book Distraction: a Balkanized United States characterised by regional power struggles and ongoing social and economic convulsions. Though Sterling's book was a work of science fiction, there are some commentators, such as Dmitry Orlov, who speculate that the social collapse of the United States is inevitable, just as it was in the USSR (n.b.: as 'pessimism porn' goes, this is hard core - you have been warned!) Mind you, for a while there I thought Ireland was rapidly transitioning to Stage 3 of his Five Stages of Collapse: but I'm more optimistic for now.

Nevertheless, America won't be the same again when this crisis has passed, nor will Ireland come to think of it. I hope that 'Hope' is enough. But in the meantime, there's always Devo ...

Wednesday, March 11, 2009

Taking Our Medicine

Deutsche Bank Research published a commentary today on Ireland's situation. If they were Americans I would summarise their message as 'suck it up'. Instead they conclude:

Due to the protracted economic recession (real GDP already contracted by around 2% in 2008 and is forecast to fall further in 2009/10) the former Celtic Tiger with annual average real GDP growth rates of 7.5% (1995-2007) has become a patient that needs to swallow the bitter medicine of correcting past exuberance.

The crucial element of their analysis is what is happening to housing (and the wider fallout from same). It is only through a recovery in house prices, land prices and with them bank balance sheets that we will see the surest signs of recovery. But as the chart shows (from a fairly gloomy analysis of the outlook for the UK's housing market), it isn't entirely clearly that the worst is over for housing yet. Irish house prices are 17% below their peak in February 2007 (coincidently - or was it? - the month the the Irish stock market peaked). But nobody seriously thinks that all the bad news on housing has been priced in to today's prices. We're in the blow off phase all right, but I suspect we're closer to the bull trap than to the slough of despair. Time will tell, and fairly soon I suspect.

The DB Research also touches on the difficulties facing the Irish government in terms of using fiscal policies to see us through the current crisis - sovereign bond and CDS spreads and all that. But I think Willem Buiter comes closer to explaining the problems facing the Irish government, though it happens to be in the context of his concerns about the current Keynesian policies of the US government. He notes in relation to the conditions for Keynesian policies under a depression-economic situation to succeed that:
... even if two of the necessary conditions for ... are met - (1) there are widespread idle resources of labour and capital to meet demand and (2) there are sufficient numbers of liquidity-constrained and current-disposable-income constrained households that act as ‘myopic’ current income-constrained, Keynesian consumers - there is still an important and potentially binding financial crowding out constraint on the ability of governments to use expansionary fiscal policy to boost aggregate demand.

In addition to (1) and (2) being met, there must be sufficient ‘fiscal spare capacity’ - confidence and trust in the financial markets and among permanent-income consumers, that the government will raise future taxes or cut future public spending by the same amount, in present discounted value terms, that they want to boost spending or cut taxes today. Without this confidence and trust, financial markets and forward-looking consumers will be spooked by the spectre of unsustainable fiscal deficits. Fear of future monetisation of public debt and deficits, or of future sovereign default will cause nominal and real long-term interest rates to rise. Ultimately, the sovereign will be rationed out of its own debt market.
That's the scary prognosis for Ireland: we simply don't have the 'fiscal spare capacity' with our budget deficit already plunging towards 10% of GDP and tax revenues in free fall even as public expenditure marches sublimely upwards. And with the construction sector in the deep freeze until house prices start picking up again then it really does look like we'll have to just take the medicine, bitter and all as it undoubtedly will be.

Monday, March 9, 2009

Let's Be Civilised

I am fascinated by ancient history. The older the better. I was intrigued by recent reports about the site of Gobekli Tepe in Turkey - described as the most important archaeological site in the world. Here's why:
The first is its staggering age. Carbon-dating shows that the complex is at least 12,000 years old, maybe even 13,000 years old.

That means it was built around 10,000BC. By comparison, Stonehenge was built in 3,000 BC and the pyramids of Giza in 2,500 BC.

Gobekli is thus the oldest such site in the world, by a mind-numbing margin. It is so old that it predates settled human life. It is pre-pottery, pre-writing, pre-everything. Gobekli hails from a part of human history that is unimaginably distant, right back in our hunter-gatherer past.

It seems the impulse towards civilisation has been around a great deal longer than previously thought. Fascinating - and kind of reassuring. Even as we deal with the consequences of irrational exuberance (and its sequel: irrational despondence), it helps to step back and appreciate how far we have come as a species. Perhaps the further back you look, the further ahead you can see.

There is no doubt, however, that the national and global stresses caused by this recession will test our civilisation. Oscar Wilde once quipped about America that it 'is the only country that went from barbarism to decadence without civilisation in between'. A bit unkind - though I'm not sure he would have changed his opinion if he had lived through the past ten years or so. America has been the fulcrum of societal and economic change for all of us: so what goes on there tends to matter here also.

And what extraordinary changes we have seen: not just the obvious (technology, globalisation etc) but also the less obvious. Like the way in which food has become the new sex, as explained in this delightful and fascinating essay by the Hoover Institution's Mary Eberstadt. No earlier civilisation had quite the same obsessions as ours in relation to food - they couldn't afford to obviously - nor did their technologies enable them to treat sex as casually as food was previously. As she notes:

One more critical link between the appetites for sex and food is this: Both, if pursued without regard to consequence, can prove ruinous not only to oneself, but also to other people, and even to society itself. No doubt for that reason, both appetites have historically been subject in all civilizations to rules both formal and informal. Thus the potentially destructive forces of sex — disease, disorder, sexual aggression, sexual jealousy, and what used to be called “home-wrecking” — have been ameliorated in every recorded society by legal, social, and religious conventions, primarily stigma and punishment. Similarly, all societies have developed rules and rituals governing food in part to avoid the destructiveness of free-for-alls over scarce necessities. And while food rules may not always have been as stringent as sex rules, they have nevertheless been stringent as needed. Such is the meaning, for example, of being hanged for stealing a loaf of bread in the marketplace, or keel-hauled for plundering rations on a ship.

These disciplines imposed historically on access to food and sex now raise a question that has not come up before, probably because it was not even possible to imagine it until the lifetimes of the people reading this: What happens when, for the first time in history — at least in theory, and at least in the advanced nations — adult human beings are more or less free to have all the sex and food they want?

Worth reading the full article.

We also think of civilisation in terms of 'civil' and 'civilised' behaviour. Or 'manners' to use an old fashioned term. Especially manners in relation to eating. As Patrick Deneen explains (in praise of the humble fork):
Even as we employ our manners as we eat - for we MUST eat - manners demonstrate that we seek to constrain and moderate, if not fully to extinguish, our natures. Manners are conventions that shape and govern our nature: we don’t cease to be creatures that must eat, but manners are a largely unconscious demonstration our governance of our nature as eating creatures, even as we necessarily submit to and even engage in a more exhalted practice of our nature. Far from being a troublesome and meaningless set of conventions, table manners are the daily manifestation of our commitment to the aspiration of human flourishing, of a realized humanity that ascends from “mere” or given humanity. To be a human is to be conventional, and among those most important conventions that express our humanity is to mediate, moderate, and master our appetites through the conventions at dinner time.
I sense most people want a more 'moderate', more 'restrained' code of behaviour in post Celtic Tiger Ireland. Partly because they may have sensed the threat posed to the binds of civilised society by the loss of manners and the capacity to consider others. The result not just of the shock of rapid economic growth, but also of the corrupting effects of the niceness movement and its emphasis on self-esteem to the detriment of self-control.

I expect to see a great many things re-evaluated in the coming years in Irish society: in relation to food, sex and manners among other things. And if things get really bad, say like in the Great Depression, we might even start dressing better as well. Though perhaps not like they did 13,000 years ago: I'd like to think civilisation has progressed at least a little since then.

Sunday, March 8, 2009

No We Can't

I had an interesting discussion last week with a number of senior bankers about what life in Ireland will be like when things 'get back to normal'. We were all agreed that the 'new normal' will be a lot different from the 'old normal'. Most people get this: after all, key features of the economic landscape have been transformed. Over 80% of the nation's wealth in equities has been wiped out (€100 billion) in the past twenty four months. The value of housing wealth has shrunk, so have the pension funds built on equities and property. There is no going back.

Which is why I find the current debate about taxation so depressing. Most of those calling for higher taxes simply assume that a bit of taxation and borrowing now will see us through the recession and we can then reduce both when things get back to normal. But the new normal won't be like the old normal. We will not return to a pattern whereby single digit growth rates were used to fuel double-digit public spending increases. Looking back, Ireland was like a country that discovered oil and then partied its way through the reserves. Only the 'oil fields' we discovered were the savings of the eurozone's ageing population: and we 'consumed' them like it could go on for ever. But it didn't.

We need to avoid the path of those countries that failed to adjust to the 'new normal', countries like the UK and Mexico. Both have past the peak of their oil production and are facing wrenching adjustments to their taxation and public spending habits as a result. In the case of the former, there are concerns that the economic crisis will lead to serious civil unrest. In the case of the latter, there are even concerns that the state itself will collapse.

Ireland's economy - like the UK and United States - is undergoing a radical restructuring: there is no going back. This 'Great Restructuring', as Jeff Jarvis has described it, will more akin to an earthquake than a passing storm. He notes a New York Times report that:
In key industries — manufacturing, financial services and retail — layoffs have accelerated so quickly in recent months as to suggest that many companies are abandoning whole areas of business.

“These jobs aren’t coming back,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than the United States. There are going to be fewer stores, fewer factories, fewer financial services operations. Firms are making strategic decisions that they don’t want to be in their businesses.”

Which brings me back to taxation. All of those advocating tax increases blithely assume that there will be same number of high earners, of businesses, of pension contributors, of retail sales, of landlords etc as before - so the government will just take more tax of them and things will continue on as 'normal'. They should get out more often: normal isn't normal any more.

So instead of fatuous comparisons with taxation levels in other EU countries (who cares?) what we need is to compare our level of taxation with a) what we need and b) what we can afford. I believe the two are not as far apart as many think: though I don't think we would have anything like the current level and pattern of public sector spending if taxpayers were actually asked to specify what they want and are prepared to pay for. Maybe one good thing to come out of our present difficulties will be to put the taxpayer centre stage in the decision making process.

If that becomes the new normal then I'm all for it.


(Image by Stenner).

Friday, March 6, 2009

Legalise It, Tax It

Here's an idea for our cash strapped government: legalise drugs and tax them instead. We've tried prohibition and it hasn't worked (or conversely it has, if you are one of Ireland's recession-proof drug lords). As I've noted before, we have a drug prohibition problem in Ireland, not a drug problem.

The latest report on Irish crime statistics from the CSO (pdf) shows crime levels in every category falling with one obvious exception: controlled drug offences. A primary reason for the fall (though usually not acknowledged by politicians and the Gardai) is the steady fall in the number of young men in the Irish population aged 15-24. They are the age group most likely to be involved in most of the crime categories listed in the chart. We should be mighty grateful for our demographic situation, by the way. Heading into a recession with a burgeoning population of young men would be a recipe for rather more than noisy protests outside the Dail.

There is a precedent: Ireland has not been shy of policy innovations in the past, so why shouldn't drug policies be another area where we could lead the way. As the Economist observes in a reflection on 100 years of failed prohibition policies:
In fact the war on drugs has been a disaster, creating failed states in the developing world even as addiction has flourished in the rich world. By any sensible measure, this 100-year struggle has been illiberal, murderous and pointless.
By legalising drugs we can apply the same controls to their production, distribution and consumption as we apply to alcohol and tobacco. And there's a triple bonus to society: 1) spending on crime prevention will plunge (not just on drug related policing but on all the criminality arising from the activities of drug financed gangs), 2) crime levels overall will plunge thanks to 1, and 3) the government becomes a net recipient of monies from drug consumption rather than a net spender via law enforcement.

Nor does it have to be a 'once-and-forever' policy shift. As organisations like Transform and others have argued, the legalisation of drugs could be tried for, say, 3 years: long enough to wipe out the gangs and criminals; to determine the wider health and social consequences; and to refine policies further. Just as we continually refine policies on alcohol and smoking consumption (both of which have declined markedly by the way, despite their legality and affordability).

As for worried parents (like me) the message is simple: your children are already living in a society with ubiquitous access to these drugs - their decision to use them is as much subject to what you advise them to do as is their consumption of alcohol and cigarettes. Just because something is legal doesn't make it something you have to approve off (does anyone encourage their children to smoke?)

So there you go: legalise it, control it, tax it. The Minister for Finance will have my full support on that one.

Thursday, March 5, 2009

The Price Elasticity of Politics

The Green Party wants to put a 1c tax on texts. The Labour Party wants to remove tax breaks from landlords. Some politicians have clearly never heard of incentive effects. Generally if you make something more/less expensive to do then people will do less/more of it. Like increasing the vat rate in December (the biggest month of the year in retailing) ... and seeing vat revenues fall in January and February.

Politicians are supposed to have superhuman powers of empathy (all those chats in their clinics every weekend must surely demand it) and yet they cannot put themselves in the shoes of the people they want to tax and ask themselves 'what would I do if it got more expensive/less rewarding to do something because of this tax'? But they're going to have to extend their empathy to taxpayers pretty soon because the gap between government spending and taxes is yawning widely - as illustrated in the chart from a recent post on The Irish Economy blog by Patrick Honohan.

The message from the chart if you are a taxpayer is pretty clear: you've got to cut expenditure. The message the government seems to be taking from it is that it must increase taxes. The problem is that the government's taxation options are extremely limited:
  • the folks who want to introduce higher income tax rates for incomes over, say, €70,000 have failed to notice the surge in married women's participation in the workforce which has raised many two-income households' incomes to this and higher levels: good luck to the politicians who want to raise taxes on the earnings of Ireland's working wives.
  • the generous increases in social welfare payments during the good times means that the introduction of income taxes on those previously outside the tax net will leave many low earners wondering why they're bothering to work at all.
  • reducing tax allowances on pension contributions (already down to a ceiling of €150,000) will stem money going into Irish pension funds (and therefore Irish equities) just as they're already scraping along at 1996 price levels (by the way: a company director contributing the maximum possible under the existing tax allowance regime would still come nowhere near to enjoying the pension entitlement of any moderately senior civil servant upon retirement).
  • the Levy-Kalecki formula means that the remaining affluent consumers may 'go on strike' and save even more/spend even less if the uncertainties created by a shifting tax regime leave them even more worried about the future.
So what spending should be cut? The answer is: I don't know. Nor does the Minister for Finance, the Green Party or any one individual for that matter. The people who know - the managers of sections, divisions and organisations within the public sector (including the health services) - are the ones who can identify where cuts could be made to maximum effect. They should be empowered to do just that: give them a budget and tell them to 'do what you need to meet it'. Including pay cuts and redundancies as a last resort (though I'm guessing more efficient work practices, less sick leave and less overtime might be the main gains).

Any government that thinks it can simply increase taxes without consumers, workers, employers and mobile phone users responding negatively in the current climate is delusional. I sincerely hope they're not.

Tuesday, March 3, 2009

Rightsizing the Government

The only insecurity which is altogether paralyzing to the active energies of producers, is that arising from the government, or from persons vested with its authority. Against all other depredators there is a hope of defending oneself. John Stuart Mill

In a democracy, the two major parties spend the majority of their time and energy trying to inform an ignorant electorate that the other party is unfit to rule. And both do that admirably. And both are right. H.L. Mencken
Ireland is being run by teenagers: the government has spent all their pocket money, all their savings and their part-time job wages and now they're asking mummy and daddy for some more cash to keep them in the style they've become accustomed to. Or at least that's how it seems to me. Tax revenues are crashing in all categories: vat, income, excise duties - according to February's Exchequer Returns. Meanwhile spending across the main categories of expenditure is up. The government tells us in a note with the returns that it's determined not to let the General Government Deficit exceed 9.5% of GDP. Kind of like the teenager that 'promises to pay it all back'.

The emerging consensus - at least among those not working in the private sector - is that taxes have to be increased in order to meet public sector expenditure commitments. Nobody is asking 'why'? I find that disturbing: when an individual or a business lacks the income/revenues to continue spending at previous levels then they cut back on their spending. But not governments: instead we're all asked to divvy up - regardless of the value of the spending we are now funding.

I get that some categories of spending will inevitably rise in a recession such as unemployment benefit expenditure. But do we need all the other spending? Do we need Fas (or want them, for that matter)? Or the defence forces (€1 billion and rising - mostly on salaries and pensions)?

We seen to have a situation in Ireland whereby government spending goes unquestioned in the boom times (e.g.: benchmarking - think of a number, then add a little of whatever you're having yourself). And it goes unquestioned in the bad times (tax revenues are falling ergo we need to raise tax rates). And nobody seems to be asking: if it's 9.5% of GDP this year then what will it be next year - and how will we plug that gap? We have a fiscal policy of make-it-up-as-you-go-along, with no strategic sense of where it is going or why (e.g.: the vat rate went up in the last budget, and vat revenues have subsequently plunged).

Even those on the left - such as Michael Taft - are querying the implied consensus on tax policies because of their potential to make things a lot worse (taking taxes off people leaves them with a lot less to spend which isn't exactly the best way to kickstart a recovery). Meanwhile, we need to recognise that it is the low level of government debt to GDP that is keeping us from shooting up the global vulnerability scoreboard (as illustrated above).

We therefore need a plan to rightsize the government (national, regional and local) to meet the needs of this country's citizens. That might mean raising some taxes/cutting some benefits (e.g.: domestic rates, third level fees, means-testing child benefit); and reducing/outsourcing expenditures to deliver services more efficiently. But that means one of the major political parties standing up for the taxpayer who has to ultimately fund present and future government expenditures (including repaying borrowings and paying for public sector pensions).

But after last week's disgraceful silence over the behaviour of CPSU members denying access to services to social welfare recipients I won't be holding my breath.
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