The Irish Economy

Adele Begin and I have just issued a working paper (available here) on the performance of foreign-owned industry and services over the recession, and prospects for the future.

The non-technical summary reads as follows:

The current global downturn has been accompanied by a collapse in international foreign direct investment (FDI) flows.  Having reached an all-time high in 2007, worldwide flows fell by 14 per cent in 2008 and by a further 30 percent in 2009.  Given the FDI intensity of the Irish economy, this collapse might be thought to have particularly adverse implications for Ireland.  FDI inflow data however are the outcome of complex MNC financial decisions and bear only a very weak relationship to MNC employment, investment and export activities in FDI destination economies.

The analysis presented here of the recent performance of Ireland’s inward FDI sectors shows them to have played an important role in helping to stabilise the economy in the face of severe downturns in both export and domestic markets. A critical factor in this has been the particular sectors in which foreign-owned MNCs in Ireland operate.  Export demand for pharmaceutical products and medical devices in particular has remained relatively buoyant.  Employment in Irish-owned exportables (i.e. in Enterprise Ireland-assisted firms), on the other hand, fell more over the course of the downturn than did employment in the entire private sector, which is largely ascribable to the weakness of sterling

The paper also explores the country’s medium-term prospects in key foreign-dominated sectors such as ICT, pharmaceuticals and international financial services, which are experiencing substantial structural change.  The consequences of ongoing developments in the global FDI market – such as the growth of China – and in the international regulatory and corporation-tax environments – including recent and prospective policy changes on the part of the new US administration – are also assessed.

The Irish Independent carries this story.

Alan Greenspan is presenting a paper at the BPEA conference today - his draft is here.

[The full programme is here.]

Brian Lucey argues for a different approach to solving the banking crisis in this IT article.

The influential Peter Boone and Simon Johnson have written a critique of the Irish approach to rescuing the banking sector: you can read it here.

This new Eurostat release shows the distribution of labour cost dynamics during 2009 for many EU countries (Ireland not included due to data availability issues).

This FT story reports that Ireland may issues inflation-indexed bonds.  I have advocated such a move in  this paper;  an interesting dimension is whether such bonds would be indexed to euro area inflation or domestic inflation.

On St Patrick’s Day, the European Commission issued its opinion on Ireland’s multi-year fiscal plan: you can download it here.

As suggested by one of the readers,  this is an interesting article on UK fiscal policy by the well-known development economist Paul Collier: you can read it here.

The latest edition of the Economic and Social Review has been published. The edition contains two policy papers by staff from the ESRI, one by Tim Callan, Claire Keane and John Walsh on property taxes and the other by David Duffy on negative equity. The Irish Independent have “seen Duffy’s report” presumably because they have access to the Internet. Now you can read it too.

Jeffrey Sachs joins forces with George Osborne to make the case for a frugal fiscal policy in this FT article.

It is not surprising that economists raise a cynical eyebrow at corporate-speak-filled innovation reports.   Last week we had the IDA’s Horizon 2020; this week it was the turn of the Innovation Taskforce with its Innovation Ireland.   But it would be a mistake for Irish economists to disengage from the debate given the impressive body of literature on the economics of innovation we have to draw on.  Read the rest of this entry »

From Wolfgang Schäuble, in the FT:

Should a eurozone member ultimately find itself unable to consolidate its budgets or restore its competitiveness, this country should, as a last resort, exit the monetary union while being able to remain a member of the EU.

If you wanted to set up a system which maximised the probability of self-fulfilling market panics and speculative attacks, this sounds like a good way to go about it.

The new issue of FInance&Development looks at the impact of sporting events on economic activity - the link is here.

I return to the case for a new fiscal framework in today’s Irish Times: you can read the column here.

The Central Bank’s new Head of Financial Regulation, Matthew Elderfield, delivered his first public speech today at the Leinster Society of Chartered Accountants (text here.). The speech is an impressive statement of intent and forms a very clear break from the past. I was particularly pleased to read this passage:

High impact firms and those with a poor track record should not expect to receive the benefit of the doubt from me or my staff when the best approach to addressing a risk is a point of contention between us. We will have an open and engaged dialogue with a firm’s senior management. But if we remain unconvinced by management’s plans we will be prepared to substitute our prudential judgement for their commercial one and say: Just do it.

This Nike approach to financial regulation could come as something of a shock to our banks.

The Taoiseach has launched the report of the report of the Taskforce on Innovation (here’s a link to a page featuring the report, a summary and a video featuring lots of people telling us how cool innovation is).

I was critical of the composition of the taskforce when it was appointed but, rather than fire off knee-jerk criticisms, I’d like to take some time to read it before commenting further. However, as always, cogent opinions from our commenters are very welcome.

Ronan has updated his analysis on property yields and its implications for NAMA and long-term economic value. It doesn’t make for comfortable reading. I wonder does Ronan understand the mystery of the standard discount rate …

In the past couple of weeks, the Oireachtas Committe on Finance and the Public Sector met with the authors of the two forthcoming preliminary banking inquiry reports, Klaus Regling and Governor Honohan (Regling was accompanied by his assistant Max Watson). The transcripts of these meetings are now available online here and here.

Last week, the IDA launched its new strategy document “Horizon 2020.”  Michael Hennigan has a critical article on the strategy in today’s Irish Times.

The Department of Foreign Affairs recently released a report on the progress toward meeting some of the goals set out in last year’s Farmleigh summit. I have to confess to a degree of unease about a process that doesn’t permit people to debate and scrutinise ideas in full open view. I am pretty sure that the vast majority of the people who attended and spoke are big enough and bold enough to have withstood an IrishEconomy type treatment for their ideas and I don’t see why it wasn’t simply podcast. As it was, the event was mostly held in private for a group of selected invitees. The progress report for what was discussed is linked below. Some of the ideas include a National Diaspora bond and an overseas graduate programme. Other paragraphs suggest that Farmleigh may have been influential in shaping budgetary policy, which is something that doesn’t sound very plausible. In general, I can’t disguise a degree of scepticism about such approaches but, having said that, some very influential and succesful people attended and gave their views so debating this document seems a good use of a thread.

link here

Bundesbank president Axel Weber gave a speech on “The Reform of Financial Supervision and Regulation in Europe” today at the Institute for International and European Affairs. The Institute has provided the text of Weber’s speech and an audio podcast here.

Update: Thanks to Michael Hennigan for noting that the impressive Mr. Weber also gave a completely different speech to Financial Services Ireland on the same day, titled “Making the Financial System more Resilient – The Role of Capital Requirements.”  Link here.

Here’s a link to the latest set of briefing papers for the European Parliament’s Economic and Monetary Affairs Committee. One set of papers (including one by me) focuses on global imbalances and the role they played in the financial crisis. The other set of papers focuses on European fiscal issues. These papers include a summary by Daniel Gros (CEPS) of his proposal with Thomas Mayer (Chief Economist of Deutsche Bank) for a European Monetary Fund.

These briefing papers are provided to MEPs on the committee prior to a meeting they will have with ECB President Trichet on March 22nd at which these and other issues will be discussed.

Daniel Kanda has written a new IMF working paper on this topic: you can download it here.

Summary: Asset booms and sectoral changes can distort traditional estimates of structural fiscal revenue, and could lead to serious fiscal policy errors. This paper extends the estimation of structural revenues to take account of asset prices and sectoral changes, and applies this to the case of Ireland, where a property bust has revealed a large hole in the public finances. It is shown that excluding these factors led to a substantial bias in the estimation of structural revenues, and the structural balance prior to the crisis was much larger than earlier estimated.

Following the approval of NAMA by the European Commission, the Department of Finance has published revised guidelines in relation to NAMA’s pricing of assets. This is a revised version of these regulations released before Christmas. Based on a quick read, there are appear to be a couple of changes, both of which show that the Commission is pushing the government towards paying lower prices.

The first relates to the discount rate used to value cash flows when coming up with long-term economic value.  These had provided for an adjustment of 0.8 percent above the relevant government bond rate. This adjustment is now 1.7 percent.  This change will lower the value of the assets.

Government bond rates are, of course, lower now than they were last September. This is probably what the Minister was referring to when he said “There will, however, be a reduction in the interest rates used for loan discounting purposes” a comment widely (and now it seems incorrectly) reported as being related to the Commission’s recommendations. We see now that the Commission’s recommendations, taken on their own, will imply lower prices paid.

The other change I can spot relates to the (to me) mysterious “Standard Discount Rate”. The regulations for this used to be as follows.

The standard discount rate that NAMA shall apply in the calculation of the long-term economic value of all bank assets shall be 2.75 per cent to provide for enforcement costs, and 0.25 per cent to provide for due diligence costs.

The 2.75 percent is now 5.25 percent. From previous discussions, the prize for best answer as to what the standard discount rate was went to Frank Galton: NAMA LTEV = LTEV*(1-Standard Discount Rate). Assuming that’s correct, then this latest change would also imply lower prices. Anyone who understands the standard discount rate (or can see any other interesting changes) feel free to explain it to us.

There are lots of stories in today’s press about the German-backed proposal to introduce a new European Monetary Fund to help out EU states in difficulty. Setting up the fund would require a new treaty, which would take a long time. So, on the face of it, this isn’t about helping out Greece, though it could turn out that Greece becomes the “test case” for how an EMF would operate.

One aspect of this story that I’m having some trouble understanding is why the IMF cannot be used to assist an EU member. The Irish Times Cantillon column explains the argument as follows. Current circumstances imply that:

The only possible lender of last resort is thus the International Monetary Fund, but an IMF intervention in a euro-zone economy would be a mortal blow to the credibility of the euro.

Ok, here’s a question. What does “mortal blow to the credibility of the euro” actually mean? And if it means something concrete (and bad) why does an IMF intervention produce this bad outcome while an EMF intervention does not? Answers on an electronic postcard …

Barry and I have updated our graphs here.

To recall: the red lines show what happen when governments respond to a worldwide economic crisis with monetary and fiscal stimulus. The blue lines show what happens when governments stick to monetary and fiscal orthodoxy. All very purgative and morally satisying no doubt, except that it led directly to the election of Adolf Hitler (something that I have been meaning to blog about for a while, but now I have to prepare for class..)

The first graph in this post is really quite alarming. (It would of course have been nice if there had been Irish data!)

For an individual country, ‘internal devaluation’ is the optimal strategy in our situation. (Optimal given our constraints that is — it is an incredibly lousy option relative to nominal devaluation, or being able to run a counter-cyclical fiscal policy.) But if everyone is doing the same thing, then it becomes collectively self-defeating.

This is a European problem, and requires European solutions designed to support demand and prevent continent-wide deflation.

Paul Krugman is alarmed here.

Paul Krugman’s NYT column focuses on the new Irish Economy Note by Greg Connor, Tom Flavin and Brian O’Kelly.

Today’s Irish Times publishes an open letter by 28 social scientists [co-ordinated by Tasc] that criticises the current set of economic policies and proposes an alternative vision: you can read the letter here.

It is hard for anyone to disagree with many of the policy recommendations in the letter. An important point is  that many of these policies could be pursued simultaneously with the current strategy of stabilising the fiscal situation and  contributing to the process of real devaluation as a mechanism to improve competitiveness. As has been repeatedly pointed out on this blog, labour demand can be boosted both through outward shifts in the labour demand curve (through productivity improvements) and through reductions in wage costs (movement along the labour demand curve) and there is no direct conflict between these two strategies.

The letter assigns at least part of the responsibility for the depth and severity of the recession to current government policies.  Policy failures during the pre-crisis period (inadequate financial regulation and pro-cyclical fiscal policies) have certainly contributed to the severe contraction and it would have been much better if Ireland had accumulated sufficiently large surpluses during the boom years to provide the fiscal space required to engage in counter-cyclical fiscal interventions.  In addition, it is possible to debate the appropriate mix between current and capital spending within the current aggregate envelope and the optimal sequence for the required increases in the overall tax burden.

However, given the massive shock to the economy and the public finances, the over-riding imperative in setting fiscal policy has been to demonstrate a commitment to fiscal sustainability. If the government had not undertaken a sizeable fiscal adjustment, the spread on sovereign debt would surely be much higher than the current elevated level and the upward movement in interest rates (influencing the funding costs for the banking system as well as for the government) would have had an even more contractionary impact on the economy.

Conditional on the environment facing the country, the path of fiscal adjustment is more certain of returning growth to the economy than an aspirational alternative that seems to rely on investment-led growth to jointly solve the fiscal crisis and the economic crisis without having to resort to cuts in the level of public expenditure (beyond any savings from efficiency gains).  The international economic consensus highlights that  the optimal fiscal response to the crisis varies substantially across countries, with fiscal adjustment required for those countries that face a difficult funding situation. As such, it is perfectly consistent to advocate more expansionary fiscal policies for some countries while also supporting fiscal adjustment in Ireland.

Finally, the letter makes a number of recommendations for re-shaping longer-term economic policies. The debate about post-crisis policies is important and the coherent vision provided by this letter is a valuable contribution - but the first order of business is to safely emerge from the current crisis.