Somers is not giving up his legacy for back of the envelope government economics.

Agreed. But you can’t entirely surprised, in the current environment, at a political party choosing to emphasise the opportunities for investment and employment, as much as the associated reforms required to promote consumer welfare.

Looking forward to carrying on the debate after a change in Government sometime!

Andrew

I think we have come almost full circle. Significant reform of the means of delivering investment is required before we can contemplate in detail the nature and level of investment required. However, it is inconceivable that the current adminstration (in office, in some shape or form, for 12 years) is capable of delivering this reform. All we can expect is this “off-balance sheet” exercise promoted by the construction industry which smells strongly of the 07-Nostalgia highlighted by Colm McCarthy.

Then lets first deal with the 4 points on which I totally agree. Only after having dealt with those points should the investment level be an issue (as you and I argue - they are not independent).

Experience tells me that there is always a temptation to deal with the under investment whithout carrying out the obvious reforms so as not to upset some interest group - that is how we have ended up with the mess we have!

At no point did I argue for investment by the semi-states simply because it was “off balance sheet”. I argued for investment by the semi-states because I believe that there is a crying need for more investment in those key networks - electricity grid, telecoms, water networks - for which current or restructured utility companies are or could be responsible. Because these investments will ultimately be paid for out of the extra consumer revenues generated from enhanced networks (subject to the necessary regulation to protect consumer welfare), and not out of taxation, such investments are not subject to the Government’s budget constraint.

I also think that it is appropriate to identify investments in these areas that we are likely to have to make over the next decade, and to bring them forward at a time of spare resources in the economy.

To add to Paul Hunt’s comments, the semi-states on their own will not avail of these opportunities because of the combination of the following factors:

(1) they are poorly managed
(2) they under-capitalised and have strict borrowing caps, and the Government will neither privatise them nor invest in them
(3) they do not face the right price signals (e.g. for carbon)
(4) the Government refuses to contemplate an independent source of revenue to finance investment other than taxation (e.g. water)

These are the issues that Fine Gael seeks to address.

Our views are not that far apart - we do need investment and we do need regulartory reform and privatisation.

I know that the semi states were not part of the NDP/exchequer - throwing the reference to the scale of public investment in was merely aimed at highlighting that the exchequer is actually going to invest a lot, even after the cuts of April. Some people seem to think that we have stopped public investment.

The key to the success of any policy in this area is its real aim - I want it to give us an efficient economy rather than one with a needlessly large construction sector.

We should probably move this off-line, but, at least, some readers should have an interest. We may be foundering on some misunderstandings, but, though the detailed numbers may have changed, my kick-off point is Economic Infrastructure, Chap 7, of the NDP 2007-2013:

http://www.ndp.ie/documents/NDP2007-2013/NDP_Main_Ch07.pdf

The initial table shows that the semi-states, where they are involved, are expected to arrange approx. 95% of investment financing. Contrary to what you may have discerned, I am not advocating direct Exchequer financing in the current straitened times. I’m simply pointing out that the State did not finance a share of the investment when it had the ability to do so and the result is gloriously inefficient financing. And the scale of investment is significant. The book value of the ESB networks has more than doubled since regulation was applied in 2000.

I am probably just as concerned as you are to ensure that investments are properly evaluated, but I see scope in the economic infrastructure area to do some sensible things and to finance them appropriately - and not just construction for the sake of it. And I would propose going well beyond FineGael’s medium to longer term indications about selling off some semi-states by advocating restructuring and selling off most semi-states immediately. This would deleverage the Government balance and access genuine off-balance sheet finance.

Andrew seemed to be arguing for investment in semi-states because it was off balance sheet - if the exchequer gets involved (as you seem to argue) it obviously won’t be.

The point I was trying to make is that it does matter whether the utilities over borrow even if it does not show up in the exchequer accounts.

The ultimate issue is whether the investment is needed. That is not independent of the regulatory setting. I have argued before that regulating and public investment can be substitutes. If we appear to need investment because of poor regulation then we should fix the regulation rather than spend lots of money on investment, which will add to consumer prices (what I am concerned about). If we realy need investment then lets go for it. In this context it is noteworthy that public (exchequer) investment is still at unprecetentedly high levels despite the cuts.

Broadband is the perfect case to show how not to do it - as I (and others) see it, poor regulation resulted in poor broadband roll out. The government response to this was investment (the metropolitan area netwoks MANs programme) rather than the fixing the poor regulation - this is costing the tax payer unnececessarily.

One way or another I am suspicious of all quick fix solutions presented anywhere if they are not properly evaluated (I have not seen any that are). There seem to be a lot of proposals coming forward that seem to be aimed at creating/keeping employment in construction. To take Colm’s phrase it smells of 2007 nostalgia. This investment is only a good idea if we realy need the stuff that is going to be invested in. Forget about the jobs we have too many builders and some of them will need to find alternative sectors to go into. To achieve that we need active labour market policies and not poorly evaluated investment.

I’m sure Andrew, if he wishes, will be well able to respond to your observations and questions, but I must point out what I see as a key misunderstanding on your part when you talk about consumers paying for semi-state utility borrowings and the “loss of competitiveness due to higher charges in this country”.

Specifically for gas and electricity networks, in the absence of direct Exchequer financing of investment and with the ESB and BGE seeking to minimise borrowing to finance this investment, network users - and final consumers, ultimately - are (and have being) paying up-front to finance a share of this investment while paying for the return of, and on, all investment. It is difficult to be precise, but I estimate that, depending on the wholesale price of gas and of other fuels in the generation mix, this has added 10-15% to final gas and electricity prices since regulation applied during this decade.

Another factor which is driving Irish electricity prices above EU 15 levels is the impact of the policy/regulatory decision to prevent the ESB investing directly in new generation. A likely shortfall in generation capacity compelled the CER to guarantee high capacity payments to secure the investment of new entrants. And a further factor which drives gas prices above EU-15 levels is the dismissal of LNG import as a feasible option 10 years ago and resulting overinvestment in interconnection capacity between Britian and the UK.

I don’t view Fine Gael’s proposals as being capable of addressing all of these issues (or similar ones in other utility or infrastructure areas), but they are the only proposals on the table which provide the possibility of reducing the excessive cost burden on final consumers and of promoting efficient investment with effective regulation.

I know you did not propose that all activities be rolled into semi-state bodies, but your argument for their borrowing not being relevant is somewhat flimsy.

Yes, usilities need not be in state ownership and indeed if properly done private ownership is preferable. But we should not pretend that our utilities as currently organised are in anyway optimal and hence their investment decisions are unlikely to be optimal either.

I also fundamentally disagree with your implicit assumption that it does not matter if the consumer pays for the borrowing (or inefficiencies) of the utilities - surely that is at the heart the debate about loss of competitiveness due to higher charges in this country.

There is little doubt that given the circumstances Eircom has behaved optimally - this is what you get when you privatise badly. The state should have regulated this properly and then we would have better broadband. The commercial case for broadband in rural areas is always going to be poor and hence this is the only area where the state should get involved - in the urban areas there is a market and that should provide the service. If it is not provided there then this is a sure sign of regulatory failings (market failures).

Ultimately, if the utilities are supposed to operate on a commercial basis why are you trying to tell them what to do? Surely if there are pots of gold to be earned they will identify them themselves and invest appropriately??

You write that “Your argument suggests that we should put all government activity into semi-state bodies and then we just keep on borrowing.”

I’m not suggesting that at all - only activities where there is a consensus that on equity and efficiency grounds, there is a clear case that consumers, not tax-payers, should ultimately finance the investment. There appears to be a consensus in most advanced countries that energy, telecoms and indeed water fall into this category. This is why statisticians (and I had thought economists) distinguish between Government borrowing (ultimately financed out of taxation) and the borrowing of commercial semi-states (ultimately financed out of consumer charges). For all the “public good” arguments that learnt from textbooks, we cannot ask consumers to voluntarily pay for national defense.

The figure I quoted for eircom (€1.4 billion) was an estimate of what it might cost to buy eircom’s network debt-free (the nominal value of the bonds are currently about €4 billion).

Colm McCarthy says it is not obvious that there has been under-investment in telecoms from a private investors’ perspective. That may or may not be true. But it also the role of the economist to advise the political system of the broader social returns to any investment (a minefield, I know).

Colm suggests that the reason the staff of commercial semi-states were exempted from the levy is because their pension schemes were funded. That does not seem to tally with the facts. The pension schemes of many state agencies are funded. Those that have a state guarantee (non-commercial semi-states and agencies) are being absorbed into the state system and were hit by the levy. Those have no state guarantee (commercial companies) cannot be broad into the state system and were exempted from the levy.

US 30 yr rates increasing?

We will all agree that the economy has been under taxed for the last 10 years or so, given public expenditure and the likely downturn that has eventually arrived, in order to partly finance the usual deficit spending that ensues.

We have just increased taxes and the deficit is rapidly increasing as the rate increases have not made up for the transaction slowdown.

We know that, false Laffer curves notwithstanding, too much disincentive via the tax rate, is bad for production overall but does identify the most productive activities. (They survive!) We are not able to borrow except at a crippling cost unless we address a balanced budget smartly. Now is not the time for expansionary spending.

Now is the time for more taxes…… unpalatable, but true. Expecting GDP and GNP to pick up? Not likely and everyone we depend upon for capital knows it.

You may have misinterpreted my post. My concern is less about the bowels of the body politic and much more about both the ability of the body economic to withstand the “Great Deleveraging” and the requirement to apply some health-restoring medication.

There are big differences between 2009 and the late 1980s, when the last Irish fiscal consolidation was consummated. The sovereign debt markets are massively risk-averse, which they were’nt back then, and they are much more crowded. The FT has been covering the avalanche of sovereign issuance daily, and numerous commentators are expressing concern about the market’s absorptive capacity over the next few years. We should not extrapolate the recent improvement, and it cannot be assumed that Ireland would be facilitated at any kind of acceptable spreads if we tried to run the debt up to > 100% of GDP as we did last time. Perhaps we would, but we can’t be sure, so ’suck it and see’ is not an attractive option. We can compute the likely exit debt to GDP ratios implied by the Government’s medium-term targets, and these could prove financeable with even average luck, but we must tack on bank bail-out costs which are perforce unknown at this stage. With a bit of bad luck on fiscal adjustment and on banks, we could get up towards 100% in due course, and the risks involved are just unknowable.

The four sets of fiscal actions taken to date (package 1 last July, Budget 1 in October, package 2 in January and Budget 2 in April) have resulted, we hope, in a prospective 09 GGB deficit about 11%. In the absence of these measures, I reckon it would have been nudging 16%. The spread over bunds at 10 years is now back to 164 bp, from over 300 at one point in January. We can’t know what would have happened if we had taken no fiscal action, but I am sure John will concede that the spread would now exceed 164 bp, perhaps by a lot, and we could have had a disaster in the bond market. Those concerned, quite reasonably, about the deflationary effect of the measures actually taken must acknowledge the risk of deflationary impact from doing nothing, or doing less.

John and others have discussed the scope for countercyclical investment policies. I have several reservations in addition to those highlighted here by Edgar Morgenroth. The downturn in Ireland has now been running for eight quarters. Some of the investment schemes proposed (ESB office building, for example) must be at least 8 or 10 quarters from sod-turning. Who knows that the labour market downturn will last 16 quarters or more? Some of the projects dropped from the PCP should never have been there in the first place, and no-one should mourn their demise. Never waste a good crisis! I think we can all agree that spending money on silly construction projects reduces sustainable employment in the long run.

Of course, cost-benefit studies need to be re-calibrated, with a shadow price for labour below 100% and possibly lower construction costs too. But they also need to be re-calibrated to lower benefits, given the demand downturn. It is not clear where the balance might lie. Virtually every daft project over the last decade has enjoyed a positive cost-benefit appraisal, including the Abbotstown stadium. In a city where one stadium has catered for all fixtures in all codes for two-and-half years, we nearly had four!. There is rightly a high degree of scepticism about Irish cost-benefit studies, a useful technique commandeered by the public relations industry.

On labour market interventions, it is up to Liam Delaney and any others who wish to come up with specific, costed, proposals. Bear in mind folks that the existing Social Welfare/FAS schemes and operations may contain some of the things you are hinting at, so it is possible to make proposals of stuff that already exists at least in some form. I don’t have a closed mind about this at all, just a sceptical one given the experience with poorly-designed schemes in the past.

Paul Hunt seeks to prescribe purgatives for ‘politicians, bankers, IBEC, ICTU and others in denial’. Paul, prescriptions are not needed for purgatives, there are numerous popular over-the-counter remedies for any pols, bankers or social partners who are experiencing discomfort. Andrews Liver Salts and Milk of Magnesia are personal favourites.

Andrew McDowell describes under-investment in telecoms as ‘obvious’. Failure by commercial companies to provide services in low density areas on the grounds of inadequate return is not obviously ‘under-investment’ to an economist. It may be socially or politically unacceptable, but that is not our line of work. He suggests in passing that staff in commercial State companies were exempted the pension levy because the pension liabilities are not guaranteed by the State. More important factors behind the exemption, I think, were the facts that (i) these schemes are funded and (ii) their payroll is not an Exchequer expenditure.

Finally, I think it is worthwhile to pursue Patrick Honohan’s notion that, while 2007 is not the aspiration, we should be thinking about where we want to be macroeconomically in the next year zero, say 2013.

Thank you all for your comments.

Your argument suggests that we should put all government activity into semi-state bodies and then we just keep on borrowing.

How much of the debt on Eircom do we have to take over to buy the network at 1.4 bn?? I suggest we give the regulator real teath and force Eircom to invest - if that breaks them then all the better, because they are doomed anyway. If they go under the state can take over for a lot less than 1.4 bn.

As you point out Bord na Mona has a huge hole in the pension fund - what is the situation in other semi-states?? Would that not affect their ability to borrow?

In any case the consumer/tax payer ends up paying for it all - how much debt do you want to load on them??

Legally, the Government is not responsible for the debts and other liabilities of the commercial semi-states. Moreover, competition law and the EU Treaties would make it difficult for the State to bail-out a semi-state that was having difficulty meeting its obligations. That is why borrowing by commercial semi-states is not counted as Government borrowing - it is not a contigent liability to the taxpayer.

It seems increasingly clear, for example, that Bord na Mona, and possibly other semi-states, will fail to deliver on their pension promises to employees, though I accept that under Irish law this is not the same as defaulting on a debt. These pension liabilities cannot be guaranteed by the State for competition reasons (which is why the staff is these companies were exempt from the pension levy).

If, as Fine Gael suggested, investments via commercial state companies in telecoms, energy and water should be at least 50% funded by private debt (not guaranteed by the State), it is safe to assume that the potential lenders will carry out the necessary due diligence and business case assessment,

By the way, on the basis of recent negotiations between B&B and its bond-holders in Australia, my understanding is that the State could recover the network assets of eircom, debt-free, for about €1.4 billion in payments to the bond-holders. The opportunities that this would create for upgrading the last mile of Ireland’s crumbling telecoms infrastructure are certainly worthy of assessment.

If you were talking about the private sectror investing then I agree with you, but if it is the semi-state bodies or the exchequer we are talking about then I still think the budget constraint holds - ultimately the government is responsible for the semi-state bodies. The only way this would change is if they are privatised and the new owners take the debt. Unfortunately the evidence of this is not good - with a debt of nearly 4 billion Eircom will inevitably have to be re-nationalised if we want to have a modern telecommunications network.

If you read recent comments by me (in the Indo & Times) you will find that I have argued for investment but on the basis of clear evaluations. It worries me that the panic about the dramatic rise in unemployment scarce resource will be wasted on the wrong projects which are committed too on a whim. Proposals for investment do not seem to be discussed in the context of either a budget constrasint or proper evaluation - somewhat reminiscent of 2007!

Maybe it was not a good idea to discuss the argument in terms of something like a feedback loop that is difficult to measure. That said one has to admit that there are vicious cycles and virtuous cycles in the economic sense and uncertainty is very damaging when we are in a vicious cycle. So anything that can reduce this uncertainty should be considered.

I would agree that the idea would probably be most suitable for construction and imports. However i was not thinking of these when i wrote this. Rather i was thinking of something like domestic tourism. One possible way that this could be organised would be as follows.

One of the large banks could invite all their customers that are in the tourism industry to join a scheme that would allow consumers to purchase tourism packages forward. The bank would hold the money until the forward date and either refund it if the consumer ends up losing their job or if the consumer still has their job pay the money to the tourism business so the consumer can get their tourism product. There are many benefits for everyone.

The banks tourism industry customers are on the whole less risky for the bank as there are future revenue streams that importantly the bank knows about.
The bank has access to additional funds until the forward date.
The tourism businesses have more certainty about future prospects.
The tourism businesses have access to a new marketing channel.

As regards the consumer there is the fact that as i said in the original post the product is consistent with what they would do anyway if they were worried about their job i.e. Save and only spend if you have a job in the future. Also i would argue that i would expect businesses to make very favorable offers to consumers for these . I must admit i am struggling a bit to explain this in a succinct way so rather i will just give an example with airline seats that are usually a lot cheaper the further into the future one purchases them.

The downside is that it’s difficult to reflate the economy. The upside is that, construction aside, I don’t believe we are anything like as susceptible to domestic deflationary spirals as most other economies.

In response to Edgar Morgenroth: why should the Government’s budget contraint limit the financing of investment opportunities in energy and telecoms, or indeed in retailing and manufacturing?

I fully agree that all investment proposals need to be carefully assessed, particularly in an environment where politicians are desperate to create jobs. Clearly, the private sector will take care of that process when it is financing the investments. Where there is public financing, whether from the exchequer or the NPRF, we need an equally disciplined approach.

But let’s not be so dismissive of the possibility that very high NPV long-term investment opportunities are available, if we can adapt our economic and regulatory institutions to take advantage of them. and find ways of financing them. This is the nature of the dialogue that political parties are now engaged in.

One way to think about the current economic malaise is that the economy is experiencing negative feedback loops. For example consumers are putting of purchasing decisions due to the fact they are uncertain about their job prospects. This uncertainty then feedbacks to businesses which have reduced sales and are then less certain about their future. These businesses then modify their purchasing and hiring decisions which effects other businesses and consumers views about their future prospects. And so on and so on.

The conventional wisdom is that at some point in the future things will turn and consumers/businesses will begin to feel more optimistic about their future and things will then start to improve. This is indeed true but at the same time it is worth exploring what can if anything be done to reduce this uncertainty.

So lets go back to the consumer worried about their job prospects. They might put off some piece of non essential spending as they are worried about losing their job. So what they do is they save their money and decide that if at some point in future if they still have their job they will make the purchase and if not then they will use the money to supplement their income while they are unemployed.

Now assume that a consumer could make a conditional forward purchase dependent on whether they have a job or not at some point in the future. At the forward date if the consumer has a job then they get the product and if not they get a refund (possibly with some interest). There are many ways that this could be implemented involving either the merchant or some intermediary holding the funds until the forward date. There are many other implementation details especially around pricing which will not be discussed here.

So would this be of any benefit? From the point of view of the consumer this is consistent with what they want to do anyway and also opens up the opportunity of getting a favorable deal if a businesses is keen to get such business. So we can say that the consumer is at worst indifferent to this. For businesses and the overall economy there are I believe substantial benefits as uncertainty is reduced.

Because of this i believe that ideas like this should at least be explored in an attempt to help the economy. One final note is that the actual idea is not unique as car makes in the US are doing something similar by linking future car payments to whether the consumer is unemployed or not and no doubt there are probably other similar examples that i am not aware of out there.

To state that governments should pursue all projects with a positive NPV is to assume that there is no budget constraint - there clearly is! In other words you cannot separate the investment decision from the ability to pay as you suggest. That is not to say that we should not pursue any projects - we clearly should but this depends on properly evaluating and then ranking projects. Then while satiflying the budget constraint the best projects should be pursued. Of course this is seldomn the case in any economy because governments pander to special interst groups as well as public opinion.

In that context I worry about the choice of these projects in practice. I am sure the Japanese made a great case for some of their projects, which we know now to have been a bad idea.

If anything the evaluation culture in this country is getting worse - while the project selection criteria for NDP 2000-2006 were published, those (if they exist) for NDP 2007-2013 are nowhere to be found! Project level evaluation is done either by the sponsoring body or for them. The counterfactual tends to be ‘do little or nothing’ rather than an alternative project.

Now we get lots of proposals, which come out of nowhere and have not passed any critical examination. What real evidence is there for the social benefits you refer to? Lets see the NPVs. All I have seen are unsupported assertions. In that context I would share Colm’s worry that what is really being proposed is to ignore the need ot the economy to adjust back to normality (which includes a substantially shrunk construction sector).

We do have experience on a variety of policy measures and different investments but this evidence does not seem to have made its way to the people making various proposals.

Regarding the off-balance sheet investment, someone has to pay for it eventually (Ricarian equivalence) whether it is through taxes or through higher charges for utilities - both will be a drag on the economy!

“Much more curious is the suggestion (from Karl Whelan I think) that any “off-balance sheet” financing of investment (which I think means off the Government’s balance sheet” is expensive and wasteful”

I’d like to just state on the record that I have never made this argument.

And while we’re on the subject of curious arguments, Andrew also wrote:
“To follow Karl’s logic through to its ultimate conclusion, all investment in an economy should be financed by Government borrowing.”

Clearly, I have never made this argument either, nor do I see any connection between any argument I have ever aired publicly and this conclusion.

May 7th, 2009 at 4:20 pm

So we had a well balanced economy during this period? What I like about exports is that they tend not to leave a legacy of debt. I’m all for building stuff we need, but at prices close to the cost of construction.

Even allowing for this, there are many steps the government could have taken to mitigate some of our current problems. If the government had applied an earnings pattern to the (direct and indirect) taxes from the property boom, we would be in a better position. For example, a person will repay a mortgage over 30 years. I’d suggest that the government should have earned a portion of the tax each year over the term of the debt. This would have curbed the “if we have it, we spend it” budgets.

Is it not a solid principle of economics that national welfare is improved when all positive NPV investment opportunities are pursued? The availability, sources and structure of the financing for those investment opportunities are important, but secondary, considerations.

If the reform of political and economic institutions to open up new long-term positive NPV investment opportunities - particularly in areas vital to competitiveness and productivity growth - is now to be dismissed as “2007 nostlagia”, the country is in a long more trouble than I had already feared. I had thought that reforms of this nature were what distinguished successful liberal capitalism from barter economies.

A more valid, in my view, line of inquiry is whether political parties are, Japanese style, proposing wasteful (negative NPV) investments so as to be able to promise more jobs. Here I have to declare an interest, as the author of the Fine Gael “Rebuilding Ireland” proposal.

Certainly, the long-term business case for any proposed investments, particularly those “directed” by politicians must be scrunitised carefully, irrespective of how they are to be financed. Creating jobs now by screwing tax-payers and/or consumers over the next 30 years would be a very shaky foundation for economic recovery.

But are the nay-sayers so sure that, with the proper financing and reforms of institutional structures, regulation and work practices, such positive investment opportunities do not exist, whether in energy, water or telecoms? It seems obvious, to me at least, that there has been under-investment in Ireland’s telecoms infrastructure over the last decade.

And in the current environment, is it not understandable, and indeed economically logical, for politicians to highlight the wider social benefits in terms of job creation of proposed investment opportunies?

Questions regarding the optimal structure and sources of financing are also, of course, valid. Fine Gael have suggested the use of the National Pension Reserve for certain investments.

If politics and industrial relations were not also a factor, and market conditions more favourable, more private equity financing might be better for long-term governance and efficiency reasons, as Paul Hunt as suggested.

Much more curious is the suggestion (from Karl Whelan I think) that any “off-balance sheet” financing of investment (which I think means off the GOvernment’s balance sheet” is expensive and wasteful. I had thought it well accepted internationally that for both equity and efficiency reasons, consumers, not paypayers, should ultimately pay for investments in sectors like energy, water and telecoms. Clearly, demand and availability risk will mean that the cost of financing for such investments is higher than the risk-free rate. But such is the price we pay for competitive markets. To follow Karl’s logic through to its ultimate conclusion, all investment in an economy should be financed by Government borrowing.

Brian P