Crisis Policy Conference programme, 20th May

Trinity College Dublin
(Department of Economics and IIIS)
and the
Dublin Economics Workshop

Conference

IRISH ECONOMIC POLICY FOR THE CRISIS: WHAT’S NEXT?

J.M. Synge Lecture Theatre (Room 2039), Arts Building,
Trinity College Dublin
Wednesday 20th May, 2009

PROGRAMME

Session 1: 1.30-3.30

Chair: Jim O’Brien, Second Secretary General, Department of Finance

John Fitz Gerald (ESRI) on Competitiveness
Karl Whelan (UCD) on Potential Output
Brian Nolan (UCD) on Inequality

Session 2: 4:00-6:00

Chair: John McHale, Queens University, Canada & NUIG

Colm McCarthy (UCD) on Pensions
Philip R. Lane (Trinity College Dublin) on Fiscal Policy
Patrick Honohan (Trinity College Dublin) on Banks
Continue reading “Crisis Policy Conference programme, 20th May”

The IMF WEO, digested

For those of you who haven’t had the time to read the April IMF WEO in full (which you all should), there is a digested version available here.

In light of all the talk about green shoots (amid continuing falls in industrial output in places like Italy and France), one crucial question which the IMF research raises is: to what extent will declining output and rising unemployment create ‘second round’ problems in our financial institutions?

Do We Really Need a NAMA?

While much of the recent media discussion about our banking problems has been framed as NAMA versus nationalisation, this has not been a fair reflection of the debate between economists. My four-point plan and the gang of 20 article explicitly allowed for the idea that a NAMA-like vehicle be used in conjunction with nationalisation.

That said, I’m a little worried now that the public may perceive the case for a NAMA as a slam dunk. My own preference for this approach came from thinking about the alternatives and deciding that the balance of the arguments were in favour of using an Asset Management Company (AMC) in conjunction with nationalisation. Since the NAMA proposals have been introduced, I’ve been getting a bit less enthusiastic about the idea, so I thought I’d write up what I see as the competing arguments for and against an AMC.

Continue reading “Do We Really Need a NAMA?”

Dail debate on NAMA: May 12 and 13

The Labour Party is sponsoring a debate in the Dail on Tuesday and Wednesday evenings this week on NAMA. The motion will call for the temporary nationalisation of the banks covered by the State guarantee.

You may follow the debate live on the web at www.oireachtas.ie. The times are 7pm to 8.30 pm on both Tuesday and Wednedays evenings this week May 12 and 13th May.

Remembrance of things past

The title of Colm McCarthy’s Post Goodbye to All That is Robert Graves’ account of his experiences in the Great War. This evoked in me some nostalgie de la boue so I had a look at a graph of Ireland’s unemployment rate.

 

Looking at the early years in the graph, it seemed that the surge in unemployment in the first half of the 1980s got built into the structure of the economy. Indeed, an influential comparative study of unemployment in OECD countries estimated that the Irish equilibrium or “natural” unemployment rate had risen from 9 per cent over the period 1969-79 to 13.1 per cent between 1980 and 1988 (Layard, Nickell, and Jackman, Unemployment: Macroeconomic Performance and the Labour Market, Oxford University Press. 1991). As if to vindicate this claim, after a faltering improvement in the early 1990s, the unemployment rate was headed for 16% in 1994, some five years after growth had resumed.

There was, of course, a lot of debate about how genuine the unemployment – especially the Live Register (LR) – figures were. In 1996 the CSO undertook a special inquiry that showed less than half of those registered as unemployed were unemployed in the ILO (Labour Force Survey) sense of the term. As a result after September 1998 all those who have been unemployed for six months were called for interview to assess whether they suitable for an existing vacancy or in need of training. To cite the OECD, “nearly half either failed to attend the interview or refused intervention, and 28 per cent were struck off the rolls . . .”. This helped close the very large gap that had emerged between LR unemployment and unemployment as measured in the Labour Force Survey. However, it would not affect the ILO estimates shown in the Graph and its timing does not coincide closely with the rapid fall in unemployment that began in 1994.

Once it started, the decline in unemployment was spectacular. By 1999 the rate had fallen to 4% and it remained close to this level for the next six years. At the same time our emigration was reversed and large-scale immigration became a feature of our economy. Behind all of this was a rate of employment growth that has few parallels in any country.

I hope Colm will permit some nostalgia for these years.

It would be nice to be able to draw lessons from this period that would serve us now that we are experiencing such an extraordinary reversal of fortunes on the labour market front. I tried to do so in a chapter over-optimistically entitled “When Unemployment Disappears: Ireland in the 1990s” [Chapter 8 in Martin Werding, (ed.), Structural Unemployment in Western Europe: Reasons and Remedies, MIT Press, 2006]. My conclusion at the time was that “The exceptional performance of the Irish labour market during the 1990s was not triggered by radical structural reforms”. This despite the fact the a new emphasis on active labour market policies did make some contribution. Note that these policies have not averted the unprecedented rise in unemployment over the last two years.

A Keynesian story does better as an explanation – increases in aggregate demand fuelled by global growth, inward FDI, competiveness etc.

These conclusions point to a gloomy prognosis for our unemployment rate as the macroeconomic conditions of the late 1990s are unlikely to reappear for some time.

Baseline Scenario on US Banks

With AIB and BOI share prices having quadrupled over the past few months thanks to increased hopes of a NAMA-based bailout from the taxpayer, it is interesting to note the similiarities with how the situation has developed in the US, as outlined in this piece by the Baseline Scenario guys.   On why the administration has not shut down insolvent banks, Johnson and Kwak write:

One reason is that taking over banks has somehow been redefined as “nationalization,” with the images it conjures up of forced confiscation of property. Yet there are no guns involved here. Ordinarily, when an investor puts a large amount of new capital into a bank, it gets some measure of control in return. Yet Treasury has bent over backward to minimize its voting shares, beginning with the initial round of recapitalizations and continuing through the latest Citigroup bailout in February.

Perhaps after fighting off charges of “socialism” from the McCain campaign, the Obama administration is wary of any steps that could be described as nationalization. And so instead of insisting on its well-understood duty to shut down failing banks for the public good, it has tied its hands by taking this option off the table.

Access to Funds for Nationalised Banks

On last night’s RTE News at 9, David Murphy (fresh from an interview with the Minister for Finance) reported his understanding of the government’s thinking on the banks as follows:

It’s had a good long hard look at the two main banks, AIB and Bank of Ireland, and it’s clear AIB has an awful lot of problems and the government may well end up owning 70% of AIB. It did look at nationalising it, I think, and the situation is that if it does go down that road, other lenders in other countries, some of them won’t even lend to banks which are owned by governments. And for that reason, it’s ruled out nationalising AIB.

I am highly sceptical of this line of reasoning.  It is possible that there are financial institutions out there who will (a) Lend directly to the Irish government and (b) Lend to a 70% state-owned bank with a government liability guarantee, and yet who will somehow refuse to consider (c) Lending indirectly to the Irish government via a loan to a 100% state-owned bank.

Continue reading “Access to Funds for Nationalised Banks”

Fiscal Policy: Plans versus Outcomes

Roel Beetsma, Massimo Guiliodori and Peter Wierts have just released a very interesting paper that examines the gap between announced fiscal plans and final fiscal outcomes for a panel of EU member countries.  These authors find that  ‘implementation errors’ are sizeable and in fact fiscal outcomes tend to be more correlated with these errors than with the original plans. Recommending reading: you can download it here.

Goodbye to All That

I’m not a fan of the Ireland Inc line of chat. But the concept has more immediacy and policy relevance since the balance sheet of the main banks has been more or less socialised. Recent discussions about the BOP turn-around, fiscal stabilisation, the rising savings ratio, NAMA, (State purchase of bank assets, risks of over-payment), and about off-balance sheet financing wheezes to sustain construction activity can all usefully be thought about in the context of the national balance sheet.

In addition to fiscal stabilisation, bank re-construction and the restoration of competitiveness, the national balance sheet needs to be shrunken and de-leveraged. By 2007, we had created an economy with an emerging public finance crisis, iffy banks, weakened competitiveness and a balance sheet with too much debt supporting over-valued assets. The balance sheet was in any event too big for comfort, even had the assets (property, equities) turned out OK.

They did’nt, net worth declined sharply in line with asset prices, and credit markets turned nasty. The declining net worth supports a smaller balance sheet anyway, and the nasty credit markets suggest contraction even if net worth was unimpared. So the decline in private sector credit demand, rising savings rate and improving BOP are to be welcomed, and substitution of private with public borrowing to be mourned, in this view. The macroeconomic strategy is to avoid  anything that looks even remotely like a return to 2007. This was not a good place to be. 

The Canadians had a phrase, in the 1980s, for the national inferiority complex occasioned by the decline in the Can $ versus the real thing. They called it ‘parity nostalgia’. There is a mood beginning to emerge, in policy proposals from opposition parties, social partnership talks, lobby group suggestions and from some economists, that I am going to call ’07 Nostalgia’. Things were better back then – we had higher employment, (incuding jobs for graduates!), higher investment, easier credit. So lets have some job creation, off balance sheet spending on infrastructure, banks that can lend again etc etc. This is 07-Nostalgia.

In three or four years time, if we are lucky, we will have an economy which needs to look very different from 2007, the final year of the first credit-fuelled bubble in the State’s history. It should look like this: (i) Government debt ratios stabilised and sovereign credit spreads back to low levels; (ii) competing banks strong enough to lend (a little); (iii) a competitive economy producing more exports, less houses, and (iv) a smaller and less leveraged balance sheet. This economy will inevitably be smaller than 07 for a while, have lower employment, a smaller construction sector, smaller aggregate bank balance sheet, bigger Exchequer debt, lower public spending, higher tax rates and possibly BOP surplusses for a few years.

All policy wheezes emanating from the commentariat over the next few months should be smell-tested for 07 Nostalgia, and rejected at the merest whiff.  We have been there and it did’nt work.

Off-Balance Sheet Delusions

This morning’s Irish Times contains a report that Irish pension funds have “indicated to the Government” that they “would be prepared to invest up to €6 billion over the next three years in a range of State infrastructure projects” under a plan “devised by the Construction Industry Council.”  This would take the form of a specially issued government bond:

The funds would receive a return on their money over a period of possibly 20-25 years at a rate superior to that paid on Government gilts – possibly 2.5 percentage points above the rates offered for gilts.

The news article and accompanying commentary piece are wildly enthusiastic about the proposal. We are told that it is “innovative”, that it would be a “win-win situation for construction and the state”, that it would “protect about 70,000 jobs” and, that “after months of relentless bad news this proposal should be welcomed.” Best of all, we’re told that

it would sit “off balance sheet” and not count towards the crucial debt-to-GDP ratio, which has to be agreed with Brussels.

On RTE’s Morning Ireland, further support for this plan came from Fine Gael finance spokesman, Richard Bruton, who quibbled only that it didn’t go far enough.  He instead put forward FG’s plan to spend €11 billion on energy, environmental and communications  projects, funded by the Pension Reserve Fund and off-balance-sheet borrowing by a new state utilities agency, as a better approach.

This all sounds like good news—potential for bipartisan agreement on innovative ways to stimulate the economy.  However, it is my opinion that these plans are bad ideas that are being mis-sold to a public desperate for positive proposals to “do something” to help the economy.  Let me spell out a number of reasons why I take this position.

Continue reading “Off-Balance Sheet Delusions”

Oireachtas Joint Committee on Finance and the Public Service to discuss NAMA

The Committee will benefit from the expertise of Patrick Honohan and Karl Whelan on Wednesday afternoon: read the announcement here.

Update: Patrick’s introductory presentation is here; text of his introductory remarks here.

Update: Karl’s presentation is here.

George Lee Enters Politics

It is now confirmed that George Lee (the RTE economics editor) will stand for Fine Gael in the Dublin South by-election.  I am interested in the readership’s views on the extent to which skills in (a) economics; and (b) broadcast journalism may be helpful in parliamentary politics and/or the shaping of economic policies.

Has Obama really bombed us?

The recent proposal by the Obama administration to eliminate deferral, under which US multinationals do not pay US taxes on overseas earnings that are ploughed back into their subsidiaries, has sent our local press into a tizzy. The discussion follows the logic that such a move would increase the effective tax rate paid by subsidiaries in Ireland to that in the US. If these firms are here in large part due to our low tax, this would presumably lead to US-owned foreign direct investment (FDI) leaving Ireland en masse furthering our downward spiral.

While this dire scenario makes for good reading for people who like bad news, there are reasons to question the extent of the shift in economic activity this might cause.

The removal of deferral applies only to retained earnings – that is income used actively (US law already removes deferral for passively invested earnings under the subpart F regulations). Thus, this is only for a subset of the earnings attributed to Irish subsidiaries. Nevertheless, it could potentially lead to an increase in repatriations by US owned firms who no longer find it advantageous to “park” them in Irish investment. What does this imply for the Irish economy? As an indication, a tax change in 2004 created a temporary reduction in the US repatriation tax from roughly 35% to 5%. This led to a massive influx of funds (around $312 billion) returning to the US from abroad. However, economic activity by US owned subsidiaries in terms of location or level of investment does not appear to have changed markedly. In fact, in response to a recent call for such a move again, Senator John Kerry noted that “It did not increase domestic investment or employment. The fact is that many of the firms that benefited from this during that period of time laid off workers after they brought that money back. They passed on the benefits to their shareholders.” Thus there was no shift in jobs back to the US before, making it less than certain it would occur under the proposed change. (You can read more about this debate here).

Why might multinational activity not respond as expected? Eliminating deferral does not necessarily increase the tax burden on foreign income. The recent firm-level study of Barrios, Huizinga, Laevan, and Nicodeme finds that multinationals’ subsidiary locations depend negatively on both the parent and host tax. This is true even for countries that offer deferral. This indicates that deferral-offering parent country taxes are already a barrier. This most likely arises because parents and hosts limit tax breaks to locally-owned, locally-undertaken activities (such as accelerated depreciation or R&D tax credits). Thus, the gap the multinationals face isn’t simply the difference between the US statutory rate of 35% and the Irish one of 12.5%, implying that whatever increase in the effective tax may come isn’t going to be the 200% increase being suggested. In addition, the US operates an income basket method of calculating foreign owned tax. What this means is that it adds up worldwide profits to calculate the US tax liability and worldwide non-US taxes to calculate the US tax credit. Thus, the excess credits earned in a place like Germany (where the tax rate exceeds that in the US) can be used to offset the liability that would be owed in an excess limit place like Ireland. Furthermore, since most US firms are in an excess credit position, they already have a buffer to soften whatever increases may result from deferral elimination. As such, it is not in any way clear that this proposed change would necessarily push Irish subsidiaries into an excess limit position (where they would owe US taxes) leading to a reduction in investment.

But all of this presupposes that taxes are a major force in multinational decision making. Evidence indicates that although taxes are useful in attracting investment on the margin, they are generally of second order performance for most investment decisions. In surveys of multinationals, taxes usually rank around 9th in importance, far behind factors such as labour costs, energy costs, infrastructure, and government stability. Turning to econometric evidence, (see Blonigen for a nice review of the literature) while taxes typically show up as statistically significant, the relatively small differences in effective tax rates across countries compared to, say, labour cost differentials, means that these latter differences are more economically significant when predicting FDI patterns. This then reinforces the survey evidence. Furthermore even the effects of taxes have deeper stories as the sensitivity of FDI to taxes varies along many firm, host country, and source country characteristics. For example, Barrios et. al find that multinationals’ tax sensitivity varies along many parameters including the number of subsidiaries it operates (peaking at 4 subsidiaries). For the US, this could be linked to the income basket described above. Therefore to predict the impact in Ireland, it is necessary to know more about the subsidiaries and their corporate networks than simply where they come from. However, even broad brush stroke predictions suggest that the decline in FDI, although present, will not be the massive outflow being predicted.

Finally, when making a decision, the choice facing a multinational is between Ireland and other location choices. This potential change hits Ireland more than a high tax location like Germany because Ireland has low taxes and benefits more from deferral. But who are we competing with for investment? High tax locations (where our relative advantage might be reduced) or low tax locations (where our relative position will roughly the same)? Given recent headlines, investment leaving Ireland seems bound for low tax Eastern European countries (who not coincidentally have far lower wages than we do). Therefore at first blush, it seems to me this change does little to affect Ireland’s attractiveness relative to our actual competition. The continual focus on taxes as THE central pillar of our foreign direct investment policy is missing the bigger point. To put it simply, taxes are not the only reason for investment in Ireland and they never have been. If they were, we would have zero investment since there are other countries with far lower taxes than we currently have. What needs to be recognized both in this instance and in our overall approach to FDI is that taxes are but one aspect of how firms make decisions. A more balanced approach will leave us far less vulnerable to changes in global conditions and less prone to needless hysteria.

So in the end, has Obama betrayed his Irish roots? To the extent that his proposals affect perceptions, maybe. A quick read of today’s papers leaves one with the impression that the one thing we had going for us is gone. However, this both overstates the change in the taxes firms actually pay and assumes that we are competing with high-tax states for US investment rather than other low-tax countries on the periphery of the European Union. But to the extent that Obama’s proposals will affect actual investment in Ireland, there is still a lot more consideration that needs to be given before Moneygall cancels its plans for an Obama heritage centre.

Obama’s Tax Proposals

Even after a string of bad economic forecasts, the news on Obama administration proposals to reform the taxation of overseas’ profits stands out as particularly worrisome news for the Irish economy. 

The White House website provides a good overview of the proposed reforms: fact sheet here. 

Let’s hope the powers that be take note of findings summarised in this recent HBS Working Paper by Harvard’s Mihir Desai (via Greg Mankiw’s blog).   The best hope is that the U.S. Senate waters down the proposals (see here from some initial reaction).  But the politics look unfavourable.

Dependency theory for the 21st century

The last time the world experienced an economic catastrophe on the present scale, governments in Latin America and elsewhere drew the conclusion that reliance on fickle overseas markets was a dangerous thing. World War II only served to reinforce this conclusion.

Similar lessons are being drawn today, with one crucial difference. Back then, the decision was made to artificially decouple national economies from the international economy by developing protected industries that would service the home market. Now, the focus is on lessening export dependence by boosting local demand, which will involve temporary stimulus measures in the short run, but more structural measures in the longer term, for example promoting “social safety nets to give Asian consumers, especially the poor, the confidence to spend”. Moving towards higher wages, a more equal income distribution, and lower savings rates in countries like China, so that more of what is produced there is consumed there, would seem to be among the more benign adjustment scenarios available to the world economy today.

Barrington Prize Lecture on May 13th

This year’s Barrington Prize Lecture on “Well-Being under conditions of abundance: Ireland from 1990 to 2007” will be given by Liam Delaney on May 13th as part of the AGM of SSISI. The meeting starts at 6pm and will be held at the Royal Irish Academy, 19 Dawson Street, Dublin 2 .

Abstract:
This paper examines the health and well-being of the Irish population in the late 20th century, the period popularly referred to as the Celtic Tiger. This period saw unprecedented increases in economic activity in Ireland. Using statistical data from administrative and survey sources, I examine whether this period of growth improved well-being and welfare in Ireland. The paper draws from theories of the development of societies such as those of Fogel and Easterlin, as well as theories from behavioural economics and econometric techniques to examine this question. In particular, I examine the extent to which Ireland fits into a pattern of declining correlation between GDP and well-being at later stages of development, a phenomenon known as the Easterlin Paradox. I also examine the extent to which individual well-being is predicted by income as compared to other aspects of welfare such as health and employment status. The results are discussed in the context of long-term demographic and health trends in Ireland.

I look forward to seeing you there. Of course, non-members are welcome to attend and participate in the discussion of the paper.

The AGM and Barrington Lecture of The Statistical & Social Inquiry Society of Ireland will take place on Wednesday, 13th May 2009,  starting at 6:00 pm. The order of the meeting will be:

Annual General Meeting:
I.                  Minutes of the 2008 AGM
II.                  Report & Accounts
III.                  Election of Council Members & Officers of the Society
IV.    The Barrington Lecture

ICTU Employment Document

ICTU’s employment document is an interesting addition to the debate. However, it is not fully clear where the one billion figure comes from and, in general, it would be worth thinking further about costing. The overall thrust of the document is important though, in particular their correct emphasis on the urgent need to address full unemployment.

linked here

Expropriation?

On last night’s Prime Time, when asked about nationalisation, Peter Bacon warned that the government would have to buy the privately-held shares and said “they can’t expropriate shareholders’ value.” On the face of it, there isn’t too much to discuss here. I have advocated that the government should purchase the shares at their closing listed stock market value. Indeed, I don’t know any advocate of nationalisation who has suggested “expropriating” valuable shares from those that hold them.

The reason I’m writing about this, however, is that a couple of other people have also mentioned to me lately that they think this legal concern about expropriation is, in fact, the “real reason” why the government is reluctant to nationalise. “Real reasons” according to this line of thinking, are reasons so important that you don’t talk about them to the public.

Continue reading “Expropriation?”

Negative Equity in Ireland

Ronan Lyons reports some striking calculations on the potential extent of negative equity in Ireland.  He estimates that as many as 340,000 homes may be in negative equity, which corresponds to about one home in five.  These calculations raise a number of other important questions.  What fraction of these loans may end up being defaulted on?  And what are the likely losses for the banks?  These losses have not been incorporated into any of the calculations relating to the loans going into NAMA, so these losses will be over and above any losses associated with NAMA transfers.

More Swedish Bank Blogging

Swedish bank blogging is undoubtedly the new craze on the interweb.  I enjoyed this story of the poney-tailed Swedish finance minister scolding Geithner for his plan and the linked-to story dubbing the Swedes “the acknowledged masters of bank rescues” (As an honour, it reminded me a little of when Ireland were the acknowledged masters of Eurovision.)  Charlie Fell also has a nice piece in today’s Irish Times comparing the NAMA plan with what happened in Sweden.

Continue reading “More Swedish Bank Blogging”

February Retail Sales

Retail sales in February were down 20.9% relative to a year earlier, up from a 26.6% year-over-year decline in January.  Total sales rose 5.7% in February but this was nearly all due to a partial unwinding of the horrible January motor trade sales.  Excluding the motor trade, sales were up 1.3% in February and the year-over-year decline stands at -6.9%, which is up a little from its low point of -8.5% recorded in November. 

I’m not going to write about second deriviatives or, god forbid, green shoots.  But, still, I’ll just observe that these numbers are not as horrible as I might have expected and leave those that know more about this release to add further comment.