Exporting electricity

UPDATE2 Over on Twitter, Antoin argues that the plan as interpreted by me would violate EirGrid’s statutory monopoly.

Minister Rabbite yesterday announced plans to export wind power to Great Britain. This is a result of the energy summit organized shortly after the last elections. It now appears ready for public discourse.

The plan is simple. Build a load of wind turbines in the Midlands, where the relative lack of wind is made good by the relative lack of tourists and nature reserves, on land owned by Bord na Mona and Coillte. Build dedicated transmission lines to Great Britain. (The Spirits of Ireland hope that there will be pumped storage as well.)

The plan makes half sense from an English perspective. It is hard to get planning permission for onshore wind turbines in Great Britain. Onshore in Ireland plus transmission is cheaper than offshore in British waters. On the other hand, the plan is driven by the EU renewables target, which is pretty tough on the UK. With Germany abandoning its green energy plans (following earlier such decisions by Portugal and Spain) and with Theresa May wishing to ban Greeks from the UK, it is not immediately clear why the UK obeys the EU with regard to renewables.

It is not clear what is in it for Ireland: English-owned turbines generating power for England, transported over English-owned transmission lines. Dedicated transmission means that there are no benefits for Ireland in terms of supply security or price arbitrage. If the new transmission would be integrated into the Irish grid, Irish regulations would apply — and subsidies too, so that you Irish would sponsor my electricity bill. Ireland does not have royalties on wind power or transmission (and if it would, the same royalties should be levied on Irish turbines and power lines). That leaves some jobs in construction, fewer in maintenance, and 12.5% of whatever profits are left in Ireland for taxation.

It may well be that this plan is a quid pro quo for the UK contribution to the bailout of Ireland.

I am not convinced that the plan will go ahead. The English power market is in turmoil, and the companies may not be interested in an Irish adventure. Recall that the UK government also confidently announced that private companies would build new nuclear power. Well, they did not. The comparative advantage of Ireland in this case is the relatively lax planning regulations. Pat Swords may have put an end to that. But even the current planning regime can be used to block to an English adventure with no Irish spoils.

It is early days for this project still. It is worrying that the minister seems to think that more state intervention is required, and that the state still has money to waste. UPDATE: Paul Hunt points out that it is indeed the Government’s plan to intervene and subsidize: See the new energy strategy.

More academic thoughts on interconnection are here.

Guest Post by Timothy King: Keynesian Policies Under the Fiscal Treaty

The Stability and Growth Pact of 1997 permitted Eurozone countries to run a general government deficit of 3% of GDP.   The only economic innovation of the Fiscal Treaty is the replacement of this deficit measure by one that restricts the “structural budget deficit”—the deficit that that would be incurred if the economy was operating at full capacity—to 0.5% of GDP where the national debt is greater than 60% of GDP, and 1% otherwise.

The measurement of the structural budget deficit is to be cyclically adjusted, which will permit larger deficits in times of economic recession.  So far from outlawing Keynesian fiscal policies, as some of its opponents have alleged, this explicit acceptance that deficits may reflect cyclical factors will allow governments to cut taxes and/or increase expenditures as anti-cyclical policies require.  One-off or temporary payments such as those to the Anglo bondholders are also excluded from the deficit calculation.

Much depends, of course on how the adjustments are made.  The IMF, the OECD and the EU, all make estimates of the structural deficit, and the first two of these agencies both regularly publish these together with other data on government lending and borrowing.  I believe all three agencies use very similar methods of estimation.  (Knowing nothing about this topic I found Box 1 in the paper Tony McDonald, Yong Hong Yan, Blake Ford and David Stephan, Estimating the structural budget balance of the Australian Government in the Australian Treasury’s Economic Roundup 2010, Issue 3  (http://archive.treasury.gov.au/contentitem.asp?NavId=&ContentID=1881) very useful as an introduction.   This gives references to more technical papers describing the estimating processes of each of the agencies in detail.

Potential output is derived using two-factor constant-returns-to-scale Cobb Douglas production functions with some assumed rate of growth of total factor productivity.  If you are an international agency needing to make regular internationally comparable estimates of the potential output of scores of countries, this may be the best you can do, but this method of calculating potential output seems particularly inappropriate for Ireland, where the sudden arrival and departure of foreign firms and fluctuating rates of international migration can change the productive potential of the economy very quickly.   The agencies can presumably also use only very approximate rules of thumb when trying to calculate how tax revenues would increase to the achievement of this potential output.  The only expenditure that is held to be cyclically determined is unemployment compensation.

The inevitable imprecision of these calculations makes it unsurprising that agencies can differ quite markedly in the proportion of a given government deficit they attribute to non-structural causes.  For example, averaging estimates for Ireland for 2000-2009, the IMF had an average structural balance of -4.4% of GDP; the OECD had -2.2%.  In 2010, the OECD had a structural balance of 25.5% where the IMF had 9.9% (presumably reflecting different treatments of payment obligations under the banking bailout scheme.)   Unfortunately I do not know of a readily available internet source of EU Commission estimates.

Since Ireland is clearly in the “excessive deficit” zone, these differences are not currently of critical importance.  But eventually this position will change, and one can envisage very considerable argument about the proportion of any given deficit which is to be considered non-structural.  It would be advisable for the Irish government to develop its own methods of estimating structural deficits, and to be prepared to defend them under sceptical questioning if they show lower structural deficits than Commission or IMF figures.  Indeed it would be worth seeking the help of one or two economics of unimpeachable international reputation, and who have not previously taken public positions in rejecting EU stabilisation policies, to guide the process of making the estimates and certifying their credibility.

There is no reason why built-in stabilisers need be confined to payments to the unemployed.  A perfectly feasible Keynesian measure would be legislation that inversely relates VAT rates to the level of unemployment.  Discretionary stabilisers, such as a list of non-essential infrastructure maintenance projects that could be speedily put into operation would be another possibility, though more likely to be challenged by the EU monitors.

Although the Treaty regards national budget surpluses with favour, they have a potential deflationary impact on the Eurozone as a whole.  If Keynes had been involved in designing this treaty, he would probably have attempted to have supplemented the “excessive deficit procedure” with an “excessive surplus procedure”, to have forced countries with large budget surpluses to reduce these, even at the expense of greater domestic inflation.  He would of course have had as little success with the Germans as he did with the Americans when he made comparable proposals about persistent creditor countries at the Bretton Woods conference in 1944 that set up the postwar international monetary system.

The concept of a structural budget deficit has been in use for decades by the IMF, but it is not one that is in general discourse, even among economists.  It does not refer to the structure of an economy, which is normally taken to be a set of productive activities, many of which are locationally fixed, and includes both capital equipment, infrastructure and human capital which can change only slowly.  The EU funds designed to help areas of high unemployment to improve their productive capacity are accordingly known as structural funds.  This structural deficit is quite different—it involves a snapshot (if a one-year flow measure can be called a snapshot) of how the existing system of taxes and public expenditures implies for an economy operating at full capacity.

It is easy to get confused about this difference.  Finance Minister Michael Noonan interviewed on RTE’s This Week on May 20th appeared to be implying that needed structural reforms—he alluded to the retraining of unemployed construction workers—were part of the programme to reduce the structural deficit.  Of course, such reforms will lead to increases in both GDP and government revenues rises (and presumably reduce the structural as well as the general deficit)  but this is to use the word “structural” in its more usual meaning, rather than in the sense used in the treaty.

When the Maastricht Treaty was first agreed in 1993, there was much criticism that it required purely monetary convergence, and paid no attention to labor market convergence, either cyclical or structural.  At that time unemployment rates in different Eurozone countries diverged sharply.  Spain had an unemployment rate of over 20%, and Finland and Ireland rates of over 15%.  In contrast, it was only 4% in Austria.  There were concerns that whole countries might find themselves saddled with uncompetitive economies unable to devalue, and become permanently depressed regions within a larger federation, rather like the Italian Mezzogiorno or the US Rust Belt.

This fear appears to have been premature.  The pre-crisis convergence of unemployment rates has been striking.  The standard deviation of national unemployment rates was 5.1% when the treaty came into force, 3.6% in 1999, the first year of the euro and only 2.1% in 2007.  Even in Spain, which appears to be the country in which unemployment has been most persistent, unemployment rates fell until in 2007 they were, at 8.3%, lower than in Germany (8.7%).  The effect of the crisis has, however, been sharp divergence among national rates. The standard deviation in 2011 was 5.4%;   Spanish unemployment was 21.7%.

None of this means, of course, that when stabilization has been achieved and a respectable rate of economic growth reestablished throughout the Eurozone, there will be no further need for reform.  The fear of permanently depressed countries has not gone away—(see, for example a recent article by Martin Wolf (Irish Times, May 21st).  This reinforces what this crisis has made sharply evident—the need for some central fiscal authority, (and also a properly empowered Central Bank).  But the 1993-2007 convergence in unemployment rates suggests that such central authorities ought to be able to adopt Keynesian policies as required.

What We Talk About When We Talk About the Fiscal Treaty

Ireland votes on the Fiscal Stability Treaty on Thursday. The local debate over the last month has been highly revealing in terms of the evolving attitude to Europe and the euro.

One strand of the debate has been narrow in scope, focusing on the technical details of the Fiscal Treaty (measurement of structural balance, implications for speed of austerity). My own take is that, if the Treaty is implemented in an intelligent, cyclically-sensitive manner (consistent with the flexible, holistic interpretation laid out in the “six pack” regulations), the new fiscal framework will be a positive force, helping Ireland and other European countries to gradually exit from high debt levels and avoid destabilising pro-cyclical fiscal policies in the future. Calibrating the optimal speed of fiscal adjustment at national and European levels is no easy task, especially in periods of shifting macroeconomic conditions, and we may expect many future debates about the balance between austerity and growth in delivering the fiscal targets laid out in the Treaty. Indeed, the recent resurgence in European discussion of growth initiatives is a good example of the type of policy rebalancing that will periodically occur in plotting the fiscal trajectory that balances short-term growth concerns with medium-term fiscal sustainability. (The Treaty does not mandate any particular mix of fiscal actions and growth actions to attain the target outcomes.)

In any event, even before the EU/IMF bailout, Ireland was already planning to introduce some type of fiscal framework along these lines and the Treaty is really a marginal addition relative to existing European commitments. Importantly, having fiscal rules built into domestic legislation should improve local accountability relative to purely European regulations.

Moreover, the Fiscal Treaty is a pre-requisite for other important reforms of the euro system. Shared responsibility for the resolution of banking crises, eurobonds and joint fiscal initiatives (such as the European Stability Mechanism, expanded EU or EIB investment programmes, EU-level unemployment insurance) all build on a common platform of sustainable national fiscal policies, as does ECB support for national banking systems and sovereign debt markets. While there is clearly a strong desire for a “big bang” approach by which all of these reforms are simultaneously introduced, that is not currently on offer and does not reflect the incrementalism that characterises the EU approach to institutional reform. Rather, it is more realistic for the Irish government to engage in the hard slog of ensuring that the Fiscal Treaty is quickly followed by progress on these other fronts. To take one example, the euro-nomics group (of which I am a member) advocates the rapid introduction of ‘European Safe Bonds’ which are a type of eurobond that do not require time-consuming Treaty revisions.

Over the last month, the referendum debate has been much broader than the narrow terms of the Fiscal Treaty. As always, a Referendum provides an opportunity for a segment of the electorate to vent disappointment and anger at the current government and widespread economic distress. However, to quote Colm McCarthy, “anger is not a policy.”

Still, two interesting alternative policy visions have emerged from the No campaign. Attracting support from elements on both Left and Right, one theme has been that a No vote would strengthen the Irish government’s bargaining position in reducing the burden of bank-related debt. This argument has two limitations.

First, it fails to accept that the European governance system relies on applying common principles to all member states – bilateral “interest-based’’ bargaining between Ireland and European institutions / fellow member states is at variance with core principles of European integration. Rather, Ireland has a better chance of success through sustained lobbying for a change in European policy (most obviously, the sharing of the fiscal costs of resolving systemic banking crises). Although progress on this agenda has been frustratingly slow, the increasing urgency of addressing similar banking problems in Spain provides extra impetus behind the broad coalition (including the IMF) seeking this change.

Second, as a practical matter, a No vote would not deliver a radical change in Ireland’s negotiating stance, since the current government is in place for the next four years and there is no sign that it would overturn its current strategy. How, exactly, does a No vote force a change in the government’s strategy?

Rather, the most coherent version of this alternative policy narrative accepts that there is a substantial risk that Ireland’s bluff would be called and Ireland enters an antagonistic relationship with our European partners. Such an isolationist strategy is especially risky for a high-income country with an economic structure that is deeply embedded into global financial and trade networks. A badly-played hand could map in significant output and financial losses over time that would be far greater than any reduction in the debt servicing burden obtained through a disorderly default.

In the end, then, the narrow Fiscal Treaty debate can be framed in terms of a broader debate about Ireland’s future relationship with Europe. Although there is much to be done at a European level to build a more stable eurosystem, it seems to me that there are more downside risks to pursuing an isolationist alternative path.

Treaty and future of eurozone

I wrote the following background piece in response to a request last week.  It’s similar to John’s Compact Logic.  My respondent wrote back:  “So a Yes will facilitate EU growth policies, the exact opposite of the No position?”. I was also asked about the consequences of a Greek exit:

Adopting the euro as our currency was supposed to give us much greater stability than the fixed exchange rate regimes that preceded it.  But if Greece leaves the euro, financial markets will no longer accept at face value a statement by a struggling country such as Ireland that it intends to remain within the single currency.  We are likely to see a repeat of the Irish currency crisis of the early 1990s when markets lost their faith in the fixed exchange rate arrangement of the time and Irish short-term interest rates quadrupled over the space of a few months.

Ironically, the currency turmoil of that time was triggered by the outcome of a European treaty referendum but, for once, not one of ours.  Everything had been proceeding smoothly towards the eventual introduction of the euro.  Financial markets believed that Central Banks would intervene to any extent necessary to defend existing exchange rates and a speculative attack on a currency could not possibly be successful.  All changed when Denmark voted no to the euro in June 1992.  It was possible that France would do likewise in September. Suddenly the single currency was no longer inevitable.  Sterling succumbed to  speculative attack and devalued, and attention shifted to Ireland.  Over a billion pounds flowed out of Irish financial markets over the course of a few days and short term interest rates soared to almost 60 percent.

The Irish government tried to hold off the speculators.  Currency control were reintroduced.  The Central Bank raised its lending to the money markets more than twenty-fold to prevent mortgage and commercial interest rates rising by more than 4 to 5 percent.  But this could not be sustained over the longer term as all the country’s foreign exchange reserves would be lost.  Ireland succumbed to devaluation in January 1993.

The same turmoil, with a run on the banks and a massive risk premium on foreign lending to Ireland, would undoubtedly follow a Greek departure from the euro.  The difference in the present case is that where then we had only our own Central Bank, we now have the European Central Bank with its vastly greater firepower.

The fact that numerous other countries would be calling on the firepower of the ECB at the same time, and possibly indefinitely into the future, is why the eurozone powers seem lately to have drawn back from the precipice of countenancing a Greek exit.

The ECB has recently shown itself ready to provide enough liquidity to stave off catastrophe.   At the behest of the Americans, the IMF and now the French, the German government now seems to agree that austerity alone on the fiscal side will fail, just as it did in the Great Depression of the 1930s. But can the Germans be expected to run deficits to stimulate the European economy, or countenance eurobonds – which would put their own credit rating at risk –  before the rest of the eurozone has promised to limit its borrowing?  As a German politician said this week, “you don’t lend your credit card to someone who doesn’t know how to control their spending”.

Compact Logic

After wavering for some time, Deputy Shane Ross has now publicly taken a No position on the Treaty. (See Sunday Independent article here.)   His position is that he is withholding judgement until he sees later growth-focused elements, and takes it that there would be another opportunity to vote on the complete package later. 

While this is a coherent position, I think it is worthwhile to stand back and recall the genesis of the fiscal compact.   The euro zone crisis was spinning out of control late last year, with runs on the sovereign bonds of Italy and Spain.  (The crisis has flared up again recently with the renewed uncertainties in Greece.)   It became ever clearer that the euro zone might not survive unless stronger mutual insurance mechanisms were developed.   Understandably enough, the euro zone countries most at risk of having to make positive net transfers under such mechanisms wanted some degree of assurance that all euro zone countries would follow reasonably disciplined policies, both to limit the expected value of the contingent liability and to minimise inevitable moral hazard.   Politicians in stronger countries also needed a degree of political cover in order to convince their electorates to take on large risks.  

For the most part, it was evident that stronger commitments to mutual discipline would have to lead that strengthening of the mutual insurance mechanisms, but the logic was clear.   In the event, the actual fiscal compact did not go much beyond what countries had already signed up to under the revised Stability and Growth Pact, but it did attempt to strengthen domestic ownership by introducing domestic enforcement mechanisms for the already existing structural balance rule.   Recent events in Spain have brought the possibility of more centralised bank resolution, deposit insurance and supervision onto the agenda as part of this process. 

An often heard complaint in the debate that the commitment to develop these mutual insurance (and related growth) measures are too vague – hence Deputy Ross’s position.    But it is interesting that where the linkage is made explicit – i.e. access to a scaled up ESM – it is considered a “blackmail” clause.  

Not surprisingly, the Treaty debate has ranged widely – the impacts of austerity measures, the implications for post-2015 fiscal adjustment of the existing SGP rules, the nature of additional commitments made under the Treaty, access to alternative sources funding if the Treaty is rejected, etc.   An unintended positive spinoff is that voters are now much better informed on fiscal issues – even if sick to the teeth from hearing about them.   But in the few days remaining before the vote, and with the euro zone again in turmoil, it is important to bring focus back to the core purpose of the compact. 

DeLong and Summers and Self-Financing Fiscal Expansion (very wonkish)

Advance warning: This post will only be of interest to those who have read the DeLong and Summers paper.

As has been referenced on this blog a number of times, the recent paper by Brad DeLong and Larry Summers has had a significant impact on the debate over optimal fiscal adjustment in a depressed economy.    Although the authors themselves note that the balance of arguments may be quite different in a non-creditworthy economy, the paper is still important to our debate (see also here and here).   

The key innovation in the paper is to incorporate the fiscal implications of potential “hysteresis effects.”  Put simply, these effects refer to long-lasting effects on future output – and thus on the future fiscal position – of fiscal adjustment measures today that reduce today’s output.   For example, the loss of a job due to weaker growth this year could have long-lasting fiscal implications if it makes it harder for the person losing their job to gain employment in the future. 

A striking conclusion in the paper is that, under what appear to be a relatively undemanding set of conditions, an expansion of government spending (or alternatively not engaging in some planned expenditure cut) could be self-financing from a long-term fiscal perspective.    Put another way, fiscal expansion could bring about improvement rather than disimprovement in a country’s underlying creditworthiness.  Thus, fiscal adjustment could be self-defeating from a creditworthiness perspective.   Given the influence of their argument, it is important to look closely at the assumptions that underlie this result.  Continue reading “DeLong and Summers and Self-Financing Fiscal Expansion (very wonkish)”

What is not in the Fiscal Compact?

At 1,395 words, Title III of the Treaty on Stability, Coordination and Governance is a very short document by official standards.  The Fiscal Compact contains just six articles and 11 paragraphs.  Understanding what is in the Fiscal Compact should not be difficult but there continues to be significant misrepresentations of the what the provisions actually mean.

As a response to the causes and consequences of the current crisis the Fiscal Compact is wholly inadequate.   From an Irish perspective it is true that “had the the Fiscal Compact been in place since 1999 it could not and would not have prevented the crisis in Ireland”.  It is possible that, in the run-up to the crisis, a greater adherence to the rules across Europe would have created some additional fiscal space to deal with the downturn but this leniency did not cause the crisis.

As regards the ongoing policy response to the crisis, the Fiscal Compact will make little difference.  At present 23 out of the EU27 (and 13 of the EZ17) are in the Excessive Deficit Procedure so even if the Fiscal Compact is torn up it would not lead to a significant change in policy.

However, when assessing whether the crisis could have been prevented it is important to realise that the Fiscal Compact only covers some aspects of the EU framework on economic policy. For example, the Compact does not mention the 3% of GDP overall deficit limit that was introduced in the Protocol on the EDP in the Maastricht Treaty.

The Compact also excludes some elements of the ‘Six Pack’ introduced last year.  From an Irish perspective, two additions worth considering are:

Continue reading “What is not in the Fiscal Compact?”