Author: Colm McCarthy

For tomorrow’s Farmers Journal:

The government announced a package of measures, described as a jobs initiative, on Tuesday. There is to be a reduction in the VAT rate for tourism-related spending and the travel tax is to end. Both measures should help a recovery in this important sector. There are also to be some modest capital spending allocations for schools, road-works and home insulation. Employers’ PRSI is to be cut for low-paid employments.

These measures will be offset by a sharp increase in the minimum wage. In the United Kingdom, the minimum wage is £5.93 per hour, which translates to €6.74 at today’s exchange rate. The Irish minimum wage is currently €7.65, well ahead of the UK figure. The unemployment rate in the UK is only about half the Irish level, but the Irish government, while acknowledging the need to restore competitiveness, has decided to increase the minimum wage to €8.65, bringing the premium over the UK to no less than 28%.

The other eye-catching wheeze is a levy of 0.6% per annum on the capital amounts saved in pension funds. The retirement incomes of workers in the private and commercial semi-state sectors are paid out of the assets contributed over the years to occupational pension funds. Many of these funds are inadequate due to improving life expectancy and the weak investment returns of the last decade. As a result both employers and employees are facing higher contributions in future as well as reduced benefits. Those with the foresight to choose employment in the public service are exempt from the new levy, since the public service does not bother to fund its pension obligations. The Minister for Finance, Michael Noonan, looked a bit uncomfortable while explaining this measure on television on Tuesday evening. His justifications included an argument to the effect that much pension fund saving is invested abroad, and that his plan will see these funds ‘brought home to invest in jobs.’ Sadly some pension funds were foolish enough to invest in Ireland, in safe Irish banks and even safer Irish government bonds for example, and are nursing the biggest losses for their pains. But they will have to fork out the levy regardless, since it applies to all funded pension schemes.

Money accumulated in private sector pension funds belongs to the people who have saved it up, and is capital rather than income. The funds are trapped given the trust law and this makes the assets a sitting duck for a cash-starved government. In October 2008, the government of Argentina, unable to borrow in the international markets, simply expropriated $29 billion of assets from private retirement accounts to plug a budget gap. One wonders if Mr. Noonan’s advisers have been studying any other elements of Argentinean policy, which also features an export tax on agricultural produce.

Around 520,000 people own the €80 billion in these funds, an average of about €154,000 per person. The levy will cost them about €920 per annum on average. About 330,000 employees have entitlements under public service pension arrangements. These schemes are unfunded and thus have no taxable assets, but the total liability has been estimated by the Comptroller and Auditor-General at €108 billion. It follows that the average sum standing to each member in these unfunded schemes is about €327,000, more than double  the amount standing, on average, to those in funded schemes and liable for Mr. Noonan’s levy. The jobs initiative is being funded, in effect, not by those who are fortunate enough to have occupational pensions, but by those who have small occupational pensions. Those with the bigger pensions, public servants in the main, will not be contributing. Interestingly, since the new levy is a levy on assets, it will affect disproportionately the older members of the private sector workforce who have more substantial funds already saved. Younger workers can relax: they have too little in the way of retirements savings at risk.

It is of course true that tax concessions for private sector pensions were excessive for those on super-duper incomes, and there have been sensible reforms over the last few years designed to place a cap on these tax breaks. Some people were able to duck tax and accumulate multi-million pension pots while managing the banking system into spectacular insolvency. Others have retired from their labours in the vineyard of public service with enormous pensions to which they never had to contribute. But the sins of these fortunate folk are now being visited on the workers in the private and semi-state sectors prudent enough to have made funded retirement income provision. In March of last year, the government released a document on pensions policy which expressed alarm at the condition of private sector funded pension schemes, including the inadequate level of contributions and limited coverage. The new government has sent a clear signal that it is content to see these problems get worse.       

We do microeconomics too! From the current Farmers Journal, and apologies for the length:

Small countries can do little unilaterally to combat climate change. The planet has just one atmosphere, and every tonne of carbon dioxide, or of the other greenhouse gases, released into the atmosphere has an identical impact. It does not matter where in the world each tonne is emitted. For every tonne emitted in Ireland, about 500 tonnes are emitted somewhere else. If Ireland somehow managed to cut emissions to zero, the fate of the earth’s climate would barely be affected. The problem is global of its very nature and requires global solutions. Every country needs to accept its international obligations and indeed to encourage international agreement on faster action. But solo-runs by individual small countries aiming for very rapid emission reductions make no sense, achieve nothing environmentally but could impose serious economic costs.

Ireland has been pursuing very ambitious targets for emission reduction going beyond our international obligations, despite a sharp reduction in the measured output of greenhouse gases in 2009 consequent on the economic downturn. The 2010 figures are not yet available but chances are that emissions fell again and could remain flat until the economy begins to recover. Under current policy Ireland has been aiming for a major switch to wind-powered electricity, more bio-fuel in transport, electric cars and a long list of other emission-reducing initiatives. All of them will cost money and the overall policy pre-dates the onset of the Irish economic collapse. It is not surprising that the new government is being advised from several quarters to re-visit our emission-reduction targets, specifically to take the downturn into account and to see if excessive costs can be avoided.

A report earlier this year from the Irish Academy of Engineering argued that electricity generating capacity is no longer under pressure: reduced demand is being met comfortably given the availability of several new gas-fired plants and there is less urgency about building extra generation, at least for the next five or ten years. The report also questioned the haste in expanding the transmission system. More recently, the Economic and Social Research Institute has argued against subsidies for offshore wind projects and for reduced wind subsidies onshore. Finally the review group on State assets, as well as proposing structural changes to the electricity industry and partial privatisation, also warned against too rapid a rush into wind generation.

John McHale has kindly posted an article I wrote for today’s Sunday Independent below. I would like to expand here on what secondary market Irish bond prices are actually saying.

The benign outcome expected, publicly at least, by our European partners is that, if Ireland ‘sticks to the programme’, things will work out OK. Working out OK needs to be defined. Here’s a working definition.

1. Ireland is able to return to the sovereign market in about eighteeen months.

2. This means the bond market, not just bills or CP.

3. It must be able to sell bonds, in large quantities, at medium duration. That means five-year at minimum, ideally ten-year and longer.

4. Yields don’t have to be as comfortable as Germany or even France, but can be no worse than say Spain.

5. Ten-year bonds at 5% would be, to coin a phrase, manageable, with five-year at say 4.5%.

If you believe that sticking to the programme, plus an average run of luck, will do the trick, without any compromise with bank creditors or sovereign default, you must also believe that bond market re-entry, on something like the above basis, is on the cards before the end of 2012.

The bond market does not believe that this outcome is likely at all. Both five- and ten-year bonds were yielding over 10% on Friday. Conveniently, the coupon on the five-year is 4.60. If the price is to exceed 100 in eighteen months time, the total return offered for the period is a capital gain of at least 23 plus about 8 in accrued coupons, total at least 31 versus Friday’s price of 77. The five-year will be a 3.5-year by then, target yield even lower on a normal curve, and the required return even higher. If you sincerely believe that this outcome is likely, buy while stocks last.

Note that a return to the bond market which takes this jaundiced view is a part of the programme, as Karl Whelan repeatedly points out. When sovereign debt gets junked by the market, it does not recover over short horizons like eighteen months. You go down in the elevator and come back up the stairs.

None of this suggests that we should not stick to the programme. The fiscal adjustment makes sense in any scenario and there is a case for doing it faster. What it suggests is that preparations need to be made for a long-haul, including sovereign re-structuring or re-scheduling, just in case the markets might have it right this time.

At the European Parliament today, ECB President Trichet was asked whether Ireland could cope with both the sovereign and bank debt. RTE has reported as follows:

‘Following a suggestion from Fine Gael MEP Gay Mitchell at the European Parliament that it was impossible for Ireland to cope with both, Mr Trichet said Ireland had to regain credit worthiness.

‘My working assumption is that Ireland can do it, Ireland will do it,’ he said.

Speaking to the parliament’s economic and monetary affairs committee Mr Trichet said the rescue programme had been approved by the international community, not only the EU.

‘The decisions taken by Ireland over the past three years are there, and there has been a programme approved by the international community,’ he said.’

The dissenters from this view unfortunately include the sovereign bond market, which Ireland is scheduled to re-enter before the end of next year. At today’s close, the Irish ten-year bond offered 9.60 on the bid.  

At this price, M. Trichet must regard these bonds as remarkably good value, and a suitable home for the ECB staff pension fund. The October 2020 issue has a coupon of 5% and has been trading recently about 72. It would be at least 100 if M. Trichet’s view was shared by the market. No distressed Eurozone member can credibly re-enter the market without selling at least some bonds at ten years or longer, and at rates below Spain’s ten-year, recently yielding about 5.15.

What precisely does M. Trichet expect to happen over the next 18 months to bring secondary market Irish yields down by the enormous amount implied by his expression of confidence? He clearly must believe that the market has got it wrong about Ireland. Does he believe things are going equally well in Greece, where the ten-year bond yields about 12.20 on the bid?

The Eurozone is in serious trouble unless his private view is more realistic.

My contribution to this week’s Farmers Journal:

 Bertie Ahern used his last full day in the Dail, on Thursday January 27^th., to offer his reflections on a career which included long spells in senior ministries, including Finance, and 11 years as Taoiseach. Reporters seemed genuinely shocked at Mr. Ahern’s lament for his lost Bertie Bowl, which unbelievably he identified as his greatest regret from his time in office. He also protested that nobody had told him about the problems in the banks.

The Bertie Bowl, described by Mr. Ahern as a national ‘infrastructural’ stadium, whatever that means, was as daft a project as ever issued from the fertile brain of an Irish populist politician. The city of Dublin contains two fine stadiums at Croke Park and Lansdowne Road, both rebuilt in recent times with substantial taxpayer support. The Bertie Bowl would have been a third. At one stage, no less than four stadium projects were under consideration, the fourth being the FAI’s Eircom Park. But during the period when Lansdowne Road was closed for reconstruction, only Croke Park was available and comfortably catered for the full GAA programme plus all the rugby and soccer internationals, as well as numerous concerts. That it was able to do so reflects the simple reality that there are not that many big matches to be accommodated. There are rarely more than about 12 or 15 big GAA match-days per annum, and not many more between rugby and soccer combined. One stadium was enough for three full years. Neither Croke Park nor Lansdowne Road will be intensively utilised in the years ahead and it is debatable whether the city needs two big venues never mind three. 

But Mr. Ahern wanted a third, at a cost of around €700 million. It was one of the very few of his spending schemes that did not go ahead, because the late lamented Progressive Democrats pulled the plug after the 2002 election and can at least claim to have spared us a ghost stadium to go with the ghost estates. The vigorous campaign against Ahern’s curious project got little support from the Fine Gael and Labour benches, mesmerised by the popularity at the time of Ireland’s first celebrity Taoiseach. Jimmy Deenihan of Fine Gael, who should know a thing or two about stadiums from his days in the Kerry jersey, and Labour’s Pat Rabbitte, are the only exceptions I can recall.

Given the current condition of the country there is something profoundly disturbing about Mr. Ahern’s choice of the demise of the stadium project as his greatest career disappointment. Fate, or the forces of darkness, deprived him of the opportunity to waste €700 million. But his protestations about the failure of others to warn him about the credit bubble are even more extraordinary. As far back as 2001, the former head of Bank Supervision at the Central Bank, Willie Slattery, who had departed for the private financial sector, warned publicly, and in very blunt terms, about the risks emerging in bank balance sheets. Mr. Slattery’s speech was widely reported and caused quite a stir at the time, given his career background and knowledge of the banking business. There were numerous other public warnings from commentators around this time about the emerging housing bubble and the excessive growth in public spending. In October 2004, the influential Economist magazine devoted a cover story to Ireland which received extensive media coverage here. The story described the Irish bubble in unambiguous terms and warned of the risks. It is simply untrue to assert that no warnings were given. There were plenty of warnings, and in public. By the time Mr. Ahern addressed the Irish Congress of Trades Unions in Bundoran in July 2007, he had begun to hear what was being said and responded to his critics in the following terms:   

‘Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide because frankly the only thing that motivates me is being able to actively change something.’

His ‘suicide’ remark, a subsequent YouTube hit, was warmly applauded by the assembled trade union brethren. Mr. Ahern subsequently apologised and quite properly, to groups representing relatives of suicide victims. He never apologised to the targets of his remarks, of course. By the time Brian Cowen replaced Mr. Ahern in May 2008 the damage was well and truly done and it has been downhill ever since. The electorate blame Fianna Fail for both the genesis and the handling of the crisis and they will have their revenge it would appear. But having run the country from 1997 to 2008, this is unambiguously Bertie Ahern’s crisis. And his greatest regret is not having wasted even more money on a stadium folly. Planet Bertie indeed.