Fiscal Policy and International Competitiveness

Two current policy problems for Ireland are to tackle the loss of external competitiveness and to determine the appropriate level and composition of government spending.  These issues are linked, since government spending affects the real exchange rate for Ireland, through its impact on the relative price of nontraded goods in terms of traded goods.

In a new paper  Fiscal Policy and International Competitiveness: Evidence from Ireland(joint with my TCD colleague Vahagn Galstyan), we show that the long-run behaviour of the real exchange rate and the relative price of nontradables is increasing in the long-run level of government consumption but decreasing in the long-run level of government investment.

The intuition is that government consumption tends to drive up economy-wide wages and nontraded prices (since the public sector competes for scarce labour and non-traded inputs), while government investment in the long run improves productivity (especially in the non-traded sector) which is associated with a reduction in the relative price level.

The appropriate levels of government consumption and government investment depend on a range of socio-political factors, but these results are worth noting in any debate about the connections between fiscal policy and external competitiveness.

ECB Financial Stability Review: Property Decline worst in Ireland

The ECB has released its latest Financial Stability Review.  From a domestic perspective, the report highlights that Ireland has seen the sharpest decline in commercial property values, from the fastest-growing market in early 2007 to the greatest contraction in 2008, with the gap growing over the course of the last few months. Similarly, the Irish residential property market is the worst performing in the euro area.

SSISI Meeting, 20th January 2009, 6 pm at RIA

The next meeting of The Statistical & Social Inquiry Society of Ireland will take place on Tuesday, 20th January 2009, starting at 6 pm [SHARP], at the Royal Irish Academy, 19 Dawson Street, Dublin 2. The President, Dr Donal de Buitleir, will be in the chair when Mr Michael Moloney and Dr Shane Whelan (UCD) will present a paper titled Pension Insecurity in Ireland. The text of the paper is available at, and an abstract is set out below:

The annual amount of the state subsidy to occupational and private pensions in Ireland is double that previously believed and is of the same order as the total annual payments under the state flat-rate contributory and non-contributory pension schemes. We ask: does the state get value-for-money from these subsidies? To answer the question we introduce the fair value approach to value pension entitlements. The current regulatory regime is shown to be very weak, with the security of pension entitlements of those in employment below that of investment grade debt (so the pension promise if tradeable would have junk status). We suggest and analyse measures to improve members’ security and recommend that the fair value of pension entitlements be made a debt on the sponsoring employer and that there should be regular disclosure to members of the level of security backing their pension entitlement. The former only gives a minor increase in security in an Irish context but the latter incentivises members to make other provision for their retirement. We conclude by suggesting that the state has a larger role to play in pension provision in Ireland in the 21st century than it played in the last century.

Spanish Banks: Well Regulated but Still Suffering

Tuesday’s FT has a long piece on the Spanish banking system: you can read it here.   An interesting difference relative to Ireland is that the Bank of Spain insisted on banks building up reserves against general future risks. However, these provisions are not formally counted as part of its capital base and the general push towards higher measured capital ratios means that the Spanish banks are also looking to raise capital.  This may reduce the chances of these banks getting involved in acquisitions in Ireland, at least in the near term.

Tax increases are inevitable: discuss

Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.

So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.

Poznan and all that

The latest round of international negotiations under the United Nations Framework Convention on Climate Change in Poznan reached its conclusion last week. The parties to this convention meet twice a year. The latest talks were a preparation for the Copenhagen negotiations scheduled for late 2009. Nothing much happened in Poznan. These were talks about talks.  Should one pity the civil servant who attends these boring meetings, or envy her for all the foreign travel at the taxpayers’ expense?

By the way, the Irish taxpayer need not worry about such expense: The Irish delegation to the climate negotiations travels on account of official development aid. Poor foreigners foot the bill.

The irrelevance of Poznan is best illustrated with the fact that the European Council met during the “crucial” end-phase of the Poznan conference — and made decisions about European climate policy. The decisions are bizarre from an economic viewpoint.

The main target of European climate policy was unchanged. We will reduce greenhouse gas emissions in 2020 to 20% below their 2005 levels. A number of countries expressed concern about the costs of meeting such a strict target. These worries were placated by grandparenting more emission permits, and auctioning fewer. This is exactly wrong. Cap-and-trade with grandparented emission permits is roughly equivalent to a carbon tax with lump-sum recycling. Cap-and-trade with auctioned permits allows for a smarter recycling of revenue. In fact, almost any recycling scheme is smarter than lump-sum. In this particular case, the revenue is essentially a capital subsidy to energy-intensive industries (but long after credit will be uncrunched), although it can also be interpreted as a windfall profit. The agreed compromise is not bad for the environment as some environmentalists have claimed because emission targets are the same. The agreed compromise is not good for the economy either, contrary to the claims of the politicians involved. It is bad for the economy, but good for shareholders in energy-intensive industries.