It is clear that when the NAMA legislation is published later today, there will be a lot of focus on the question of long-term economic value and the European Commission’s guidelines for pricing assets transferred to government asset management agencies.
I have written about this issue before and don’t want to repeat myself. However, I’d like to emphasise two issues.
There’s a lively debate going on about Philip’s earlier comments about competitiveness and recovery and I wanted to add to it but then wrote something so long I decided it would be best to exploit privilege and start a new post.
David Begg criticises the ‘deflationary’ strategy in an article in today’s Irish Times (you can read it here). In reading this article, it is helpful to remember that the term deflation requires subtle interpretation for a member of a monetary union. In particular, the main substantive issue is whether real devaluation is a necessary part of a recovery strategy, where real devaluation means a decline in relative wages and prices in Ireland relative to our trading partners. For a low-inflation monetary union, an individual member country may require a temporary period of deflation in order to attain a significant real devaluation.
David Begg argues that there is little evidence that deflation facilitates recovery. However, there is a strong body of evidence that real devaluation is helpful. Just taking Irish economic history, the devaluations of 1986 and 1993 were contributory factors to economic growth.
It is certainly true that the global recession means that the level of external demand is low. It is also true that the re-orientation of spending in the world economy towards Asia and away from the United States does not help Ireland, given the nature of trading patterns. However, these external factors simply underline the scale of the negative shock that Ireland is enduring.
It is also true that high levels of household debt means that deflation carries an extra cost in terms of raising the real burden of debt repayments. However, the single biggest risk factor in debt repayment is unemployment and a strategy that minimises the growth in unemployment through the restoration of competitiveness dominates.
The real question is whether there is a credible alternative. If Ireland had run a counter-cyclical fiscal policy during the good years, there may have been room to do more in terms of counter-cyclical fiscal expansion now. However, the scale of the fiscal deficits and the fragile state of international bond markets mean that significant fiscal expansion cannot be entertained.
Rather, the focus has to be on restoring international competitiveness through real devaluation (plus other measures to fight monopoly power in the economy and improve productivity). This will stimulate not only the export sector but also the domestic nontraded sector, since the level of domestic consumption will be boosted if Ireland can establish a sustainable growth path. In relation to the export sector, the gain will not only be in terms of the performance of existing sectors and firms but also in relation to the ‘extensive margin’ (new firms exporting for the first time, sectors emerging as internationally competitive). In turn, suppliers of domestic services to these firms will gain, such that the employment impact will be wider than just the export sector itself.
As I write this, the government is continuing to mull over its NAMA proposal. The proposal has been around so long that it is easy to forget that we are actually still at an early stage with this process, with the legislation yet to be published even in draft form and no vote due for a couple of months. For these reasons, it is still worth discussing why alternative approaches may be worth taking.
I’d like to set out one such approach. But before doing so, let me explain why I think things have moved on since the NAMA proposal was introduced.
A remarkable recommendation from An Bord Snip Nua is to suspend payments into the National Pension Reserve Fund (NPRF). In today’s Irish Times, Fintan O’Toole comes out in support of this proposal (see his article here). The relevant text from the report is:
D.2 Suspend payments into the National Pension Reserve Fund
Under the National Pensions Reserve Fund Act 2000, one per cent of GNP is paid into the NPRF each year. The Group considers that continuation of this annual payment is difficult to justify at this time, given the rate of growth of the public sector borrowing requirement. These payments were affordable when the budget was generally in balance but the Group considers they should be suspended as the State is in effect borrowing to finance the purchase of financial instruments.Transfers to the NPRF amount to approximately €1.6bn a year. Suspending this €1.6bn transfer would have no impact on the General Government Balance, but would reduce the annual Exchequer Borrowing Requirement.
(page 182 of second part of report)
It is odd that the NPRF falls within the remit of a report on public expenditure, since payments into the Fund do not constitute public spending as it is normally understood. Rather, the Fund is a vehicle to enable partial pre-funding of the projected sizeable increase in future public spending that is connected to the ageing of the population. The logic of pre-funding follows from ‘tax smoothing’ principles – it is better to have a higher tax burden now in order to make payments into the Fund rather than to experience a discrete jump in the tax burden in the future. The annual payment into the Fund is also an important commitment device, especially during periods of scarce fiscal resources. In particular, the Fund protects the interests of those who will be paying taxes in the post-2020 period versus those who have a much shorter horizon.
There is certainly plenty of room to discuss the appropriate investment strategy for the Fund, especially when the government is running a deficit and there is a sizeable risk premium embedded in the yield on Irish sovereign debt. Moreover, the ad hoc revision of the Fund’s investment strategy to enable its investments in the main Irish banks provides a further reason to re-think the strategy for the Fund.
One dimension of this review could include the Fund’s strategy vis-a-vis Irish government debt. Although the founding legislation for the Fund prohibited the purchase of Irish government debt, this prohibition could be reviewed. Just as the US Social Security Fund holds only US treasury bonds and retirement funds in other countries have a heavy concentration in domestic government debt, it may make sense for the Fund to have the option to purchase Irish government debt under certain conditions. This is also in line with the trend towards localisation in investment decisions, as described by Gillian Tett in the FT yesterday (her article is here).