Notes On The Front

Ratings Downgrade? Blame Raspberry Vinaigrette. The Recession Diaries - August 27th

One can only chuckle. Last year the pronouncements of rating agencies were treated as though they were written on Mount Sinai. Downgrades, or the threat of such, were interpreted by our high priests of deflation as demands to cut public spending. That’s what we did – big time; slashing public spending by nearly €9 billion in one year (nearly two-thirds more than the McCarthy committee recommended). Surely our sacrifices would please the gods.

Now the high priests are confused. Our bond performance kept weakening and the downgrades have kept coming, even after all our fiscal sheep and goats were sacrificed (and earnest assurances that our bank bail-outs are affordable and manageable). So, instead of questioning whether they got the translation wrong, the high priests have turned on the gods themselves. The economy hath no fury like a deflationist scorned. Some of us, however, never treated the rating agencies as anything other than culprits in the international financial crisis.

But that doesn’t mean we shouldn’t be worried. Maybe the ‘international markets’ know something that is not being reported here. Take the recent projection of the ESRI.

According to the ESRI, if the Government persists with its present strategy our debt as a percentage of GDP will be 106.9 percent by 2020 and rising. With regards to GNP, it will be 134.1 percent and rising. No wonder the Government’s policies are getting hammered.

What has been the response? What little there has been shows that old habits die hard. It was suggested that the Government should, maybe, considering cutting €4 billion out of the next budget, not €3 billion as they have announced. Shovel. Hole. Dig.

What effect would this have? Hardly any. Using the ESRI’s real growth projections (and taking the consumer price estimates as a proxy for the deflator) I calculate the following.

Our general government debt will be approximately €275 billion by 2020. Is anyone really suggesting that cutting an extra billion in 2011 is going to have any impact whatsoever? Even on a static basis, it would only reduce the debt by a couple of percentage points. Actually, it would be less because the impact of the cut would be to slightly reduce economic growth, slightly reduce tax revenues, and slightly increase unemployment costs. Overall, the impact would be a fraction.

Cut €2 billion more? Cut €3 billion more? Twice, thrice a fraction still remains a fraction.

We are at the end of the road but the deflationary wagon train still keeps going forward. It’s heading towards the abyss. And the problem is that we can’t jump off. Unless we stop the train – and stop it now – we’ll be heading over the edge with it.

And no doubt the high priests of deflation will then find a new scapegoat. I nominate the decadent effect of raspberry vinaigrette on modern fusion cooking. For the purposes of avoiding the truth, it works as good as any.

The Suffering of the Rich - Can You Feel It? The Recession Diaries - August 25th

There have been some outrageous and hilarious things said in this economic debate. I don’t know how economic historians will come to rank them. But surely at the top must be the claim that the rich have paid a ‘far higher price’ than other groups in society as a result of the economic downturn. You could dine out on that one for a long time.

This issue is not academic. In the run-up to the budget progressives will put particular emphasis on increasing taxation on high-income groups. There are two good reasons for this: first, because they have a lot of money and, second, because it will have a less deflationary impact on domestic demand than, say, taxing low-income groups or cutting public spending.

But would it be fair? If they have paid a ‘far higher’ price than other groups during the last couple of years are we in danger of victimising this hard-done-by group of individuals? Let’s look through some of the data, bearing in mind that information on income and wealth is sketchy and dated.

The Rage and the Ridiculous. The Recession Diaries - August 23rd

The Central Bank Governor, Patrick Honohan, is outraged. In particular, he is outraged that Irish bond spreads are so high, ridiculously high. Don’t the ‘international markets’ realise the dynamism of our export sectors, the budgetary and tax reforms, the pain we have suffered to get our public finances under control? Why are they still doing us down?

I find this outrage hard to fathom; not because the international markets are any more prescient or knowledgeable (they did, after all, lead us into the financial meltdown). Rather, that Governor Honohan surely knows better. It is one thing to be positive; it is quite another to ask all of us to be blind to certain realities.

First, it should be noted that much commentary on our bond performance has an insular character to it. Ireland is a minnow in the global bond market. Analysts don’t spend a lot of time examining the highways and byways of the Irish economy. When constructing their investment strategies, Ireland is seen as a good risk for a good price. Unless you think we’re going to default anytime soon, our bond yields give good value for money. This is what the National Treasury Management Agency has been able to exploit. That is why we have borrowed all we need this year and still have €20 billion in our back-pocket – even after all that bank bail-out money.

But let’s not lose the run of ourselves. The Irish economy is well known internationally as the ‘double Irish’ – a significant tax-laundering staging post in a complex world-wide network of corporate tax avoidance. The combination of our ultra-low corporate tax rate along with our accommodating rules on transfer-pricing are what we are well known for. The audiences that Governor Honohan spoke to would have known this. So when he spoke about the dynamism of ‘exports’, there must have been some wry smiles.

There are other reasons why international markets might be unimpressed with the PR campaign being launched on behalf of Government policy. The ESRI recently showed that the current fiscal policy will lead to an incredible level of debt – over 100 percent of GDP and over 130 percent of GNP by 2020. This would make any investor nervous.

Nor is there evidence that Government policy will bring the deficit under control anytime soon. Again, the ESRI projects it won’t be done this side of 2020. The Oxford Economics/Ernst & Young study showed that, maybe, by 2018 or 2019 we’ll get it back to Maastricht compliance.

And then there’s that ‘affordable’ and ‘manageable’ bail-out of Anglo-Irish and INBS.

With the OECD, the EU Commission, and the IMF all warning the Government that its growth projections are too optimistic, investors might see dangers down the road. Low growth equals low tax revenue and higher unemployment costs equals sluggishly high deficits.

Still, with all this deflationary luggage, Governor Honohan took to the road to sell ‘Ireland’. The result probably wasn’t what he was hoping.

We might better served if public officials got down to the hard task of repairing a dysfunctional economy. And being a bit more open about what this will require.

It's a Tax pure and simple - and It's a Bad Tax. The Recession Diaries - August 10th

Do not be confused. The Government’s recently announced increase in electricity prices through the Public Service Obligation levy (PSO) is a tax, pure and simple. And it’s a very bad tax.

The PSO levy subsidises electricity suppliers who are required to purchase electricity from renewable and peat-generated sources. This is because the costs of electricity from those sources are ‘uncompetitive’. In other words, the cost of electricity generated from these sources are higher than other sources and, if it was left to the ‘market’, no on would buy their high-priced product. The State requires suppliers to buy these products and, in return, they are compensated. The Commission on Energy Regulation has assessed that the cost of the subsidy is approximately €157 million.

In principle, there is nothing wrong with subsidising producers of renewable and peat-generated electricity. There are sound social, environmental and long-term economic reasons (which the market can’t accommodate) for subsidising these activities. The problem is the manner of the subsidy.

The state can do one of two things (or some variant):

• It can directly subsidise the producers of renewable and peat-generated electricity or the energy suppliers who are required to purchase that electricity out of general taxation
• It can impose a tax on all electricity consumers and distribute the proceeds to the producers or the suppliers.

The difference is key. In the first option, companies are directly subsidised from the Exchequer. This increases current expenditure which has to be met by increased general taxation, borrowing or cutting back on other spending. But it doesn’t affect the price.

In the second, a tax is levied on all consumers – in other words, the subsidy is paid through higher prices. But it doesn’t directly affect the Exchequer.

What the Government is doing transferring the cost of the subsidy from the Exchequer to the consumer and the wider economy through higher energy costs.

The levy is regressive. If the subsidy was paid out of general taxation, this would mean that, by and large, people with taxable incomes would pay (you could always impose a special levy on high incomes to pay for the €157 million but let’s not get all Leveler about this).

However, the levy will be paid by everyone, regardless of income or employment status – from the elderly pensioner living alone to high income households, from profitable companies to unprofitable companies. And this will be regressive as low-income households pay a higher proportion of their income on electricity than higher income households according to the latest CSO data.

The lowest income households – the 1st and 2nd deciles – pay three to four times more of the disposable income on electricity than the highest or 10th decile, households. So it’s no surprise that a levy on electricity prices will be highly regressive. As I’m using numbers from the CSO 2005 survey the percentages will have changed but the ratios between low and high incomes will stay roughly the same.

The PSO levy will be regressive. It will impact on low-income households five times harder than on higher income groups. This is socially unjust.

It is also economically irrational. As pointed out in the previous post, domestic demand in the economy remains weak (‘anaemic’ is the word the ESRI used). The last thing – the very last thing – you do is to fleece low and average income earners who are more likely to spend. High income groups will easily absorb the minuscule impact on their incomes; those on lower incomes will compensate by reducing spending in other areas.

This is not an argument against public subsidy to renewable energy producers. If anything, there might be an argument for increasing that subsidy.

The problem is the way the subsidy is being delivered. What the government is doing will be bad for most households, it will be bad for the economy, it will be bad for those non-energy businesses who are reliant upon consumer spending, it will be bad for fuel poverty.

You couldn’t make this stuff up.

Straight Talking Our Way to Bankruptcy. The Recession Diaries - August 9th

Oliver Gilvarry of Dolmen Securities is writing in the Sunday Tribune in a column entitled ‘Straight Talking’. He has a solution to our problems. On his way to this straight-talking solution he quotes uncritically from a number of reports – a potted repetition of much of the real devaluationnist cannon which been dealt with here (pricey nurses) and here (pricey teachers) and here (pricey restaurant workers).

Oliver puts all this together (including his disappointment that flat-rate water charges and pension cuts have seemingly been removed from the Government’s agenda) and proposes that pay cuts and tax increases are vital to economic recovery.

Pop quiz. Sean and Maria are average income earners. They’ve been hit by income levies, health levies, child benefit cuts, etc. in the last 18 months. Now they’re heading into a period of wage cuts and more tax increases as prescribed by Oliver. What would happen to them?

First off, they would probably have no choice but to find ways to cut their spending even further – as they are not likely to have much in the way of savings.

Second, they may find the burden of their debt rising. Their disposable incomes would fall but their debt would remain the same.

How would this affect the economy? Let’s put this in some background. The ESRI estimates that consumer spending will fall by 12 percent between 2008 and 2010 (in the Eurozone average decline is less than 1 percent). Over €11 billion was lost to the economy in collapsed consumer spending. This collapse contributed to over 40 percent of the fall in the GNP.

The prospects for next year are modest, at best. The ESRI hopes that consumer spending will rise by 1.5 percent but the Central Bank is more pessimistic at less than 1 percent. Given this fragility, does it make any sense to hammer disposable incomes, turning this small advance into a negative? We will be inviting more businesses into creditors’ meetings and more people on to the dole queues.

And with wages falling, what impact will this have on tax revenue and, so, the deficit? The Government looks set to miss its deficit target this year. With falling wages, and most independent forecasters projecting more job losses next year, this will put more pressure on the deficit. Throw in falling consumption taxes (VAT/excise) due to falling disposable incomes; throw in spending cuts (which will reduce people’s spending power even further) - and you have a big pile of deflationary TNT.

Oliver has provided a solution that will cut consumer spending, cut business profitability, cut employment, cut growth, increase household debt burden cut tax revenues and increase the deficit. It makes absolutely no sense from an economic, fiscal or social perspective.

Any more straight-talking like this and the economy will surely blow up.

The Never-Ending Jobs Recession. The Recession Diaries - August 5th

Pretty grim. Back in March and April we got a lot of commentary – about how the unemployment was stabilising, how we’re starting to turn the corner, how the dismal asphalt of recession is cracking – letting green shoots of recovery to appear. Yes, unemployment remained constant at 13 percent for the two months March and April – down from a peak of 13.3 percent in November last year. But then the great ship Irish Economy started turning south. Unemployment creeped up in June, then July. Now the CSO has released the August figures and, well, they’re grim, now standing at 13.7 percent.

A number of commentators have focused on the changing composition of those made unemployed in the last month. While previously it was craft, production and retail workers who took the disproportionate hit, in July there was a substantial rise among professional and clerical/secretarial occupations. In the first six months of this year unemployment in these two combined categories rose by 4,727. In July alone more than 7,800 in these two occupational categories lost their jobs. And women made up 85 percent of that job loss.

Why is this happening? One explanation is that a number of companies tried to hold on as long as possible to skilled workers – until they could no longer hold on. The moratorium in the public sector could be another contributing factor. In any event, none of this should be too surprising. FGS predicted that insolvencies would continue to rise in 2010 – spilling out beyond construction and retail, and beyond Dublin. The Insolvency Journal.ie’s recent survey showed this trend continuing.

If all this is grim, here’s something grimmer: the jobs recession, even in the best case scenario, will continue until 2020. In reality it will probably last longer. In the ESRI’s high-growth scenario, employment won’t return to pre-recession levels until 2020. In their low-growth scenario (which, in comparison with other forecasts, is more of a medium-growth scenario) it could be as long as 2024.

So settle in, ladies and gentlemen – it’s going to be a long decade.