Wednesday, March 31, 2010

The trouble with debt

NAMA has begun the process of buying toxic debt from our ailing financial institutions.  The first tranche sees €16 billion in loans being bought for a price of €8.3 billion – a ‘haircut’ of 47%.  This €8.3 billion is being borrowed to finance these purchases.  In essence, public debt is being created to buy private debt which may or may not be paid back.

Three years ago the amount of money being borrowed by Johnny Ronan, Liam Carroll, Bernard McNamara and their ilk had no effect on the ‘man on the street’.  With NAMA buying the loans issued to these developers with public debt it is not only Johnny Ronan who is taking a kick in the groin.

At the end of 2009, Ireland’s general government debt stood at €106 billion.  In 2009 the total amount of economic activity in Ireland was valued by the Central Statistics Office at €163.5 billion.  Using this Gross Domestic Product (GDP) figure means that Ireland has a debt to GDP ratio of 64.5%.

For households this figure may appear to be a very low debt figure.  Consider a household with a net income of €40,000 and an outstanding mortgage of €200,000.  This household has a debt to income ratio of 500% and this would be normal for many families.  If the state has a debt ratio that is eight times less surely this should not be a problem.

If the household was to devote all of their income to paying off the mortgage it would take five years before the balance would be cleared (assuming zero interest).  In order to clear the National Debt of €106 billion, Ireland would have to devote the value of all economic activity to paying off the debt for just under eight months.  What takes a family five years could take the country eight months.  There are two reasons that make this comparison false.

Firstly, while a family make have access to their entire income to spend as they wish the government can only spend that part of national income they collect in taxes.  In 2009 the Irish Exchequer collected €33 billion in tax revenue.  With this amount available it would take three years and two months to pay off the National Debt if we poured every euro of tax revenue into it (again assuming zero interest).

Second, the average household will borrow a large amount of money once and then proceed to pay it off over the following years.  Therefore a young family might start off with a huge debt ratio and this will reduce over time as the family hopefully pay the debt back.  The parents in the family would like to bequeath a house to their children rather than leave them the legacy of a huge debt.  Governments tend to borrow, keep borrowing and show little inclination to every pay it back.

In 1995 the Irish General Government Debt was €38 billion.  Ten years later with some years of unprecedented economic growth the General Government Debt in 2005 was €38 billion.  We had not paid back one cent.  What family would enjoy ten years of huge earnings and not pay down their debt.  Families may try to avoid leaving a huge debt legacy to their children, governments have no problem leaving such a legacy to the future generations.  Ten year olds can’t vote.

In 2009 the Irish government ran an Exchequer deficit of €24 billion.  In last December’s Budget the Minister for Finance announced that we would be borrowing a further €20 to fund government expenditure in 2010.  There is no sign that borrowings over subsequent years will be substantially lower.

The announcements this week will see further huge increases in the National Debt.  NAMA will borrow about €45 billion to buy huge amounts of rubbish loans.  The realised value of these loans may be substantially less.  The State is borrowing another €8.3 billion to plough into the rubbish bank that is Anglo Irish Bank.  There could be another €10 billion put into this black hole.

There are plenty of families around the country who have substantial amounts of debt.  But that likelihood is that over the coming years they will pay this off and be debt free by retirement.  The Irish state is in huge debt but the problem is that we are showing no indication of paying it back and in fact are likely to add huge amounts to it over the coming years.

Greece is the problem child of the Eurozone and they have a debt ratio of around 115%. By the end of 2010 Ireland is predicted to have an ‘official’ debt ratio of 78%. And that is only because we have convinced to EU to allow us to keep the NAMA borrowings and the further Anglo recapitalisation funds ‘off balance sheet’. Our true borrowings are much closer to Greece.

Brian Lenihan finished his statement to the Dail saying ‘others believe in us, we must believe in ourselves.’ He finished his budget speech last December saying that “we have turned the corner”. It is very clear that was not true. A quick analysis of the true debt figures from Ireland will mean that others will not believe in us for much longer.

Can we measure Private Sector Credit in Ireland?

One of the most commonly used measures of the “bubble economy” in Ireland was the expansion of private sector credit in Ireland.  This is the total amount of money lent to Irish residents from our financial institutions.  The pattern on this variable for the past decade is very clear.
private sector credit
Private sector credit rose continually from €100 billion at the start of the decade to break through the €400 billion mark towards the end of 2008.  This has been a fall back since then, and the most recent figure from February is €365.5 billion.  This has occurred because repayments on existing debt have been more than the issue of new loans and because the banks have begun to slowly write down the value of bad debts on their balance sheets.
The huge increase in PSC from 2000 was often quoted to back up the claim that Irish households were “swimming in debt” and had borrowed huge amounts of money.  Statistics were quoted which divided the total amount of debt with the total population to give measures of borrowing per capita. For example €400 billion in debt divided by a population of 4.4 million gives an average debt of over €90,000 per capita in 2008 or over €200,000 per household.
But with all the revelations about NAMA and the Irish banking collapse there must be doubt now cast on how these PSC figures actually relate to the ‘man on the street’.  We are only now getting a clearer picture of the activities of bankers and developers in Ireland.
Yesterday, NAMA announced they were taking €16 billion in loans off the Irish banks in the first tranche of a total of €80 billion.  NAMA have revealed that half of this $80 billion total relates to just 100 borrowers.  The other €40 billion relates to some 1,400 people.
These 100 biggest borrowers are having an average of €400 million in debt transferred to NAMA.  These are figures that are almost beyond comprehension.
What has this to do with Private Sector Credit? Well, it is clear that a huge amount of the credit issued in Ireland was going to a very small group of people.  This had little effect (up to now) on the debt of the average person in Ireland.
If we ignore the borrowings of these 1,500 being transferred to NAMA there is €285.5 billion in private sector credit remaining.  Dividing this by the current population estimate of 4.5 million people gives an average debt per capita of just under €63,000.  Taking out just 1,500 people from a population of 4.5 million sees the average debt per capita fall by nearly €30,000 or nearly 33%.  This group of borrowers makes up 0.03% of the population.
Of course we can’t ignore these borrowings.  They may be removed from private sector credit.  But they have been transferred to the public debt (even if it is off balance sheet).  Public debt is debt owed by the public.  This means it is now owed by ‘the man on the street’.

Is Eurozone inflation about to become an issue?

Eurostat today released a flash estimate of Eurozone inflation for March.  They estimate the annual rate of inflation to be 1.5% – a big jump from the 0.9% rate recorded in February.

Eurozone InflationFrom an Irish perspective the important thing is not necessarily the factors that determine the rate as we are a small proportion of the Eurozone (<2%).  Rather the issue is the impact the rate has on ECB interest rate policy.

The ‘price stability’ target of the ECB is measured with an inflation rate of ‘about 2%’ (shown by the red line in the graph).  We can see that for 2005, 2006 and most of 2007 the inflation rate stayed very close to this target.  This was achieved through of set of interest rate increases beginning in December 2005 which say the ECB rate increase from 2.00% to 4.00%. 

In mid-2007 the inflation rate went about the 2% target.  This prompted a further rate increase of 0.25% to 4.25% in July 2008 when the inflation rate was above 4%.  This move was met with widespread criticism as the ‘Global Financial Crisis’ was in flow and the inflation rate quickly plummeted, even turning negative for a time in mid-2009.

The ECB responded with large cuts in interest rates and by May 2009 their key rate was at a record low of 1.00%.  It remains at this level.

As we can see the inflation rate for the Eurozone is showing a trend that may bring it back up to the 2% target.  This may accelerate the ECB’s desire to increase rates.

With the Irish economy still in the grip of the recession and many struggling to make repayments on loans and mortgages, an increase in interest rates is not what we want to see.

Of course, this is not the first time that ECB interest rates will not have been suitable for Ireland. See here.

CSO Data from last week

The CSO were busy last week with a lot of key economic data released.  The data published included

  • Quarterly National Accounts (Q4 2009)
  • External Trade (Jan 2010)
  • Balance of Payments (Q4 2009)
  • Quarterly National Household Survey (Q4 2009)
  • Construction Output Index (Q4 2009)

Below is a set of slides on some key indicators using the updated data series.  I may add commentary on some of the patterns at a late date but for the moment I will allow the reader to draw their own conclusions.

Tuesday, March 30, 2010

Cooking the books

Today has been a tumultuous day on the economic front with public sector pay negotiations concluding, Quinn Insurance going into administration, and, of course, all the banking and NAMA related announcements.

The biggest of these is undoubtedly the latter of the three.  The numbers used in today’s analysis of the Irish banking failure are staggering.  The ‘Big Bang’ was that Anglo Irish Bank will require anything up to an additional €10 billion on top of the €8.3 billion it will receive “this week”.  With €4 billion given to the bank last year this is a total state contribution of €22.3 billion.

Yet, in interviews after today’s statement, the Minister for Finance, Brian Lenihan, said that today’s measures would not lead to any additional borrowing by the National Treasury Management Agency on behalf of the State.

The borrowing projections for the year were outlined in the Budget and are best seen from Table 10 of the Stability Programme Update (page 19).  The actual outturn for 2009 and the projections for 2010 are given below.  The table in the SPU also gives projections for 2011 to 2014 but the European Commission has already rubbished these as being based on overly optimistic growth predictions.  Anyway here’s my version of the table.

Table 10: Projections for the Public Finances
Gross Voted Current Expenditure
Non-Voted (Central Fund) Expenditure
Gross Current Expenditure
less Expenditure Receipts and Balances
Net Current Expenditure
Tax Revenue
Non-Tax Revenue
Net Current Revenue
Gross Voted Capital
Non-Voted Expenditure
Payment to the NPRF
Gross Capital Expenditure
less Capital Receipts
Net Capital Expenditure
Capital Resources
% of GDP

The key figures for 2010 are Net Current Expenditure of €47.123 billion and Net Current Revenue of €33.405 billion.  Both of these figures, and in particular the revenue prediction are doubtful, but they give a best-case Current Budget Deficit of €13.718 billion.  It is true that today’s banking announcements do not change this.  The Public Service Agreement 2010 - 2014 may do so.

On the capital side the Government have planned for Net Capital Expenditure of €6.734 billion.  With Capital Resources of €1.672 billion this gives a Capital Budget Deficit of €5.062 billion.

Combining the Current and Capital Deficits gives an Exchequer Deficit of €18.780 billion, down from €24.641 billion last year.  This is the money we need to borrow to keep the government operating.  Today’s announcement, we are told, will not lead to any increase in this borrowing, with the NTMA target to raise €20 billion still standing.

With the Current Budget Deficit forecast to deteriorate by at least another €2.5 billion this year, the planned reduction in the Exchequer Deficit of almost €6 billion comes from the Capital Account.
The deficit on the Capital Account is forecast to improve by almost €8 billion this year.  This is driven by two factors.
  1. Capital Expenditure in 2009 included a €3 billion contribution to the National Pension Reserve Fund.
  2. The 2009 Non-Voted Capital Expenditure figure of €4.8 billion included the €4 billion used to recapitalise Anglo Irish Bank last May.
Budget 2010 did not include a provision for either of these.  We will not be making a contribution to the National Pension Reserve Fund in 2010.
However, in relation to the state-owned Anglo Irish Bank, the Minister for Finance today said that:
“I am providing €8.3 billion this week to support the capital position of the bank to take account of the bank's losses to date…I must point out that the bank will need further capital to cover future losses and accomplish the restructuring of the bank and its balance sheet. The current estimate is that this could be of the order of a further €10 billion.”
If everything else in the government’s projections held, the addition of this one provision will increase the Exchequer Deficit to €27 billion (€18.7 billion + €8.3 billion).  This would mean Exchequer borrowing of 16.7% of GDP this year!
But we are told there will be no additional borrowing and the NTMA target of €20 billion holds. What gives? Cue the Minister again:
“The bank’s capital support is being provided by the State in a way which spreads the cash requirements over an extended period of time. I am injecting the capital this week in the form of a promissory note, payable over a number of years into the future. In essence this means the amount will be paid over a period of 10 to 15 years, thereby reducing the impact on the Exchequer this year and stretching the payments into the future.”
Ah, the bank needs the money now so we’ll give them a ‘promissory note’ (a what?) for the €8.3 billion.  We’ll give them the actual money over 15 years so it doesn’t look bad on the books.  And this to a bank he hopes to partly sell on in five years.

What Minister Lenihan seems to be saying to everyone (including bond markets) is “I know we have a liability because of Anglo. You know we have a liability because of Anglo. Everyone knows we have a liability because of Anglo. But if I keep it off the books with a ‘promissory note’ everything will be appear fine and we’ll definitely look good in comparison to the Greeks.”

With the borrowings to fund the NAMA operation also ‘off balance sheet’ there seems to be little relevance to the officially published government debt figure.  This should rise by €16.8 billion based on today’s measures: €8.5 billion for the money spent by NAMA on rubbish loans and €8.3 billion given to Anglo to recapitalise a rubbish bank.  But our debt figure won’t change one jot.

They may “believe in us” now, but how long will it last?

“Others believe in us”

Minister for Finance, Brian Lenihan, concluded his statement to the Dail today by saying:

[O]thers believe in us. We must now begin to believe in ourselves.

He used quotes from some external commentators to support this view. A short extract from his statement shows this.

Our determination to deal with this imbalance in our public finances through firm and decisive action has engendered real confidence in our economy on the international stage. The world out there believes in us and in our ability to work our way through our difficulties and return to growth.

Jean Claude Trichet said: "In the case of Ireland very, very tough decisions have been taken by the government and rightly so,"

More recently, Mr Trichet’s colleague, Jose Manuel Gonzalez-Paramo on the ECB said: “The Irish measures are very courageous. They are going in the right direction.”

The French Finance Minister, Christine Lagarde said: "Ireland has set the high standard the rest of us must follow".

On a recent visit to Ireland, the German Minister for European Affairs, Dr. Werner Hoyer said: “I think there is a deeply rooted trust and confidence in this country’s ability to sort out its problems. … There is a fundamental belief that the Irish are going to solve it.”

Already, we have reaped the benefits of this growing confidence. Since last April’s Supplementary Budget and the announcement of the decision to establish NAMA, borrowing costs have fallen and our bond spreads have halved.

We have wondered about this before with some posts under the banner ‘they like us, they really like us’.  See here and here for examples.

This week has seen more pieces in the international media along similar patterns.  For example, today Bloomberg carries a piece under the heading ‘Ireland Breaks From Greece to Lead Europe Bond Gains’.   The piece was written before the NAMA announcement was made.  The first paragraph begins the positive view that pervades through the entire piece.

Ireland’s bonds are poised to outperform those of every other euro member except Austria this quarter as investors bet it will be more successful than countries such as Greece in cutting its budget deficit.

Further on in the piece an economist from Ignis Asset Management declares that “Ireland has left the pigsty for the time being and it has come out smelling of roses”.

The Financial Times have already given their view on the state of the nation and even predict the quick return of the Celtic Tiger!  In a piece called ‘Signs of Celtic Tiger clawing back growth’ they start:

After almost two years of unrelieved misery during which Ireland had sometimes appeared, in local parlance, to have lost the run of itself, a battered and moth-eaten Celtic Tiger may be picking itself up.

And this piece finishes:

Taken together, and with the right policy tweaks, this could offer Ireland a route back to the authentically Tigerish 1990s rather than the long recession of the 1980s.

You can listen to the author of the above piece make the case in an interview with Tom McGurk from 4FM here.

The Minister is absolutely right.  Others do believe in us.  But why? 

How will the “others believe in us” quote fare in comparison to the way the Minister finished his Budget speech last December?

Our plan is working.

We have turned the corner.

I commend this Budget to the House.

It is clear that “turning the corner” has not gone to plan.  How long will the “others believe in us” mantra last?

How big is a billion?

Big numbers are back in the news today.  It seems timely to offer an update of this post.  Today there will be lots of talk of billions here and billions there: NAMA, the banks, Quinn Insurance.  Just how big is a billion?

Here is me and a million euro in 100 euro notes.

millionI could pick it up, put it in a bag  and walk around without anyone noticing I was carrying a million euro.  What about me and a billion?  The answer is below the fold.

billionI won’t be putting that into a bag anytime soon!  We have already given 11 billion euro (77 pallets of 100 euro notes) to our ailing banks.  They are due to get a lot more as we will learn from announcements later today.

Million and billion might sound similar but in real terms they are worlds apart.  How many times will be hear the word ‘billion’ on the news tonight?

Thursday, March 25, 2010

Ireland is in a Depression

The release of the fourth quarter 2009 Quarterly National Accounts reveal that Ireland is in a depression.  The commonly cited definitions of a depression are:
  1. A recession which lasts for more than two years (eight quarters)
  2. A decline in GDP of more than 10%
GDP in Ireland has declined for each of the last eight quarters and ten of the last 11.
GDP in Q4 2009 was 12.3% lower than the equivalent GDP figure in Q4 2007. (€47.885 billion versus €41.913 billion).  If we were to look at GNP figures the outcome is even bleaker – a drop of 16.7%.
Here we can see when we entered recession and when we entered depression. Click to enlarge.
The trend in both GDP and GNP is still down.  If a depression is worse than a recession, what’s worse than a depression?

‘Turning the Corner’ – not a chance!

The Irish economy was declared to have ‘turned the corner’ towards the end of 2009 when the CSO released the Q3 quarterly national accounts last December.  At that stage the CSO reported a quarter on quarter change in GDP of +0.3%.  We questioned it at the time.
Today, the CSO have released the quarterly accounts for Q4 2009 and have revised the Q3 figures.  The revised figures show a quarterly change in Q3 of  -0.1%.  GDP actually fell! With the CSO saying that the change in Q4 was a much accelerated fall –2.1% the Irish economy has not contracted for eight quarters in a row and 10 of the last 11.  Remember a recession is defined as two consecutive quarters of negative growth.
Here are the quarterly GDP growth rates for the past 11 quarters.
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
Growth Rate
See Table 4 of the CSO release.
The current drop of –2.3% in Q4 2009 is the second largest in the recession (depression?).
In a statement reacting to the figures the Minister for Finance, Brian Lenihan said:
“Today's figures show that the annual pace of decline in GDP slowed considerably as the year progressed. There was a fall in GDP of 2.3 per cent between the third and fourth quarters. Excluding the impact of the ongoing decline in new house building, GDP was roughly unchanged in the fourth quarter.
Today’s figures are consistent with my Budget Day projections for this year and as I outlined, I expect that the economy will resume growing in the second half of the year. ”
It is pretty easy to check if the Minister’s assertion that if we exclude construction that “GDP was roughly unchanged in the fourth quarter”.  A quick calculation shows that GDP excluding construction declined by –1.8%,  not quiet unchanged.  Here’s a little graph of the two quarterly growth rates: total GDP and GDP excluding construction.
GDP ex con

QNHS and the Composition of the Labour Force

The CSO have released the data for the Q4 2009 Quarterly National Household Survey.  Here are some updated graphs from a previous post. Click all graphs to enlarge.
First we see that the number of non-Irish nationals in the labour force continues to decline, with 14,400 fewer in the labour force compared to Q3 2009.  There were declines in both the employed (-7,600 to 255,200) and the unemployed (-6,800 to 47,900).
As a percent of the workforce, the number of non-nationals continues to decline and from a peak of 16.4 in early 2008 is now down to 14.1%, a level last seen in late 2006.
The origin of these workers continue to show that the main driven of change in this category is workers from the EU Accession states.  There was a drop of 11,700 in the number of workers from these countries in the Irish labour force.
The non-seasonally adjusted unemployment rates for Irish and non-Irish workers show that there was a sharp drop in the unemployment rate of non-Irish nationals.  This dropped from 17.2% to 15.8%.  This drop occurred because a large number of this group who were unemployed left the labour force (and by assumption the country).
Breaking down the unemployment rate further we see that the best performing group are those from the EU15 (excluding Ireland and the UK) with an unemployment rate of 8.4% (up from 7.8%).  The group worst affected by unemployment are workers from the EU Accession states with an unemployment rate of 18.6% (down from 19.5%).

Tuesday, March 23, 2010

Spot the Difference

Here’s a graph of a decade’s worth of data from Eurostat on the General Government Deficits in Ireland and Greece. Click to enlarge.


The estimate from each country for 2010 is also provided, and represented by the dashed lines.  I can’t see much difference for the most recent data. 

The EU’s Stability and Growth Pact target of a GGD of no more than 3% of GDP is shown with the dashed red line. Through most of the 2000s this was of no real concern in Ireland as we ran a series of budget surpluses.  This changed in 2008 as we plunged in deficit.

The only year Greece met the 3% limit was 2006 (2.9%).  In all other years Greece ran a budget deficit of more than 3% of GDP.

For the past three years the similarity between the two is striking.













Why then has the international reaction to the two countries being so different? 

The following graph shows the gross debt position of both countries for the past decade.  We are starting from a position of a much lower debt base and have been well below the Stability and Growth Pact limit of a debt to GDP ratio of 60% (shown in red). Again click the graph to enlarge.

IreGr Debt

For a  country running annual budget deficits the Greek gross debt figures look remarkably stable until very recently.  Why is this? Greece cheated!

EU Growth Rates

Way back on March 4th Eurostat published the Quarterly Accounts for the 27 members of the EU.  This gives data on GDP and the components of GDP for the fourth quarter of 2009.  The headline figure of a QoQ growth rate of 0.1% suggested that the European recovery was continuing, albeit at a slower rate.

However, in Ireland we are still waiting for Q4 data from the CSO.  If you look at the table on page 3 of the report you will see that Eurostat are missing data for three countries: Ireland, Luxembourg and Malta.

EU Growth Rates

When Eurostat are drawing up figures for the EU region the omissions of Malta and Luxembourg are not significant.  Malta makes up only 0.05% of the entire EU economy with, Luxembourg representing 0.32% of the EU area economy.  A full list of the relative sizes of EU economies for 2009 is available here.

While Ireland is only 1.39% of the EU’s economy it would be nice to think that we could get our data in along with the other 24 countries who manage to do so.  [A similar problem occurs with labour cost data as noted here.]

According to the CSO’s release calendar we will have the Q4 quarterly accounts this Thursday.  This will be important in determining if the ‘turning the corner’ hypothesis is correct.  The CSO will also issue revised Q3 figures.  The ‘turning the corner’ hypothesis was based on a 0.3% Q0Q growth rate reported for Q3.

Monday, March 22, 2010

Economically Damaging and Fiscally Irrelevant

On the Progressive Economy blog, Michael Burke and Michael Taft have a fine post with the above title.  They provide an analysis of the effect of the combined expenditure cuts announced in last April’s Supplemental Budget and the 2010 Budget from last December.

As an analysis of the impact of the ‘cuts’ the piece is excellent.  They use the results of the ESRI’s macroeconomic model of the Irish economy published here to estimate the effects of the changes on the economy.  Burke and Taft’s analysis of the public sector pay cuts is based on the results in Table 3 on page 15.  Other cuts in public expenditure are proxied to cuts in public sector employment using the results in Table 7 on page 21.

As an partial equilibrium analysis of the expenditure measures announced the piece is fine, but the author’s push their conclusions to a general equilibrium setting.

We have shown that ‘savings’ are minimal and the impact on GDP severe. And such is the fractional impact on borrowing there is a distinct downside possibility that such cuts will increase the deficit burden. This is reinforced when we note the deflationary impact on the domestic economy is even more severe. Whereas GDP will decline by -3.1 percent by 2014 as a result of the current spending cuts, GNP will decline by -3.8 percent. This is what the TASC letter referred to as ‘a low-growth, high debt future’.

Cuts do not equal savings. Cuts degrade economic activity with only a marginal impact on borrowing. The next time a commentator says ‘we’re borrowing €400 million a week’ as a justification for more spending cuts, they can easily be answered: cutting spending won’t affect that ‘€400 million a week’ and it may only make things worse.

To bring the deficit under control we need another alternative – one based on growth and not deflation.

To see whether the government is running a contractionary policy we can consider just one measure – the size of the budget deficit.

  • Deficit Jan-Feb 2009: (€2,084,760,000)
  • Deficit Jan-Feb 2010: (€2,407,292,000)

In 2009 (before any of the measures covered in Burke and Taft’s analysis were even announced) we ran a budget deficit of just under €2.1 billion for the first two months of the year.  In 2010 (after the measures have been announced and implemented) we ran a budget deficit of over €2.4 billion.  The deficit is increasing.  This is an increase of about €320 million in the gap between what the Exchequer is taking out of the economy (taxation) and what the Exchequer is putting into the economy (expenditure).

A budget that is adding more money to the economy rather than taking it out, does not fit the definition of a contractionary policy I am familiar with.

The Distortion of Taxation

Here is a great little example of the distortionary effects that taxation can have.  Taxes have a ‘deadweight loss’ over and above the amount collected by the taxes.  Here the loss is an asset that in the absence of taxation would continue to be used.

Newly independent Aol is still struggling with the fate of Bebo, the social network they acquired for $850 million in 2008.

No one argues that Aol underpaid for Bebo. And the social network has fallen from 22 million monthly unique visitors when it was acquired to just 14.6 million today (Comscore worldwide). But even so, Bebo clearly has some value on the open market.

Despite that value, Aol’s best financial option for Bebo will likely be to abandon it rather than sell it, say corporate tax experts we’ve spoken with.

Here’s why – complicated corporate tax rules will let Aol write off the full purchase price of Bebo if they declare it worthless and abandon the asset. With Aol’s effective tax rate of around 45%, that’s $380 million and change in their pocket in taxes that they’d be able to avoid.

A sale of Bebo would almost certainly be less attractive. If someone were to pay them $100 million for the service, which is optimistic, Aol could still offset the remaining $750 million as a tax loss. But it could only apply against long term capital gains, and Aol doesn’t have any to offset against. They’d have to carry that loss forward and hope for future gains to offset it against.

Private Sector Wage Cuts

The RTE website carries a story this morning on a survey carried out by the Small Firms Association (SFA):

Almost Half of Small Firms Cut Wages Last Year

The headline would lead us to believe that there had been falls in wages in small firms last year.   In actual fact, the survey indicates very little about wage changes, though we do get some detail on wage levels. 

The only wage change that information is provided on is for entry-level graduate positions, which '”decreased across almost all job categories”.  More details of the survey are available at the SFA website here.

In RTE’s defence the text of their story is correct.  About half of the small surveyed cut their overall wage bill.  This can be done through two means.

  1. Cut wage levels
  2. Reduce employment numbers

The survey reveals that 43% of the firms cut employee numbers.  Although we are given little detail on wage levels we can infer that a large amount of the fall in payroll costs can be accounted for with the fall in employees.

We still have little evidence of wide-ranging private sector pay cuts.  The CSO collect data on pay levels with the Earnings Hours and Employment Costs Survey (EHECS).  An analysis of the most recent figures (Q2 2009) is available here

The CSO are due to publish the Q3 2009 before the end of the month.  That should add to our understanding of the pattern of wages in the current recession.

Data on all other EU countries are available up to Q4 2009.  See this release from Eurostat where the only missing data are for Ireland.  Across the EU wages rose 2.2% in 2009.  The only countries to show a decrease were: Denmark (-0.3%), Estonia (-6.2%), Latvia (-6.5%), Lithuania (-11.4%), Malta (-0.4%), Slovenia (-2.5%), and Slovakia (-0.3%).

Tuesday, March 16, 2010

Rugby makes you thirsty

The issue of pubs closing on Good Friday has been brought to the fore in recent weeks with the upcoming Magners League game between Munster and Leinster scheduled for Thomond Park on the same day. 

There have been pleas from many sources for Limerick pubs to be allowed open to cater for the crowds.  Many strange claims have been made.  For example, in a piece on the RTE website we can extract the following.

Vintners spokesperson Dave Hickey said they hope their application will be successful.

They say they will be making the case that publicans could lose up to €6m in trade brought into the city by the sell-out match.

If the pubs are going to ‘lose’ €6 million alone surely their case has some merit.  However, consider that the capacity of the redeveloped Thomond Park is 26,500.  In order for the pubs to earn €6 million in revenue, each and every person (all of them) would have to spend €225 euro on drink or have about 50 drinks each!

Thirsty work, going to rugby matches! 

Monday, March 15, 2010

Estimating Ireland’s Black Economy

In a nice little paper from 1997 published in the now defunct Irish Banking Review, Gabriel Fagan produced the following estimates of Ireland’s Black Economy from 1963 to 1995.

Fagan Estimates

Fagan’s 1997 paper is available here.  Fagan also wrote a more detailed paper that was published in The Journal of the Statistical and Social Inquiry Society of Ireland.  This paper published in 1994 is available here.

The estimates provided above are based on the monetary approach to estimating the black economy.  The assumption is that there are ‘excess currency holdings’ in the economy over and above what is necessary for the volume of transactions reported in the National Accounts.  The next step is that this extra currency in circulation is used in the black or cash economy so as to avoid detection.

Fagan (1997) estimated the following equation


where C is the amount of currency in circulation, M1 is the narrow money supply (currency plus deposits), Y is Gross National Product, R is a long government bond interest rate and T is a measure of the tax burden (total tax revenue as a proportion of GNP).  Fagan (1997) also included a time trend and reported the following results


Fagan used the increase in currency holdings as a results of increases in the tax burden to produce the estimates of the black economy up to 1995 provided above.

Updated data on the same variables used by Fagan is provided here.  This dataset has observations from 1960 to 2007.  Using this new dataset a version of Fagan’s original equation is estimated.


The full results are available here which suggest that all may not be well with the model specification.  We will ignore these and use this simple model to find an estimate of the black economy.

We can do this by using the following steps.

  1. Find the change in proportion of the money supply held as currency in the economy that are the results of changes in taxation.
  2. Estimate the volume of these excess currency holdings.
  3. Find the volume of currency needed for the transactions reported in the national accounts.
  4. Calculate the velocity of circulation in the formal economy.
  5. Use 2 and 4 to find the level of income in the black economy.
  6. Find the percent of GNP that this estimate comprises.

An updated spreadsheet with all of these calculations is available here.  Here is a graph of the estimates from Fagan (1997) and those calculated here.

Black Economy

Although there are difference from 1960 up to 1980, the two series track each other through most of the 1980s and for the years in the 1990s for which Fagan estimates are available.  This is highlighted in this graph.

From the new estimates we see a downward trend in the size of the black economy during the Celtic Tiger period.  This continued up to 2003, for which there is a black economy estimate of just 5.6% of GNP.  A rise since then gives a most recent estimate for 2007 of just over 8.5% of GNP.

Presentation to the Cork Society of Chartered Accountants

Last week I gave a presentation to the CSCA Annual Practice Day.  The presentation followed the ‘turning the corner’ theme that has been a feature here.  The slides used in the presentation are given below.

Danny McCoy on Supply Side Incentives

Danny McCoy picks up on a theme made in the preceding post.

"We know from history that when growth comes it can be jobless growth. Our success will be shortening the distance between growth resuming and employment increasing. Our social welfare system can be a drag in terms of ensuring that employment comes along significantly."

Social welfare rates – even after reductions to some payments in December's budget – are a disincentive to some people returning to work, he said, and added that the government needs to look at the amount of time for which those on the dole can claim the full allowance. So how long should that period be? One year, two years?

"Nobody wants to see people left destitute or anything like that, and there should be safety nets, but there is no tapering off in social welfare benefits. We can't afford, for their human dignity, to leave them on the dole for the rest of their lives. If two years is what people believe that they could stay out of the labour market, it's far too long. Businesses would like to see people having the facility to get back [to employment] at rates which employers can afford."

The full interview is from yesterday’s Sunday Tribune.

Tuesday, March 9, 2010

People respond to incentives – the supply side edition


This amazing graph (click to enlarge) shows the percentage of unemployed people who returned to work in Pittsburgh in the period 1980-85.  The horizontal axis on the graph represent weeks relative to the time when unemployment benefit payments to the individual cease (week 0).

Negative numbers indicate the number of weeks of unemployment benefit remaining for the individual.  Positive numbers tell how many weeks it is since the individual stopped receiving unemployment benefits.

In the weeks just before the payments stopped about 2% of those unemployed returned to work.  On the week the payments stopped this shot up to over 25% and quickly went back down.

The evidence is clear. People respond to incentives.  Why work when your income can be replaced with welfare payments?  As soon as the payments expire some 25% of people find a job.  More here.

This is not evidence to support the abolition of unemployment benefits. Instead is argues that the payments should possible be staggered downward to try and smooth out a pattern like that seen in the above graph.

[In an interesting aside I was recently asked to consider what would be an appropriate comparison to make when evaluating the level of unemployment benefit.  One suggestion could be that we should treat our unemployed no worse than we treat our prisoners.  After all, to do otherwise would suggest that crime pays.  How much do we spend on a prisoner in Ireland each year? Answer: €97,700!]

Spend, spend, spend

During the week 28 people associated with the Irish Left published a piece in The Irish Times that outlined their preferred policy strategy for Ireland.  The piece is available here and claims “all the wrong options have been pursued”.  The group of 28 have come together under the TASC banner and more of their thoughts are available on the Progressive Economy Blog.

Reaction to the piece has been mixed. Philip Lane and others on have been moderately positive in this thread. Some dissenting voices emerge in the comments.  On the other side Constantin Gurdgiev is comprehensive in his negative reaction to the proposals.

My scepticism of public works and public expenditure can be related to in the short parable published in The Royal Bank of Scotland Review in 1987 - A Desert Island Economic Tale.

Duncan and our food


In a recent episode of his RTE show, Eco Eye (not yet available online), Duncan Stewart explored the source of Irish food.  He seemed alarmed at the fact that in 2008 Ireland imported just over €4.5 billion worth of food.  He failed to mention to we also exported over €7 billion in the same category.  Full retails of our external trade in food are given here. Click to enlarge (figures in €millions).

Food Trade

Duncan is correct though the 2009 figure will down to about €4.2 billion.

During the show Duncan went to fresh food producers around the country, spent a few enjoyable Saturdays at some of the ever increasing number of Farmers’ Markets, and wondered why a small number of multiple retailers have virtual control over our food supply.  The thoughts of domestic food producers feeling pressure from the retailers were to the fore.

The programme raised many interest points and is worthwhile viewing from a number of perspectives.

Duncan ended the show with the following quote (paraphrased):

“Ireland imports €4.5 billion worth of food every year.  Of that €3 billion could be produced here.  That is €3 billion euro that could be flowing around the Irish economy and sustaining 10,000 jobs.”

This reminded me of a quote often attributed (possible in error) to Abraham Lincoln:

“I don’t know much about the tariff, but I know this. If I buy a coat in England, I get the coat and England gets the money. If I buy a coat in America, I get the coat and America gets the money.”

What is the flaw in Lincoln’s (and Duncan’s) logic?

Monday, March 8, 2010

They really like us

A piece from last week’s Los Angeles Times is headed Irish public pays a price for nation's fiscal austerity but the general impression is of an economy that has ‘turned the corner’ and is a ‘shining light’ when compared to some of our EU colleagues.

Some excerpts:

The outside world applauded last December when Ireland unveiled its harshest budget in a generation. Stinging cuts and higher taxes were needed to tame a runaway public deficit and give the limping Celtic Tiger some of its roar back, officials said.

Three months later, Ireland has become something of a poster boy for good behavior in bad times, held up as an example to Europe's other debt-laden economies, particularly Greece.

Officials say they had no choice but to inflict painful cuts in order to start bringing down a whopping deficit of about 12% of gross domestic product, far in excess of what's allowed under rules for the 16 countries that use the euro. The nation's total debt is about 47.4% of GDP.

Although international markets greeted the austerity plan favorably, as an indication that Dublin was serious about reining in its deficit, opinion at home hasn't been so kind.

Indeed, economists around the world cite Ireland as a positive counterpoint to Greece, which is also grappling with a debt crisis that has threatened the stability of the euro.

Where Athens concealed its financial woes for years, Dublin copped early to its deficit and took emergency action to stop the rot. Greece's credibility has been shredded, enough that the European Union has essentially put the government there under supervision; Ireland has managed to repair some of the damage to its reputation and maintain its independence.

The piece does go on to cite some examples of domestic disharmony with the policies enacted, but the general perception of a positive international reaction is developed further.  Why is this?

There is nothing to suggest the budget deficit is been brought under control.  Tax revenues continue to fall.  Expenditure cuts are being offset by increases in social welfare payouts.  Our deficit may be worse this year than last.

We are applauded for not concealing our financial woes.  Yet the NAMA experiment is ‘off-balance sheet’.  The quoted Debt/GDP ratio of 47.4% will not increase once €54 billion is spent to buy distressed loans from the banks.  Including this would bring out debt ratio to about 85% and the ongoing deficit will see this race past 100% in the next 18 months. 

There is no doubt that this international perception is good for Ireland and our borrowing costs, but in order to ensure it doesn’t evaporate we will have to live up to it at some stage. There is no sign of that happening yet.

Saturday, March 6, 2010

Playing with words

A generally uninteresting report on the RTE website discussing the Sinn Fein Ard Fheis contains the following gem.

Delegates have voted in favour of a motion calling on the Government to decommission the National Asset Management Agency.

Friday, March 5, 2010

Tax Defaulters 2

After collating the data published on tax defaulters available from the Revenue Commissioners it has been possible to track some additional trends to those reported in The Irish Examiner and looked at here.

First up we can examiner the number of cases reported each quarter from 2001: Q4 to 2009: Q3

Tax Defaulters by Quarter 

As can be seen the numbers were below 100 for the first five quarters in the same and then shot up as the investigation in the bogus non-resident accounts (DIRT evasion) reached a conclusion.  Since then the number has shown a gradual downward trend and figures are now back to 2001 levels.

Although the number of published defaulters may be trending downward the average settlement has been rising.

Tax Settlement by Quarter 

The average settlement started out below €100,000.  The average settlement in 2009 Q3 was just below €250,000.

The total settlement is made up of two elements:

  1. The amount of tax outstanding
  2. The level of interest and penalties imposed

A clear pattern from the data is that the total settlement is determined as much by the interest and penalties as it is by the amount of the tax.  Over the 32 quarters in the sample, the Revenue established that there was €355.5 million in evaded tax due.  The total settlements made by the 4,959 defaulters total €867.6 million.  The difference of €541.1 million is due to interest and penalties.

The interest and penalties imposed are 160% of the total amount of tax due.  There were some cases where the interest and penalties were some 700% greater than the original amount of tax due.  In one case, €75,000 in tax was due but the total settlement was nearly €600,000 as a result of the interest and penalties imposed. 

Settlements and Penalties

Here we see the increase in the total settlements made above the amount of the tax as a result of the interest and penalties. Ouch!

The largest penalty imposed was of €9.7 million on Bovale Developments who had an underpaid tax bill of €12.5 million from a total settlement of €22.2 million.

Tax Defaulters

On January 1 The Irish Examiner  ran a report on tax defaulters in Ireland.  They carried a number of short articles on the issue.  See here, here and here

Accompanying the article were a number of tables which are not available online.  Scans of these tables are available below.  Click title to see table.

The data used by The Irish Examiner covers the period Q4 2001 to Q3 2009.  The data is available from The Revenue Commissioners here.  The cases reported come from Part 2 of the Defaulters list.  It is interesting to note that the proportions of the total settlements that are made up of “tax due”  and “interest and penalties”.

The 4,961 cases in the analysis meet the following criteria.

Settlements are not published where the amount is less than the threshold (€12,700 (pre 2005) or €30,000), where the amount of fine or other penalty does not exceed 15% of the amount of tax or where the taxpayer has, in advance of any Revenue investigation, voluntarily furnished complete information relating to undisclosed tax liabilities.

These cases only make a small proportion of the overall tax evasion cases processed by the Revenue Commissioners.

Using the numbers in the third of the articles linked to above it is possible to create the following table.


Number of Cases

Average Settlement





not given


Company Directors









Thursday, March 4, 2010

Mortgage Arrears Data

The Financial Regulator has published some interesting data on mortgages and mortgages arrears in Ireland.  The release is available here.
The numbers show that there are nearly 800,000 outstanding mortgages in Ireland with a total balances of about €118,000,000,000 (€118 billion).  This gives an average balance of just under €150,000.
Some 28,603 mortgages are in arrears of more than 90 days.  The total balance on these mortgages is €5.33 billion.  The average balance of the mortgages in arrears is €186,000.

Retail sales data

The CSO have published the preliminary January figures for the Retail Sales Index.  When the December figures were released we concluded that they were not 'turning the corner'.  The conclusion is largely unchanged on inspection of the January figures.
Retail sales in January 2010 are down on the January 2009 figure but the annual rate of decline on a monthly basis is showing some signs of improving.
The improvement in the volume index is less pronounced.  See here.
We have still got quite a way to go until we reach the 0% line and return to positive growth.  This is unlikely to get much better in February as the Exchequer Returns just released indicate that the VAT take for February was down on the Feb 09 figure.
The pattern of the index does not make pretty viewing.

Getting even smarter

We have previously seen that Singapore is considered one of the ‘smartest’ places in the world and considered how this might tie in to our goal of Building Ireland's Smart Economy.  We also saw that we may be getting smarter with the introduction of a 50c per item prescription charge.

Yesterday we took a step to taking another leaf out of the Singapore book with the release of the National Pensions Framework. (Abridged press release also available.)

This will see the introduction of a compulsory system of pension savings in 2014.  Singapore introduced a system of retirement savings in 1955 and this has evolved into The Central Provident Fund.  While initially established to provide savings for retirement the CPF has evolved into a system that provides and savings and investment across a range of areas:

  • Retirement
  • Education
  • Home Ownership
  • Investment
  • Health

The total contribution rates to the CPF are around 35% of gross earnings (20% by employees and 15% by employers).  The contribution has an upper limit and also the rate drops with age.  Around 6% of earnings are allocated to the Special Account which is used to fund retirement.  A presentation I gave on the overall CPF system with particular emphasis on the health savings is available here.

The proposed contributions to the Irish retirement scheme is also 6% of gross earnings (4% from employees and 2% of employers).  One of the biggest issues to be addressed before the system can be introduced is getting the IT infrastructure in place.  The website for Singapore’s CPF gives an excellent template.  See here.

The CPF was established in 1955 and has been improved and expanded slowly since then.  The system of health savings through the Medisave accounts was not introduced until 1984.  Who knows, maybe in 2043 we will be even smarter and have introduced our own system of medical savings accounts.

Constantin Gurdgiev has some great questions on the proposed scheme.  I do not know how they will be addressed in the Irish system.  From what I know of the Singapore model I have tried to provide answers to his questions based on their system.  These answers are available here

We must wait to see how they will be answered here but I would hope that Gurdgiev’s conclusion that this will just be an additional tax (on private sector workers) will be proved wrong.

Tuesday, March 2, 2010

February Exchequer Returns

The Department of Finance has released the Exchequer Returns for February 2010.  As with the previous month’s figures they do not make for cheery reading.  The documents available are:
The headline tax figure indicates that the rate of decline in tax revenue shows no sign of improving.  January 2010 tax revenues were 17.7% down on the January 2009 return.  For February 2010 we see that the difference on the equivalent month last year was 17.9%.  The decline is actually worse!
If we look at the returns across the main tax headings for the period January-February we see that the returns for all taxes are down on their 2009 equivalents.  The big tax heads of Income Tax and VAT are both down by more than 10%. Click table to enlarge.Tax Returns
In this table you can compare the actual outturn to the Department’s forecasts made at the start of February.  They appear quite good as they are only out by €64 million or 1.3%.  Note though that the forecast of €4.8 billion was made after €3.074 billion was known to have been collected in January.  Thus the €64 million error was made on the February forecast of €1.726 billion, giving an actual forecast error of -3.7%, nearly three times greater.
However, it is the forecasts for the rest of the year that seem even more erratic.  The Department is forecasting that tax revenue for the year will come in at €31.050 billion, about €2 billion or some 6% down on the outturn for 2009 of €33.043.
As we have seen the first two months of 2010 are already down more than €1 billion or nearly 18% on the same period last year, but this is largely in line with the Department ‘forecasts’.  They obviously see an improvement in the remaining ten months of the year as more than half of their forecast fall in tax revenues has occurred in the first two months!
In the period Mar-Dec 2009 some €27.284 billion was collected in taxes.  For the same period in 2010 the Department predict that €26.314 billion will be collected – a drop of just 3.6%. Let me emphasis (again!) that the drop in the first two months of the year was 17.8%.  This has to slow to 3.6% for the rest of the year in order for the €31.050 billion forecast to materialise.  I think this forecast is optimistic.  Here is how the Department thinks we will get there.
Monthly Tax Forecasts
Notwithstanding the increase in tax revenue they predict for March, the stand-out figure is the year-on-year jump of nearly 35% in September.  I do not know what factor leads them to believe that September 2010 tax revenue will be more than €800 million ahead of the September 2009 outturn.  Should this figure be 2,148 instead of 3,148?  That would bring the overall figure very very close to €30 billion!
However, the figures for July and August seem overly pessimistic and it is the overall annual figure that matters. It doesn’t matter when the tax is collected, but at this stage it is hard to see €26.3 billion being collected for the rest of the year and even the €25.3 billion needed to bring tax revenue over €30 billion appears unlikely.

Monday, March 1, 2010

Grade Inflation

Based on reports we know that Minister for Education, Batt O’Keeffe, is considering the impact of grade inflation in second- and third-level education in Ireland.

It has emerged that the Minister has ordered the State Examination Commission to examine Leaving Cert. results and the Higher Education Authority to report on third-level results.  I’m not sure why he has needed to do this as the data is already available in the Department of Education website!  In particular, findings on the Leaving Cert. are available here and here.

Using the data we will consider the pattern of results in the Leaving Cert. Economics exam.  A graph such as the following is strongly suggestive of grade inflation. Click to enlarge.

LC Econ Grades

The graph gives the percentage of students taking Leaving Cert. Economics who score a Higher Level Grade C or above.  The graph is based on data presented in the following table.  Let’s have a look at some of these numbers.

It shows that from 1990 to 2002 the percentage of students getting a Higher Level Grade C or above rose from 34.3% to 53.9% for males and from 31.0% to 57.2% for females. 57% more males and 85% more females are getting these grades.  This would seem to support the grade inflation hypothesis.

However, an important determinant of the number of students getting a Higher Level Grade C or above is the number of students taking the Higher Level Paper.  The table linked above shows that in Economics this has also been increasing: from 60.5% to 77.5% for males and from 55.1% to 81.0% for females. 

If we just consider the proportion of students taking the Higher Level paper who get a Grade C or above we see that for both genders this rose from about 56% to 70%, from 1992 to 1997 and has been relatively stable since then.  This represents an increase of 25%.

Is 25% more students getting a Grade C or above indicative of grade inflation?  Possibly, but there are lots of reasons that could be driving this increase.

  • Better teachers, teaching and learning facilities
  • Better textbooks and study aids
  • Better students
  • Better exam preparation
  • Grade inflation

If there has been grade inflation it appears to have been applied discriminately against males. See this graph.  Is it possible to  increase the grades of only one gender in an anonymous state exam? I don’t think so either.

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