Thursday, December 12, 2013

Facebook or Faceless!

Reading a summary of the financial position of Facebook Ireland recently, once again brought home to me the extent to which the activities of such well-known profitable companies clearly display a crass regard for any true ethical obligation with respect to tax liabilities.

According to the Financial Times, Facebook used a complex tax avoidance scheme to limit its corporation tax bill to €1.9 ml. in 2012 (based on a turnover of €1.79 bl.) That would work out as just a little over .1%!

However of the €1.79 bl. turnover a truly incredible €1.75 bl. relates to administrative expenses for the use of intellectual property. This money (i.e. royalty payments) is paid into a special holding company Facebook Holdings that is incorporated in Ireland but registered elsewhere for tax purposes. So the money in turn passes through this company on its way to subsidiaries based abroad. Many of these appear to be located in the Cayman Islands where no tax is payable.

Of course Facebook is not alone in this respect with Google and Apple (among others) using similar tax avoidance schemes.

And Ireland is clearly not the only country benefiting from such schemes with for example several  other European countries such as the Netherlands, Luxembourg and Switzerland offering especially attractive incentives.

Now these companies can still brazenly keep a straight face in maintaining that they conscientiously fulfil all their tax and regulatory obligations. When asked why they have located in Ireland they routinely provide gushing accounts regarding the quality of the work force (while opportunities for tax avoidance are never even mentioned).

Unfortunately we are presented here with stark evidence of the unacceptable face of capitalism.
Countries such as Ireland can derive considerable benefits through attracting key multinational operators like Apple, Google and Facebook into their midst. The whole national tax system is then deliberately skewed to the liking of these companies.

For example, though the Irish economy has been going through a deep recession since 2008 with domestic taxation rising and expenditure on services falling, not alone has there been a unanimous official agreement to maintain the low corporation tax rate (12.5 %) but additional incentives have been made available (e.g. tax concessions for top executives) to make the island even more attractive.

In many ways however the tax rate is used as a red herring to divert attention from the reality of how these companies  pay virtually no tax here through a seeming ability to declare any amount of revenue they wish as royalties. They then use the double Irish system of incorporating a holding company that is registered in a tax free haven elsewhere to then effectively screen all these revenues away from tax.

So theoretically for example in the case of Facebook, it does not really matter how high the official tax rate is here in Ireland if it can in effect declare all revenues as administrative expenses and then transfer this revenue to a tax haven registered in another country (where no tax liability applies)!

Thus everyone involved seems therefore more than happy to focus sole attention on the merits or demerits of the official corporate tax rate on profits, which effectively then acts as a smokescreen against looking at this deeper issue of how these companies effectively avoid paying almost any tax in Ireland.

Presumably the fact that are willing to pay some small amount of tax (regardless of how minuscule) creates the appearance of tax compliance (which again can be seen as the best tactical approach from their perspective).

Now the multinational companies play an increasingly important role in the Irish economy.

However you will scarcely ever hear any word of objection to the tactics which these companies employ as it would not be seen to be in our national interest.

For example yesterday we had the directors of a big charity here in Ireland rightly being grilled by the public accounts committee of our national parliament regarding the apparent misuse of its voluntary funding.

Now one might think that the activities of multinationals (such as Apple, Google and Facebook) are of much greater significance both in economic and ethical terms. However it is highly unlikely that a similar public grilling of its representatives would ever happen as the very attempt to seek accountability would be seen to run counter to our narrow self interest.

And we would not be alone in this regard! As competition for such international investment is intense, other countries where such companies might locate would be likely to behave in exactly the same manner!

Therefore if the ethical issues of massive tax avoidance are to be properly addressed, this will require an internationally agreed system of regulation (with every country willing to play by the same rules).

However by the very nature of capitalism this will not easily transpire while each country is still motivated to maintain its own competitive advantage (relative to others).

Indeed this is a huge weakness of capitalism which eventually could wreck havoc on the international system.

We have quickly moved in modern times to a system where genuine global co-operation is increasingly required on a broad range of fronts.

For example our climatic problems cannot be addressed while countries still seek to maintain a short-term competitive advantage with respect to others.

Likewise global financial problems cannot be solved while institutions seek to maximise returns for the benefit of their own executives and shareholders.

And the enormous problems associated with the manner in which multinational corporations wield so much power, cannot be dealt with while again individual countries seek to maximise their short-term advantage through turning a blind eye to the significant ethical issues involved.

Tuesday, December 10, 2013

Ireland in Transition

I was watching an interesting programme presented by Ian Kehoe (from The Sunday Business Post) showing how the recent resurgence in the Irish economy owes a great deal to a considerable amount of overseas capital investment, especially with respect to sales of distressed property.

As is well known the Irish property boom came to a shuddering halt in 2008 leading to massive falls in value with respect to both residential and commercial property.

Many of the largest loans on these properties were sold to NAMA (an Irish state organisation that has arguably now become the largest property company in the world). Likewise, many other assets however still exist on the banks' balance sheets, which they are anxious to sell to the highest bidder.

And as Irish developers no longer possess the financial means, these assets are being quickly sold principally to the US (on both coasts) the UK and other international investors.
Some of these assets have been bought up also by successful Irish developers based abroad (though these would be in a minority).

For example the programme focussed on one Neville Isdell (former Chief Executive of Coca Cola) who has purchased the CHQ in Dublin's Docklands. This was developed with the intention of becoming an iconic commercial centre before the crash quickly ended all hopes. Though €45 million had been spent on its development it was purchased by Isdell for just €10 million.

Another excerpt featured William J. McMorrow of Kennedy Wilson a real estate auction company that is already invested billions in buying up large portfolios of property in Ireland.

Then there was the owner of a British chain of pubs Wethespoons that are now buying up pubs at knock down prices in Ireland with a view to becoming the biggest operator.

There was also a broker Michael Hasenstab from Franklin Templeton that invested several billion in buying up Irish bonds at the height of the crisis (when interest rates were very high). This audacious act paid off handsomely with large profits being made on the investment. It also injected much needed confidence into the bond market at the time with interest rates subsequently falling dramatically.

We also saw Wilbur L. Ross who bought a substantial stake in the Bank of Ireland (one of Ireland's two largest banks) again helping to stabilise its fortunes at the height of the crisis.

So what do we make of all of this from a wider economic perspective?

Undoubtedly the popular mood here would be one of deep resentment. Thus, as many ordinary folk still struggle greatly with an overhang of debt in their personal lives, they see these outside (largely anonymous) wealthy investors as vultures that our seizing large swathes of property at bargain basement prices.

Of course the attitude of the investors themselves would be somewhat different. They would point to this as healthy capitalism where market forces reign supreme. They would further maintain that they are in fact helping significantly to regenerate the Irish economy through their willingness to invest with the prospect of recovering markets thereby promoting new activity and employment.

And certainly from a short-term perspective there is a great deal of truth in this view.

However it does raise the very disturbing longer term spectre of Ireland becoming increasingly dependent on the whims of these outside investors.

Even before the crash Ireland had become heavily dependent on multinational investment (especially of US origin). Though this greatly increased wealth generation, a very significant proportion of this wealth then flowed out of  the economy through profit repatriation (running at about 1/6 of GDP).

Since the financial crisis, not alone has Ireland becoming even more dependent on such foreign investment in manufacturing industry and services but this has now spread dramatically into commercial retail and residential property activity.

So in the short to medium terms, what we are likely to experience in Ireland is a significant increase in the amount of money being repatriated from the economy each year.

Profit flows themselves are likely to increase due to the intensification of investment, especially in internationally traded services, with a growing contribution of outflows also from the retail sector.

Outflows with respect to interest repayments abroad will also sharply increase due to Government repayments on the substantial bail-out funds we received during the crisis from our Troika partners.

Now strictly these payments would be measured with respect to debt borrowed from abroad. However there is the further complication that since the crisis increasing amounts of Irish debt are now held by non-resident institutions (e.g. Franklin Templeton) which means in effect an additional large outflow.

On top of both these profit and interest outflows we will also see a large rise in outflows relating to rental income (as so much commercial and residential property is now controlled by foreign landlords).

Though it is very difficult to put an exact figure on it, it is not beyond the bounds of possibility that we could see in the next decade an effective doubling in the proportion of net foreign outflows. That would mean that up to 1/3 of the money generated from economic activity in Ireland could subsequently be repatriated to other countries!

This would imply that though a substantial - and even sustained - recovery may well emerge in the Irish economy over the next few years, its effects are likely to significantly bypass most ordinary citizens living here. Put simply for many years economic growth in Ireland is set to repay outside investors (rather than the majority of domestic citizens).

I would also fear that it may work in an very uneven fashion with a considerable amount of money (though domestic and overseas investment) eventually finding its way back into property thus inflating prices unduly once more. This in turn will create an artificial market for many domestically produced goods. Though this will enable higher levels of employment to be maintained, greater levels of inefficiency will operate. So the cost of living in Ireland is likely to stay above and even increase with respect to the EU average.

There is also the worrying fact that investor sentiment can just as easily turn against our interests in the future.

For example if Franklin Templeton considered (on shrewd profit calculations) to sell a substantial amount of its Irish debt in the future, this could have a very damaging impact on the Irish bond market generally.

So from this perspective, institutional investors (with no commitment to national economic priorities) now have the power to effectively blackmail small countries with respect to their own private interests.

This cannot be a healthy development for capitalism internationally. In fact, if the mistaken capitalist view that private greed somehow translates into public virtue, is allowed to continue unchallenged, then the international economic system itself is likely to be its eventual casualty.

We were given a severe warning sign of this through the financial crisis of 2008. However its deeper message has clearly not yet been heeded!

Wednesday, May 29, 2013

Apple's iTax

The US Senate hearings on the tax avoidance activities of Apple last week places uncomfortable attention on Ireland’s relationship with this key multinational company.

This followed a Public Accounts Committee into the affairs of Google who again are effectively using Ireland as a means of legally paying virtually no tax in the UK.

And they are by means alone in this regard. For example an article in the Wall Street Journal back in 2005, highlighted the manner in which Microsoft used two subsidiary companies operating within a law firm in Dublin to again substantially reduce their overall tax liability.

Then when questioning the extremely high cost of prescribed drugs In Ireland, one can also point to a growing concentration of the pharmaceutical sector. 9 of the top 10 multinationals are now in operation here with - I strongly suspect - tax avoidance on their global operations a major consideration.

One of the key consequences of all of that due to a growing unhealthy level of dependence on foreign direct investment (mainly of US origin) that it has now become the elephant in the room that is stifling honest economic debate on many important economic issues here in Ireland.

For due to the  exorbitant price of drugs under our national health schemes (with so satisfactory official explanation) I reached my own conclusions i.e. that this in fact represents a hidden subsidy with the Government fearful of the short term employment consequences in the sector if it were to adopt a tougher bargaining position.

Ireland is now one of the most open - if not the most open - economy in the world.
Some of the statistics are truly extraordinary (though rarely the focus of economic debate). 
At present the total value of stated exports (goods and services) is now over 100% of recorded GDP (with up to 90% accounted for by multinational companies).

Thus the wealth in the economy is largely generated by overseas companies (principally of US origin). However they account directly for a relatively small amount of overall employment.

So the vast majority of jobs in our economy relate to the trade of low value services which we buy and sell to each other at very high prices.

One of the fallacies surrounding the EU internal market (trading without restrictions) is that it would thereby ensure the benefits of competition in all sectors.

However this clearly does not apply to many services. If I need to buy groceries, get a car repaired, visit a dentist or a solicitor, use the health service etc., the prices will be largely governed by purely local circumstances that are largely immune from outside competition.

During the earlier part of the Celtic tiger (1994 – 2000), Ireland - in comparison to its EU neighbours - was a competitive economy . However the wealth created by growing multinational activity considerably fuelled demand for local goods and services.

It particular this led to a highly artificial form of domestic wealth creation through an unprecedented boom with respect to both commercial and residential property. This then in turn created a growing demand for domestic services that were largely protected (geographically and otherwise) from overseas competition.

So when the financial crash came in 2008, ending the property bubble, prices in Ireland had now risen well above the EU norm for most goods and services.

With debt levels rising and demand plummeting, this led to a significant loss of employment in these sectors.
This in turn has created an even greater level of dependence in recent years on ever more investment being attracted to our shores in the hope of counteracting adverse domestic trends.

So we now effectively have a two-tier economic system in Ireland.

On the one hand multinational activity in Ireland is booming (helped recently the location of leading financial service companies such as City Bank and Merrill Lynch and Internet giants such as Google and Facebook).

However the domestic economy is largely on its knees with many smaller firms on the verge of extinction.

Though this has led to a series of distortions with potentially enormous consequences, the official unspoken consensus is that no negative questions should be raised regarding the role of multinational investment in Ireland.

Not surprisingly therefore the official reaction to the hearings in the UK and the US last week have been highly defensive with continual protestations that Ireland meets none of the criteria for a tax haven, that no special deal ever applied to any investor here and that we are totally transparent in all our tax arrangements. The same sentiment has then been largely shared by the media and tax commentators.

Unfortunately this response is most unconvincing. The same kind of official propaganda was used during the latter years of the Celtic tiger to quell to criticism of anyone who dared question the enormous excesses of the property boom.

The official mantra then was that the fundamentals in the economy were all sound and that growth in Ireland was the envy of our European neighbours. Then when the credit policies of the banks were questioned we were continually assured that they were stress tested with capital reserves greater than required so that no problem could emerge.

Then when it was no longer possible to ignore the possibility of a property crash the new official position was now that Ireland would have a “soft landing”  and that after a short period of adjustment would quickly return to a sustainable growth rate (in excess of 4% pa).

The main research Institute the ESRI - despite its fears and misgivings - in effect largely shared this cosy official consensus as did the media and the main political parties.

In the 2007 elections the programmes of both Fianna Fail and Fine Gael were predicated on maintaining growth rates in excess of 4%.
(In fact the projected growth rate of the opposition party Fine Gael was slightly higher than Fianna Fail!)
So any retrospective attempt by FG to maintain that it warned of the impending crisis is without foundation.

Let’s look briefly at some of these distortions created through the significant presence of multinational companies in Ireland.

Firstly important issues arise regarding the accuracy of a great many of our economic statistics.

The official measurement of growth is in terms of GDP. As we have seen exports contribute disproportionately to Irish GDP. However one could validly question the true extent of these exports.

Take the activities of Google as one example! Google at present considerably benefits from its double Irish arrangement. Clearly it trades in Ireland (currently employing over 2,000) with the offshore company here owning its intellectual property rights. However under Irish law Google also has set up a 2nd company which is allowed to be tax resident elsewhere, - in this case in Bermuda - where no tax on profits applies.

The 2nd company then charges the other Irish company license and royalty fees (based on the holding of its intellectual property rights). Not surprisingly these are designed to effectively wipe out any liability for tax under our system (where officially a 12.5% rate applies).

In fact it has been revealed that Google has paid a miniscule amount in tax to the Irish exchequer in the past few years of its operation (.13%).

They pay even less in the UK (where a substantial amount of the advertising revenue is effectively generated).

The UK authorities would like Google to pay tax on the revenue (effectively generated in the UK). However Google cleverly uses a technical loophole whereby they maintain that all sales are closed in Ireland thereby avoiding such a liability.

One might validly ask why the Irish authorities are therefore not protesting – since Google attributes UK sales to their Irish operation – about the tiny amount of tax paid here on such large amounts of income.

Well, let’s say it is a convenient arrangement that benefits both sides. On the one hand Ireland has located here one of the most prestigious companies in the world providing high skilled jobs in an expanding enterprise. On the other hand Google is enabled to legally pay a very small amount of tax (on its non-US earnings).

Paradoxically the very arguments of the Government demonstrate the effectiveness of Ireland as a tax haven. So while it validly protests that it does not fulfil any of the legal criteria for a tax haven, this offers further cover for companies such as Google and Apple (who use it precisely for this purpose).

This is not to maintain that Ireland is by any means alone in this regard. In Europe  the Netherlands, Luxembourg and Switzerland for example are involved in similar type activities.

The case of Apple is even more curious in that its 2nd (tax avoiding) company does not seem to have a designated tax residence.

So, all in all, perhaps Apple’s greatest design is with respect to this ingenious iTax which renders vast sums of money invisible for taxation purposes anywhere in the world.

Considerable distortions also arise through transfer pricing policies that are deliberately designed to artificially lower reported costs with respect to an Irish subsidiary. This criticism has recently been made of Marks and Spencers who operate in both the UK and Ireland. However with corporate taxation higher in the UK, some of this burden can be transferred through the company selling goods and services to the Irish subsidiary at artificially low prices. This then enables the Irish branch to show higher profits which are then taxed at the lower Irish tax rate.

However with multinational activity at such a high level in Ireland, this raises serious question marks regarding the accuracy of many of our leading economic statistics.

Once again the official measurement of economic performance is based on GDP which is designed to measure the total value of what is produced in a country.

However because of the significant use of Ireland by large multinationals to reduce their international tax liabilities this figure is likely to greatly overestimated. For example as we have seen with Google they attribute large amounts of sales advertising to Ireland that effectively is sold elsewhere in Europe!

So a substantial amount of what is reported in Ireland as GDP, represents artificial profits (created to legally avoid tax payments). Significant amounts of these profits are then - according to our Balance of Payments - treated as negative income flows.

At present over €30 bl. of profits is reported as flowing out of the economy annually representing nearly 20% of GDP. So our GNP (which takes count of this movement) is considerably less than GDP and arguably a much more accurate indicator of our economic performance!

But even this figure must be severely questioned. Though “profit repatriations” is commonly used with respect to these US multinationals, it is very unlikely that the money is going back to the US. Presumably in many cases it is being held in their tax resident location e.g. in the case of Google, Bermuda. However in other cases as revealed in the case of Apple, the profits do not seem to be going anywhere. So in effect Ireland here seems to be the location for the artificial generation of vast amounts of profits that are not officially recorded in our statistics.

Apart from profits flows (recorded and unrecorded) we then have huge amounts recorded under licence fees and royalties (again at nearly 20% of current GDP). Now these would be treated as services imports in the Balance of Payments. However one could validly question – like the profits - how accurate these figures can be!

Thus enormous question marks hang over the accuracy of our GDP, GNP, import and export figures.  And all of this matters in several important respects.

For example our contribution to the EU Budget is largely based on GDP.

Now if one accepts that in the case of Ireland – for the reasons stated -  this figure represents a substantial overstatement of our true economic performance - then significant sums of money are being lost to the domestic exchequer each year (at a financially difficult time).

Also growth performance in Ireland can be highly misleading. Once again the official emphasis is on GDP growth. However official GDP figures can be rising while GNP figures (which are more representative of true performance) are falling at the same time. 

The official position at the moment is that the Irish economy now in recovery with moderate GDP growth taking place. However this belies the fact that many parts of the domestic economy are still in deep recession.

And in any case - again because of the uniquely important role of multinational activity in Ireland - it is especially difficult to trust the accuracy of key recorded statistics.

Associated with this is a growing dichotomy as between two economies i.e. the one based on the multinationals and the other relating to locally traded goods and services.

It is no accident that the very conditions that have led to record success in the last couple of years, with respect to attracting multinationals, equally are causing growing problems for the domestic sector.

In many ways the Irish economy is now more attractive than ever to US multinationals.

The US authorities understandably are annoyed at the manner their companies legally avoid paying tax in their own country.

So as a first step they are now clamping down on the use of pure tax havens (i.e. where companies register solely for tax purposes with no productive activity taking place).

Some of the companies affected have thereby moved to less overt tax havens - such as Ireland - where genuine production is required and can to an extent be used to mask the nature of tax avoidance adopted. 

As a result of the domestic recession, labour and rental costs have dropped making it more attractive for foreign investors.

Also because of high unemployment the Government is more anxious than ever to meet their special requirements with an ever expanding range of new proposals such as write-offs on R&D, income tax waivers on earnings of top executives located here and even suggestions to further lower the current corporation tax rate of 12.5%.  

As these multinational mainly use Ireland as a base for selling into the wider European market and elsewhere, the recession in the domestic economy is not of direct concern. Also they are not affected - unlike domestic producers - by the continuing liquidity crisis in our banking system.

However one feature of special concern with respect to our continued reliance on multinational investment that it is leading to considerable distortions with respect to acceptable notions of social justice.

Since the property crash in 2008 a huge burden has been placed on young middle income earners.

Many of these have suffered substantial negative equity on their properties struggling to repay mortgages taken out at the height of the boom.
Indeed many are now unemployed with little immediate prospect of finding work in Ireland!

Then to finance the huge debts that have accumulated at public sector, corporate and private levels, the Government has resorted to austerity measures leading to substantial increases in taxation and a decline in customary public services.

The domestic retail sector has then suffered the fallout from the rapid decline in disposable income while also facing further considerable obstacles.

So while everything is done to make Ireland even more attractive for outside investors, in effect a reverse set of circumstances applies to domestic business.

Due to the banking crisis Irish business is starved of credit. Meanwhile because of a crazy system of upward only reviews, rental costs for retailers remain far too high  forcing many out of business. Other important costs such as communications, energy, insurance and waste disposal are among the highest in Europe.

It is not surprising therefore that the wider public is now taking more notice of the tax avoidance activities of multinationals.

Put simply they ask: Why should these massively wealthy companies be assisted to allowed  pay virtually no tax when low to middle income earners are being squeezed for tax at every turn? Where is the equity, where is the social justice in all of this?

In fact I believe that this represents a growing crisis for the way in which the capitalist system works.

Multinational companies are immensely powerful due to the considerable resources they control. Because they can bring obvious short term advantages to the economies in which they locate, effectively they can play off one Government against another so as to get the best deal.

Considerably hypocrisy attaches to the stance for example of the US government (which held its Senate Hearings into Apple). They could change their  laws so as to make Apple liable for tax on its foreign earnings. However they will not do this, as they are fearful of the consequences with Apple perhaps then threatening to move its entire operations elsewhere.

So in the absence of a globally agreed approach to the issue of taxing their profits, multinationals will continue to exploit the tax loopholes that inevitably emerge with respect to separate systems designed to maximise national advantage.

Unfortunately, the very notion of global cooperation does not fit in with capitalist notions of competitive individualism (at either firm or state level).

Thus accepting this, the US is likely in the end to attempt to improve its national competitive advantage by providing additional incentives for Apple to repatriate their substantial overseas profits e.g. through a much lower rate of tax applying.

I have long been of the opinion that our standard economic concepts have increasingly become outdated in the modern world and that we can no longer attempt to disassociate economic activity from moral notions of social and personal justice.

Equally we can no longer seek to operate from merely an individual national perspective on a wide range of issues.

For example the environmental crisis can only be properly tackled on the basis of true global cooperation (based not on the interests of any individual nation in isolation but rather their combined long term collective benefit) .

This also applies to the international financial system which will be quickly subject to further major upheavals if the inherent greed and selfishness on which the system operates is not faced through a disinterested form of global cooperation.    

At a deeper level this will require substantial revisions in the accepted capitalist notion of profit which we will return to in a future blog entry!  

Friday, January 7, 2011

Health Matters

The earliest days of the New Year sadly only act to confirm my worst fears regarding the state of the public sector in Ireland (and in particular health facilities).

Like an ever repeating broken record, we hear accounts at the beginning of January regarding the gross over-crowding of our public hospitals. Though we are told that lessons have been learnt with new plans in place to ensure that the same problems do not arise the following year, unfortunately it is always the same old story (with however matters even worse than before).

Of course the HSE will immediately point to the cuts in the health budget as a ready excuse. However the problem is really much worse than this with the truth being that we have an health service now in Ireland that in many ways has become increasingly dysfunctional.

There are many reasons for this sorry state of affairs pointing to key weaknesses in the Irish personality in dealing with administrative failure.

Firstly there is a huge lack of leadership at the political level in tackling the many powerful vested interests in the health system. The present Minister, Mary Harney represents a party that no longer exists. However far from disqualifying her from the job, the main Government party Fianna Fail has been quite happy to leave her in this important position (so that it can thereby avoid direct responsibility for any unpopular decisions taken.) So the Minister has been effectively out on a limb without enjoying the total support of her Government colleagues.

Secondly a new monolithic structure - Health Services Executive (HSE) - has been created ostensibly charged with the running of the health sector. However this has created a new problem with no one ultimately responsible for problems arising. The Minister hides behind the HSE, while the HSE is a somewhat faceless organisation with roles of responsibility deliberately blurred. So it is all designed to lead to the typical Irish problem of continual "systems failure" with conveniently no one ever directly responsible.
The HSE in any case represents a bureaucratic nightmare with far too many managerial staff who have no clear direction or purpose. Meanwhile the Government has persistently lacked the will to tackle this obvious problem of inefficiency head-on!

The health sector in Ireland has become riddled with powerful vested interests. Unions are very strong and not slow to defend their members' interests. In particular, consultants in Ireland enjoy an immensely privileged position in this system being paid substantially more than in other countries. Also it has to be said that they have proved pretty expert at defending such privileges in negotiations with weak Government!

Doctors also do very well out of the system in particular out of older patients for which they receive more than generous remuneration from the state. Also because of fears of medical litigation (and the exorbitant cost of medical insurance) rather than directly dealing with complaints, increasingly they refer patients to the hospitals for further tests thus worsening the logjam in the system.

The cost of drugs is also very high in Ireland which again reflects on the power of the pharmacies' union and also the weak bargaining position which the Government has exercised in negotiating payment with the pharmaceutical companies.

The hospitals too tend to be a law unto themselves with astronomical charges often indirectly applied to customers through the health insurance market.
So there appears to be little control exercised over health insurance costs.
Only yesterday for example the main health insurer, the VHI, announced increases in annual premiums that for some customers would be as high as 45%!

And it is not that this represents a once-off charge, for premiums have been escalating in most years by double digit increases in annual charges. And this is at a time when the economy is plunged in recession with disposable incomes for many citizens significantly reduced!

And as it stands things can only get worse. Because of the financial situation, the health budget will have to be sharply constrained for several years.

Meanwhile however, medical inflation here is escalating completely out of control. When one additionally considers that the age profile of the population is changing rapidly, with an ever higher proportion in the over 65 category, then the demands on the system will sharply increase.

In fact, given the lack of political will to enforce radical reforms and the absence of any creative response to problems that have already arisen, we are inevitably heading here in Ireland for a health crisis of truly considerable proportions.

Wednesday, November 24, 2010

Crisis Deepens

Since I last wrote several significant developments have taken place making it clear that the present crisis both in Ireland and in Europe is much deeper that initially realised.

Indeed there is an even growing risk now that the whole financial system - not just in Ireland - but in the Eurozone generally could spiral out of control with disastrous consequences for its citizens. And unfortunately this risk is aggravated through a lack of effective action at the EU level (where intervention is most necessary).

To be honest I was deeply shocked at the manner in which the EU reacted to the growing Irish problems last week.

Though I have been a persistent critic of the terrible mismanagement of our economy (especially since 2000) at least I could not fault the Government for its determination to play by European rules. So for example, despite considerable domestic criticism, Brian Lenihan consistently maintained the Government's intention to fully redeem all senior bondholders in our banks (despite the inevitable huge burden that this would place on domestic taxpayers).

Now I had always assumed that this assurance was pressed on him by the the ECB who in return for such loyalty would guarantee liquidity to the Irish Banking system. After all, given that our National Central Bank is part of the European System of Central Banks, the ECB is now in effect "our" bank.

One of the essential functions of a properly functioning Central Bank is to act as lender of last resort! And as the Irish banks cannot borrow from anyone else at present then certainly this "lender of last resort" facility could never have been more necessary.

Last week as the threat of contagion spreading to Portugal and then Greece increased, the ECB panicked to assume its new role as "part lender of last resort" Admittedly because of the enormous liquidity hole in the Irish Banking system it was using up a great amount of the resources it had available (about 20%).

However the attempted solution to this problem is so inept as to beggar belief.

Ireland had already become a seriously overburdened nation debt wise, with growing doubts as to whether it was at all viable to expect taxpayers to absorb all these losses (without any sacrifice asked with respect to senior bondholders).

Then the ECB decided to pull the plug by setting a limit to the extent to which they willing to fund the Irish banks. So Ireland was inevitably pushed into an ignominious bailout that seems inadequate from every point of view.

From Ireland's own perspective it greatly increases debt at a time when the nation is already overburdened debt wise. Therefore this bailout is not "free money" but rather comes at an onerous interest rate close to 6%. Furthermore it means that independent decision making will be forfeited now for some years.

Personally though in the circumstances we had no option but to accept the bailout, I believe that we have been let down badly by our European partners (who unfortunately are now quickly changing their role to that of our European masters). Worse still despite Government loyalty we find ourselves to a degree betrayed by that very institution on which we believed we could most trust. So it was the ECB that put out the rumours that Ireland would need a bailout and then decided to have the matter confirmed through the Governor of our Central Bank.

This bailout is highly unlikely to reassure the markets in any case. If the ECB cannot guarantee full funding to support the Irish bank losses, how can it possibly have sufficient reserves to deal with the financial problems of the much bigger economies? And a remedy that attempts to place the entire burden for the losses (recklessly funded by large European banks) on to the domestic taxpayers of Ireland is not only morally unjust but is very shortsighted in economic terms. For such a tactic only reduces the ability of the economy to attain growth (which is a precondition for honouring those debts).

So as I write - the day after the package was finalised - the markets have responded in predictable fashion with share prices around Europe falling.

I take no satisfaction in now stating that so many of the problems that I have always seen in the economic system are now coming to a head.

Make no mistake about it! What we are now witnessing throughout Europe is endemic of deeper inherent faults in the way the capitalist global system operates.

Important decisions, so often decided by narrow domestic considerations are hugely inadequate in relation to the scale of problems we are facing (as exemplified by the bailout package to Ireland yesterday).

Perhaps even more serious is that the time scale for which decisions are taken is far too-short term (again largely dictated by sectional political interests).

Also the attempts to treat the market system as an impersonal mechanism (without due concern for the moral implications of those taking decisions in the markets) leads inevitably to great injustice in social terms.

In particular this has already led to an enormous build-up of problems with respect to financial and environmental issues.

So what we are now witnessing is not just a crisis for Ireland or for Europe. It is in fact a defining crisis for the capitalist system.

Sunday, November 7, 2010

Looming Crisis

Things are not looking good at present in Ireland with an enforced economic bailout from the EU/IMF Stability Facility in the new year looking ever more likely.

Unfortunately the damage already done to the economy during the totally reckless latter phases of the Celtic Tiger has been so great that in truth it is hard to see how any credible response can now be made to deal with the financial implications.

As I had always feared, losses from the banking system have been much greater than recognised.
Indeed I suspected that the government was engaging in an unconvincing game of bluff in hiding the extent of such losses. From an initial position that the banks "would cost us nothing" it is now admitted that the losses will be in the order of € 50 bl. (which unfortunately is likely to be a severe underestimate). The projections with respect to property prices on which these figures were made were far too optimistic. Furthermore there is a considerable amount of - yet - unrecognised debt in the banking system relating to mortgages and other loans which represent yet another important aspect of an enormous financial problem.

Effectively therefore our banking system remains on life support and is being almost entirely funded though ECB borrowings.

On top of this despite a severe budget last year, no real improvement has taken place in the budgetary position of the Government. Even with all the banking debt excluded, the current deficit stands at about 12% GDP. With a commitment to get this down to 3% by 2014 this requires that even more severe adjustments will need to be attempted over the coming years. So the Government is trying to reduce the gap by a massive €6 bl. in the forthcoming budget (mostly through expenditure cuts). However for this to have any hope of success, several assumptions (e.g. projected growth in the economy) will need to be realised which do not seem to me at all realistic.

So even if the Government succeeds in overcoming the considerable political difficulties in getting its budget passed in December, it is very likely that the downward scale of adjustment required will erode any chance of economic recovery in the short-term. If this scenario is proven correct then the revenue side will further deteriorate in 2011 so that we could be facing a largely similar gap in the finances next year.

Meanwhile the bond markets already have made this judgement so that interest rates on longer term issues have risen to nearly 8%. And quite simply if such rates continue it is not tenable for the Government to borrow from the market!

However perhaps there is one little chink of light remaining. Given that Greece has already been forced into a bailout and that there are other Euro economies such as Portugal and Spain also suffering major financial difficulties, the EU will be extremely reluctant to accept that yet another country requires an "official" rescue. Acceding to such an outcome could hasten the end of the whole Euro experiment! Therefore everything possible may be done behind the scenes to actually help Ireland financially (without resort to the Stability Facility).

As I suspect that the very targets (and broad strategy) of the forthcoming Budget have been effectively decided by EU officials, therefore a measure of responsibility falls on them to see that they can be successfully realised.

So in a very real sense Ireland has already handed over a considerable amount of sovereignty to the EU and this process is likely to be intensified in future years (even without formal recourse to a bailout).

However this does raise very interesting questions with respect to economic management.

1) Given the nature of our political system with the petty in-fighting that is so typical of our political parties. it seems that we cannot agree on a coherent overall strategy unless it is enforced by the EU. We already have a precedent for this as the Maastrict criteria laid then in the 90's as a condition for entry to the Eurozone greatly assisted in attainment of financial discipline at that time.

2) As a member of a viable Eurozone, a considerable amount of economic sovereignty would need to be ceded in any case.
Though this has happened immediately with respect to monetary policy we still believed that somehow we could keep control of our fiscal affairs. However the very logic of what has now happened would suggest that overall control of fiscal policy in the Eurozone needs to be conducted at a central level.

Not surprisingly therefore the Germans - who see themselves as the ultimate paymasters - are already suggesting conditions for future bailouts that would significantly erode national sovereignty.

In the case of Ireland these problems are considerably magnified by the fact that we one of the most open economies of the world (with the great bulk of our exports relating to multinational firms).

On a more general note as global interdependence with respect to finance and economic activity increases, the traditional model of taking key decisions at a national level makes less and less sense. Though larger nations will still dominate with respect to influence, smaller nations like Ireland will have to become ever more realistic regarding the inevitable erosion of real power.

3) Despite our present difficulties I still think that the penny has not really dropped as to the highly artificial nature of Irish economic activity.
Though the property bubble has indeed been exposed, a potentially bigger issue relates to the manner in which multinational companies dominate our economic landscape.

This can be highlighted by an interesting statistic.
It now seems that Ireland has risen to no. 9 in the World with respect to the value of export services (which is the fastest rising component internationally of trade). For a small economy of 4.5 ml. inhabitants this does indeed seem highly impressive!
However about 90% of the value of these services relates to the multinationals and when one examines further, a considerable proportion can be attributed to dubious activities with respect to income diversion for tax purposes. To put it bluntly much of our export sales do not in fact originate in Ireland! However we are still happy to turn a blind eye to this fact (and of course the tax loop holes that make it all possible).

In fact the vast bulk of employment in Ireland relates to the generation of domestically produced services (which are very much overpriced). So if one shops in a supermarket in Ireland one can expect to pay about 25% more (than the average EU price). Likewise if one goes to a car dealer, a dentist, a pharmacist, seeks childcare or eats out in a restaurant one is likely to pay well over the odds. Of course providers of such services will immediately counter that their costs are very high (though in some cases this is used to justify excess profit margins)! But this only underscores my general point regarding the uncompetitive nature of the local indigenous economy! And lack of value is even more pronounced with respect to many publicly provided services. For example in the health sector, the law of diminishing returns has been operating for some time with a vengeance. Therefore despite a huge increase in employment over the past 10 years there is little evidence of an overall improvement in service.

The root problem goes back to the days when the public sector was used to provide employment (which was not available in the private sector). Not surprisingly a whole set of practices were then built up that were not based on the need to promote efficiency. And then with these now well-established (and vigorously defended by powerful public sector unions) it becomes extremely difficult to make effective changes.

Much as I hate to admit this, it may even be necessary that the radical changes required be enforced from an outside agency (such as the EU Commission or IMF) for the urgent action now required is unlikely to materialise from within our present partnership type model.

So to conclude the bulk of employment in the Irish economy relates to over priced goods and services which we buy from and sell to each other in the domestic economy.
We thus have an opportunity therefore during the next few years to get to grips with a fundamental weakness (which is the serious lack of competitiveness with respect to the indigenous economy).

And if we cannot do this voluntarily ourselves then we cannot really complain if eventually such changes have to be enforced on us from outside.

The Celtic Tiger was a period of great illusion in Ireland. Part of this illusion is being slowly stripped away (in the shape of the property bubble). However we are still in considerable denial as regards the bigger part i.e. reliance on multinational activity built on artificial tax advantages that are effectively exploited here due to a - deliberate - lack of regulatory discipline.

Friday, October 1, 2010

A 30 Year Cycle

It struck me recently that the prolonged recessions (lasting up to a decade a length) have been a consistent feature of the Irish economy since independence. Furthermore these recessions have occurred on a fairly regular 30 year cycle.

When we obtained our Independence in 1922, the country became ravaged by a very damaging Civil War. Manufacturing industry was practically non-existent with the country almost totally dependent on agricultural production.

Though little progress was made during this first decade of freedom, surprisingly, in a qualified fashion, the economy started to revive during the era of the Great Depression. The high tariff barriers now in place enabled the replacement of - formerly - imported commodities by new domestic firms. Also the Government, recognising the lack of private capital took the initiative in setting up several large state-owned enterprises. Then we escaped the worst ravages of the 2nd World War through our neutral stance.
However during the next decade of the 50's the limitations of this strategy were cruelly exposed. As the import substitution phase of industrial development (afforded by tariff protection) neared completion, further possibilities for growth were stunted through the small sized uncompetitive nature of Irish industry. So in contrast to the rest of Europe which was now booming, the Irish economy stagnated with an enormous amount of associated emigration.

A dramatic change in policy then took place. Rather than using significant tax and grant incentives in a vain attempt to promote Irish export growth, we now sought to attract foreign enterprise to Ireland. Half a century later, this policy is still very much in place and so successful that we are now one of the most open economies in the World with about 90% by value of exports (goods and services) coming from foreign multinationals located here.

So the 60's and lesser extent 70's were a period of comparative growth and prosperity. In addition Ireland had joined the EC in 1973 creating further opportunities for trade and significant financial support (e.g. agriculture and regional policy).

Then in the 80's we had another prolonged recession. The root cause of this was due to an accumulation of borrowing (mostly foreign) in a vain attempt by the Government to maintain an illusionary boom.

However the harsh adjustment required to adapt to this new situation eventually brought about many of the conditions for a return to growth in the 90's with the commencement of the famed Celtic Tiger. When the first phase of this - based initially on a genuine competitive advantage - had run its course by 2001, we embarked on an ill advised second phase almost totally fuelled through an enormous property bubble. Then all of this came crashing down as the result of the financial shocks in 2008 (after the collapse of Lehman Brothers).

So as we entered the new decade in 2010 we were facing the aftermath of another major economic recession, the effects of which are likely to last for the entire decade.

Enormous losses have been accumulated in the banking system. The domestic economy is now very uncompetitive compared to neighbouring countries and there is an enormous hole in our public finances with current expenditure greatly exceeding tax revenue.

Though it is perhaps small consolation to the many struggling to cope with such adverse financial circumstances, the economy will eventually recover. And if the past is to be a guide this will be due to many painful adjustments lasting the best part of a decade.

However perhaps it is time to learn an important lesson. If we do not manage the next recovery wisely we could be facing an even greater economic crisis in 30 years time.
Perhaps it is not accidental that these prolonged recessions have been recurring at regular 30 years cycles. They all have had a similar pattern 1. A decade of pain and slow adjustment 2. a following decade of recovery based on a new competitive advantage 3. a further decade of attempting to prolong the good times in the absence of such advantage. And inevitably this has then paved the way for the next economic crisis.
So if we do not properly learn from our mistakes, we are likely to make them yet again with perhaps even more devastating consequences.