Wednesday, October 14, 2009

Lack of Competitiveness

I have considered for many years that the Irish economy suffers from a fundamental lack of competitiveness. Unfortunately this was persistently ignored during the crazy property bubble years of the 2nd phase of the Celtic Tiger. So what was misleadingly trumpeted then by politicians as "inherent strengths" of the Irish economy e.g. continuing high growth and employment were in effect hiding the true reality of a highly artificial economy, with bad value and poor work practices evident in every sector.

One of the unchallenged assumptions that was made here was that removal of barriers in the EU internal market would in itself guarantee competition in Ireland.

However for a number of reasons this argument is highly suspect due to grave faults with respect to the way the market operates.

Though the market works better in relation to freely traded goods, even here major impediments exist. For example Governments prevent cars being freely imported from lower price jurisdictions. So apart from differing road regulations here favouring right hand drive cars (as opposed to left hand drive on the Continent) hefty regulation fees have been put in place to deter direct customer buying from other EU states.

Then well known prescribed drugs (such as for blood pressure and cholesterol) are available in other EU countries for as little as 1/10th of the price of what is charged in Ireland. However rigid prescription practices are deliberately used to deter customers availing of much lower prices elsewhere.

Also many products for which the economy is inherently suited to produce, sell at especially high prices in Irish supermarkets e.g. bottled water, yogurts and cheese.

Ireland is a small economy that - apart from Northern Island - is geographically isolated from the rest of Europe. Thus when the price of bottled water is pitched at an outrageous level, the consumer is left with the option of either directly importing from another countries, which due to the bulky nature of the product is impractical. Alternatively one could travel to Northern Ireland which can be time consuming and inconvenient (creating its own additional expenses). So where goods are perishable such as food, or alternatively bulky of relatively low value, little competition can be enforced on domestic sellers. Then as all can mutually benefit from maintenance of high prices, an effective cartel is often then operated by the oligopoly sellers.

The situation is even worse in the provision of services. Dental charges for example are wildly excessive in the Republic again through high costs and collusion amongst providers. One is therefore forced to travel to another jurisdiction to avoid such charges. However this involves additional travel costs, a considerable amount of inconvenience and problems regarding effective follow-up.

One could argue that the answer is to encourage outside service practitioners to set up in Ireland. However there are considerable difficulties to this as the EU still does not provide the same rights of establishment to service providers.

The services sector is now the most important, both in terms of output and employment throughout the EU. So one can realise the restricted nature in practice of competition.

So the Irish economy as an isolated geographical entity on the West of Europe is most easily able to avoid the rigours of competition. As so many services are consumed locally, there is little need to match prices in other member countries. And where the domestic market is concerned local competition is often avoided through cartel type arrangements between providers.

Likewise many goods providers are insulated from foreign competition through prohibitive costs and time delays with respect to the importation of foreign products. And once again because of the small size of the market, it is much easier for sellers to operate informal cartels and price fixing arrangements which distort competition further.

And as over 90% by value of exports (goods and services) comes from multinational subsidiaries located here mainly for tax advantages, to a considerable extent we have been able to ignore the problem of competitiveness.

As measures to tackle this issue would indeed prove unpopular among sellers, the Government has so far largely evaded the issue.

Due to the damaging effects on sales, the deep recession in the economy will gradually take care of competitiveness for many firms in the private sector. This problem is further compounded for indigenous exporters by the current high value of the euro against sterling and the dollar. However far tougher implementation of competition regulations is required with respect to many service providers e.g. doctors and dentists, as we cannot maintain a model whereby practitioners here continue to enjoy unrealistically high earnings.

The Government should also introduce a specific regime to continually monitor costs and prices in various sectors (both over time and in comparison to other EU countries). The very fact of making the information publicly available would serve to highlight key problems thus causing pressure for change. Also campaigns focusing on special anomolies would be in order.

A particular difficulty exists with respect to public services. Payment here e.g. in health and education is out of line with rates in other EU countries and also with private sector pay in Ireland. We have allowed this problem grow during the inflated riches of the Celtic Tiger. The problem is that many people have entered into financial commitments based on this lax approach which then creates considerable resistance to any proposed reforms. This is worsened by a patent lack of social justice whereby privileged groups such as politicians, judges, bank directors and hospital consultants seek to live by different rules than those that apply to the rest of the community. So this issue will create distortions in our economy for some time. Public sector unions enjoy an unduly powerful role in Ireland (effectively acting as coalition partners) largely because of weak government. So when demands for pay cuts and reduced numbers are made the unions will stoutly resist. And then I expect the Government to back off making cuts to capital rather than current expenditure.

This is a sure recipe for continued recession in the economy with short-term recovery highly unlikely.

Of course competitiveness involves more than just consideration with unit wage costs. Largely because of our reluctance to properly face up to the cost issue, many seek to promote Ireland as "the knowledge economy" presumably concentrating on high skilled activities where pay competiveness would not be so important. However there is considerable delusion in this. So far Ireland's competitive advantage largely springs from artificial tax provisions. Also other countries will quickly see the benefit of developing the "knowledge economy" with much lower costs.

So we need to stop fooling ourselves. We have been trading for years off artificial advantages i.e. low corporate tax and the propery boom and in the process lost any real compass as to future directions.
We need to quickly get back to basics i.e. low costs, hard work and genuine pride in the country. Even then we will need all the ingenuity at our disposal to develop new competitive strengths that can serve us well into the future.

Friday, October 9, 2009

Dealing with Recession

There is little doubt that Ireland is in the grips of a deep recession at present. The inflation rate is currently - 6.5% (on an annualised basis) and real output could fall by 10% this year.

Because liquidity is so tight with banks at present many small and medium sized businesses are finding it extremely difficult to survive. In deed it is heartbreaking to hear on programmes like Joe Duffy's "Liveline" the incredible pressures that many of these are now, with unpaid debts mounting and the prospects of survival looking slim.

We all know the reasons why banks are refusing these firms credit. Because of the huge losses they have suffered from wildly speculative lending during the property boom, their balance sheets are now in a bad way. Therefore they have a vested interest in preserving money to meet uncertain future liabilities, rather than lend it to stressed businesses in the midst of a recession. And despite all the efforts of the Government here at capitalisation and taking the riskiest loans off their books, this situation is likely to continue for some time.

To get credit flowing sooner rather than later in the economy, the state itself needs to take responsibility by setting up its own bank precisely for such purposes. It is ironical that we used to have two state banks i.e. ACC and ICC in the economy until quite recently. Though these had become more commercialised in any case before privatisation, their original purpose had been to provide credit to businesses (where full commercial criteria would not apply).

In a sense this is precisely what is required now! The (private) banks will argue that they are open for business and willing to extend credit. However quite clearly in the current economic climate very few enterprises can match the tough criteria they are setting. Therefore many businesses that are starved of credit are on the very brink of failure.

Therefore because the existing banks are not likely to extend such credit, the only way it will be made available is through a government willingness to make up the shortfall. So quite simply an urgent need now exists for such a bank to be created. Though a large number of businesses are probably bad bets at present and should not receive assistance, many others with credit more easily available, could indeed have a reasonable chance of survival.
And we need to consider the multiplier aspects of all this. Each business that fails puts more workers on the dole. So there is a price for the government to be paid through additional social welfare payments and loss in tax revenues.

Once the economy has properly recovered with banks finally returning to "normality", the activity of the state bank could be wound down considerably. However it would be a good idea to keep it in existence in the event of a further baning crisis arising in future.

The other possible option for stimulating economic activity would come through the old Keynesian approach whereby the Government would directly increase its own spending in certain selected areas. However there is a problem for Ireland in all this in that we no longer have our own economic destiny in our hands. So whatever measures we take have to receive the broad approval of our EU masters and international financial markets. And given that state finances are out of control at present with expenditure greatly exceeding revenue, Keynesian prime pumping (however well intentioned) might not meet the necessary approval.

Above all Ireland has to tackle a severe loss in competitiveness due in large part to the excesses of the Celtic tiger. It would be better if we took the necessary courageous steps here in a voluntary manner. Failing this it will indirectly be forced on us in any case through a continued long contraction in our economy.

Thursday, October 1, 2009

Tentative Recovery

It was fascinating following the three BBC Money Programmes on the financial crisis following the collapse a year ago of Lehman Bros.

My gut instinct at the time was that the situation was gravely serious. I indeed considered for how long money could be withdrawn from bank deposits and whether the Government here would be able to maintain payment to public sector workers. Then when the system survived I began to wonder whether my initial fears represented an over-reaction.

Viewing however the re-enactment of the Lehman collapse and the great uncertainty which followed, I can now see that my fears were indeed well grounded with the international financial system literally hanging on the edge of a precipice and the very real threat of total collapse a genuine possibility.

Now a year later we are beginning to hear optimistic noises regarding the prospects of economic recovery. Today for example the IMF has forecast an overall drop in world output of just 1% for 2009 with a return to a very respectable 3% in 2010. Even here in Ireland - where the recession has been especially deep - unemployment figures have unexpectedly stabilised with one stockbroking firm predicting a 4% growth rate in 2011.

While such upbeat news is indeed welcome after the doom and gloom of the past year, I think we should remain extremely wary. In effect once the seismic events of September 2008 unfolded, the international banking system was placed on life support by governments around the world with no guarantee of survival. Now, though showing welcome signs of recovery, the patient still remains on life support. So even if the recovery continues, considerable damage has been already done to health with the possibility of all sorts of future complications arising.

I have long maintained that the fundamental weakness of the capitalist system as we know it is the manner in which an attempt is made to treat it purely in mechanistic terms thus divorcing economic events from the moral responsibility of those involved.

One manifestation of this problem is the manner in which short-term decisions based on immediate economic benefits greatly outweigh wiser longer term consideration of what is truly in the collective interest.

Thus we have seen the rapid growth of a deregulated financial system based on greed and fuelled by speculative profits.

It is generally believed that the sub-prime crisis was the direct cause of recent financial problems. However the problem is much deeper than this.

Success in the goods economy requires product offerings that may take a long time to develop. Thus a period of hard graft and initial loss often precedes the making of significant profits (where these occur).

However the financial sector offers the opportunity for vast profits in a short time frame through purely speculative trading.
Thus in order to extend these speculative opportunities more widely, financial operators - greatly assisted by light touch regulation - have in fact been busily constructing, through complex financial products, a giant pyramid scheme. They were thereby creating the illusion that risk could be largely eliminated from financial decisions.

Because financial activity has become so free of regulation, a virtual monster has been created, which through its voracious appetite, can gobble up the real economy. In other words no clear correspondence exists anymore as between the real and financial economies with the total nominal worth of financial products vastly exceeding the value of goods produced.

Thus the financial system remains extremely vulnerable to further severe crisis. For example real interest rates were already too low before the recent crisis which in many ways served as the root cause of what eventually folded. Now in an attempt to deal with the credit squeeze that unfolded in the aftermath of the crisis, central bank interest rates have been lowered further to virtually zero in the major markets. And this is a sure recipe for future trouble. Given that confidence has already been so greatly weakened, the next great crisis could have even more damaging consequences.

There is a related problem with respect to growing environmental problems on our planet. These have arisen through the manner in which short term economic concerns with profitability continually override concerns with the long run sustainability of resources. Oil reserves have now peaked though potential demand will undoubtedly increase for some time. Also climate change strongly related to Co2 emissions could among other effects have major consequences for future food production.

It could well be that a significant environmental threat - with potentially vast economic implications - will coincide with the next great financial crisis.

Perhaps then we will finally realise the fundamental weaknesses that were always inherent in our capitalist system.

Ireland's Hidden Tax Bubble

The success of the Irish Celtic Tiger (1994 - 2008) can basically be divided into two main phases. The first more successful phase witnessed a tremendous expansion in multinational corporate investment in Ireland (largely of US origin). Exports were the main driver of growth during this period dramatically surging from less than €30 bl. in 1994 to over €90 bl. (current prices) by 2000. For anyone who studied these figures an alarming trend however was in evidence post 2000 with merchandise export growth completely stalling. So present figures are now lower (even in current price terms) than almost a decade previously.

Though there were worrying signs in evidence by 2000 that the property boom had already grown out of control, such fears were quickly disregarded. So after a brief slowdown lasting a couple of years (2001-2002) - the second phase of the Celtic Tiger took off almost entirely fuelled by a hugely artificial property bubble.

As we now are now slowly coming to terms with the dire consequences of such madness - greatly aggravated by the international financial crisis - potentially an even greater problem for the long-term stability of the economy lurks in the background. This relates to the nature of multinational activity in Ireland which is largely based on the artificial tax advantages that the country currently offers.

It is hard to overstate the extent to which these multinationals dominate our economy.

Ireland - as is well known - has one of the most open economies of the world so that when the value of merchandise and service trade is combined exports amounts to well over 80% of GDP (and nearly 100% of GNP). Over 90% of the total value of these exports comes from multinational firms. About 70% of these multinational exports in turn relate to US corporations with the vast bulk of activity in the IT and chemicals/pharmaceuticals sectors.

When one examines closely the precise reasons why Ireland is so attractive for these firms, artificial tax considerations loom large. For example research based activity is very important with potentially huge profits to be made from a successful new product (e.g. software or drug). Though most of the research in many cases is carried out by the parent company in the US, because of the much lower corporate tax system in Ireland, a considerable incentive exists to shift much of these profits to the research division in Ireland (so as to avail of the lower tax rates).

Also license fees would comprise the major bulk of earnings for a software company such as Microsoft. As there is no tax on such fees in Ireland, again this offers a reason to route most profits - made on earnings throughout Europe - through Ireland. As mentioned before on these blogs, Microsoft uses little known subsidiaries Round Island One and Flat Island for such purposes. Though these now enjoy an unlimited status, Round Island One in all likelihood remains by far the most profitable company in Ireland (operating from the offices of a South Dublin legal firm).

When one looks at the the level of profits and license fee income transferred from Ireland, the figures are truly staggering. With profits repatriated currently running close to $30 bl. and licence fees at over €20 bl. per annum, a combined total of about €50 bl. is thereby generated in this manner (representing close to 30% of current GDP).

Ireland is officially listed as the No. 1 software exporter in the world. However again this is a largely artificial ranking due to the manner in which so much of Microsoft's income is transferred from other countries (mostly European) back to Ireland.

Also, as long recognised a considerable amount of transfer pricing is used by multinationals here artificially reducing costs so as to inflate reported profits. The combined effect of these procedures therefore, together with the sheer magnitude of what is involved makes it extremely difficult to assess the true nature of many Irish statistics e.g. exports, imports, balance of payments, taxation, productivity etc. For example a considerable amount of the corporate profits tax collected by the Government relates to income diverted from higher tax jurisdictions in Europe!

Another damaging feature of all this is that the domestic indigenous sector has been able to hide in the shadow of the success of such multinational activity. The Government and other economic bodies have been pointing to the recent comparative success of "Irish" exports during a time of deep recession (making favourable comparisons with Germany). However this "success" is almost entirely due to the dominant multinational element involved (where again much artificial pricing is involved). In truth there has been a significant collapse of Irish indigenous exports over the last year especially with respect to its key market i.e. the UK.

Therefore the success of Ireland's economy owes a great deal to the fact that it is operating as a very efficient tax haven (especially for US firms). Indeed along with the Bahamas, Ireland currently serves as the largest tax haven in the world for such firms. It is true that we differ from the Bahamas in the sense that these firms have genuine production facilities operating here. However it could be argued that such facilities in fact offer even better cover for tax diversion opportunities.

Paradoxically as the Obama regime attempts to tighten up on the tax diversion activities of its own national companies it could even offer a short term advantage to the Irish economy, as it is likely that the pure tax havens will be tackled first. This could then lead to a further shift to partial tax havens such as Ireland (where more seemingly legitimate reasons can be offered for hiding profits). However ultimately these tax havens will be also tackled which could then have very big repercussions for the Irish economy.

Huge mistakes were made due to the failure to act in time to deal with the property bubble.

Potentially even more damaging consequences may flow from a failure to react to this hidden tax bubble in our midst. Even while enjoying its benefits for some more years we should be formulating new economic directions to deal with economic life after this bubble.