Sunday, January 17, 2010

Water - too much, yet too little

It has been very strange living In Ireland in recent times.

Ireland is a country which even at the best of times experiences a great deal of rainfall. And during summer 2009 we had one of the wettest Summers on record.

Then in November the country experienced some of the worst floods in living memory.
This was followed - starting in mid-December - by a long spell of snow and ice.

Yet after all this we are experiencing great problems with our water supply. For example in Dublin many houses have been cut off for several days. In many others water supply has been greatly restricted.

What on Earth is happening?

Unfortunately heavy rainfall does not necessarily translate into a properly functioning water supply.

Like so much other infrastructure, insufficient attention has been paid to the maintenance of the water system in Dublin and elsewhere in the country.

Most of the underground piping that serves Dublin was laid in the late 19th century (when the population of the city was just a fraction of present levels). Though this served well for many years, the lead pipes are now very old and cracking in many places. So a considerable amount of water (instead of flowing through to household taps) leaks out earlier in the process.

Though some limited upgrading of this system has taken place in recent years, it was apparently done in a slipshod and careless manner (as so much construction work during the Celtic Tiger). Though local councils are slow to admit as much, it seems that regulations with respect to laying of new pipes during the housing boom were frequently ignored. Many have been inserted far too close to ground surface and have shown little tolerance therefore for the prolonged cold weather (such as we have experienced in recent weeks). So ironically it is in newly built areas that many of the worst problems are occurring. So this clearly points to pipes being laid "on the cheap" far too close to ground surface.

So it will now perhaps require extensive excavation to find the many leakages and breaks with this new piping (arising from the job not being properly done in the first place).

Another contributory problem in recent weeks has been the fact that many residents - in the desire to avoid pipes freezing over - have allowed taps continually run. However I do not honestly think that this problem has been as bad as the authorities are claimimg (who in many cases are deflecting attention from their own negligence).

There is another huge in-built problem. Dublin has grown enormously in recent years with the streets now very congested with traffic. Therefore proper upgrading of the system has been continually delayed to avoid the major disruptions that would thereby inevitably affect business. Though it should have been done many years ago (when conditions were much more favourable) this did not happen. And now because of the fear of ever increasing disruption, the issue is now continually put on the long finger.

Another problem relates to the financing of local authorities. In recent years Central Exchequer funding has been restricted with councils required to raise revenues from their own operations (such as waste collection). However the councils are always claiming that they are underfunded in an attempt to get Central Government to bear more of the costs.
So as it stands now there seems little chance that major infrastructural works will be instigated by the councils!

It has also to be said that in other parts of the country, water supplies in recent years have suffered increasing contamination (from slurry and chemicals draining from landfill dumps). For example this has been a persistent problem in Galway with many residents still having to boil their water before use.

However there are opportunities also arising from the present situation. The days of unrestricted water usage (even in a rain rich country such as Ireland) have come to an end.

The time is now ripe to install water meters in all houses. A certain minimum amount could be granted free with charging applied above that limit. This would create an incentive for people to economise on usage. It would also provide a big short-term business opportunity in an economy gripped by recession.

However all these problems represent a huge lack of forward planning.

We see frequently in the business press Ireland promoted as an ideal location for companies (needing a plentiful supply of water). However the fact remains that several businesses in recent weeks had to close down (for lack of water).

The same lack of foresight was in evidence in relation to our promotion of Ireland as a premier IT location where the basic need of building an adequate broadband infrastructure was never tackled.

However on a deeper level, problems with water shortages worldwide are likely to grow significantly in future years. My own belief is that we are finally beginning to witness "the inherent contradictions of capitalism".

The very nature of the capitalist system tends to foster short term opportunities for the private pursuit of profit over longer terms concerns with sustainability of physical and social resources.

Because of the - literal - exploitation of nature, key resources such as oil and gas are becoming increasingly scarce. Also climate change in large part, accentuated through unsustainable economic growth, is likely to create basic shortages with respect to food and water in many regions of the world. This is then likely to lead to significant problems of migration from affected countries creating huge political and social tensions.

A major change in attitudes is required. Though I would be optimistic that this eventually will occur, in the short-term major economic and social crises are inevitable.

Sunday, January 3, 2010

Breaking with the Euro

I have been reading David McWilliam’s most recent book "Follow the Money".

It provides a gripping account of the nature of our recent economics problems with the mania for property and easy money being likened by him to a serious drug problem!

However what is always a little weaker in accounts such as this are practical suggestions as to how the problem might be eventually alleviated. Just as the drug addict becomes especially prone to need for the constant "quick fix" solution, popular commentators such McWilliams often fall into the same trap of creating the impression that there are likewise "quick fix" solutions to be found (if only the authorities could fully embrace the author's own particular pet scheme of the moment).

So in the final stages of the book, McWilliams offers as his key solution to the present recessionary crisis in Ireland that we should leave the Euro.

Now to be fair I would not completely deride this suggestion as the validity of our membership of the Eurozone and indeed the validity of the whole Eurozone currency area generally in Europe has never undergone appropriate critical analysis (especially here in Ireland).

In the past the vast bulk of Irish trade was with the UK and not surprisingly Ireland effectively preserved monetary union with Britain though maintaining our punt at an exact 1:1 ratio with sterling. Up until 1979 the Irish punt effectively represented sterling with an Irish face (as sterling was likewise freely accepted in exchange for goods in the Republic). The first major decision was to break this link when we opted for the more limited European Monetary System (EMS) which effectively meant tracking the mark (rather than sterling).
In fairness there were some good economic arguments for this strategy at the time. The UK had been proving less competitive than other European economies and this had been leading to a growing problem of inflation in Ireland. So breaking the link was seen as one way of tackling this problem. Also there was the view that as members of the EU that we should be diversifying our trade away from dependence on the British market.

However it has to be also admitted that part of our enthusiasm was also due to the additional aid we expected to receive from the EU for such a decision. As the poorest member of the EU at the time Ireland benefited disproportionately from EU transfers (e.g. agriculture and structural funds). Then, as a result of this decision to join the EMS we stood to achieve massive amounts of money in borrowing from the European Investment Bank (at very attractive rates). Indeed this was subsequently to lead to a huge increase in our National Debt in the early 80's!

There was also more than a touch of economic nationalism as well regarding the decision. Political independence from Britain had been obtained in 1922. However because of the strong trading relationship with the UK and the link with its currency, economic dependence continued. So the break with sterling signalled an important transition in this respect.

Having taken the decision to join the European Monetary System in ’79 (without Britain’s participation) it was always likely that we would likewise opt for joining the new Euro currency (irrespective of Britain’s decision).

The general view at the time when the single currency first came into existence in 1999, was that Britain would eventually join in any case (thus relieving us of an important exchange rate difficulty). However this has not in fact happened and a decade later still looks very unlikely in the forseeable future.

As regards the Euro project generally I have always considered that it contains a special weakness. Whereas it is strong in the monetary area with the common currency (and the European Central Bank exercising a key level of control) it is very weak unfortunately in the equally important fiscal area.

If we compare the situation with the US (which represents another good example of Economic and Monetary Union) we can appreciate the difference.
In the US the federal budget represents an important level of central control where authorities can influence the overall economy through decisions taken. For example in the present recession the standard fiscal expansionary policies are being pursued so as to encourage more spending and greater economic activity generally.

However no such mechanism exists in the Eurozone. Though there is an EU Budget it is tiny in terms of overall spending (and in any case is not designed to deal with cyclical type adjustments). Therefore in dealing with a a sudden shock (such as the current recession) huge weight is placed on cooperation between the various fiscal authorities so as to obtain a coordinated response.
However if effect this is not how fiscal policy is pursued with each member state bringing in budgets largely to deal with merely domestic circumstances. Though there are overall controls placed by the EU on the parameters within which budgetary policy can be exercised (the Growth and Stability Pact), these have not worked well. The largest countries (e.g. France and Germany) have ignored them (even in relative good times). Now in recession the limits (such as a 3% deficit budget limit) are totally impractical in dealing with recessionary conditions.

Coordinated response at a European level is also further hindered by the fact that while many members are part of the EMU (the Eurozone) other important countries such as the UK lie outside with freedom to pursue interest and exchange rate policies (more in keeping with domestic circumstances).

There is also a particular problem associated with Irish membership as our two principle trading partners - the UK and the US - lie outside the Eurozone. Therefore one of the main benefits of a single currency area (exchange rate stability) does not apply to the bulk of Irish trade.

This situation is even worse when one considers the breakdown as between indigenous and multinational trade.
Most of indigenous exports still go the UK market. In fact it is the multinational companies here (especially US) who benefit from our membership of the EMU for most of their exports are indeed destined for the wider Eurozone economy. In particular US multinationals tend to use Ireland as a convenient satellite bridging state (between the US and Europe). They locate here because of special tax and regulatory advantages in an English speaking country (that then in turn provides the benefits of Eurozone membership with respect to trade).

Ireland is a small island on the outer fringes geographically of Euroland (accounting for 1-2% of overall GDP).
Policies for control of the Eurozone are applied by the ECB in a general manner. It is much more likely therefore than – for example – inflation in a larger country such as Germany will approximate more closely with the target set than Ireland. Because Ireland is so small, inflation could in principle be running at 10% while the ECB overall is successful at keeping inflation at the target rate of 2% in the Eurozone.
Therefore there is every reason for believing that overall policies would not in fact suit domestic circumstances in Ireland.

This in fact was a major contributory factor to the property bubble that engulfed Ireland by the mid noughties. The economy was already overheated due to a prolonged boom in 2001. However because the Eurozone was in recession at the time, the ECB cut interest rates thereby pouring petrol on an enflamed situation. This also enabled extensive euro borrowing abroad by Irish banks at very cheap rates (which has greatly aggravated our present financial crisis).
Now we have the opposite fear that the ECB may start increasing rates and curtail lending while the Irish economy remains in deep recession.

However, having acknowledged these problems, this by no means establishes that a break with the Euro would help our current situation.

As regards the precise mechanics of a break, I do not understand precisely what McWilliams is advocating. Is he suggesting that we now reintroduce the punt and devalue it against the Euro? Or does he have notion of a separate “green” version of the Euro operating in Ireland (where again it would be effectively devalued against the official Euro)?

Surely he realises that major political as well as economic repercussions would flow from such a decision!
The EU would be extremely reluctant to sanction such a course as it would threaten to jeopardise the whole Euro experiment. If Ireland today why not Greece, Spain and Italy tomorrow?

Now perhaps he is proposing that we should take the decision unilaterally (issuing it as a fait accompli).
Surely, however he understands that this would greatly erode good will for the country in future. For example the ECB has provided an extraordinary amount of liquidity funding for our banking system during the present crisis. Without this help, it is hard to see how the system could have survived. Why would continued assistance be provided to a rebel member that has decided to leave the Eurozone?

In any case it would also be very hard for such a decision (as regards leaving the Eurozone) to be taken without speculation arising as to its possibility. Such speculation in itself could prove very destabilising threatening to undermine any possible benefit that could ultimately be realised.

Where I would differ most from McWilliams is however the simplistic view that devaluation of the currency would magically transform our economy.

Though devaluation could certainly ease short-term problems with competitiveness, its benefits from a long-term perspective are much more questionable.

Prior to the formation of the EMU it was the countries such as Germany and the Netherlands that historically had the strongest currencies that as well as the strongest economies. By comparison Italy that resorted to frequent devaluations of the lira, had a much weaker economy.

In fact there is a particular problem in relation to Ireland resorting to devaluation. Everyone knows that costs are far too high. One could argue therefore that the present recession though unpalatable and very uneven in its effects, is at least forcing costs downwards which is a prerequisite for any long-term restoration of competitiveness.

Imagine if Ireland was to resort to – say - a 30% devaluation of a new separate currency against the Euro!
Clearly exporters for a while would be happy as they would find it easier to compete price wise. And tourism to Ireland would almost certainly improve! However this very easing of the present problem would greatly reduce pressure to keep costs down. Also imports – which represent the other side of the equation – would significantly increase in price. As the demand for much of Irish imports is inelastic (e.g. oil), prices would sky rocket here. So consumers would face growing inflation while increases in raw materials prices would considerably erode any initial benefit from devaluation.

Now McWilliams might point to the apparent beneficial effects of the 1993 devaluation which coincided with the rise of the Celtic Tiger. However looked on from an equally valid perspective this served as one important factor that led to a subsequent loss in competitiveness (eventually undermining the whole Celtic Tiger).

It also must be said that during membership of the EMS, exchange rate adjustments (such as took place then for the Irish punt) were allowed under the system. Indeed 1993 was a period of such general turbulence for EMS currencies (with several forced to devalue) that the exchange rate regulations were later significantly modified to enable the system to continue.

However equally it was the experience of this time that convinced me that the introduction of the Euro was a premature idea. Though with further turbulence due to the financial crisis, the Euro has held firm, this has been at the cost of significant deflationary pressures in several member countries.

So I would go a certain distance with McWilliams in arguing that EMU was in fact prematurely conceived and even further that with our peculiar economic circumstances that it only makes sense for Ireland for the wrong reasons (i.e. in that it suits US multinationals). However our huge dependence on such multinationals arises largely from artificial tax considerations.
So ironically far from strengthening indigenous ties with the EU, the single currency has led to a greatly increased dependence on US investment in Ireland. Such investment is conveniently served by the single currency together with several other artificial reasons for locating in Ireland.

Also the devaluation of a currency is potentially of most advantage when the countries with which it trades remain on fixed currency rates. However this clearly is not the case with Ireland as both Britain and the US have floating currencies. Also if we were to devalue it is likely that the whole Euro experiment would significantly unravel leading to perhaps several other countries joining the floating party.

Now it is not at all clear what the correct exchange rate policy should be for Ireland (if we were to break the link with the Euro).

In dealing with the present crisis, the first thing that we need to realise is that there there is in fact no sustainable "quick fix" solution and that appropriate policy choices represent various options all of which will prove difficult with many unpalatable consequences.
The problem is that during the Celtic Tiger, damaging habits of behaviour took hold in the national psyche which now need to be faced and uprooted before genuine progress can be resumed.

Unfortunately at present, because of so many poor choices in the past we are now heavily compromised on many sides. Costs are far too high; in addition lack of consumer discernment leads to the frequent imposition of "premium mark-ups" on goods sold in the Irish markets. I would also be of the view that in a wide range of areas, not alone is the price of essential services far too high, but the quality of what is offered has fallen considerably.
In many ways Ireland has an extremely artificial economy. During the latter phases of the Celtic Tiger, wealth in the economy was largely based on an unsustainable speculative property boom. However of even deeper concern is the fact that we have become so totally dependent on multinational companies, spurred on by artificial tax advantages and light touch - or perhaps more accurately no-touch - regulation, for the vast bulk of wealth creation (with over 90% of all exports coming from this source).

As an extremely open economy based on shifting sands we are now heavily compromised in dealing with the situation.

It would be much better in my opinion that we use the next few years (of comparative hardship) to address more fundamental issues. We need to develop a new more authentic indigenous spirit based on hard work and genuine pride in country. Then we need to realistically look at developing new sustainable sources of competitive advantage.

Perhaps in the future we could even review issues such as membership of the Eurozone.
Then if continued experience in fact demonstrates its unsuitability for the economy, we could threaten to leave (from a greater position of strength). Unfortunately at the moment we do not have that luxury and need all the help that we can get from the EU to cope with our present financial problems.