EU CAN HELP, BUT STATES MUST TAKE PRIMARY RESPONSIBILITY FOR THEIR OWN REFORMS

The EU Summit last week discussed the digital economy, a youth guarantee, apprenticeships, and the European Semester. During the Semester, each EU state will have an input to the policies of each of the other states. Hopefully, they will learn from one another. 

But it would be a mistake to think that the main ingredients of a solution to the economic problems of the countries of the euro zone will be found at European level, because the problems did not, in the main, arise at European level. 

Although they had the same currency, some countries did much better than others did.

Between 2008 and 2013, the growth in the euro zone ranged from plus 6% growth in Slovakia, to minus 6% in Greece.

Some countries (Bulgaria, Sweden and Germany) grew faster than the United States, between 2008 and 2013, while most of the other EU countries saw their economies contract.

It is good that, at EU level, we will now, through the European Semester, have detailed peer review of one another’s growth policies, including market liberalisation, taxation and public spending.

But it would be a great pity if this encouraged national governments to delegate strategic thinking, about how to maximise the growth of their own economies, to the European Union.

Growth promoting reforms, whether these reforms be 

+ of professional restrictions,+ of slow and costly courts systems+ of welfare systems that penalise work, + of educational systems that leave too many 15 year olds unable to read properly,+  or of public sector wage and pension policies that are unaffordable,

will all differ from country to country, and can only be made on a country by country basis. The EU cannot do that job for national governments. They must do it themselves.

EUROPE MUST TAKE RESPONSIBILITY FOR THE EURO ZONE BANKING SYSTEM

The EU has some things it must do.

It must set up a single banking system for the euro zone.

Given that most money takes the form of bank credit of some kind, it makes no sense to have a single currency without a single banking system.

It makes no sense either that, at the moment, a badly run, and possibly insolvent, bank in a well run country can borrow much more cheaply, than can a well run and  solvent bank in a country, whose public finances are in a mess.

These things can only be put right by EU action.

Nor is it right that European arrangements to deal with banking and currency problems should be held hostage to the decision of the constitutional court of one country (Germany).

NEXT GENERATION WILL BE LESS ABLE TO REPAY THIS GENERATION’S DEBTS, THAN THIS GENERATION IS TO MAKE SAVINGS

I find the arguments against “austerity”, in countries that whose governments are spending more than they are collecting, to be lacking in rigorous thought.

If a state is spending more than it is taking in by taxes, to borrow more today is simply to decide to pass the “austerity” on to a later generation, and to do so with interest!

As a result of compound interest, a future generation will have to repay a lot MORE that the present generation will have borrowed.

But the next generation will be far LESS able than are to meet our bills, that this one is.

This is because, 35 years from now, there will be two Europeans at work, for every European who is retired ,whereas today there are four Europeans of working age for every European who is retired. 

Thus the future burden, of debts taken on today, will have to borne out of the earnings of a smaller number of working people than are at work today. And those working people will also have to provide for a larger number of retired people, than this generation has to cater for. I wonder what the anti austerity protesters think of that! 

SERVING MORE PEOPLE, AND SPENDING LESS...A BIG ACHIEVEMENT

SERVING MORE PEOPLE, AND SPENDING LESS...A BIG ACHIEVEMENT

There were some interesting points made in the commentary on last weeks Irish budget proposals for 2014.

Minister Brendan Howlin drew attention to some of the push factors that are driving spending levels upwards.... Since 2008,

+  the numbers in schools and universities have risen by 8%,+  the number  of medical card holders(entitled to free healthcare on income grounds) has risen by 40% and+  the  number of people of pensionable age has risen  by 13.5%

Meanwhile, the number employed in the public service has fallen by 10% and the size of the public service pay bill has fallen by 17%. So there are fewer people who have to do more. This is a considerable managerial achievement for which all Ministers can take a lot of credit.

JOB NUMBERS INCREASING

Minister Michael Noonan drew attention to another very positive development, the fact that there is now a net increase in jobs in the Irish economy of 3000 per month.

On public spending, Michael Noonan said there will be a ceiling on public expenditure of

+   51.5 billion  euros in 2015, and
+   51.9 billion in 2016.

Given the ongoing, demand led, upward pressures on spending, referred to by Minister Howlin, these caps will require policy changes in future budgets.

Michael Noonan said Ireland would still have a budget deficit of 4.8% of GDP in 2014, which he intends to reduce to 2.9% of GDP by 2015.

MOST OF THE DEBT CAUSED BY DEFICITS, NOT BANK RECAPITALISATION

As Pat Leahy put it in the Sunday Business Post, the Irish state is spending 13 billion euros more than it raises in taxes this year, and its debt is scheduled to reach 205 billion next year. He says that only 60 of the 205 billion is due to  bank recapitalisation, the rest is due to  simply spending more than revenue on an ongoing basis.

This is a fact that those who say they are against “austerity” fail to deal with. What would they/we use for money if they/we spent more? Who would provide it, and on what terms? 

FISCAL COMPACT WILL STILL APPLY AFTER BAILOUT EXIT

The Department of Finance’s own figures see the debt reaching 211.6 billion euros by 2018, when the Fiscal Compact will come into force.

From 2018 on, we will be obliged to move towards a structural deficit of no more than 0.5% of GDP (as against out structural deficit of 5% in 2013).

My own sense is that the burden of interest on our over 200 billion euro debt is going to get higher, rather than lower. Global interest rates will eventually rise. So we need to reduce the debt, and remove factors that push spending upwards.

Against that background, it might have been better to use the 200 million euro proceeds of the sale of the National Lottery to reduce the national debt.

Free GP care is to be made available for all children under the age of 5. This will benefit only the 60% of families, whose incomes are above the medical card income limit. The under 5 year old children of medical card holders get free GP care already.

This is a step towards free GP care for everybody, which again would only give something new to those whose incomes are above medical card limits. Unless free GP care proves to have no net cost because it saves on hospital treatment, it will add a new, long term, challenge to the many unfunded, and demand led, spending challenges Irish Governments already will have to meet, based on the combination of demographic trends with existing policies on health, pensions etc.,( along the lines mentioned by Brendan Howlin in his speech).

As noted in an earlier post on this site, these 2014 draft budget proposals will be subject to peer review by the other Governments of the EU, before their final adoption at the end of the year. So also will be the budget proposals of every other EU government.....large or small, and whether in a bail out or not.

WHAT MAKES SOCIETIES MORE CREATIVE?

.......SOME POSITIVE INSIGHTS FROM IRELAND

I was in the Korea this week speaking at the World Knowledge Forum.

This year the theme of the Forum this year was promoting creative societies and cities.

Creativity is difficult to define. It is an ability to make connections that are not obvious, and to see problems from a different and new angle. It is not confined to money making or the economy, but can be applied to social problems, like the ageing of societies, and urban loneliness.

TRANSITION YEAR

I spoke about initiatives in Ireland to promote creativity. I highlighted the Transition Year which enables 15 year olds to step off the academic, and exam driven, treadmill for a year and develop skills and interests of their own choosing, with the guidance of their teachers. 

During Transition Year students can try new or experimental subjects, do project work, do work experience or community service and become more adaptable and well rounded people. Transition Year was introduced by the then Minister for Education, Dick Burke, in 1974 and has grown in coverage since.

Research has shown that students who do the Transition Year (about 50% of the total population,) do markedly better in their final exams two years later than those who do not do so.  I believe it made a lasting contribution to Ireland’s economic development and that Dick Burke does not get enough credit for it.

CURRICULUM REFORM,   HELP FOR START UPS

I also dealt with new Irish initiatives in early childhood education, and the reform of the second level curriculum.

Another Irish contribution to creative development is the Digital Hub in Dublin, and the funds that have been set up to promote new business start ups. Information and communications technologies has enabled start up ventures to enter the global market place, much more easily and quickly, than was possible even three years ago.

Ireland aims to be one of the world leaders in business start ups and has achieved great success in service exports in field like software, computer games and financial services.

Also speaking at the Forum in Korea were leading economists Larry Summers, Tyler Cowen, Herman Simon, and Greg Mankiw, and I will return to some of the interesting things they said in future posts. I met the former Prime Minister of Israel, Ehud Barak and the former Mayor of Los Angeles, Antonio Villaraigosa at the Forum.

WILFRIED MARTENS RIP, PRESIDENT OF THE EUROPEAN PEOPLES PARTY AND NINE TIME PRIME MINISTER OF BELGIUM

I was really sorry when I heard of the death of my friend, Wilfried Martens. I extend sympathy to his wife, Miet, and to his children.

Wilfried was the longest serving Prime Minister of Belgium. He was master of creative compromise, immensely patient but with a clear and unshakeable value system. 

I worked with him over a period of 14 years in the bureau of the European Peoples Party. He brought the skills he had honed in Belgian politics to the service of the European Union and won the confidence of people of widely differing linguistic, cultural and political backgrounds  in the service of a great cause.

He will be missed, and very hard to replace.

Tribute by John Bruton, vice President of Fine Gael, and former Taoiseach of Ireland.

ARE THE US PRESIDENT, AND THE US CONGRESS, FORGETTING THE REST OF THE WORLD?

Because it cannot resolve a domestic political argument about how to provide and pay for health services for its own people, the United States might soon default on its debts. This is shocking.....literally.

60% of US Treasury bonds are held by foreigners. The vast bulk of these are held by China and Japan. The idea that these bonds would not be honoured would undermine trust in the United States. A bond means, after all, a promise.

Military might is not much use if you gain the reputation of not keeping your promises.

The present stand off undermines the role of the dollar as a global reserve currency, at the very time when there is no other democratic entity able to provide an alternative reserve currency to step into the dollar’s place. The EU cannot yet fulfil that role because it has not yet remedied the structural defects in the euro (Banking Union, Eurobonds, mutual deposit guarantees, too big to fail etc.)

Gamesmanship is out of place at this stage. Collective leadership, including a willingness to put country before party, is needed in Washington.

THE IRISH BUDGET FOR 2014.... ARE WE ASKING THE RIGHT QUESTIONS?

OCTOBER 15 BUDGET WILL BE A DRAFT

Under new EU rules ,which entered into force on 30 May this year and which apply to ALL euro area states, whether in a bailout programme or not, each country must publish its draft budget on or before 15 October.

The Irish government will do so on the 15th. 

The European Commission will then examine the draft budget of all euro area states and must give its opinion before 30 November.

If the Commission detects severe non compliance with the Stability and Growth Pact, it will ask the state in that position to submit a revised budget. This possibility will exist for Ireland, whether or not it is a bailout programme.

The Commissions opinions will then be discussed in the Eurogroup of Finance Ministers, in December, where each Minister will be free to express opinions on the others budget.

The final budget of each country must be adopted by 31 December, up to which time, changes, within the overall numbers are possible.

This new process obviates the need for budget secrecy, which is an antique hangover from Victorian times.

THE DIFFICULT LEGACY OF THE 2001 TO 2006 PERIOD, WITH WHICH THIS GOVERNMENT MUST COPE 

The worst legacy from its predecessor, with which the present Government must cope, is not the bank guarantee.

It is the permanent increase in spending levels that it allowed between 2001 and 2008. The then Government agreed these permanent increases in spending  on the strength of revenues from the construction boom, that it had to KNOW were temporary.

For instance, between 2001 and 2006, number employed in the health service grew from 92000 to 112000.The number of items prescribed in the GMS went from 22 million items to 53 million in 2009. Are we any healthier for all that spending?

Number employed  in the Education sector increased by 25%  between 2001 and 2006, but our educational outcomes measured by the OECD’s PISA test went down quite badly.

Numbers employed in the civil service increased by about 25% too, but numbers in the top grade increased by 86%. These people and posts are mostly still there, even though the revenues that allowed for their recruitment have long disappeared.

Social Welfare rates of payment went up by 67% over and above price inflation between  2000 and 2006, and these rates remain in place.

LOOK AT THE NATIONAL BALANCE SHEET, NOT AT ONE YEARS FIGURES

The debate in the Irish media, and between parties, about whether the gap should be  closed this  year by 3.1 billion euros, or by a lesser figure, is beside the point.

Rather than looking at one year’s figures, we should  focus on the national balance sheet.

We should ask ourselves four questions

+ what are our likely revenues over the next twenty years, 

 + what is the value of our saleable assets, and 

+ what are our obligations, both in explicit debt repayments and rescheduling, 

+ but, just as importantly, if policies remain as they are, what will we have to pay over the next 20 years to keep the promises we will have made  in respect of

      incremental increases to pay,      pensions,      health services,      unemployment benefits and      education,

in light of trends in the age structure of our population and the (reducing) numbers of working age?

These may be among the questions Finance Ministers of the euro area countries will be asking about one another’s budgets, when they meet in December, before each of them finalises their budget for 2014.

The Irish Fiscal Council has estimated that, on the basis of present policies, ageing related liabilities of the Irish state are likely to increase by 5.4% a year up to 2060, as against a euro area average increase of 4.1% a year.

It also draws attention to big shortfalls in the Insurance Compensation area, the VHI, and even a possible state obligation for shortfalls in private sector pensions, arising from a recent Waterford Crystal case.

A recent EU Commission report on ageing  suggest that, between 2010 and 2040, on present policies, pension spending by the state will have to rise from  7.5% of GDP to 10% of GDP, and long term care expenditure from  1.1% to 1.9%.

Constantin Gurdgiev in the Sunday Times has claimed that most of the savings in public sector pay, in the Croke Park and Haddington Road Agreements, are liable to end and be reversed when the latter Agreement expires .

The OECD drew attention to the fact that one in five of Irish children are growing up in a home where no one is working. Will those children grow up to be able to support themselves, and pay taxes, or will they be dependent on the state for income support? That is a vital matter for everybody, not just for the families concerned.

In sum, what Ireland needs is a 10 year budget, and a 20 year balance sheet. Then people will see more clearly what has to be done and what needs to be changed in good time.

IS THE CYPRIOT FORMULA THE RIGHT ONE FOR BANKS IN DIFFFICULTY?

I have just spent three days in Cyprus talking to political and economic figures in the island. I encountered a very strong sense of determination to overcome their present severe economic difficulties. 

These difficulties arise from mistakes made in the banking sector, whereby very large overseas deposits (mainly from Russia) were invested by the banks in lending to the Greek private sector and in Greek Government bonds. Banks exposure to Greece totalled 28 billion euro, or 170% of the entire Cypriot GDP. This concentration of risks in one place was bad banking practice, in the same way that excessive concentration of risks in the construction sector, was bad banking practice in Ireland and Spain.

Meanwhile the Cypriot economy also lost competitiveness.

At the end of 2011, the EU/IMF/ECB found that the situation of the public finances of Greece was so severe that senior bondholders(whose position had been famously protected from haircuts by the ECB in the Irish case) would have suffer a 75% haircut. This created an immediately critical situation for the Cypriot banks. They lost 33% of their capital. 

This crisis for the Cypriot banking system was known to the EU/IMF and to the Cypriot Government of the time of the Greek haircut.  Apart from a temporary loan from Russia, nothing was done. The EU/IMF/ECB, who should have confronted the problem immediately, did not do so, and it got worse.

THE MYTH ABOUT RUSSIAN HOT MONEY

Meanwhile a press campaign was mounted to suggest that the Russian depositors in the Cypriot banks were tax evaders, money launderers, oligarchs or worse.

This campaign seemed to be designed to  persuade public opinion that depositors in Cypriot banks were less deserving of protection than depositors in banks in  Athens, London, or Frankfurt. In fact, little evidence has subsequently emerged to justify any of these stories.

And, indeed, there is a perfectly good, and legitimate reason for these Russian deposits in Cypriot banks. 

Many Russian businesses did not trust their OWN legal system, and felt that their assets would be better protected in a country like Cyprus, with a common law legal system, and which was in the euro. But in March of  this year, they were to be brutally disabused of the notion that euro zone banks were a safe haven. 

Eventually the problem was tackled, in March 2013, in an agreement by IMF, the EU, and the ECB with a newly elected Government in Cyprus, who had had little or no time to assess the options for themselves.

TROUBLING ASPECTS OF EU DEAL

The March 2013 agreement contained a number of elements that are troubling.

For the first time this century, depositors have had to take a haircut. The fact that this procedure was followed creates a new and permanent uncertainty for depositors who hold more than 100000 euros on deposit in any bank in the euro zone. They now must, to protect their assets, scrutinise the situation of their bank on an ongoing basis, and move money out of banks that seem to be pursuing risky strategies.  But getting the relevant information will be difficult and time consuming. There will be a tendency to move money towards bigger banks, which will aggravate the “too big to fail” problem.

No haircut was, however, imposed on the depositors in the Greek branches of the Cypriot banks, and those branches were transferred to Greek banks. This inflicted additional losses on Cyprus, and  is hard to justify, within a monetary union that comprises both Greece and Cyprus as equal partners. 

CREDIT FROZEN FOR CYPRIOT BUSINESS

The Cypriot banking model of attracting overseas deposits has been destroyed, although Russians continue to invest and holiday in the island, which disproves the suggestion that they were all fly by night tax evaders and hot money merchants. . It would be interesting to know which country’s banks are now benefitting from these Russian deposits that were formerly in the Cypriot banks.

Meanwhile, viable Cypriot businesses, that were well capitalised and equipped with working capital before March, are  struggling to access funds to keep going. 

Deposits they could have used have been reduced by haircuts, and capital controls mean that what remains in their  accounts cannot be used freely. Bank credit is frozen.

A Cypriot export model, to replace the old bank deposit led model, cannot be put in place without access to day to day funding.

I left Cyprus feeling that, if Cyprus did not constitute a mere 0.2% of the euro zone GDP, and was physically closer to the centre of Europe, it would not have been the subject of these radical experiments in European banking policy.

It would, instead, have been the subject of much timelier, and less harsh, actions by its partners.

Of course, Cyprus must abide by the terms of the March agreement, and, like Ireland, establish a good track record.

But if it does so, it should, like Ireland, see progressive easements in the terms of its bailout, so that its economy can be allowed to breathe again.