After a remarkable economic success based on market capitalism, Ireland has drifted back into misery since the crisis of 2008 and risks turning into a Southern European type of state capitalism. Back in January 2011 we explained in this blog (see here) why the IMF program for Greece’s external adjustment would not work. Some of the reasons given then apply equally to Ireland (or Spain for that matter).
First, the Troika misdiagnosed the situation as a liquidity problem while in fact Ireland and Greece faced a solvency problem (albeit of a different nature).
Then, they treated the problem of excessive leverage in the wrong way. The two major mistakes in Ireland were the conversion of private debt into public debt and the reliance on internal devaluation to deleverage. It is easy to see why both policies were wrong.
Ireland had a typical situation faced by a family with irresponsible children that took excessive debt to pay for gambling losses at the Casino (or in its case to speculate in real estate). An obvious option to erase gambling debts was to default on the casino loans (in the case of the Irish real estate bubble the British and German banks). They could be charged with allowing bets that the gambler could not pay. One alternative would be to demand a debt restructuring involving partial debt forgiveness and a longer repayment period, so that with the help of family and friends (i. e. grants by national and EU institutions in the case of Irish borrowers) they could repay the remaining debt without damaging the credit of his family. Another alternative would be to ask the casino to accept an IOU without a redemption date (in case of the British and German banks accept money printed by the ECB).
Yet, the casino owners decided instead to force the collection of their loans from the children’s parents (i.e.Irish government). To save its reputation the family promised to honor the debts by putting them in their business balance sheet (the state budget in the case of Ireland). However, the debts were so huge that they would necessarily cripple an otherwise successful business (economy). It is easy to see why.
First, such an increase in leverage would bar the firm from market financing. Second, it would be forced to halt all modernization and maintenance investments. Finally, it would force the family to downsize by selling some of the best assets. Combining these three measures would inevitably lead to a lower competitiveness, declining productivity and a depressed local economy. As expected, in the last four years, investment in Ireland more than halved in real terms, while domestic demand declined by about one third.
However, the recourse to internal devaluation only made things worse. Imagine that the clientele of the parents business was mostly local (i.e. produced non-tradable goods in economists’ parlance). Therefore, cutting the wage of their workers would reduce its sales proportionally and reduce further the firms’ debt capacity.
Moreover, reducing nominal contracts in the labor market without a concomitant reduction in credit markets would inevitably lead to an increase in non-performing loans (which in 2011 indeed rose from 12% to 20%).
It is obvious that the policy of switching the debt burden from the private to the public sector only made things worse in Ireland. What we said about Greece applies equally to Ireland. It has only three options: a) to force a significant hair-cut on its bond-holders, b) to receive a major grant from other EU countries, or c) a mix of both. None of these is a pleasant solution but there is no other way out.
Showing posts with label Southern European. Show all posts
Showing posts with label Southern European. Show all posts
Saturday, 15 September 2012
Tuesday, 11 January 2011
Krugman finds the Portuguese macro story harder to tell...
It is simply a question of looking deeper. I posted a comment on his blog that lists five of the major cancers killing the Portuguese economy.
Wednesday, 10 February 2010
How close are we getting to a market capitalism ideal?
The ideal of market capitalism is necessarily vague, but can be broadly defined as an economic system where individuals execute most of their economic transactions in competitive markets. It requires a reasonably atomistic distribution of economic resources and well-regulated markets. A few indicators come to mind on how to rank countries in accordance on how close they are to this ideal system. Among such indicators, we must include the share of large corporations and governments in GDP and some index of economic freedom. Traditionally we tend to identify the OECD member countries as representative of what we would call capitalist markets. However, when we scrutinize its members we find that only a few countries come near to the market capitalism ideal.
Take the case of the USA for instance. The USA would normally qualify under the share of government in GDP criteria (around 35%) and in terms of economic freedom (among the top ten in the Fraser Institute list). Nevertheless, its share of big business in GDP remained at around 50% throughout 1998 to 2004 as estimated by the SBA. Another interesting case is South Korea, which has the smallest weight of government in its economy (about 26% of GDP) but ranks very low in terms of economic liberty (32 in the Fraser list). Disregarding the share of big business criteria, which is difficult to obtain for most countries, we end up with just a handful of nations (Australia, Switzerland, Luxembourg and Ireland) that qualify for the status of close to the ideal of market capitalism.
Among the Western countries with a mixed economy system in the sense defined by the late Paul Samuelson we have two models of state capitalism that are worth considering - the Scandinavian and the Southern European types of state capitalism. There are many other types of state capitalism, ranging from democratic systems of big-business capitalism in Europe and North America to crony/oligarchic systems in Russia or dictatorial systems like in China, but these are of no concern to us in this post. We need to compare the performance of those two sets of countries against those closer to the market capitalism ideal to verify if there are substantial differences. Note that the Southern European system would be more interesting because it went through two distinct periods of about forty years each – an authoritarian right wing and another period of democratic socialism. However, we only have comparative data for the recent period where both groups had generally socialist governments.
Over the last 37 years, the real annual GDP growth in the market capitalism group ranged from 1.43% (Switzerland) to 4.71% (Ireland) against a range between 2.00% (Sweden) and 3.76% (Norway) for the Scandinavian state capitalism, and from 2.66% (Italy) to 3.61% (Portugal) for the Southern European system. Overall, with the exception of Switzerland, the growth of the market capitalism economies was faster than that of all economies under state capitalism. These growth rates were achieved by 80% of the Swiss working an average of 1702 hours per year and 55% of the Irish working 1966 hours, while among the Scandinavians 78% of the Swedes had to work 1570 hours and 74% of the Norwegians worked 1599 hours. In Southern Europe it took 53% of the Italians working 1870 hours, while 68% of the Portuguese worked 1917 hours. In terms of productivity growth, Switzerland is the odd case lagging substantially behind all the state capitalism countries. In terms of ranking, Ireland tops the league, followed by Luxembourg, Norway, Spain, Australia and Portugal. In terms of purchasing power relative to the OECD average, Ireland again improved the most (89.4%) between 1971 and 2008, followed by Norway (80.2%), Luxembourg (57.0%) and Portugal (23.2%). During the same period, Switzerland was the country that declined the most (30.1%), followed by Sweden with a decline of 14%.
Despite the exceptions of Switzerland and Norway, overall, the countries with a system closer to market capitalism outperformed both groups with a system of state capitalism. Nevertheless, definitive proof will require a more detailed study taking into account the fact that during this period, some of the countries have gone through several changes in relation to their pro-market stance. Equally, we have a few countries that benefited from exceptional shocks like the North Sea oil and gas in the case of Norway and the process of decolonization in the case of Portugal. For instance, if we look for periods where a major roll back on the weight of the state in the economy occurred we find that they took place in Ireland, Finland, Norway and Sweden during 1994-2000, in Australia during 1986-1988 and again in Norway during 2004-2006. Conversely, there were episodes of state build-up in Switzerland and Finland during 1990-1993.
Take the case of the USA for instance. The USA would normally qualify under the share of government in GDP criteria (around 35%) and in terms of economic freedom (among the top ten in the Fraser Institute list). Nevertheless, its share of big business in GDP remained at around 50% throughout 1998 to 2004 as estimated by the SBA. Another interesting case is South Korea, which has the smallest weight of government in its economy (about 26% of GDP) but ranks very low in terms of economic liberty (32 in the Fraser list). Disregarding the share of big business criteria, which is difficult to obtain for most countries, we end up with just a handful of nations (Australia, Switzerland, Luxembourg and Ireland) that qualify for the status of close to the ideal of market capitalism.
Among the Western countries with a mixed economy system in the sense defined by the late Paul Samuelson we have two models of state capitalism that are worth considering - the Scandinavian and the Southern European types of state capitalism. There are many other types of state capitalism, ranging from democratic systems of big-business capitalism in Europe and North America to crony/oligarchic systems in Russia or dictatorial systems like in China, but these are of no concern to us in this post. We need to compare the performance of those two sets of countries against those closer to the market capitalism ideal to verify if there are substantial differences. Note that the Southern European system would be more interesting because it went through two distinct periods of about forty years each – an authoritarian right wing and another period of democratic socialism. However, we only have comparative data for the recent period where both groups had generally socialist governments.
Over the last 37 years, the real annual GDP growth in the market capitalism group ranged from 1.43% (Switzerland) to 4.71% (Ireland) against a range between 2.00% (Sweden) and 3.76% (Norway) for the Scandinavian state capitalism, and from 2.66% (Italy) to 3.61% (Portugal) for the Southern European system. Overall, with the exception of Switzerland, the growth of the market capitalism economies was faster than that of all economies under state capitalism. These growth rates were achieved by 80% of the Swiss working an average of 1702 hours per year and 55% of the Irish working 1966 hours, while among the Scandinavians 78% of the Swedes had to work 1570 hours and 74% of the Norwegians worked 1599 hours. In Southern Europe it took 53% of the Italians working 1870 hours, while 68% of the Portuguese worked 1917 hours. In terms of productivity growth, Switzerland is the odd case lagging substantially behind all the state capitalism countries. In terms of ranking, Ireland tops the league, followed by Luxembourg, Norway, Spain, Australia and Portugal. In terms of purchasing power relative to the OECD average, Ireland again improved the most (89.4%) between 1971 and 2008, followed by Norway (80.2%), Luxembourg (57.0%) and Portugal (23.2%). During the same period, Switzerland was the country that declined the most (30.1%), followed by Sweden with a decline of 14%.
Despite the exceptions of Switzerland and Norway, overall, the countries with a system closer to market capitalism outperformed both groups with a system of state capitalism. Nevertheless, definitive proof will require a more detailed study taking into account the fact that during this period, some of the countries have gone through several changes in relation to their pro-market stance. Equally, we have a few countries that benefited from exceptional shocks like the North Sea oil and gas in the case of Norway and the process of decolonization in the case of Portugal. For instance, if we look for periods where a major roll back on the weight of the state in the economy occurred we find that they took place in Ireland, Finland, Norway and Sweden during 1994-2000, in Australia during 1986-1988 and again in Norway during 2004-2006. Conversely, there were episodes of state build-up in Switzerland and Finland during 1990-1993.
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