Thursday, January 16, 2014

16/1/2014: Some thoughts on Ireland's Rankings in the Index of Economic Freedom

Here are my thoughts on the Heritage 2014 Index of Economic Freedom scoring for Ireland (covered here: :

First off: the positive is that Ireland's score is rising (the ranking improvement is a major positive, but I have some reservations about that, voiced below). Another positive is that the improvements are occasionally structural although predominantly they risk being cyclical:

  • Government spending gains are, in my view, largely cyclical (driven by tax extraction measures and capital spending cuts, plus banks measures tapering of) with some structural changes (some of tax systems put in place are sustainability enhancing, such as property tax).
  • Fiscal policy gains are largely symbolic and driven by the EU-wide changes (6-pack, 2-pack and Fiscal Compact, etc).
  • Labour markets improvements, especially some activation measures deployed are structurally sustainable and often positive. Unfortunately, their impact today runs against high unemployment and low jobs creation. In other words, we are pursuing right reforms at the wrong time. Aside from these, there is preciously little change in the structure of the labour markets. Competitiveness gains, stripping out the effects of sectoral composition, are flattening out, albeit these are still significant compared to pre-crisis.
  • Trade freedom improvement is puzzling. There has been no major improvement in the EU treaties or bilateral trade agreements. Aside from this, there has been little change to the regulatory systems and costs involved in exporting from and importing into Ireland. On financial services side, there has been an increase in regulatory barriers to transactions, including compliance tightening, enhanced reporting requirements and higher costs.

Now on to unpleasant bits. The report on Ireland is raising some questions:

1) Debt restructuring is cited in relation to the February 2013 swap of the IBRC Promissory notes for senior sovereign bonds. It is alleged that this resulted in a significant reduction in debt levels. In my opinion, the swap did not deliver significant material alteration to the total debt. Instead it achieved markedly improved maturity profile of debt, and reduced front-end cash flow requirements relating to the original promissory notes. The swap was a net positive, but of modest impact when it comes to debt levels.

2) On property rights: since May 2011 the Irish Government is engaged in expropriation of private pension funds via a levy on capital component of the funds and this levy was increased in the Budget 2014. Further, Irish Government forced (since 2010 and ongoing under the IBRC shutdown proceedings) sales of distressed assets to the State agency, NAMA. This can be treated as a de facto (de jury bit remains to be tested in the courts) expropriation of a large number of private assets, especially where such assets included at-the-time fully performing loans.

4) Top income tax rate is 41%, but it applies to earnings above a very low threshold. Heritage analysis also excludes the USC and PRSI both of which are taxes on individual income. The analysis ignores the differences in taxation of the self-employed and PAYE incomes. Counting all income tax measures, upper marginal tax rate on income in Ireland stands at above 50%. In the case of businesses, the report does not cite rates - a major component of tax costs. The report quotes tax receipts as a share of Gross Domestic Income, which really means GDP. However, stripping out transfer pricing and tax transfers by the multinationals (which are not fully captured by the tax base) Irish Government tax burden is significantly above 27.6% of our economy.

5) The report cites prices as being 'generally set by market forces'. However, many goods and services traded in Ireland's domestic economy are either directly priced by the state regulators, disproportionately impacted by state taxes, levies and duties and/or are set by state oligopolies. These include energy prices, prices relating to all forms of public transport and even some private transport, majority of health services, pharmaceuticals, education, alcohol, tobacco, fuel, social protection, etc. They also include many professional services costs set under the power of professional bodies that are granted market power by the state. Whilst private sectors are in a deflationary environment, state-controlled prices are up double digits over the course of the crisis.

6) Irish lending and investment climate is assessed as unchanged year on year. Credit supply in Ireland is continuing to contract, especially to indigenous firms, while domestic investment in new enterprises is now nearly fully state-captured via state-controlled or regulated funding schemes. Meanwhile, the banking sector saw no meaningful reforms other than continued shift toward a duopoly model. Competition in banking sector is collapsing and this is an ongoing development. Irish banks are becoming  more domestic, cross-border financing is becoming less available.

7) The report cites 'public debt' at 117% of GDP. Assuming this covers General Government Debt the actual figure is at 124.1% of GDP per latest official estimate for 2013. Public debt traditionally includes liabilities of the local authorities and state bodies, which pushes the above figure well ahead of the reported percentage. Once again, given that a meaningful comparative for Irish economy is not GDP, but some metric closer to GNP, even 124.1% figure is a massive underestimate of the true extent of the 'public' debt overhang.

Conclusion: In my opinion, the above caveats do not necessarily imply that Ireland's position in the IEF deteriorated significantly year on year in 2013. However, they do pose some questions about the improvement recorded in the overall ranking for Ireland compared to 2013.
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