Job Creators No More

Corporate profits as a share of GDP are way up.  This is supposed to be good for all of us—higher profits, we are told, means greater investment and job creation.

Unfortunately, this is not what is happening.  Investment as a share of GDP is down.  Job creation is anemic.

The reality is that corporations no longer appear interested in channeling their earnings into productive activities.  As the charts below highlight, they are increasingly content to use their profits to purchase stock, including their own stock.

The charts were republished by Yves Smith in her blog Naked Capitalism from the Financial Times. The first shows the growth of stock purchases by non-financial corporations.

As Smith explains:

Notice that US corporations have been buyers in aggregate since 1985. Now admittedly, that does not mean they stopped investing, since the primary source of investment capital is retained earnings, and companies also typically prefer to borrow rather than issue stock. But as of the 1980s, they were already preferring buying stocks (then mainly of other companies rather than their own, as in acquisitions) to the harder work of expanding their business de novo. Deals are much sexier than building factories or sweating new product launches.

But by the mid 2000, companies had indeed shifted to being net savers rather than net borrowers, which was an unheard of behavior in an expansion. That is tantamount to disinvesting.

The second chart reveals the new corporate orientation even more clearly, with corporate profits increasingly channeled into stock purchases rather than productive investment.

This corporate behavior is highly beneficial for both managers whose salaries are tied to the stock prices of their respective firms and those few at the top of the income scale who own a commanding share of the country’s capital assets.  As for the rest of us . . . well, it’s a bad deal.   

Tax Tricks And Globalization

Globalization offers companies many ways to boost profits at the public expense.  A case in point: they can use differences in national tax laws to slash their taxes.

Google, Apple, and Microsoft are among the most skilled at this, although they are far from alone.

For example, a recent report on Google’s tax strategy, which takes advantage of differences between U.S. and Irish tax regimes, highlights what is at stake:

The Financial Times reports that … Google Netherlands Holdings … received €8.6bn in royalties from Google Ireland Ltd and €232.8m in royalties from Google’s Singapore operation. All but €10.4m of this was paid out to Google Ireland Holdings, a company that is incorporated in Ireland but technically controlled in Bermuda, where there is no corporation tax.

The FT says that differences between the Irish and US tax codes mean that this dual-resident company is viewed as Irish for US tax purposes but Bermudan for Irish purposes. It acquired much of Google’s intellectual property in 2003, which it licensed to Google Ireland Ltd, a Dublin-based business that is at the heart of its global operation. The business, which employed 2,199 people last year, paid €17m in Irish corporation tax, having reported pre-tax profits of €153.9 on turnover of €15.5bn. . . .

Google’s provision of €17m in corporate tax in 2012 to Ireland on the foreign net income of $8.1bn it booked in Ireland, gave an effective tax rate of 0.21%.

Google’s foreign-paid tax rate in 2012 was 4.4%.

Pretty complex stuff—but that isn’t surprising.  A lot of money is at stake and the companies can afford to hire the best legal and financial help.

What is critical to understand is that governments are well aware of these corporate maneuvers and have done nothing to end them while simultaneously demanding cuts in public services because of a lack of tax revenue.

These maneuvers are so widely employed that the IMF decided to provide the following explanation of one of the most popular–the “Double Irish Dutch Sandwich” tax avoidance strategy–in its October 2013 Fiscal Monitor:

• Here’s how it works (Figure 5.1 above): Multinational Firm X, headquartered in the United States, has an opportunity to make profit in (say) the United Kingdom from a product that it can for the most part deliver remotely. But the tax rate in the United Kingdom is fairly high. So . . .
• It sells the product directly from Ireland through Firm B, with a United Kingdom firm Y providing services to customers and being reimbursed on a cost basis by B. This leaves little taxable profit in the United Kingdom.

Now the multinational’s problem is to get taxable profit out of Ireland and into a still-lower-tax jurisdiction.

• For this, the first step is to transfer the patent from which the value of the service is derived to Firm H in (say) Bermuda, where the tax rate is zero. This transfer of intellectual property is made at an early stage in development, when its value is very low (so that no taxable gain arises in the United States).
• Two problems must be overcome in getting the money from B to H. First, the United States might use its CFC rules to bring H immediately into tax*.
• To avoid this, another company, A, is created in Ireland, managed by H, and headquarters “checks the box” on A and B for U.S. tax purposes. This means that, if properly arranged, the United States will treat A and B as a single Irish company, not subject to CFC (controlled foreign corporation) rules, while Ireland will treat A as resident in Bermuda, so that it will pay no corporation tax. The next problem is to get the money from B to H, while avoiding paying cross-border withholding taxes. This is fixed by setting up a conduit company S in the Netherlands: payments from B to S and from S to A benefit from the absence of withholding on nonportfolio payments between EU companies, and those from A to H benefit from the absence of withholding under domestic Dutch law.

This clever arrangement combines several of the tricks of the trade: direct sales, contract production, treaty shopping, hybrid mismatch, and transfer pricing rules.

*The United States will charge tax when the money is paid as dividends to the parent—but that can be delayed by simply not paying any such dividends. At present, one estimate (cited in Kleinbard, 2013) is that nearly US$2tn is left overseas by US companies.

In considering the financial significance of these types of tax maneuvers, Finfacts Ireland notes:

The IMF says that assessing how much revenue is at stake is hard. For the United States (where the issue has been most closely studied), an upper estimate of the loss from tax planning by multinationals is about US$60 billion each year – – about one-quarter of all revenue from the corporate income tax (Gravelle, 2013). In some cases, the revenue at stake is very substantial: IMF technical assistance has come across cases in developing countries in which revenue lost through such devices is about 20% of all tax revenue.

In short, globalization dynamics tend to boost profits at the public expense.  We need to be resisting rather than strengthening them.

The Art Of Research

There is serious research and then there is obfuscation that poses as serious research.

I am spending time in Dublin, Ireland, learning about developments here.  One thing that is obvious is that the Irish government remains committed to a growth strategy based on using low taxes and low wages to attract foreign investment.

Other European governments are not pleased with Ireland’s low tax strategy.  They accuse the Irish government of promoting a tax race to the bottom.  Interestingly, no one seems to object to the low wage part of the country’s policy.

During a recent visit to Paris, the Irish prime minister, in the words of the Irish Times:

faced repeated questions over the decision of US internet giant Yahoo to transfer its finance operations from France to Ireland.

Mr Kenny [the Irish Prime Minister] quoted a report by consultants PwC [PricewaterhouseCoopers] and the World Bank Group which found Ireland’s effective corporate tax rate was about 11.9 per cent, higher than France’s effective rate of 8.2 per cent.

This is all well and good, except it appears that the report is based on some strange assumptions.  As the Irish Times article goes on to note:

A research paper by Prof James Stewart, professor in finance at Trinity College Dublin, . . . challenges Government claims that effective corporate tax rates in Ireland are just below the headline rate of  12.5 percent.

Instead, [Stewart’s] study suggests Ireland’s effective tax rate for American firms is similar to jurisdictions regarded as tax havens such as Bermuda, based on latest US Bureau of Economic Analysis statistics.

Stewart found that the PwC/World Bank study based its analysis of Irish tax policy on a “hypothetical Irish company that sells ceramic flower pots and has no imports or exports.”  Such a company is hardly the best starting point for an investigation of Ireland’s tax treatment of multinational corporations.

Another Irish Times article discusses Stewart’s research results in more detail:

“It is surprising that this [PwC/World Bank] study is frequently cited by Irish Government sources to the effect that effective tax rates in Ireland are not that different or even higher than in other EU countries,” Prof Stewart’s research paper states.

Publicly available data which shows corporate tax payments and profits on a consistent basis across countries is not widely available, according to the paper. However, one such data source is the US Bureau of Economic Analysis which, Prof Stewart maintains, provides a more accurate estimate of effective tax rates for US subsidiaries.

This indicates that effective tax rates for US subsidiaries in Ireland fell from 5.5 per cent in 2006 to 2.2 per cent in 2011.

This reduction is likely to be linked to wider use of tax write-offs – such as tax credits for research and development activity – and profit-shifting measures such as the “double Irish”.

Google is one of the most high-profile beneficiaries. Latest figures indicate that its Irish operation had revenues of €15.5 billion during 2012. However, it ended up paying Irish corporation taxes of just €17 million.

That’s because it charged “administrative expenses” of almost €11 billion to other Google entities abroad, some of which are ultimately controlled from tax havens such as Bermuda. . . .

By contrast, effective rates were many times higher for US firms in the UK (18.5 per cent), Germany (20 per cent) and France (35.9 per cent).

I guess one cannot blame the Irish government for trying to have it both ways—offer low rates while denying it.  But what is one to make of the research done by PwC/World Bank?  The study’s core deceptive assumption brings to mind all the World Bank and U.S. government studies of free trade agreements which find that free trade benefits all.  They obtain this result in large part because their researchers begin their work assuming full employment, balanced trade, and no capital mobility both before and after the agreements.

 

Fighting Inequality

The following post by the economist Michael Taft appeared in the Irish Left Review.    Although Taft is addressing an Irish audience, I think his discussion of Swiss initiatives against inequality should be of interest to many Americans as well.

As the [Irish] Government does its post-mortem on the Seanad referendum [to abolish the upper house of the Irish parliament], Switzerland is gearing up for a vote in November on a referendum that is truly reforming.  It’s called the 1:12 initiative. It proposes that monthly senior executive salaries cannot exceed 12 times the pay of the lowest paid in a firm.  And it proposes that this be put into law.  This is pretty heavy in a country which is home to major financial institutions and multinationals.

Imagine the impact here.  In the Bank of Ireland, the CEO Richie Boucher has a salary of €843,000 (no, that’s not a typo).  A bank clerk on starting pay is approximately €22,000.  Under this law one of two things would have to happen:  either Richie’s salary would have to fall by three-quarters – to €264,000 a year. Or the starting pay would have to rise to €70,250.  I leave you to decide which is more likely to happen, if either.

But there is more going on in Switzerland than just a pay ratio debate.  Earlier this year, the people voted on a referendum that put controls on executive pay and gave shareholders’ more rights over executive compensation.  There has been growing anger over excessive salaries and the bonus culture among Swiss companies.  The referendum passed overwhelmingly despite the fact that opposing business lobbies outspent the ‘yes’ side by 40-1.

Now there are three more referenda coming down the line.  First, there is a proposal to increase the minimum wage to approximately €18 per hour.  Even in an economy with high living costs this is a hefty rise.  Proportionately, for Ireland, this would amount to somewhere between €11 and €12 per hour (using the median wage as the comparison).

There is a referendum on a basic income – guaranteeing every adult a basic income of €24,500 a year.   Again, even factoring in living standard difference, this is hefty sum, designed to ensure a safety net for everyone.

And then there’s that 1:12 initiative – designed to do two things:  put upward pressure on low-pay and downward pressure on excessive pay.  As you can imagine, the business lobbies and the Government are predicting all manner of plagues and pestilence if this referendum succeeds.  First off, there is the claim that businesses will leave Switzerland if this is passed.  There is something in that.  Multi-national capital can be relatively mobile and many companies can punish a people for taking democratic decisions that companies don’t like.  This is not the case for all companies, though but the blackmail threat permeates the body politic.

A second argument put forward by the business lobbies is that they will just avoid the law by breaking up their companies into smaller units.  In this scenario, all the low-paid will be put into one sub-company and the high-paid into another.  This will mean that each sub-company can maintain the 1:12 ratio.  There is no doubting that companies get up to all sorts of activities to avoid democratic interventions  (the ever-vigilant WorldbyStorm highlight Ryanair’s byzantine employment contracts to prevent employees from collective bargaining).  However, this threat could be easily dealt with by legislation that treats sub-companies that sell exclusively into a main company as part of the main company itself.

Could such an initiative work here?  Eventually, but as always we must treat all such initiatives as part of a process that must be rooted in today’s reality.  We have an extremely poor indigenous sector and an over-reliance on foreign capital for value-added employment and participation in the global market.  A 1:12 initiative would immediately become hostage to multinational blackmail (this will cost jobs, etc.) and with the economy still in a domestic-demand recession such an initiative would understandably raise fears.

However, this is not to say we put this on some shelf to be dealt with sometime in some future (like Seanad reform).  A first step would be to require all companies to publish their company accounts – profits, executive pay, etc.  Publicly-listed companies are already required to do this but many private unlimited companies (Dunnes Stores) and foreign branches (Tesco) don’t have to.  There is no rationale why some companies are required to publish and others are not.  Freedom of economic information would be a first step in creating a more informed public and efficient market relationships.

Second, we could take up the idea put forward by ICTU sometime ago – that wages that exceed a certain ratio should not be deductible for income tax purposes.  If, for instance, there was a 1:12 pay ratio in a company, then the company would have to pay corporate tax on incomes that exceed the upper threshold.  Taking the Richie Boucher example, Bank of Ireland would have to pay tax on that portion of his salary that exceeded €264,000.  We may not be in a position now to stop excessive pay, but we certainly don’t have to subsidise it with taxpayer money.

So we could take positive concrete steps.  However, let’s not lose the overall sight of what’s happening in Switzerland.  There is a democratic revolt against high pay and low pay:  limitations on executive pay, increased minimum wage, and a basic income.  There is a lively debate about equality and inequality.  There are concrete proposals and there will be votes.  But even if the 1:12 initiative fails, that’s not the end of it.

Of the many issues that we will need to address on the other side of austerity (and there are many:  employment, investment, indigenous enterprise development, universal public services, social protection, etc.) there is the issue of reducing inequality, creating strong social protection floors and raising income floors.

What the Swiss are debating is how to raise that floor while toppling a few golden towers.  This is what we should start debating.  And the sooner the better.

Interesting Note:  Despite all the blackmail threats and warnings of doom about the 1:12 initiative, recent polls show it is too close to call:  36% for yes, 38% for no, with the rest undecided.

 

Corporate Taxes And The Public Interest

It is no secret that our public sector is in trouble.  Our roads and bridges desperately need upgrading.  Our schools and libraries are being forced to slash staff and activities.  Our social services and program are being cut.  And the reason: not enough money.  

Yet at the same time, it is also no secret that our most powerful and profitable corporations are merrily finding countless ways to avoid paying taxes.  It might seem like this situation would produce a serious discussion about societal aims and values—but it hasn’t.  Our political and business leaders appear quite content that business as usual should not be inconvenienced for the sake of the economy.

The New York Times recently provided an excellent study of, in its words, “How Apple Sidesteps Billions in Taxes.”  How does the company do it?  The answer is tax loopholes and a number of subsidiaries in low tax places like Ireland, the Netherlands, Luxembourg and the British Virgin Islands.  Why does it do it?  We are talking real money here.  According to the New York Times, Apple “paid cash taxes of $3.3 billion around the world on its reported profits of $34.2 billion last year, a tax rate of 9.8 percent.”  By comparison, Wal-Mart was downright patriotic—paying a tax rate of 24 percent.

Foreign Travel

Get your passports ready.  If a U.S. consumer buys an Apple product like a song from iTunes or an iPhone the royalties earned are routed to an Irish subsidiary.  That is because Apple assigned the rights to royalties on patents developed in its California operations to the subsidiary.  The royalities gathered in Ireland are then transferred, with few tax obligations thanks to Irish law, to another Apple subsidiary in the British Virgin Islands, where tax rates are extremely low.  Thus, not only does the U.S. lose out on tax revenue, so does Ireland.  And in case you have forgotten, Ireland is suffering massive cuts in public spending because of a lack of revenue.

If a product is purchased by someone residing outside the U.S., the patent royalties are routed to a different Irish subsidiary.  Apple then transfers those royalties through the Netherlands, tax free thanks to European laws, back to its primary Irish subsidiary and then on to its Caribbean subsidiary.  

If this is confusing check out this graphic.  How important is Ireland to Apple? In 2004, the country received more than one-third of Apple’s world wide revenue.  The U.S. corporate tax rate is 35 percent.  The Irish corporate tax rate is 12.5 percent.  And the British Virgin Island tax rate is even lower.  

Of course Apple’s profits are not limited to patent royalties.  That is where its Luxembourg subsidiary comes into play.  As the New York Times explains:

 when customers across Europe, Africa or the Middle East — and potentially elsewhere — download a song, television show or app, the sale is recorded in this small country . . . In 2011 [the revenue of this Luxembourg subsidiary] exceeded $1 billion, according to an Apple executive, representing roughly 20 percent of iTunes’s worldwide sales.

The advantages of Luxembourg are simple, say Apple executives. The country has promised to tax the payments collected by Apple and numerous other tech corporations at low rates if they route transactions through Luxembourg. Taxes that would have otherwise gone to the governments of Britain, France, the United States and dozens of other nations go to Luxembourg instead, at discounted rates.

“We set up in Luxembourg because of the favorable taxes,” said Robert Hatta, who helped oversee Apple’s iTunes retail marketing and sales for European markets until 2007. “Downloads are different from tractors or steel because there’s nothing you can touch, so it doesn’t matter if your computer is in France or England. If you’re buying from Luxembourg, it’s a relationship with Luxembourg.”  

Back Home In The U.S. 

Of course Apple also makes money from sales in the United States.  But it has a way of handling that “problem” as well.  The company’s headquarters is in Cupertino, California but it has a Reno subsidiary, Braeburn Capital, collect and manage its profits.  According to the New York Times:

When someone in the United States buys an iPhone, iPad or other Apple product, a portion of the profits from that sale is often deposited into accounts controlled by Braeburn, and then invested in stocks, bonds or other financial instruments, say company executives. Then, when those investments turn a profit, some of it is shielded from tax authorities in California by virtue of Braeburn’s Nevada address.

Since founding Braeburn, Apple has earned more than $2.5 billion in interest and dividend income on its cash reserves and investments around the globe. If Braeburn were located in Cupertino, where Apple’s top executives work, a portion of the domestic income would be taxed at California’s 8.84 percent corporate income tax rate.

But in Nevada there is no state corporate income tax and no capital gains tax. What’s more, Braeburn allows Apple to lower its taxes in other states — including Florida, New Jersey and New Mexico — because many of those jurisdictions use formulas that reduce what is owed when a company’s financial management occurs elsewhere.

California has lost billions of dollars in tax revenue—oh yes and is deep in a budget crisis.  

In fairness to Apple it is far from alone in using these tricks of the trade.  Almost all technology companies do it.  So, here is the thing—if we really care about our public infrastructure and programs we have to start getting tough on these companies.  Their success was aided by past public investment–there should be payback.   But then again perhaps there is no such thing as society–only the corporation counts.   

Confronting Savage Growth

The media is full of stories about the ever more heated debate over the best way to reignite growth: austerity or deficit spending.  

Paul Krugman, a leading proponent of the deficit spending side, puts it like this:  

For the past two years most policy makers in Europe and many politicians and pundits in America have been in thrall to a destructive economic doctrine. According to this doctrine, governments should respond to a severely depressed economy not the way the textbooks say they should — by spending more to offset falling private demand — but with fiscal austerity, slashing spending in an effort to balance their budgets.

Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the “austerians” insisted that the reverse would happen. Why? Confidence! “Confidence-inspiring policies will foster and not hamper economic recovery,” declared Jean-Claude Trichet, the former president of the European Central Bank — a claim echoed by Republicans in Congress here. . . .

The good news is that many influential people are finally admitting that the confidence fairy was a myth. The bad news is that despite this admission there seems to be little prospect of a near-term course change either in Europe or here in America, where we never fully embraced the doctrine, but have, nonetheless, had de facto austerity in the form of huge spending and employment cuts at the state and local level.

There is no doubt that the European experience has put those supporting austerity on the defensive.  As the New York Times explains:

Britain has fallen into its first double-dip recession since the 1970s, according to official figures released Wednesday, a development that raised more questions about whether government belt-tightening in Europe has gone too far. Britain is now in its second recession in three years. . . .

In a packed British Parliament, Prime Minister David Cameron had to defend his austerity drive against critics like Ed Miliband, head of the opposition Labour Party, who called the economic numbers “catastrophic.”

The raucous scene was the latest manifestation of growing popular frustration with the strict fiscal diet that has been prescribed by the European Central Bank and German leaders in response to the euro zone’s sovereign debt crisis. While Britain is not a member of the euro zone, its economic fortunes are closely linked with those of the currency union.

The discontent was on view in French elections last weekend and played a role in the collapse of the Dutch government on Monday. Greece, Spain and Italy have been the scene of mass demonstrations for months, but the turmoil now seems to be spreading to countries that were not seen as being at the heart of the crisis. Britain joined Belgium, the Czech Republic, Greece, Italy, the Netherlands and Spain in recession.

Of course, as Krugman notes, that doesn’t mean that the austerity defenders have given up. Here is the solution to the crisis put forward by Mr. Draghi, head of the European Central Bank, as reported by the New York Times:

He urged national leaders to take steps to promote long-term growth even when it is politically difficult. Some leaders have raised taxes or cut infrastructure projects, when instead they should be reducing government operating expenses, Mr. Draghi said.

Tragically, those in Mr. Draghi’s camp continue to blame Europe’s crisis on too much government spending when its roots lie far more in the collapse of speculative bubbles driven by private financial interests and German austerity policies.  Of course, this understanding would require taking a critical stance against dominant capitalist interests; far easier to make the working class pay.  

However, we should also be careful about assuming that the bankruptcy of the austerity strategy proves the wisdom of relying on deficit spending to solve our economic problems.  The fact of the matter is that spending to stimulate growth will not solve our problems.  The reason is that existing economic structures operate to generate what the United Nations Development Program has called “savage growth.”  Savage growth refers to a growth process that enriches the few at the expense of the many.  In other words, a process that is neither desirable nor sustainable.  Therefore, unless we change the nature of our economy, deficit spending will just temporarily postpone the start of a new crisis.

Here are two charts from an Economic Policy Institute report that highlight the workings of savage growth in the United States.  The first shows a sharp divergence, beginning in the mid-1970s, between productivity and hourly compensation for private-sector production/nonsupervisory workers (a group comprising over 80 percent of payroll employment).  In other words, the owners of the means of production have basically stopped sharing gains in output with their workers.  This wedge between productivity and compensation helps explain both the growth in inequality and the need for debt to sustain consumption.

The second provides a closer look at post-1973 trends.  A key point: median hourly compensation basically stopped growing starting early in the 2000s, even though the economy continued to expand for several more years, and it continues to fall despite the end of the recession.

In sum, if we are serious about improving economic conditions we need to move past the austerity-deficit financing debate and begin pressing for adoption of trade, finance, production, and labor policies that strengthen the position of workers relative to those who own the means of production.  Anything short of that just won’t do.

European Nightmare

Europe is experiencing a growing economic crisis.  Tragically, the recent meeting of the 27 European Union nations in Brussels produced an agreement, which if ratified, is bound to make things worse.

Growing numbers of European countries are running large national budget deficits which their governments are finding increasingly difficult to cover through borrowing.  According to the New York Times, “Euro zone governments have to repay more than 1.1 trillion euros, nearly $1.5 trillion, of long- and short-term debt in 2012, with about 519 billion euros, or $695 billion, of Italian, French and German debt maturing in the first half alone.”  The Wall Street Journal provides the following national breakdown:

The danger is that some European governments will be unable to secure the funds required to pay their debts.  Such defaults would threaten the financial stability of a number of large European banks, which are major holders of government bonds, and eventually the U.S. financial system because of the close ties between many large European and U.S. financial institutions.

At the Brussels meeting, government leaders agreed to raise some $270 billion and give it to the IMF which is supposed to use it provide loans to those governments in need, with its usual austerity conditions attached, of course.  The leaders also agreed to speed up the introduction of a new European rescue fund that would do much the same.  This determination to impose austerity on European workers stands in sharp contrast to another agreement. According to the New York Times, “The leaders sent an important signal to the bond markets by scrapping a pledge to make private investors absorb losses in any future bailout for a euro nation.” 

The leaders rejected what would have been the most useful action—empowering the European Central Bank to directly buy government bonds, much like the Federal Reserve does for the U.S. government.

The leaders did approve two major long term policy initiatives.  As the Wall Street Journal explains:   

After a marathon session of negotiating that started Thursday and ran until early Friday morning, the leaders emerged with two principal achievements: Euro-zone members who run outsize government deficits will face automatic penalties, and all governments will put balanced-budget procedures of some form in their national laws.

Germany had wanted this limit on government borrowing made part of the EU constitution, thereby giving EU institutions the authority to enforce it.  It was unsuccessful in achieving its goal only because of UK opposition; such major changes require unanimous approval on the part of all 27 member countries.  As a result, the other 26 leaders have agreed to implement this “fiscal stability compact” by winning approval for it in each of their respective national parliaments.

This fiscal stability compact reflects the continuing belief of European political leaders that the current crisis was caused by runaway government debts and can only be contained through adoption of a balanced budget amendment.  This is precisely the argument being made by conservatives in the United States.  And it is just as wrong headed in Europe as it is in the United States.

Paul Mason, the economic editor of Newsday put it well, saying:

I can only add at this stage that, by enshrining in national and international law the need for balanced budgets and near-zero structural deficits, the eurozone has outlawed expansionary fiscal policy. . . .

It has done what the US Republicans would like to do – and if you think about it, it has made what Gordon Brown did, and what Barack Obama (and indeed Wen Jia-bao) is doing illegal. 

The result, if it works will be stability. It is hard to see how it promotes long-term growth.

Mason is probably overoptimistic that such a policy will even prove able to ensure stability.  As for the claim that the current crisis is the result of out-of-control deficits, take a look at the chart below:

  

As you can see, Spain and Ireland, two of the countries with the biggest debt problems, were actually running strong surpluses before the crisis.  On the other hand, Germany was in violation of the Euro zone agreement to keep yearly budget deficits below 3% of GDP from 2001 to 2005.  Not surprisingly, once the crisis hit, almost every country was forced into running large deficits.  Said differently, in almost all cases, large budget deficits are the result of the crisis not the cause.     

In short, pushing austerity will produce a deeper economic downturn, resulting in bigger government deficits and a worsening debt problem.  As the economist Kevin O’Rourke explains:

One lesson that the world has learned since the financial crisis of 2008 is that a contractionary fiscal policy means what it says: contraction. Since 2010, a Europe-wide experiment has conclusively falsified the idea that fiscal contractions are expansionary. August 2011 saw the largest monthly decrease in eurozone industrial production since September 2009, German exports fell sharply in October, and now-casting.comis predicting declines in eurozone GDP for late 2011 and early 2012. . . .

What is needed to save the eurozone in the medium term is a central bank mandated to target more than just inflation – for example, unemployment, financial stability, and the survival of the single currency. . . . This will require a minimal fiscal union; a full-scale fiscal union would be better still. Yet none of this was on the summit’s agenda.

Europe’s current approach to its crisis is crazy, and one can only hope that few if any national parliaments will endorse it.  I suppose there is some reason to be optimistic.  As the Wall Street Journal reports:

One particular complication is the bid to make sanctions automatic. It recycles an idea that the euro zone rejected in October 2010. At that time, the European Commission, the bloc’s executive arm, proposed that penalties for violating the fiscal rules be automatically imposed; unless the countries voted affirmatively to block them, they’d stand.

The longstanding rules work the other way around. Penalties are imposed only if countries vote for them. That led to the ignominious spectacle, in 2003, of France and Germany each breaking the deficit ceiling and each voting against condemning the other, killing enforcement efforts.

In the meantime, governments in Europe, much like in the United States, continue to defend the very economic structures and patterns of economic activity that led to the current economic mess while demanding that working people pay the costs.  What a nightmare.

Ireland: “Good” Countries Finish Last

Good old Ireland—according to the leaders of France and Germany, things would be a lot better in Europe if all the countries were like Ireland.  Their reason: the Irish have generally accepted their austerity “medicine” quietly while workers in other countries (like Greece and Spain) have been in the streets protesting.

The problem with being the “good” country is that while austerity helps ensure that the Irish government is able to make payments to the country’s international investors (especially French and German banks), the Irish people are suffering and their economy is close to sinking back into a new recession.  Some deal.

Not so long ago Ireland was known as the Celtic Tiger.  Ireland’s recent economic rise, which began in the 1990s, was fueled by multinational corporate investment, much of it from US high-tech firms.  As Andy Storey explains:

Ireland, accounting for a mere 1% of Europe’s population, managed to attract 25% of all US greenfield investment into the EU in the early 1990s. US investment in Ireland, at $165 billion, is greater than US investment in Brazil, Russia, India and China combined. Multinationals, the majority of them from the US, account for 70% of Irish exports.

The attraction: Ireland’s extremely low tax rates and tariff-free access to the EU.

Unfortunately for Ireland, the 2001 collapse of the US high-tech bubble meant the end of US investment in the country.  Ireland was “saved,” however, by a debt-driven housing boom. Sound familiar? 

Irish banks were able to borrow cheaply thanks to the country’s 1999 adoption of the Euro.  And with manufacturing in a slump, they aggressively and profitably pushed loans to Irish home buyers and builders.  Storey highlights the importance of real estate activity to the Irish economy as follows:  

Investment in buildings accounted for 5% of output in 1995 but for over 14% in 2008. By 2006/07, the construction industry was contributing 24% to Irish income (compared to the Western European average of 12%), accounting (directly and indirectly) for 19% of employment (including high levels of migrant labor) and for 18% of tax revenues (property transaction taxes have now collapsed as construction activity has nosedived).  

Just like in the United States, this housing boom temporarily masked the fact that the country’s industrial base and public infrastructure was decaying, overall job growth was slowing, and household debt was soaring.  When the global crisis hit in 2008, triggered by the collapse of the US housing market, it was the end for Irish growth as well.  Irish banks lost access to foreign credit at the same time as their own real estate loans went bad.  The Irish financial sector was on the ropes and unable to repay its creditors.

So, what did the Irish government do?  In September 2008 it announced that it would guarantee all deposits and payments to foreign creditors.  Thus, the people of Ireland found themselves taking on all the debts of the Irish financial sector.  Not surprisingly, government debt as a share of GDP greatly increased.  

The main beneficiaries of this policy were the country’s foreign lenders, including French and German banks.  No wonder the French and German governments view Ireland as a good nation and role model for Europe.  This history challenges the notion, widely pushed by the leaders of France and Germany, that the region’s crisis was caused by out-of-control government spending.  

Of course, with low tax rates and an economy in recession the Irish government was in no position to pay the private debts it had taken over.  The answer, supported by European elites, was austerity.  The Irish government slashed spending on public sector projects and workers as well as social programs to free up funds.  But even that was not enough.  The Irish government had to borrow as well, an action that further increased the country’s national debt.   

The foreign creditors got paid, all right.  But the austerity only made things worse for Ireland.  The cuts drove the economy deeper into recession, again driving down revenue, and forcing the government to seek new loans.  However, foreign lenders could see the handwriting on the wall and were unwilling to substantially increase their lending to Ireland.  Instead of renouncing or renegotiating the debts, the Irish government went to the IMF and EU for help.  It was “rewarded” with a major loan of approximately $90 billion in December 2010, at the cost of yet more austerity involving higher sales taxes and sharply reduced spending on social programs. 

And the consequences of this strategy for the Irish people?  As the New York Times reports:   

“This is still an insolvent economy,” said Constantin Gurdgiev, an economist and lecturer at Trinity College in Dublin. “Just because we’re playing a good-boy role and not making noises like the Greeks doesn’t mean Ireland is healthy.”

Ireland’s GDP fell by 3.5 percent in 2008, another 7 percent in 2009, and a further 0.4 percent in 2010.  The economy grew 1.2 percent the first half of this year but even this weak expansion will likely be short-lived.  According to the New York Times:

The Economic and Social Research Institute, based in Dublin, recently cut its 2012 growth forecasts for Ireland in half, to under 1 percent. It cited an expected recession in the wider euro zone, in part because the austerity being pressed on much of Europe by Germany and the European Central Bank is seen as worsening the prospects for recovery rather than improving them.

In fact, the Irish government announced in November that it will be forced to raise taxes and cut spending again in 2012.  The reason: despite all its efforts the size of the national debt continues to growth.  The budget deficit is projected to hit 10 percent of GDP this year, still sizeable even though down from 32 percent of GDP in 2010.  The government fears that without drastic action it will be unable to continue paying its debts. 

Perhaps not surprisingly, the Irish people are beginning to say “enough is enough.”  The New York Times highlights one indicator of the change:

On a recent frosty night in Dublin, David Johnson, 38, an I.T. consultant, stepped outside a makeshift camp set up by the Occupy Dame Street movement in front of the Irish Central Bank. “This is all new to Ireland,” he said, pointing to tarpaulins and protest signs that urged the government to boot out the International Monetary Fund and require bondholders to share Irish banks’ losses that have largely been assumed by taxpayers. “The feeling is that the people who can least afford it are the ones shouldering the burden of this crisis.”

The December 3rd Spectacle of Defiance and Hope in Dublin, captured in the video below from Trade Union TV, is another.  

 

 

The following charts published in the New York Times highlight some of the trends discussed above.

Ireland’s road to debt and austerity is illustrative of the general situation in Europe.  Working people are being squeezed to protect profits and ensure the stability of existing economic relations.  Significantly, the leaders of France and Germany have just announced their long term plan for ending Europe’s crisis: adoption of tough new limits on government borrowing.  Clearly this is a desperate attempt to head off any meaningful challenge to the existing system.  At some point, and one hopes sooner rather than later, working people throughout Europe will see through this game, recognize their common interests, and take up the difficult but necessary job of economic restructuring.