Physics and the natural sciences explore questions of truly enormous significance. I’m fresh from reading the Existential Issue of New Scientist magazine, which tackled such questions as “Why is there a universe?” and “Am I a hologram?”. Economics and the social sciences in all reality have “science envy” but do their best to tackle questions that, if not so profound for the life of a dog, an atom or an alien on Alpha Centauri, certainly matter for the lives we live today.
In particular, economists focus a lot on the Industrial Revolution, as before that time there had never been a society where prosperity had risen steadily. Instead, prosperity and the wages of the common labourer tended to be inversely related to population. When population crises occurred, those who survived were able to reap the rewards of the scarcity of human labour. Since the Industrial Revolution, though, a growing number of people – now the majority of the world’s population – have enjoyed steadily increasing incomes, generation after generation, all while the human population grows and grows.
Growth and banking
Understandably, given such a shift change, every economist – indeed probably every social scientist – has their own pet theory for the answer to social science’s Big Question. And perhaps predictably, most tend to think that the most important factor was something they have spent their lives working on. As I develop my research career, I won’t have that option, as the intriguing economic force I hope to understand better (urban agglomeration – what happens when people come together and live in cities) clearly only dates from the Industrial Revolution and thus cannot have caused it!
There is general agreement, though, on the necessity – if not the sufficiency – of a number of conditions an economy needs for people to enjoy increasing incomes, generation after generation. Property rights and the enforceability of contracts is one: if you can’t prove you own something, it’s harder both to trust the system you work in and to motivate yourself to generate wealth. Extreme temperatures have, at least until now, proven a block to human industry: a brief pause to consider the role of air conditioning in the development of the US South will surely convince people of that.
Another factor that no economy has growth without is banking. This is the process of turning savings into investments, i.e. of turning current production into future consumption. Much of modern macroeconomics has tended to ignore the fractional reserve system of banking that we all depend on: this is probably part of a broader issue with modern macro, which is less concerned with why incomes grow over the long run and more concerned with why incomes bobble up and down around that trend in the short run.
However, the power of banking is undeniable. Even if I were writing before the tumultuous economic events of the last few years, history is replete with examples. For instance, one of the main reasons the mighty Spanish empire was defeated by the United Dutch provinces in the early 1600s was because, for all Spain’s New World silver, its Genoese bankers just couldn’t mask the empire’s lack of creditworthiness. The Dutch, on the other hand, could borrow at will.
A banking-free Ireland
My worry is that Ireland is adding itself to the list of powerful examples of the importance of banking. Not only what happened in the run-up to 2008 – and the effect of the Anglo-Irish Bank model of banking – but also in what’s happened since. Currently, banks are worried solely about day-to-day, month-to-month survival. They are not in the slightest bit interested in generation-long mortgages. The result? Two friends of mine, recently married, decided to buy. They were told that even though they currently pay a monthly rent of €1,300, his job “doesn’t really count” and she “could get pregnant” and thus they would only be eligible for a loan whose monthly repayment would be €600. I’ve argued before that current asking prices look high relative to long-term averages… but it shouldn’t be rocket science for banks lend based on ability to pay and according to standard valuation methods for properties.
An economy without mortgage credit will muddle on with falling house prices and widespread negative equity. House prices will probably overshoot on the way down. But ultimately, people will survive. The even greater worry is an economy without business credit, because an economy without business credit will never be able to create jobs. And Ireland is not just an economy without business credit. It’s an economy where there are no banks interested in business banking whatsoever.
That’s a strong statement. For evidence, though, I need look no further than my fiancée and her friend, who run a very successful online wedding magazine, One Fab Day. The site has over 30,000 readers a month, making it one of the most popular wedding websites in the world on a per capita basis. Audience is one thing, revenue another and it has a lot of paying clients and some excellent ideas for how to generate new revenue streams. However, like any modern business, it requires a bank account. What amazed me was just how long Irish banks were able to drag their heels, no matter how many client cheques were waved in front of them, before they would even open a bank account!
SMEs, banks and jobs
In any ordinary developed economy, with their track record over recent months, One Fab Day would now be taking out a working capital loan, hiring staff and expanding. Instead, in the modern Irish economy, they realise that they will have to grow without credit and thus significantly more slowly. There are lots of things they could be doing but without the credit, they just can’t.
One thing they could certainly do without credit, though, is start selling their services online and reach international markets. (In fact, as proof of concept, they’ve already had paying clients from both North America and Europe!) However, to trade online properly (i.e. beyond PayPal), you need an online merchant account. And guess what? Irish banks are just not interested.
To even consider approving your business for online trading, they do the whole chicken-and-egg thing: they expect you to have two years of online trading behind you and audited accounts to prove it! They are prepared to make an exception and accept a business plan, but only if you can produce three years of forecasts for online trading that they will then judge to be realistic or not. If you haven’t traded online yet, this of course gives them ample room to refuse. And lastly, even if you do meet the above conditions, it will take at least four months to process!
This might be understandable prudence on the part of Irish banks but for two facts. The first is that there is almost no marginal cost for the banks in helping SMEs trade online. They are not exposing themselves to huge risk – as they might with mortgage lending – by enabling transactions from which they take a cut. Effectively, they are only interested in online trading if you are a large company and thus there are large amounts of euro on the table for them, risk-free, Day 1.
The second is the bigger picture (lest you think this was all written out of a sense of nuptial duty!). Information & communication technology have done a huge amount to flatten the playing field between large and small firms. Things that had been prohibitive fixed costs (like buying a supercomputer) have been turned into utilities that can be tapped on demand. However, if you literally cannot take the money in, it’s all for naught.
The graph above shows the percentage of enterprises trading online. In Ireland, one in three companies with more than 50 employees is selling online, while for those with 10-50 employees, it’s one in six. There are only a handful of countries that produce statistics for micro enterprises (1-4 workers) or mini ones (5-9 workers) [not shown above]. Portugal is one and its profile is similar enough to Ireland’s that it’s fair to say probably no more than 5% of micro enterprises in Ireland are selling online. The figure in Germany is 18%.
It’s a truism to say that SMEs provide the bulk of jobs in Ireland, a cliché to say that there is no recession online, and a mantra that export-led growth will lead Ireland out of recession. Sitting in the middle of all three of these statements is an obvious point for the new Government, if it’s truly serious about turning the SME sector into an engine of jobs growth through online exports. The Government, as key shareholder in practically the entire Irish banking system, must make bank management, who are only there to execute the wishes of shareholders, set ambitious but deliverable targets in relation to SME online trading. The first step is giving AIB and Bank of Ireland targets for new online merchant accounts by the end of this year, say 2,000 each.
With the will and the support systems in place, across banks, Enterprise Ireland, the county enterprise boards and Irish companies such as Realex, it should be entirely possible to have one in four Irish SMEs trading online in less than five years. As you may have guessed, I know a business that will do it tomorrow, if only they got the chance!