Shocks and Great Expectations

The IMF produces twice-yearly estimates of their World Economic Outlook, complete with a dataset tailored for number-crunchers like myself. The dataset covers dozens of economic indicators for almost 200 economies, stretching back to 1980 where it can and also – crucially – giving forecasts for the coming five years. These forecasts are an excellent benchmark of expectations about future economic performance. Revisions to the forecast for, say, growth in 2012 across WEO reports tells us a lot about how economic conditions have changed.

We can see this by, for example, comparing the October 2008 and October 2010 WEO reports. The former would have been written largely before the tumultuous events of September 2008 and forecast growth in developed economies of 2.1% in 2009. For 2012, it predicted growth of 4.8%. The latter report showed growth in 2009 to be negative, at -2.4%, and its forecast for growth in 2012 was 4.1%. The first difference shows the impact of shocks – the second difference shows how expectations can change.

What has all this got to do with the Eurozone and sovereign debt crises? Well, according to the September 2011 WEO, the IMF estimates that this year the world’s developed economies will have a combined GDP of $40 trillion (that’s $40,000 billion). About $11 trillion of that is the Eurozone economy, a further $15 trillion is the US economy, with Japan, Korea, the UK and various other developed economies comprising the remaining $14 trillion.

This $40 trillion figure is about 6% below what the IMF expected it to be as of late 2008. Most would argue that the IMF’s expectations in 2008 – which reflect expectations of the broader economic community, including governments and the markets – were overly optimistic. The correction in expectations about what developed economies would look like in 2011 had already occurred by this time last year. Estimates from both last year and this year for 2011 GDP are close enough as to make no difference.

The cost of the debt crisis

However, looking to the future, one can see the cost of inaction around Europe’s sovereign debt crisis. The 2010 WEO estimated OECD growth over the period 2012-2015 to average 4.1%. The current estimate is for average growth of just 3.3%. In the Eurozone, the downward revision to growth has been even more dramatic. The average growth rate of 3.4% has been revised down to just 2.4%, a far cry from 2008 when the expectations were for growth of 4.4%.

The total cost to developed economies of the crises of the last twelve months amounts to lost growth of $1.3 trillion, or more accurately $1,342,000,000,000. Let’s face it – that looks like little more than an international phone number, making it very easy to forget that there are real jobs and incomes on the line – both ones that exist now and ones that do not exist yet but would have been created in the near future under different economic conditions.

The graph below tries to correct for that. It takes the average lost GDP over the period 2011-2015 and expresses it as a multiple of GDP per capita for the Eurozone, the USA and the rest of the developed world. In other words, the graph shows the IMF’s implicit estimate of the number of livelihoods destroyed by politicians’ inaction regarding the sovereign debt crisis… over the past year alone.

Estimated number of annual livelihoods, 2012-2015, lost since October 2010

There will be those who would argue that some of the livelihoods that will be lost were jobs that shouldn’t have existed in the first place – that what’s happening now is not so much the cost of inaction by political leaders by the inevitable consequence of the bursting of a global asset bubble. Even if they are right, it doesn’t really matter because it doesn’t mean that the losers are any less real. Anyone in Ireland will tell you, seeing large chunks of the population suffering from some combination of unemployment, negative equity and mortgage arrears, that it matters not one iota for public policy if one person’s lost job in construction was unsustainable while another’s wasn’t.

Talking to Peter Mathews, a banking expert and now TD (representative of the Irish Parliament) and government backbencher, he estimated that what is required is about a €75bn write-down of Irish banking debt, a similar amount for Portugal and slightly more for Greece. In other words, for the sake of about $300 billion in debt, which the markets believe are largely unsustainable anyway (hence the crisis), Eurozone leaders are willing to forsake $300 billion over the coming five years in output, jobs and livelihoods.

The interesting times continue this week, with two of the eurozone’s largest member states – Italy and Spain, who between them account for one third of the eurozone’s population – in an apparent slow crawl towards expulsion from international capital markets. These events have led many people to question whether the eurozone was ever a good idea to begin with.

While it’s easy to go with the momentum on these things, it’s worth looking at who exactly is, for example, advising UK travellers to bring dollars not euro on their holidays to the continent. You’ll typically find that the people shouting loudest about the impending collapse of the euro are those who for ideological reasons never liked it to begin with. In truth, these commentators are about as instructive as their counterparts, those for whom the euro is an unquestionable part of the present and the future: these people know the answer (and the problem) before they even know the facts.

Show me the money area

But what does economics tell us about this situation? Undergraduate economics students – the good ones anyway – will be able to rattle off what economists believe the four ingredients for a good currency area are. Two are about mobility: whether people and money can move around the currency area to where they are needed. A third is about “risk-sharing”, usually interpreted as the ability to redistribute funds (through taxes and spending). But these three factors would be unnecessary were it not for the final element of currency areas, namely that the various constituent parts have similar business cycles (booms and busts).

Average annual growth in eurozone member states, 2001-2010

The graph above shows the current business cycle in the eurozone. Countries are sorted from left to right by how sharp the contraction has been since 2007: as you can see, Ireland and Estonia have been worst hit, while Malta and the Slovak Republic have merely seen their growth slow down. In the good times, growth ranged from 1% per year in Portugal and Italy to over 8% in Estonia. Since 2007, there has been a similar spread, from growth of 1.6% to annual contraction of almost 6%.

With such a spread of countries across the business cycle, was the euro project an exercise in futility from day 1? It would take a particularly blinkered commentator to think so. The graph below shows the same growth rates for 17 U.S. states, from Hawaii to Maine. No, I haven’t forgotten to change the data in the graph – surprising as it may seem, each eurozone country has a business cycle twin in the USA! Greece is the new Florida, France the new Mississippi and Cyprus the new D.C.

Average annual growth in selected U.S. states, 2001-2010

Average annual growth between 2001 and 2007 in these states ranged from 1% in Ohio to 5% or more in states like Idaho and Nevada. Similarly, since 2007, there have been a wealth of experiences, from growth of 1% in Nebraska to contraction of 4% in Arizona. And these are states that have had the same currency for centuries!

Lessons from States-side

To me, this variety of economic life in the dollar zone shows conclusively that there is nothing intrinsically unworkable about the eurozone. But what about tax harmonisation and the size of the federal government in the US? Surely they are key elements that are missing in the eurozone’s package.

Firstly, remember also that individual states in the U.S. can set their own taxes, with corporate income tax rates varying from zero in Washington State to 10% or more in Alaska and Iowa. The eurozone is most definitely not stuck between a rock (its break-up) and a hard place (fiscal union with tax harmonisation).

Remember also that the “risk-sharing mechanism” in the EU – its ability to share from rich region to poor – is not as weak as many people think. In the USA, excluding healthcare, the federal government spends about $200bn a year in grants to States. About half of this is spread across housing/urban development and transport infrastructure, with most of the remainder spent on agriculture, education and the labour force. $200bn is €140bn, almost exactly the size of the EU budget. Of this, €110bn is spent on what are effectively federal redistributions in areas like education, agriculture and competitiveness.

Not only does the eurozone not need harmonisation of tax rates, it doesn’t even necessarily need any ramp-up in the level of redistribution across member states. For the eurozone to have a healthy future, it will need to explore issuing euro-bonds and concurrently formally setting aside the first percentage point or two of VAT and/or corporate tax receipts as revenues for the top level. Individual states will certainly have to sign up to new rules in relation to how they spend, while the punishment for a state going bust will have to be set out.

However, tax harmonisation and a big increase in federal-level spending are not necessary ingredients. Those who argue that these are foundations of the solution are about as useful as those who argue out of economic illiteracy that economies as varied as the eurozone’s can’t share a currency.

The single thread running through these worries is public debt: governments spending too much relative to their income. In Ireland and Greece, in the U.S., and in the UK, governments are borrowing a pretty astonishing 10% of the entire country’s income every year to spend. These problems are real. They are serious. And they are hogging the headlines, as analysts and politicians pore over them and obsessed about them.

But ultimately, the problem in the North is one of spending too much. Elsewhere in the world, though, there are much more serious problems – problems of too little, not too much. In particular, last week the UN officially declared famine in southern Somalia, following the worst drought in decades. Like Haiti in the Americas and North Korea in Asia, Somalia is one of the world’s basket cases. It has had no functioning national government since 1991. For reasons I don’t comprehend, no-one recognises a perfectly functioning breakaway state, Somaliland (the successor to the British protectorate in the coastal north-west part of the country).

I’ll admit something that I suspect is probably true for many of us. When the news from Somalia first emerged, my reaction was one of “yet another African crisis”. It’s a short step from there to thinking “What’s the point? Things in Africa will never change.” But this is not a story of business-as-usual from the world’s poorest continent. This is a humanitarian crisis of almost unprecedented severity, a story of a failed state being run into the ground by Al Shabab, making the lack of recognition of Somaliland even more perplexing.

The UN’s designation of famine comes after estimates that, every day, up to one in 1,700 children is dying every day in two southern regions in Somalia (southern Bakool and Lower Shabelle). To put this in perspective, if this continued for a year, 20% of the population would be dead. The graph below tries to put this unfolding catastrophe in historical perspective, by comparing current death rates in southern Somalia with those in Ethiopia a generation ago, those of Europe’s Jews in the Second World War and those of Ireland’s population in Western Europe’s last great famine in the 1840s. (It should be barely necessary for me to point out that I’m not trying to equate any of these events, merely trying to make the scale of human tragedy comprehensible.)

Deaths per 100 people, per month, selected events

The current rate of deaths in southern Somalia is of the same order of magnitude as Ireland’s Great Famine and indeed of the death rate of European Jews in the Holocaust. But there is nothing inevitable about these deaths in Somalia, and there is nothing “un-liveable” about countries such as Somalia. Drought doesn’t kill – it’s just the absence of rain. Drought in California in the mid-1980s didn’t kill, at the same time as drought in Ethiopia killed hundreds of thousands. So this drought doesn’t need to kill tens of thousands of children over coming weeks and months. While the ultimate solution is sorting out the political system in Somalia, the first step is getting humanitarian aid to the people who need it.

As bad as our economic woes seem, there are nothing compared to what is happening in Somalia. To put it in context, I’m going to see Roger Daltrey in concert tonight. Between the cost of the ticket, getting there and back and having a couple of drinks at it, I’m sure to spend in excess of €100. The same amount would feed a family of six in Somalia for a month. Please bear this in mind and, if you can, make a donation through your organisation of choice. Links to three appeals are below:

• The UN Office for the Coordination of Humanitarian Affairs
• Oxfam
• Concern

Ireland cheaper than the average?

Irish readers will no doubt be interested to discover that across the twelve areas of spending analysed, prices in Ireland are below the EU-27 average (which includes many central and eastern European countries) in five segments: clothing, footwear, furniture, household appliances and consumer electronics. Meanwhile, utilities like communications (4%) and energy (11%) are somewhat above the average, as are transport services (21%). While eyebrows will be raised at the fact that Ireland has the most expensive alcoholic beverages and tobacco (70% above the EU-27 average), two areas are of greater concern for policymakers.

The first area of concern is food prices, which are 20% above the EU average. What is quite amazing, digging deeper into the statistics, is that food prices in Ireland rose just 2% in the six years to January 2011, compared to a 20% rise on average in the EU (15% elsewhere in the Eurozone). This means that the food price gap between Ireland and the rest of the EU was about twice as large in 2005 and has been closing rapidly since then.

Closing the gap

A year ago, I presented a graph that showed the evolution of price levels across the Eurozone, based on the 2005 batch of surveys and annual rates of inflation before and after. I’ve updated that graph now using the latest HICP information (EU-wide statistics on inflation) – it doesn’t match with the EU survey above perfectly, but the general picture is very similar.

Consumer prices in eurozone countries compared to the average, 2001-2011

Zero marks the Eurozone average each year. Three of the “periphery” economies – Greece, Spain and Portugal – are the only economies that are below the average; over 15% below in Portugal’s case. The D(e)utsch grouping of Germany, Austria and the Netherlands effectively represent the average, while – until recently – Ireland and Finland were about 20% more expensive. Since 2008, though, Ireland has closed about one third of the gap between its price levels and those of the Eurozone average.

Unfortunately, barring something dramatic, it will take another three years of falling prices – or more realistically five to six years of inflation in Ireland that is substantially below inflation elsewhere – for Ireland to be no more than 10% more expensive than the average.

The power of devaluation

Ireland was happy to join the euro in the 1990s. It meant an end to high and volatile interest rates – and thus volatile investment – and an end to being at the whims of markets and currency speculators. Indeed, this mode of thought lasted throughout Europe well into 2009: the initial reaction in late 2008 to the global financial and trade crisis was for countries like Sweden, Denmark and Iceland to look to join the euro, as “shelter from the storm”.

However, once the decision to join a currency union is made, competitiveness comes down to nothing other than price levels (including wages), and – as economists know but find incredibly difficult to explain – prices are sticky… very sticky. The second chart below shows price levels in a range of countries in the two most recent EU surveys (2005 and 2010), relative to the EU average. Yellow marks Scandinavia, red marks new EU member states (only a handful of the costlier ones are given) while green marks the PIIGS countries.

Price levels in 2005 and 2010 compared (EU27=100)

There are only three countries “south of the line”, i.e. that improved their competitiveness position: one is Ireland (green), which has seen the smallest improvement. The other two are the UK (blue) and Iceland (the dramatic yellow outlier), both of which have suffered significant falls in their currency. These falls have been largely unwelcome by-products of poor macroeconomic fundamentals, but the alternative is not “no falls”. The alternative is an adjustment through prices, which – as Ireland is discovering – is a slow and painful process.

For those unfamiliar with the context, last November, the new UK government announced its plans to reform how higher education in England and Wales is funded. A report from a group set up under the outgoing Labour government recommended abolishing a cap on fees entirely. The new Government, however, increased the ceiling for tuition fees from 2012 on from £3,300 to £6,000 and up to £9,000 “in exceptional cases”. (The phrase ‘exceptional circumstances’ effectively means that a particular university must use the extra money to widen access beyond “white middle-class teenagers”, as the Guardian puts it.)

The key feature stressed by the Government was that no-one would have to pay back until they started earning more than £21,000 a year. For reference, the typical worker in the UK earns £18,500 and if you earn £30,000, you’re in the top quarter of earners.

“Lobby group objects to funding cut”

Unsurprisingly, though, this was not a popular decision among students. “Lobby group happy with having funding cut” is a headline that is rarely seen. Perhaps equally unsurprisingly, most universities in England and Wales will indeed be looking to charge the maximum £9,000 off at least some of their students. The graph below shows the maximum fee to be charged by almost one hundred universities in England and Wales. They are sorted by the Guardian’s 2012 ranking and show a remarkable degree of homogeneity: only two of the top 40 universities by this ranking won’t be charging the full £9,000, while only two of the entire group will charge less than £8,000 at the top.

Maximum tuition fees, 2012, by university (Guardian rankings)

While some will look at this and shout collusion, a moment’s thought should reveal that this just doesn’t stack up. Only 10 of the lowest 25 ranking universities are charging the maximum, so clearly, prices are being used a selling point. However, it is significant that once the “£9,000 seal” was broken, it broke only to about £8,000.

It’s clear that a service as intensive in skilled labour as higher education is very expensive to provide. And it’s clear – from the actions of universities across England and Wales – that even £9,000 doesn’t cover the costs. Ultimately, the costs have to be borne, though. The only question is how.

Why both sides are wrong

“What’s wrong with the status quo?” current and soon-to-start students (and their parents) may ask. Unfortunately, if students themselves don’t pay for their education, then someone else has to. And in a country where only half of young people get a third-level qualification, that means that working class families have to pay for middle class and upper class kids to go to university. Surely, everyone will agree that this is not fair. With limits to the UK Government’s ability to spend, due to the necessity to close the deficit, it’s also not sustainable.

“What’s wrong with the proposed solution?” others may ask. The threshold for earnings is raised significantly, so access should indeed improve. At least on paper. And unfortunately, that’s where the problem lies: debt aversion. People don’t like making commitments about the future in an uncertain world. So even though the system is set up to be fairer, people actually think it’s more unfair. The focus is entirely on the headline £9,000 and the debt accrued, and not on the return that people get on education.

Indeed, this is a topic that has a much wider resonance than just higher education. Investor Bill Ackman summed up the Global Financial Crisis very neatly when he said: “There’s too much debt and not enough equity in the world.” If you give someone equity, it means you benefit and suffer along with them. If you give them debt, you’ll drive them to bankruptcy if you have to, to get your money back. If you sit back and think about it, this has been the root of a lot of the issues in the world economy over the past few years.

Replacing student debt with student equity

Can this type of reasoning be applied to higher education? Not only can it, it is actually being applied as we speak. A Colombian social enterprise called Lumni has helped almost 2,000 students go to university in Chile, Colombia, the U.S. and Mexico by offering them “human capital contracts”. How does it work? Effectively, Lumni provides you with the cash up front to attend college. In return, you promise to pay a certain percentage of your salary (say 15%) every month for ten years, once you start work after your degree. In corporate speak, “You, Inc.” has Lumni as shareholders, rather than a bank or the government as bondholders.

Because it’s a fraction of your income, whatever that income is, students are no longer worried about “debt burden” if they don’t get a good enough job after graduating. Instead, the question for the student is: “will I earn 15% more after I graduate than if I don’t go to college?” And the evidence says yes – research from the UK for people born in 1970 suggests that the premium for a good degree (a first or an upper second) is 22% for men and 25% for women.

By significantly raising the income threshold, and by tapering the interest rate, the Conservative-LibDem Government has already shown it is concerned about debt aversion. However, the general reaction suggests that there is considerable debt aversion based on headline fees.

The Government should consider, instead, a “debt-for-equity” swap: taking equity in students, rather than giving them debt. For someone who earns £25,000 coming out of university, an (arbitrarily chosen) 15% contribution for ten years would yield the Government £37,500 in real terms – more than £9,000 a year on a four-year programme. Meanwhile, the graduate enjoys a higher stream of income throughout their life, long after they’ve bought out the Government’s minority shareholding in them!

According to the best estimates of economic history, in the year 1AD, Asia constituted almost three quarters of the world economy. Most of the rest of the world economy was in the sphere of the Roman Empire. Fast forward to 1500 AD, and Portugal, Spain and other European countries were beginning to fill the vacuum on the global sea-routes left by China’s sudden introspection. Medieval Europe had been developing for almost half a millennium by this point, but still half the world economy was in China and India alone, with just one quarter coming from Europe – now expanding across Russia and over the seas.

The following 500 years have been ones of turmoil to the traditional economic pecking order. Known as the “Great Divergence”, Western European and its offshoots in North America and Oceania have seen small populations become extraordinarily wealthy. By 2000, those small parts of the planet had come to account for not 15% of the world economy – as they had done for the bulk of human history – but almost 50%. Eastern Europe, Russia and Japan accounted for a further 20%.

Asia – the bulk of the world’s population and for so long the bulk of its economy – accounted for less than one quarter of all economic activity. The fall in relative power of Asia took place most dramatically in the century between the end of the Napoleonic Wars and the start of World War 1, when China alone went from being one third of the global economy to being less than 10%. India’s fall was more prolonged but just as severe. By contrast, the four Anglo-Saxon offshoots went from just 2% of the world economy in 1820 to 20% at the eve of World War 1.

While that is interesting economic history, what can it tell us about the future? At the risk of being trite, it is of course very difficult to say anything about 2050 with certainty. However, we do know something about demographics and can thus hazard a reasonably good guess at population by region in 2050. It looks currently as though there will be about 10 billion people living on the planet at that point, about 3.3 billion in China and India, a further 2.3 billion elsewhere in Asia and 2.1 billion in Africa. Europe and its offshoots, including North America and Russia, will be home to about 1.3 billion.

This is an excellent starting point, as calculations about the size of the world economy use population combined with real per capita income. So, let’s suppose people in “developed economies” were to have a standard of living about twice as good in 2050 as they enjoy now (i.e. they enjoy growth of about 1.5% a year between now and then). The overwhelming evidence from post-Industrial Revolution global economic history is of regions one-by-one catching up, by and large, with the better-off regions. Should this process continue to happen over the coming four decades, we might expect to see living standards in India, Latin America and Africa reach about half of those in Western Europe, with China and Eastern Europe somewhere in between.

Percentage of the world economy by region, 1AD - 2050AD

That scenario is outlined in the graph above, which shows the approximate percentage of the global economy constituted by various regions in 1AD, 1500AD, 2000AD, and – somewhat ambitiously – 2050AD. The likely dramatic resurrection of India and China as economic powers over the next forty years – and the propulsion of the rest of Asia and of Africa into the limelight – stands in stark contrast to the recession of Europe and its offshoots into the shadows. The sheer size of population means that we may see the African economy rival the European and North American economies combined by mid-century.

As I see it, there are three lessons for Europeans to take from this overview of economic history and maths of demographics:

• Firstly, the economic histories of India and China in particular show that economic pre-eminence is not guaranteed. As the case of China shows, even a few decades is a long time in economics.
• Secondly, the emergence of new regions – as Oceania and North America have shown – means that the world will not simply revert to old pecking orders. There are no new continents to physically discover, but population growth means some continents – Africa and Asia in particular – are certainly getting bigger.
• Thirdly, even if the wealthiest humans continue to live in Western Europe and North America, the maths is unforgiving. The weight of population and the track record of region-by-region catch up means the balance of power will shift.

Western European countries in particular are currently engaged in a Canute-like effort to hold back the tide of economic power. Unlike Canute, though, who used the exercise precisely to show the limits to his power, Western European countries seem to want one last go at being the big shots. The sooner they realise the lessons of history and maths, the sooner they can adapt to the realities of the 21st-century world economy.

There may be a certain irony in having an Asian head of the IMF telling Europe how to put its financial house in order – after decades of the opposite – but there is also a certain justice.

The global economic outlook looks, on the whole, pretty fragile. The Asia-Pacific region seems to be in the middle of a period of heightened seismic activity, as Japan and New Zealand know to their cost. The Middle East and North Africa is a mix of insurrection, often violent political disagreement and, in Libya, NATO air-strikes. The world’s largest economy, the USA, will soon have a national debt that is larger than the size of its economy and faces a huge task to narrow its gaping deficit of over 10% of GDP.

Europe’s challenge

As all this is going on, Europe faces its own challenges. Many of them are similar in nature to those in the USA: countries such as Greece, Ireland and Portugal have already paid the price for high debts and a large gap between the money the government spends and the money it raises. Making Europe’s problems worse are internal differences, with growth and inflationary pressures in Germany at precisely the time countries such as Spain and Italy are struggling to resurrect their economic fortunes.

The IMF figures give a detailed insight into one core economic statistic that is often overlooked, the volume of goods and services that a country exports. Exports create jobs and spending, effectively financing a country’s imports. The more a country can export, the more its citizens can enjoy everything from tourism to cars and iPads. It’s no surprise to see that the countries enjoying the fastest growth now – China and India – are projected to see phenomenal growth in the volume they export over the period 2000-2016. India will export six times as many goods and services in 2016 as it did in 2000, China twelve times as many. In contrast, the “Anglo-Saxon offshoots” – USA, Canada, Australia and New Zealand – will see the volume of their exports double in the same period.

In Europe, the increase will be even smaller on average, 84%, the lowest of any region in the world economy. But again, there are huge differences across Europe. The graph below shows the average annual growth rate in the volume of total exports for 17 West European countries for two periods: pre-Great Recession (2000-2008) and post-Great Recession (2008-2016). The most obvious finding is that the average growth rate in exports is set to fall from 5.3% to just 2.5%. This is driven in part – but not completely – by flat-lining exports between 2008 and 2012.

Average annual growth in export volumes in European countries

This disappointing trend is not all that surprising, and makes a mockery of the various politically-determined targets for a competitive Europe by 2010, or 2020, or indeed 2030 as no doubt the target will become in due course. What is surprising, though, is the ordering of some of the countries. While one would have perhaps expected “super-competitive” Germany to top the charts for overall export growth and Italy to be close to the bottom, the fact that France and Norway score so poorly must surely be a cause for concern in both countries, for very different reasons.

Norway’s extremely poor growth in the volume of exports – less than 1% a year for 16 years – will be largely offset by higher oil prices. However, Norway’s long-run development cannot depend on an infinite supply of highly priced oil and when that source of growth diminishes, where will its future growth come from?

However academic or far-flung you may regard Norway’s problems, those of countries like Italy, France, Greece and Portugal are certainly pressing. There are three engines of growth in any economy: domestic sentiment, the government, and international trade. High government debt and deficits, coupled with ageing and shrinking populations mean that if these countries are to continue to grow, they will have to export more and more. It does not look like they are developing the capacity to do that.

Two-tier Europe (revised)

At first glance, the chart confirms stereotypes about a two-tier Europe, with a Germanic core booming ahead and a PIGS-Mediterranean periphery lagging behind. However, not only does Norway throw up a surprise, so too does Ireland – at the other end. Ireland’s volume of exports is projected to grow 132% between 2000 and 2016, below only Germany (137%) and even then only marginally so. Its export volumes are projected to grow by an average of 3.5% a year from 2008 to 2016, among the highest in Europe. This is being driven by an impressive performance in services exports. Indeed, Ireland may become the first major economy where half of all exports are from services, the growth area for developed country trade. This very real difference in economic performance further underscores the gap between Ireland and other troubled European economies, a difference that will hopefully translate into real economic growth for the Irish economy in the years ahead.

Squaring the circle of restoring growth in countries with both high debt and ageing and shrinking populations requires international trade. The worrying thing for Europe, though, is that the trend is going the other way: growth in exports is slowing down. Governments cannot create trade. They can, however, put in place the conditions for international trade to flourish. In the end, after all the talk about debt, PIGS, the euro and the banks, future prosperity may ultimately come down to whether Governments can do just that.

The rumour mills were buzzing over the weekend that, despite the Government’s stance that the country’s corporate tax rate was off the table, a deal was being discussed between Ireland’s Minister for Finance Michael Noonan and some of his European counterparts. The “deal” in question was a swap of sorts: in return for Ireland budging on corporate tax, there would be a one percentage point cut in the interest rate on the European part of the IMF-EU loan.

The arrogance on the part of Ireland’s European partners is flabbergasting. It is not even the case that the concession being offered to Ireland recognises the very different position Ireland is in, compared to countries like Greece and Portugal.

Ireland is not Greece or Portugal

Greece and Portugal are in need of loans from their closest partners because of profligate Government spending for a generation. Ireland’s track record on fiscal policy has been far from ideal, but nothing like the problems faced in Greece or Portugal. Ireland’s problem was not about how much revenue the Government raised and spent, but how it did this.

For example, when 2008 rolled around, the ratio of the national debt to the size of the Irish economy was about 30%. In Portugal, the figure was 70%, while in Greece – as in Italy – it was over 100%. A bit like Spain (40%), Ireland’s government had mismanaged the economy but did so in a low-debt way, at least during the good years.

No, Ireland has had to borrow at punitive rates from its closest allies because it made the decision to protect those who had lent to Irish banks… principally banks based elsewhere in Europe. The two-year banking guarantee should have been used as a period for winding down insolvent banks but instead Ireland found its banks stuffed to the gills with ECB funding so that existing bondholders could escape, which they by and large have.

The result is that Ireland’s taxpayers have taken a banking bailout bill of €70bn, in the name of European solidarity. The payback from those who benefited elsewhere on the continent? Nothing at all. In fact, Ireland is giving more: each of the countries lending to Ireland will do so at a large profit, so taxpayers elsewhere not only take no hit on their banks’ dodgy lending to Irish banks but actually make a profit.

That was a bitter enough pill for the Irish taxpayer to stomach. But now, in addition to having their banks bailed out by Irish taxpayers and making a profit on the whole thing, Ireland’s closest partners – in particular France and Germany – want to go a step further and meddle in Ireland’s sovereign fiscal affairs.

Hypocrisy and economic illiteracy

Late last year, there was much talk of Ireland’s sovereignty having been lost, as the IMF came into town and set out a plan for the next few fiscal years. But the IMF’s plan was one obvious to anyone with a passing interesting in fiscal sustainability: it involved improving Ireland’s deficit by setting out a plan for cutting spending while normalising those one or two areas of taxation that are out of step – in particular overly generous income tax credits and the lack of an annual property tax.

What France and Germany want to do is completely different. For a start, it is economically illiterate and hypocritical. It is economically illiterate because available evidence suggests that raising corporate tax rates reduces inward investment. Ireland is a hotbed for inward investment and so has much more to lose, from lost jobs and exports to lower government receipts due to income and consumption foregone. Raising Ireland’s corporate tax rate will not improve investment into France or Germany – countries like Switzerland and Singapore will gain – but such a move will worsen Ireland’s deficit and – ironically? It’s hard to tell any more – make it more dependent on loans from allies.

It is also hypocritical, because countries like France hide effective corporate tax rates as low as 8% under much higher headline rates while they want to punish Ireland for having effective rates similar to the headline rate of 12.5%. The message from the EU seems to be clear: countries in the EU are less sovereign than US states like North Carolina, New York and Delaware, who can all set their own corporate tax rates.

Perhaps most importantly of all, though, a “corporate tax rate for interest rate” swap is just a bad deal for Ireland when you add up the amounts involved. Ireland’s EU partners are lending €45bn as part of the EU-IMF deal. Suppose all of that were drawn down now. What would one percentage point gain Ireland? €450m a year – an amount that is largest in real terms in the first year and will gradually shrink in importance, due to inflation and growth.

Costs and benefits of an interest rate-corporate tax swap

And what would such a move cost? Well, Ireland’s currently attracts about 10,000 new jobs a year through foreign direct investment. Suppose a move on tax was either a five point increase in the rate (to 17.5%) or a move through some Consolidated Corporate Tax Base scheme that had a similar effect. An OECD review from 2008 suggests that this could put up to a quarter of Ireland’s new FDI at risk.

Deal or no deal?

What economic impact would this have over five years? Let’s be very generous to our EU partners and leave aside entirely revenues raised from corporate taxes – in effect, let’s assume the new changes don’t really affect existing FDI, just new FDI that Ireland would like to attract. Ireland currently hopes to attract 50,000 new jobs through FDI by 2016. If one quarter of those do not happen, that’s about €625m in salaries that the Irish economy is out of pocket.

Indeed, using the rule of thumb that ten new jobs from investment create a further seven new jobs indirectly, it’s more likely that the Irish economy would be €1bn less well-off per annum by 2016. The government would alone miss out on more than €450m, through foregone tax revenues on income and consumption. And whereas the benefit of a lower interest rate would fall in real terms over time, the costs would rise, as each year the new pot of FDI coming into Ireland is smaller than it would otherwise be. This is shown in the graph above.

If you were in charge of the Government’s coffers, would you pay €1bn for something worth less than €500m? You don’t have to be the Minister for Finance to figure out that’s a bad deal!

“I could be a millionaire if I had the money. I could own a mansion, no I don’t think I’d like that…”

So sang Clifford T Ward in his beautiful song, “Home Thoughts from Abroad“. While wealth and property may not have had an allure for him, the two topics have dominated Ireland’s recent economic history, since a domestic property bubble fuelled by inappropriately low eurozone interest rates replaced competitiveness and net exports as Ireland’s primary growth driver about ten years ago.

Last Friday, while enduring the worst economic contraction of any developed economy since economists and statisticians started measuring these things, the Irish people went to the polls. They did so amid much international attention, as Ireland’s government was the first of the eurozone to be a casualty of the ongoing debt crisis. The result was utterly unsurprising to poll-watchers yet still momentous: the two parties of the outgoing government saw their representation reduced from 83 seats (77+6) to 20 (20+0!).

Even to an outside audience, this is a remarkable turn-around in fortunes. What makes it all the more momentous is that the largest party, Fianna Fáil, which had never before in its history received less than 39% of the first-preference vote, garnered just 17% of the vote! The graph below – which is courtesy of state broadcaster RTE – shows which party topped the poll in each constituency in 2007 and again in 2011. The complete disappearance of light-green is a picture worth a thousand words.

Which party got most first-preference votes in each constituency in the 2007 and 2011 elections?

But for all the interesting theses generated for future PhD students in political science, do we know anything now that we didn’t know before the Irish election? I would argue that we know three things.

(1) Ireland voters have emphatically ruled out sovereign default…

Ireland and Greece are very different animals. Greece has walked itself, through bad fiscal management and even statistical deceit, into an unsustainable debt position. Faced with this prospect, many Greeks have taken to the streets, arguing among other things that the required realignment of taxation and spending is somehow a transfer from poor to rich. The situation in Greece looks increasingly unsustainable and it is perhaps only a matter of time before its debt is restructured.

In Ireland, it’s a very different picture. No riots, instead people have waited for the election to have their say. All major political parties ruled out any sovereign default. Even Sinn Féin, which is opposed to austerity measures (favouring instead increased taxation), had as part of its manifesto standing by Ireland’s self-imposed debts. The fringe left-wing United Left Alliance – and their position on sovereign debt is at worst ambiguous – only garnered 2.5% of the popular vote.

The typical Irish citizen may only be learning now the full extent to which the last three Governments increased permanent spending commitments on the back of temporary or fragile revenues. But the election shows clearly that Ireland’s citizens believe the country should not welch on debts honestly accrued, however painful that might be. This is because the price to be paid would be a poorer economy for their children.

(2) …but Ireland does not view banking debt as part of its sovereign debt

Only the two outgoing Government parties viewed Ireland’s banking liabilities as an integral part of its sovereign debt. All other parties - and most of the non-party candidates, such as the New Vision electoral alliance - campaigned on a platform of “burden-sharing” and/or renegotiation of the IMF-EU debt, i.e. that the collapse of Ireland’s financial system should have costs for more than just the Irish taxpayer.

The Irish people have overwhelmingly endorsed the latter view, with the outgoing Government parties taking less than one in every five votes cast. In other words, the new Government has been given a mandate based on the belief that tying banking debt to the Irish taxpayer is part of the problem, not part of the solution. With Irish bond yields at record highs, it seems the markets and the Irish electorate are in agreement on this. Only some EU-ECB elites seem out of step.

“I’ve been reading Krugman, Sachs and Joseph Stiglitz. And they all seem to be saying the same thing to me…”

As Clifford T Ward might have said… The solution is obvious. It’s not only obvious, it’s mostly good news for the EU and ECB. While it’s embarrassing for them, it’s not painful. They will have to admit that they were wrong to pump Irish banks to the hilt full of loans and deposits, long after the private sector had deserted the same institutions. But they can protect the bondholders and all it will cost them is giving the ESF loans to Ireland at no interest rate premium. This cuts the cost of banking debt in Ireland more or less in half, enough to convince the market the burden is manageable.

There is no moral hazard argument as the externality here – contagion in Europe’s financial system – does not apply to any of the Club Med economies, at least not in the same order of magnitude. Profligate economies cannot be rewarded with cheap loans – but the reason Ireland is in need of help from its neighbours is not its own profligacy. The reason Ireland is need of support is because the EU extended credit for a lost cause well beyond any measure of common sense. One of the clearest voices on this is Peter Mathews, who has just been elected as a representative for Fine Gael, which will lead government, and who is set to be a vital part of the team that will be sent to talk to European chiefs.

But – odd as this may sound to a global observer – there was a lot more to Ireland’s election than the global sovereign debt crisis. In fact, that was probably only the side show…

(3) Ireland’s underlying issues are nothing to do with bondholders or deficits

Firm statistical evidence of this will be hard to come by, but it is clear that what the Irish electorate is really smarting from is not austerity or the lack of burning bondholders. These have just lit the touchpaper on the two real issues facing Ireland: unemployment and negative equity. According the most recent official figures, 300,000 people are unemployed in Ireland, up from just 100,000 before the current economic crisis. While Ireland’s under-18s are lucky enough to be able to choose skills that are in demand, their older siblings are not so lucky. The burden of unemployment is falling on Ireland’s 20-somethings, with one third of men between 20 and 25 unemployed, and they are set to emigrate.

Things are hardly better for Ireland’s 30-somethings. At least 200,000 households - and maybe as many as 300,000 –  are in negative equity. This is out of a total of 800,000 households with a mortgage. Just yesterday, the Central Bank published its latest mortgage arrears figures, including a new series on numbers of mortgages that have been restructured. All in, about 10% of mortgages are already in trouble.

The solution to both of these issues is of course not burning bondholders or austerity. It is what every politician seeks: jobs. Ireland has three engines of jobs growth: international demand, domestic investment and domestic consumption. Consumption and domestic sentiment is out for the count and won’t recover until the other sources deliver. Opportunities for domestic investment are few and far between, although a national retrofit program and schemes related to renewable energy may provide some boost.

The onus will fall on Ireland’s ability to compete internationally. Fortunately, Ireland is relatively well placed. It has consistently out-performed in attracting FDI jobs in the last three years. Its manufacturing sector – which was hardly affected by the collapse in trade at all – has just recorded its strongest performance in 11 years. With property costs about half of what they were five years ago, and with a general improvement in relative costs of the order of 10% on the rest of the eurozone, Ireland looks set to do so again over coming years. And who knows? Maybe NAMA’s “gift from history” of nearly-free accommodation for workers and firms may turn out to be a further shot in the arm for Ireland’s competitiveness.

The switch away from a narrative of dependence also allows us to look at sub-Saharan Africa’s economic prospects. Most of us in the West/North have been quite wrapped up in our own bubble (and its bursting) the last twenty years or so. Economists refer to the period from the mid-1980s to 2007 as the “Great Moderation”, with by and large low and stable inflation and high economic growth. This is contrasted to the turbulence of the 1970s and early 1980s, and a new wave of issues since 2007.

In sub-Saharan Africa, however, the picture is very different. The 1980s and 1990s were decades to forget. In current dollar terms, the sub-Saharan economy was about $730 billion in size in 1980, $930 billion by 1991 and $1,150 billion by 2001. While this average annual growth of just over 2% might sound healthy enough, population was growing at close to 3% a year. This means that throughout the 1980s and 1990s, living standards were falling on average in sub-Saharan Africa. Given the huge impact of HIV, which has reduced life expectancy by one third in some countries, and the ongoing impact of malaria, which is estimated to slow growth by 1.3% a year, this is an unsurprising fact.

However, since 2000, economic growth in Africa has more than doubled in speed. The region grew in real terms by an average of 6.1% each year between 2001 and 2008 and is expected by the IMF to grow by 5.9% a year between 2008 and 2015, in effect largely shrugging off most of the effects of the apparently global financial crisis. At the same time, population growth is slowing: it is currently 2.3% and is expected to average 1.4% over the next forty years. This means, for at least the first time in a generation, real living standards are improving and noticeably so (6% economic growth over 2% population growth). All the talk may be of China and India having become the drivers of global economic growth since 2000, but that may miss an every more exciting story in Africa.

Economic growth in sub-Saharan Africa, 2001-2015

The map above shows average annual growth across sub-Saharan Africa across the pre- and post-2001 periods. (The full visualisation is here.) Larger countries are by and large growing faster, a reflection of a combination of bigger consumer markets and typically greater resources. Using physical resources for economic growth can only be a temporary strategy (they’ll run out one day) and does leave an economy more open to external shocks, if the price fluctuates. But the lesson of countries like Norway is that natural endowments can be harnessed to build long-term prosperity. I am sure if you ask Ethiopians whether they would prefer their current double-digit economic growth, and having every chance of meeting the Millennium Development Goals and developing industrial and service sectors, or having no chance through a policy of economic isolation, the answer will be a resounding one.

It’s not all resources, either. At least some of the economic growth that Africa is seeing may be down to what could be regarded as a luxury: mobile phones. There are ten times as many mobile phones as landlines in sub-Saharan Africa, and almost two in three people in the region has access to one. As a forthcoming article in the Journal of Economic Perspectives outlines, mobile phones are not a “silver bullet”, but they do offer a range of benefits that could be missed at first sight. These phones don’t just connect individuals, they connect individuals to information and markets, for example, corn and tomato farmers can find out today’s prices. They also connect individuals to services, from reminder text messages for those on AIDS medication to mobile phone credit as a form of currency in parts of Africa without more traditional banking services.

None of this is to diminish the scale of Africa’s challenge. Poverty, malaria and HIV continue to mean that standards of living for many are worse than their ancestors’, something that jars with any sense of progress. Perhaps, though, that story was the story of the twentieth century. During the 1990s, six of the world’s fifty fastest growing economies were in sub-Saharan Africa. Currently, one in three of the world’s fastest growing economies is African – from Malawi and Mozambique in the south-east to Ghana, Sierra Leone and the Gambia in the north-west. Maybe, the narrative is changing.