April 18, 2004
Subsidising the cowboy economyPosted in · 2 comments ·
The other week I was out for lunch with two friends – let’s call them Mr
Radioman and the Builder. All three of us were in good form as there were things
to talk about, issues to debate and we were looking forward to Easter
Both men are from the Midlands and as a result, much of the talk revolved
around developments beyond the Pale.
Mr Radioman spoke enthusiastically
about his hopes for a new radio licence he had just won.The Builder told us
about a new development of holiday homes that he was about to launch. Both
sensed that 2004 was already shaping up to be a good year.
As we talked,
it struck me that both men were involved in
surprisingly similar businesses.What do holiday homes and local radios have in
common? Despite all the talk about competition, both are operating in the
protected sector of the Irish economy. Both benefit hugely from inexplicable
government intervention and both these subsidised businesses make it harder for
real businesses to survive and prosper in the free market.
both my lunch mates are personally in receipt of extraordinary government
The Builder is profiting enormously from a tax break given to final buyers of
holiday homes all around the country. On his calculations, his golf-side
apartments will cost €300,000, but
after a ten-year tax break,the buyer will only actually forkout half of this after. So instead of the apartment costing the buyer €300,000, it will cost him, net of tax, €150,000.The state subsidises the other €150,000 in taxes foregone.
Why does the state subsidise the
Builder to this extent? Why does the building industry need this helping hand?
Is it suffering under excessively high interest rates that are preventing
expansion in the sector? Is there enormous uninsurable risk involved in building apartments?
contrary,the building sector has never been more productive. So why the subsidy?
Does it make economic sense in 2004?
Ten years ago,when large swathes of
our cities and rural towns were actually falling down, the urban renewal schemes worked brilliantly, and
were probably the most successful public/private partnership ever witnessed.
But today the opposite is true.We are building too many houses, and
recent evidence indicates that supply is far outstripping demand. But the
tax breaks incentivise more, not less,
building. Therefore, the more the market is distorted the more supply will
outstrip demand and the more stretched valuations will be. If we are worried
about house prices, is this not counterintuitive?
Well it is
counterintuitive if the aim of government policy is to clarify for investors the
risk in the second home market.
But what if the opposite is the aim?
What if the aim is to keep investors in the dark about the true risk, yield and
valuations in the property market?
If this were the objective, there
would not be a better way of hoodwinking the punters – because valuations on
Irish holiday homes only make sense in the context of the tax break.Therefore, the state is
actively pulling the wool over investors’eyes bygiving them a Panglossian, tax-distorted notion of the real
value of their assets. Meanwhile, the builder is laughing all the way to bank.
Why would a government or political party want to keep Irish builders
sweet? Political donations? Never! It must be something more complicated,
sophisticated and enlightened.
Therefore,we have a situationwhere the
builder is placing a one-way bet, financed by bank leverage and underwritten by
the Revenue Commissioners.So who gains as a result of legislation passed on our
behalf in the Dáil? Surely the public must gain somewhere?
with the builder and the banks.They benefit because they do not bear the full
risk. Once the property is flogged, the builder is on the first plane out to the
Algarve for a round of golf; and the bank gets to lend €300 grand for the risk
associated with €150 grand – a nobrainer.The punter gets his gaff overlooking
the 18th, and the Revenue effectively picks up half the tab.
enough – but does anyone really lose? Not in this snapshot analysis. The economy
works via a series of multipliers that amplify the impact of any initial
spending.These knock-on effects work as follows: if you buy something from me
for €10 and with that tenner I buy something for €8, and the recipient of that
€8 buys something for €6, and so on, it is easy to see how the initial €10 spent
can have a positive knock-on effect.
Traditional economics suggests that the
knock-on effect of spending diminishes over time, because people always save a
proportion of their wages. But what happens if, rather than saving,people
respond to their increased wages by availing of cheap bank credit?
Possibly the opposite occurs.When you buy something from me, I not only
spend this but also borrow against it amplifying dramatically the impact of the
knock-on effect. For example, I receive €100 from you for writing an article on
a weekly basis. Instead of spending the money, I borrow €1,000 against the
€100′s ability to service the loan.
Now we’re motoring! The positive knock-on effect is huge – and this is
most likely what is happening currently in Ireland. So where is the snag?
The snag comes about because an unwarranted state subsidy affects
everyone’s investment decisions and ultimately leads to jaundiced investment
decisions that follow the tax break to
the detriment of other investments. In short,we start to over-invest in the
Now, if you think land is valuable today, let’s look at
the ballistic asset of the future – band spectrum. Band spectrum is what you own
if you have a radio licence. Band spectrum is the motorway system on which
wireless technology works. It is already built.The question is who will own it.
In the United States,wireless networking – such as wireless broadband –
is the fastest-growing segment in telecommunications. In poor countries with
unsophisticated phone systems, it is seen as the means to leapfrog the lack of a
Today in the US there are roughly 1,500 wireless
internet service providers (WISPs) already using unlicensed spectrum to offer
high-speed broadband to homes and businesses.This is particularly important for
rural areas,where wired connections are unavailable or unaffordable.
According to the NewAmerica Foundation, as the world goes wireless,
demand for access to the airwaves will explode. Big retailers and manufacturers
are already investing millions to replace barcoding with wireless inventory
He who owns the band spectrum owns the future. Ireland’s radio
licences are the thin edge of the wedge,but they are a good example. Mr Radioman
knows that he has the monopoly on that piece of real
estate on the band for a certain period of time. Therefore, the ultimate
price of this piece of the band will rise more dramatically than it would do if
the band was open to competition.
The licence,by preventing competition,
acts like the builder’s subsidy on the holiday home. It creates false value.
Opening band spectrum to competition will have to be the way of the future.
Otherwise, huge gains will be made by those fortunate enough simply to own a
licence.This is made all the more bizarre because the licensing of band spectrum
- whether it is for broadband or radio stations – is totally unnecessary.
What has emerged in Ireland is a parallel economy where a series of
subsidies, licences and tax
distortions are the norm. Each falsely increases the return on equity invested
in the respective businesses. This funnels surplus cash into subsidy or licence
“hunting”, to the detriment of other activity.
Why would you invest in
the non-distorted economy if you can get a 50 per cent tax break or a 10-year protection from
competition somewhere else?
Therefore, the cost and availability of
capital falls dramatically in the protected sector, leading to overinvestment,
falling yields, cushioned risk and someone making out like a bandit. It’s
profitable, but free-market capitalism it ain’t. More like cowboy capitalism.
To make matters worse, I picked up the tab for lunch.