State spending can’t go down the drain

If Kerry invests €100m in the food sector, where investors expect a minimum return of 8%, but it actually generates a return of 12%, financial alchemy occurs. Outside investors who attempt to put a capital value on the earnings stream Kerry’s investment is generating will apply a cost of capital, or minimum expected return, of 8% when 12%, or 150% of the cost of capital, is being achieved. Outside investors will value that new Kerry investment at €150m, 150% of what the food group originally invested.

This is the computational foundation behind the 20% annual increase that Kerry’s share price has shown in the past five years. The strategic foundation has been a decision to shift Kerry’s emphasis away from high-competition and low-reward areas such as dairy processing and towards low-competition and high-reward areas such as food ingredients. Since 1986 and the company’s first stock listing, Kerry’s share price record is comparable with that of Warren Buffett’s Berkshire Hathaway. Is it not high time RTE woke up and told us the story behind this exceptional performance?

Back to public investment: the logic of classifying something as an investment is that it should at least retain its financial value by earning a rate of return in excess of its cost of capital. If you look at official documentation from the Department of Public Expenditure and Reform, this is what the government seeks in that part of its public spending code that sets out standard analytical procedures for project appraisal.

However, there are two problems with that document. First, the document “provides an overview of the main analytical methods and techniques which should be used in the appraisal process”. Note the use of the word “should”, not “must”. Second, there are too many techniques offered for use, some of which may lack the rigour required to ensure that an investment is what it should be: spending today that should bring back even more money tomorrow.

So there is scope to use various cost benefit, cost effectiveness and cost utility methods and multi-criteria analysis where all sorts of heroic assumptions about an investment’s social benefits can be smuggled into the appraisal. Mutton can be made to look like lamb.

All of the recent blather about the special needs of rural Ireland reminded me of the last time a similar coalition of poor-mouth merchants, clerics and opportunisitic politicians mobilised. It is to my eternal shame that I was part of the government apparatus that approved spending on what was grandiosely termed the Western Rail Corridor. This corridor was supposed to link Sligo by rail to Limerick. connecting en route Collooney, Claremorris, Tuam, Athenry, Gort and Ennis.

The grandiose term “corridor” provoked faint echoes of the term valley, as in Silicon Valley. Yet Collooney, Claremorris, Tuam, Athenry, Gort and Ennis will never be in the same league as Menlo Park, Palo Alto, Stanford and Burbank. Nonetheless, a head of steam was built up behind a campaign for the rail corridor led by sociologist Fr Micheál MacGréil SJ.

There were at least two big problems with the project. First, there was little indication that there was much demand for rail services along this route. Second, public transport investments in rail routes are, by their very nature, very inflexible — in contrast to investment in bus services.

The first phase of the network — the Limerick to Galway line — cost €105m to build and initially experienced disappointing passenger numbers. There was a substantial increase in 2014. Yet, even with passengers approaching 50,000 a year on that section of the line, the numbers remain pitiful; they translate into 1,000 passengers a week, or 200 a workday. That means that the state has recently “invested” more than €500,000 for each of those 200 passengers.

The state may classify this as “investment”. However, since it so clearly fails to earn a satisfactory rate of return, I classify it as money down the drain. Little wonder that, in 2011, then transport minister Leo Varadkar postponed the next section, linking Athenry to Tuam, with its estimated cost of €58m. That position has been confirmed by the current acting minister, Paschal Donohue. In its capital investment plan for 2016–21, the government projected it would invest €27bn over that period. That would leave Irish capital spending at a low rate compared with the EU average, even as we expect our population and economy to grow faster than our EU partners’. And, with the government able to borrow at rates of 1% and less, there are many public projects in which it could invest that should be able to earn a higher rate of return — thus economically justifying the expenditure.

Average rent yields of 5%-6% suggest there is potential for profitable public investment in housing, especially in and around our cities. A motorway linking Galway, Limerick and Cork could probably pay its way. There is also a strong case for state investment to ensure a high level of broadband across the country. New schools are needed in those areas, around our cities, that have the greatest population growth. And I imagine there could be considerable savings if new ergonomically designed hospitals and prisons replaced the 19th-century buildings still in use.

Some may bridle at the notion that this is my instinctive position. But there’s another advantage to additional state investment: it counts towards the total amount the state spends in a year. So, the more the state budgets for capital spending, the less it may engage in current spending. And, with borrowing rates low and investment opportunities aplenty, I’d rather the state invested more in the future and spent less propitiating the wage demands of our public “servants”.

PS: Most of our attention on the UK’s looming Brexit vote has been on its possible implications for Ireland. But a much bigger country is anxiously considering what might happen were Britain to leave the European Union. The fear in Berlin is that a UK withdrawal would deprive Germany of a natural economic and political ally at a time of mounting pressure. Britain generally favours expanding the EU in size and membership, but not in powers. This contrasts with France, Italy and Spain, who would all favour a more interventionist and distributive EU. Such a stance cuts across German national interests.

This all comes at a time when the EU is facing pressures on several fronts. The flood of refugees from the south and the east shows little sign of abating. Though there may be fewer coming into Greece from Turkey, there seem to be as many trying to make their way across the Mediterranean from north Africa.

On top of that, the eurozone crisis hasn’t gone away, with the Economist Intelligence Unit (EIU) saying: “It is questionable whether any Greek government could implement the measures required under the third bailout programme.” The EIU feels there is a 60% chance Greece will leave the EU by 2020. Germany has already had to get used to being permanently outvoted at the European Central Bank as Mario Draghi has successfully pushed through quantitative easing and negative interest rates.

These policies suit Europe’s debtor countries, including Ireland. They don’t suit Europe’s creditors, particularly Germany. These policies are especially damaging to Germany’s large banks and insurance companies. The share price of the country’s largest commercial bank, Deutsche Bank, has dropped nearly 50% over the past 12 months, while that of its largest insurance company, Allianz, is down nearly 10%. If Brexit occurs next month, this could all just be a foretaste of what’s to come for Germany.