Thursday, February 4, 2010

Moral hazard or moral turpitude in the hotel industry.

Last week the labour court was hearing how it was necessary for the irish hotel sector, and other hospitality sector companies to cut minimum wages in order to increase their survivability.

Their survivability is something that interests us of course. We want to see strong economic activity in the country, companies paying decent wages and keeping the local and national economy ticking over and folks in jobs.

Many folks in Ireland and of course the media will meekly accept that this is bad but necessary. But rather than tackle the usual Govt. spoon fed line that There Is No Alternative (TINA) to shafting these ordinary people I'd like to focus on another common phrase these days - moral hazard.

one defintion of moral hazard is:
Moral hazard occurs when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk.

Which means if I know you'll bail me out every time I fall flat on my face then why should I change my behaviour and cop on.

Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its doings, and therefore has a tendency to act less carefully than it alternately would, leaving another party to hold some responsibility for the consequences of those actions.

Less careful than it otherwise would! Leaving another party to hold some responsibility! Could this in anyway be similar to whats happened to the minimum wage workers. Is it possible that they are carrying the can for others mistakes.

Sinead Pentony in an excellent post on the progressive economics site TASC looks at the issue of hotel insolvency and examines an important twist on the minimum wage issue being discussed.

Peter Bacon of NAMA fame has reviewed the south Irish hotel industry and found a mess - (As an aside its interesting to note how Bacon is the go to man for reports it seems – NAMA, reports for the car industry, for the Hotel industry etc etc.)

The hotel sector is insolvent basically. But this is no recent swing of events. Its not one bad year that’s turned the tide on a healthy sector. No quick plaster of a minimum wage cut will do here. Far from being a bad patch the report makes apparent that the hotel sector has much bigger issues. By the end of 2008 there were a total of 59,000 hotel rooms in the south of which 15,000 should be closed down urgently. In other words there is gross over capacity. How could this have been allowed to happen? More on that later.

Not only is there gross over capacity there is also an estimated €1billion in debt in the industry which is not secured by assets. This was clearly an industry out of control. What could have driven such insanity or is it case of “we are where we are” and somehow or other this just magicked out of thin air.

Well the report highlights a couple of reasons why this happened. Firstly tax breaks for the hotel sector created significant over-supply of hotels. Hotels whose viability was questionable from the outset. According to Bacon the stock of new hotels has been seriously insolvent since 2005 and in every year since 2002, new hotels on average have been insolvent from the year of their construction. Clearly there was no useful strategic vision for this sector and that falls into the Govt’s. lap. Tourism is a key aspect of our economy and here as elsewhere they failed to provide positive direction and leadership

The report also highlights the sorry nexus with the financial institutions and banks. The report suspects banks are keeping afloat a large number of insolvent hotels so as to avoid any write downs of their loan books. The banks want to keep open these walking dead hotels because they “need … hotels to remain open for seven years to allow investors to avail of capital allowances and to avoid the creation of a tax liability due to a clawback”. In order to ensure the developers continue to enjoy the advantage of tax breaks which created about 25% unneeded room capacity and landed the sector with €1 billion in unbacked loans the banks are going to take it easy on the hotels and developers and let the zombie hotels keep on going..

The upshot is that hotels with a fighting chance are being forced to compete against “zombie hotels” who are remaining only to ensure previously granted tax breaks are enjoyed. The whole hotel sector is now paying the price and saveable jobs are being put at risk. And whats worse there is suspicion that the solvent hotels are not being lent sufficient credit because the zombies are more important to the banks.

How to solve this dilemma? The Bacon report recommends the next financial act allow these zombie hotels leave the sector without having to pay back the tax incentives.

As Tasc notes :
Essentially, the Report is recommending that developers who took advantage of tax breaks to build hotels that were never going to be viable should not be subject to the clawback of those capital allowances - because they won’t have an incentive to close these hotels but rather, keep them open for the seven years, which will further undermine the hotel industry.

This is the moral hazard described earlier. The rules are bent later in the day to help the developers who over supplied the market. And who will bend the rules. The Govt. that put in place the policies that caused the over supply in the first place.

The estimated amount of hotel related capital allowances which remain to be claimed or have already been claimed, and which potentially could be clawed back by the Revenue, are estimated at over €1.5bn.

The Govt. was instrumental in driving the build up of significant over –capacity without, demonstrably, any clear plans for the tourist sector with the end result that the entire hotel sector is a mess.

So whats the plan? The first step is to cut the minimum wages of those working in the hotel sector which brings us back to our definition of moral hazard. The hotels, developers and Govt. walk away from the problem about as happily as they can and someone else, the minimum wage workers carry the can for a total lack of strategic vision by the govt.

The debate in the background is about wages destroying our competitiveness. Yet nary a peep about the lack of purpose to Govt. planning, the introduction and abuse of distorting tax allowances and what may well be another bailout of developers. All of which have cost us hugely and are the real problem.

There will be no increase to Irish competitiveness while the issue of gross mismanagement and either lack of strategic vision or maybe simply corruption is tolerated in southern Ireland.

So let the Media propose reducing the minimum wage down to zero if they want for hotel workers! Maybe then we could have a debate on what the real problem is and what will help our economy re-establish itself.

Will minimum wages cuts make up for the blind work that brought hotels so low?
Will it wipe of the €1billion in unbacked debt?
Will it make south Ireland a country that invests wisely, plan for the future and structure its growth in a sustainable way?

As David McWilliams said today “The country needs to be fixed, not patched up”.

Hacking the minimum wage is a patch and a patch designed to leave those who have really destroyed compeitiveness off the hook.


  1. What is needed, and what this government lacks, is some imagination and a willingness to look at problems as opportunities.

    There is a massive shortage in good rented student accommodation, good rented single person accommodation, sheltered housing for the elderly etc etc.

    Hotels would be easily refurbished to meet these needs so why not tackle the problem of over supply of hotel accommodation by changing the use of these hotels?

  2. Some good points there, I agree with pretty much everything.. It makes me wonder sometimes what thier aim is when they carry on with such things..