Out of the traps and into the abyss

Michael Burke: A piece in today's Guardian reports on the downgrade by Moody's, and expresses some surprise that there wasn't much of a reaction in Ireland.

The journalist goes onto to argue that the downgrade was subsumed by the latest twist in the saga of NAMA, the banks and the property speculators- who want to be bailed out but to keep all their assets too.

But the muted reaction may also have something to do with self-delusion. Mark Fielding of ISME is quoted in the piece as saying that the government is going in the right direction. And there is this quote from the financial journalist Simon Carswell, "The main story here is our problems are huge, but we are doing the right things to fix them. What Ireland has done better than any other country is that it was the first out of the traps to try and fix things. Darling and Brown went in the completely opposite way. They thought they could spend their way out of the recession."

Yet, the British economy did indeed come out of recession, and it was entirely due to increased government spending. The domestic economy expressed by GNP recovered in Q4 2009, at the same time as GDP rebounded. Government current spending and government investment rose by a combined £10.36bn during the British recession, which is greater than the £9.65bn in the recovery to date. Apart from declining imports demand, it was the only category of the national accounts which made a positive contribution to growth in 2009.

Surely, though, spending like this would have produced a huge widening of an already large deficit? By happy coincidence the British ONS also published today the June report on Public Sector Finances. And the short answer is No. In the period since the beginning of the Financial Year, the April-June 2010 public sector net borrowing is £4.6bn lower than in the same period a year ago. And the reason is that taxes are higher, up £9bn. The rolling 12-month borrowing total is down to £143bn. That's just 6 months after the Pre-Budget Report projected a £178bn for this Financial Year.

How can that happen? How can increased government spending lead to a declining public sector deficit? It's actually based on a simple lesson, painfully learnt in the 1930s, after a prolonged period of austerity measures failed to close the deficits. In a slump increased government spending increases total demand, thereby increasing taxation revenues and decreasing welfare expenditures. In short, government spending more than pays for itself- it provides a positive net return to the exchequer. And the opposite is the case; decreased government spending in a slump depresses total demand and so lowers tax revenues and increases welfare payments (even when welfare entitlements are cut).

Irish government policy was first out of the traps- and headed straight for disaster. The British, being relatively slow learners, are now emulating Dublin's policy and will reap the same dubious rewards.