The butler did it

Michael Taft: On Morning Ireland, Fergal O’Brien, economist from IBEC, stated:

“Austerity is not killing the economy."

Oh. We are treading into, what Michal Burke called ‘the realm of forgetting’. Forgetting the past, forgetting the link between fiscal policy and economic impact, forgetting basic lessons in Economics 101. Fortunately we have a source to help us remember – and from no less an institution that has done its fair share of forgetting: the Department of Finance.

In the previous Government’s Information Note on the Economic and Budgetary Outlook, published prior to the last budget, it stated that it’s growth projections:

‘ . . . takes account of budgetary adjustments amounting to €6 billion, which are estimated to reduce the rate of growth by somewhere in the region of -1½ - 2 percentage points.’

In other words, for every 1 billion of fiscal contraction (spending cuts, tax increases), economic growth is, on average, cut by -0.25 and -0.33 percent. If this ratio has held since the beginning of the crisis, the result is unnerving.

Since early 2009 there have been effectively four budgets: the February measures (pension levy, current spending cuts), the April Supplementary Budget and Budgets 2010 and 2011. In total these contractions totalled 16.8 billion.

Current spending: 8.4 billion
Capital spending: 3.5 billion
Tax measures: 4.9 billion

There were tax increases and spending cuts in Budget 2009 but much of this was offset by tax cuts (extending the standard rate tax band) and social welfare increases. So we’ll leave that out, though it should be noted that the contractions in this budget amounted to a minimum of 2 billion.

Taking the DoF’s recent fiscal adjustment/growth reduction ratio, we would find that these budgets cut economic growth between -4.2 percent and -5.5 percent. Given that overall economic growth has fallen by -10.4 percent, this would mean that government policy is responsible for between 40.3 and 52.9 percent of the fall in GDP.

This should be treated as indicative. When the full model of the macro-economic impact of fiscal measures on the economy is eventually done, we might find the impact to be less. For instance, capital spending has been cut 3.5 billion, but some of this was absorbed by the fall in tender prices. Not all current spending cuts have the same impact – the fall in procurement prices from multi-nationals will not have the same impact as cutting whole contracts with the indigenous private sector.

However, we should note that fiscal adjustments impact more negatively on the domestic economy. The ESRI, for instance, shows that cutting 1 billion from government spending on public services reduces the GDP in the medium term by -0.9 percent, but cuts GNP by -1.3 percent; cutting public sector wages hits GNP twice as hard as GDP.

So the DoF adjustment/growth ratio may even underestimate the deflationary impact, especially as the fall in GNP was even greater: - 12.3 percent.

The Irish recession was not driven by external demand; exports increased in this period in volume terms. It was driven by a collapse in domestic demand; in particular, investment. Austerity’s impact was mostly felt here, not in the external sector.

Even the DoF admits that austerity policies have lengthened and deepened the recession. But IBEC and many others, including the current Government, refuses to acknowledge this relationship.

It might be convenient for some to ‘forget’. But we shouldn’t. Proceeding with further austerity will undermine growth even further with little to suggest that this is the pathway to fiscal stabilisation.

No, the butler didn’t do it. What killed the economy was the irrational pursuit of deflation at a time when the economy was already deflating. When we ‘remember’ that, we will be starting on a real path to economic recovery and fiscal stabilisation.