The ECB and the Forthcoming Referendum

Jim Stewart: A recent speech delivered by Mr Asmussen (Executive Director of the ECB) at a seminar organised by the IIEA in Dublin (The Irish Case From An ECB Perspective), gives powerful (though unintended) grounds for a no vote in the forthcoming referendum.

Mr Asmussen emphasised that from an ECB perspective it was of the “utmost importance” that all euro area countries adopt the fiscal compact to regain the confidence of markets. The overall policy can be summarised as austerity (raising taxes cutting expenditure) releases, what Paul Krugman has called the ‘confidence fairy’ and recapitalising banks and repaying senior bond holders, releases the ‘banking fairy’ – banks will once again start lending. Both policies in the absence of policies to encourage growth and investment will simply result in further stagnation. The Fiscal Treaty will make the adoption of policies supporting growth more difficult if not impossible.

Specifically in relation to Ireland, Mr Asmussen clearly outlined ECB thinking on the origins of the crisis and subsequent developments. In summary the view of the ECB is that while the crisis largely originated in Ireland, the solutions devised in conjunction with the Commission and the IMF and set out in the EU/IMF Programme for Ireland are working . The ECB has been particularly generous in its support to Ireland (“working as a true partner”), and because the programme is working there must not be any deviation from it for example in relation to the payment in full of the promissory notes, issued to finance the Irish Bank Resolution Corporation.

The following examines three claims made by Mr. Asmussen:-
1 “The Programme is on track. So far Ireland has delivered” (p.1);
2 The ECB is “a true partner” to Ireland (p.3);
3 “No other institution has provided more help to Ireland than the ECB” (p.7).

“The Programme is on track. So far Ireland has delivered”
Many might query that the EU/IMF Programme is working. Mr Asmussen states Ireland “is the only programme country that has managed to close its deficit and to return to growth last year” and cites growth last year of 0.7% and projected growth of 0.5% in 2012. But we should note projected growth (Table 1) at the time the Memorandum of Understanding was signed (16 December 2010), and on which the programme was predicated, was considerably larger than actual and projected GDP.

Table 1:

	'10	'11	'12;	'14	'15
Department of Finance forecast of GOP growth, December 20101	0.3	1.7	3.2	3.0	2.8
Actual 2010-2011 IMF forecast, 2012-2017	-.04	0.7	0.5	2.0	2.5
Department of Finance forecast of unemployment rate, December 2010	13.4	13.2	12.0	10.9	9.8
Actual Unemployment rate for 2010-11 and IMF forecast April 2012	13.6	14.4	14.5	13.8	13.0
Department of Finance forecast of change in total numbers at work 10th, December 2010	-4.0	-0.2	1.3	1.6	1.8
IMF forecasts for change in numbers at work April 2012	-4.2	-2.0	-1.0	0.07	—

The ECB does recognise unemployment as an issue. Mr. Asmussen states, (p. 6) “worst of all, perhaps, is the fact that a large portion of the population is currently out of work”. What is not stated is that unemployment in Ireland is the second highest in what the IMF classifies as advanced Europe (IMF World Economic Outlook April 2012, Table 2.1 p. 53) at 14.4% in 2011 and is forecast at 10.5% in 2017. Examples cited by Mr Asmussen such as deregulating the market for legal and medical services (p. 5) are most unlikely (even if implemented), to “expand activity and increase employment” in any meaningful way.

The ECB is “a true partner” to Ireland;
Mr Asmussen describes the ECB “as a true partner”. In fact many of the policies implemented and required by the ECB have magnified the crisis in Ireland. In his address Mr Asmussen clarified that the ECB regarded repayment of Anglo bondholders as a key consideration to prevent negative effects to “banks in other European countries”. This clarification is strangely absent from the written statement (available here). These ‘negative effects’ are uncertain. Bondholders may have held insurance in the form of credit default swaps. Default on senior bank debt by banks in Denmark had no or very little (reported consequences) for banks in other countries (see Denmark Takes Over Second Bank to Trigger Bail-in Resolution, Bloomberg 27 June 2011) and yields on Danish Government debt are close to or below those for Germany. But the main implication of Mr Assussens comments are that the ECB sought to give preferential treatment to banks in other countries at the expense of the Irish State and Irish society. This transfer in wealth (it was a transfer as Anglo-Irish and other banks senior debt was trading far below the value at which it was redeemed before the new government took office) has helped increase the cost to the State of the bank recapitalisation to €62.8 billion by March 2012 approximately 38% of General Government gross debt. Without any bank recapitalisation Irelands Debt/GDP ratio would be approx 65% of GDP (ignoring interest savings)- amongst the lowest in the eurozone.

In February 2011 the five institutions recapitalised, held €35 billion in senior unguaranteed secured and unsecured bank debt (see Senior Debt and Subordinated Debt Issuance by Irish Credit Institutions, Central bank March 2, 2011 available here). If this were written down by 50%, the Debt/GDP ratio (as measured by the IMF), would fall from 105% for 2011 to 94%. (Note this excludes the approximately €71 billion in bonds redeemed at face value prior to February 2011). Any policies that reduce government borrowing and the Debt/GDP ratio, without advesely affecting economic growth will enhance Irelands ability to access market based funding. The ECB belief that negotiating a reduction in the cost of the promissory notes would adversely affect Ireland’s credit rating is delusional. The IMF has recently urged the need to reduce the links between sovereign debt and bank debt. In Ireland the policies of the ECB have the effect of increasing these links.

“No other institution has provided more help to Ireland than the ECB”.
The one area where ECB policy is beneficial to Ireland has been through Eurosytem liquidity provision. Mr Asmussen implies that this liquidity provision was in some sense preferential aid to Ireland. He states “Relative to the size of the economy, no other euro area country has received so much support from the Eurosytem. And no other institution has provided more help to Ireland than the ECB”. However the provision of unlimited liquidity is one of the main functions of a Central Bank and liquidity was provided to banks in Ireland fully in accordance with ECB rules (a point acknowledged by M. Asmussen) and cannot in this sense be preferential. Furthermore the benefit of this liquidity provision accrues not just to Ireland but in a monetary union given large scale interbank borrowing and the presence of a large EU owned bank sector in Ireland, throughout the monetary union. A collapse in Ireland’s banking sector would have been a calamitous event not just for Ireland but for the Eurosystem.

Mr. Asmussen states that the level of this “support” contradicts claims that the ECB “bounced” Ireland into the EU/IMF programme in late 2010. Rather the level of liquidity provision which the ECB erroneously believed was in some sense a gift or aid, exclusively to the benefit of Ireland, and the desire of the ECB to reduce this as quickly as possible were likely to be prime factors in the initiation of the EU/IMF programme. Reducing ECB liquidity provision to Irish banks remains a key policy objective of the ECB. Mr Asmussen states “There can be no doubt that the current amount of liquidity support by the ECB and the Central Bank of Ireland needs to be substantially reduced over time”.

The expressed wish to reduce the amount of eurosystem liquidity provision is not in Ireland’s current interest. A policy objective should be to maximise the amount of liquidity provision from the Eurosystem, given the risks of bank deleveraging as a response to the economic crisis. This risk has been exacerbated in Ireland by the imposition of a higher core Tier 1 capital ratio (equity/risk weighted assets) than that required by the European Banking Authority (10.5% compared with 9%) and at the same time reducing the loan to deposit ratio from 180 to 122.5% (See Central Bank, Financial Measures Support programme, p. 7 and 12).

The crisis in Ireland is largely of our own making involving multiple failures at many institutions (public and private) and at many levels, but ECB policies have magnified the crisis. Policy at the ECB and other EU institutions can and must change to support a pro-growth strategy for Europe as a whole. This is in the interest of all countries in the EU, and in the vital long run interest of Germany. Irish Government policy should be to support the likely new Hollande administration in amending the fiscal treaty and in reforming the ECB (See “Hollande seeks wider EU fiscal pact”, Financial Times April 24, 2012).

Ireland's financing alternatives - the EFSF

Tom McDonnell and Michael Taft: In our first post, we outlined some of Ireland’s financing alternatives; namely through the IMF and the European Stability Mechanism. There is, however, a more compelling source of institutional funding in the eventuality of a No vote: the European Financial Stability Facility (EFSF).

The EFSF is one of four external sources of funding for the current Irish bail-out (along with the IMF, the European Financial Stabilisation Mechanism, and bi-lateral loan agreements with the UK, Sweden and Denmark). The EFSF remains a source of funding for all Eurozone countries until the middle of next year.

The EFSF stands apart from the ESM and the Fiscal Treaty. Ireland, and all countries who are members of the EFSF, has access to this fund as of right, depending on the following conditions:

• They cannot access funding at reasonable rates on the international markets
• They have negotiated a Memorandum of Understanding with the EU and the IMF

A further stipulation is unanimous consent from the Finance Ministers of the Eurozone (Eurogroup), which would follow on from an agreement with the EU/IMF. Applications for this funding can be made up to the end of June 2013. After that the EFSF will only administer funding that has already been agreed.

According to the recent Eurogroup statement (the Finance Ministers of Eurozone countries):

‘For a transitional period until mid-2013, it (the EFSF) may engage in new programmes in order to ensure a full fresh lending capacity of EUR 500 billion (for the ESM).’

This is confirmed by the EFSF itself which states:

‘ . . . following the Eurogroup meeting held on 30 March, it was decided that the EFSF would remain active until July 2013 . . . For a transitional period until 2013, EFSF may engage in new programmes in order to ensure a full fresh lending capacity of €500 billion . . . after June 2013, EFSF [will] not enter into any new programmes.’

Therefore, were Ireland to apply for a second bail-out prior to July 1st 2013, it would be granted if such an application were accompanied by a Memorandum of Understanding negotiated between Ireland, the EU and the IMF – similar to the first bail-out. This funding is not contingent upon the ratification of the Fiscal Treaty.

In all probability, funding for Ireland’s second bail-out – whether it approves the Fiscal Treaty or not – will be routed through the EFSF. The EFSF (the temporary bailout fund in place up to July 2013) and the ESM (permanent bailout mechanism) are different companies. The EFSF has €440 billion (see page 1 of the EFSF document) of which €192 billion already committed to Ireland, Portugal and Greece (see the diagram on page 20 of the EFSF document). The remaining lending capacity of the EFSF for programmes initiated before July 2013 is therefore €248 billion. The EFSF will remain in place to manage its existing programmes (see diagram on page 20 of the EFSF document) and any other new programmes approved prior to July 2013, until such time as all these programmes are all wound down.

The ESM itself has €500 billion and is scheduled to enter force on 1 July 2012. As stated above, the intention would be to ensure the ESM retains its full lending capacity of €500 billion. This no doubt refers to the prospect of larger countries, in particular Spain, needing a bail-out. The ESM would require full capacity to accommodate new countries’ need for a bail-out.

Ireland’s continuing access to institutional funding beyond the current bail-out programme has been guaranteed not once, but twice, by the Heads of States and Government; first, on July 21st of last year when the establishment of the European Stability Mechanism was agreed, and most recently on January 30th of this year – after the Fiscal Treaty was signed:

‘We welcome the latest positive reviews of the Irish and Portuguese programmes which concluded that quantitative performance criteria and structural benchmarks have been met. We will continue to provide support to countries under a programme until they have regained market access, provided they successfully implement their programmes.’

This is an important and helpful guarantee. There is no condition set on continued support until we return to the markets – except that we implement agreed programmes. If continued support were contingent upon acceptance of the Treaty, we should have expected it to be highlighted in this statement.

This helps explain another issue we highlighted in the first post. The drafters of the European Stability Mechanism Treaty inserted clauses that provide manoeuvrability in negotiations with any Eurozone country in need of financing, regardless of the Fiscal Treaty. In particular, they inserted references to ‘new programmes under the European Stability Mechanism’, a clause which would have been unnecessary if all financing under the ESM were strictly conditional on a yes vote. They have seemingly factored in a situation whereby a second bail-out for Ireland (and potentially Portugal and Greece) would constitute ‘rolled-over’ financing, rather than ‘new’ financing. This buttresses the guarantee given by the Heads of States and Governments – namely that Ireland will continue to be supported until we return to the markets.

This is an important debate as there is a high probability that Ireland will require a second bail-out. We are expected to return to the markets in late 2013 and fully by 2014. However, the IMF is cautious:

‘Debt sustainability remains fragile, especially with respect to medium-term growth prospects . . . In this context, the prospects for regaining the substantial access to market funding that is assumed in 2013 remain uncertain.’

Were a second bail-out required, we estimate that it could be as large as €45 billion and possibly more for the years 2014 and 2015, taking into account the Exchequer balance and bond redemptions. This does not include bank payments. While this is less than the current bail-out provision it is clear that Ireland, without access to either market or institutional funding, would not be able to cope with this fiscally. We would be heading into a default – quite possibly on both sovereign and banking debt. This would have negative spillover effects for other Eurozone countries.

We reiterate the point from our first post: there is no reason to resort to counter-posing ‘appalling scenarios’. Some argue that Ireland will be frozen out of both market and institutional funding if we vote No. Clearly, this would be an appalling scenario. Others argue that it would never come to this because of the impact on the Eurozone (defaults, contagion) – another appalling scenario.

This is not a satisfactory way to debate this issue. This will trap us in a ‘race-to-disaster’ debate which will be particularly uninformative. We have attempted to outline concrete alternative funding scenarios for Ireland. Whether these would become available is a subject for legitimate debate. However, those who claim that Ireland would be denied access to EFSF funding – or any other funding sources – should provide concrete evidence to this effect. Evidence one way or the other would be a valuable contribution.

The debate over the Fiscal Treaty should be just that – a debate about the provisions of the Treaty. In this respect, it is helpful to note wider European developments. Spain has, unsurprisingly, officially re-entered recession putting at risk their deficit targets; the prospect of a Socialist Party victory in the French second-round Presidential vote raises the prospect of some renegotiation of the Fiscal Treaty; the fall of the Dutch government over failure to agree budget cuts highlights the problems posed by the Fiscal Compact in a major core country.
As Ireland prepares for the referendum vote, the ground under the Fiscal Treaty may already be shifting. Resort to ‘appalling scenarios’ will only confuse the issue when the debate should be focused on whether the provisions of the Fiscal Treaty are good, or even sustainable, for Ireland and the Eurozone.

Why we need an Economic Plan B

The NERI (Nevin Economic Research Institute ) will hold a seminar on Wednesday 25th April 2012 entitled ‘Why we need an economic Plan B?. Further information here. To register your interest in attending and for further details please e-mail info@nerinstitute.net.

Changing the way companies are taxed

Sheila Killian: As reported by the Irish Times, yesterday, the European Parliament approved a resolution proposing amendments to the CCCTB (the common consolidated corporate tax base). So what is this all about? Well, the CCCTB aims to streamline the basis on which companies pay tax in the different countries in the EU, and to allow companies established in any EU country to make a single tax return covering all EU states. The tax base would then be allocated among the countries on the basis where the assets are located, where the payroll bill is, or where the sales are made. So if a company made most of its sales in France, for example, and had all its assets and payroll in Ireland, then France would be entitled to tax some of the company’s tax base at French rates, while Ireland would tax the remainder at Irish rates.

This is a fundamental change from our current residence rules, which allow a company resident and operating here in Ireland, but making sales all over the EU to pay all of their tax in Ireland. The idea behind it is to streamline administration for companies operating in the EU, eliminate double taxation and double non-taxation more efficiently than bilateral treaties would, and essentially make irrelevant intra-group transfer pricing arrangements within the EU.

Not surprisingly, the CCCTB is seen in Ireland as a threat to our ability to raise taxes from companies operating here. More significantly it’s seen as damaging to our policy of seeking foreign direct investment on the basis that our 12.5% rate will apply to all their profits.

Up until now CCCTB has been proposed by the European Commission as a voluntary system: companies could opt-in to the system at their discretion. Furthermore there was a sense that the relatively slow process of decision-making at EU level would mean a long lead-in to the operation of the CCCTB. Yesterday, however, the European Parliament passed a vote to make the CCCTB mandatory for all but the smallest companies within the next five years.

The resolution passed by the Parliament also had three other interesting aspects, which were less widely reported. Most importantly, they recommended a change to the weighting between the three factors – assets, payroll and sales. The European Commission's original idea was that these three would be equally weighted. The Parliament proposes putting a 45^ weight on each of assets and employees, and only 10% on sales. This amendment would be good for Ireland, and seems fair in the sense that most profit is generated through the workforce and assets. http://www.blogger.com/img/blank.gif

Parliament also proposed that if some countries were not ready to embrace CCCTB, then others could move ahead without them. This is an idea that would have seemed far more radical a few years ago, before the Fiscal Compact. Finally, the parliament’s amendment specifically includes a review of the usefulness of corporate tax harmonisation when the CCCTB comes up for review after five years.

The vote means that the interesting times promised by the CCCTB are more immediate than before. A focus on the relative weightings of the three criteria for apportioning the tax base – assets, workforce and sales – is now of critical importance. There may be scope for making the CCCTB both more politically palatable and more fair with an increase in the weightings of assets and workforce.

Power, Trust and the Household Charge

Sheila Killian: This afternoon Erich Kirchler gave a very interesting seminar here at the Kemmy Business School on the factors that affect taxpayer compliance or evasion. He finds two dimensions – power and trust – impact on the overall tax take. If the taxing authorities are seen to have high power, unsurprisingly this will mean greater compliance with tax laws. However it is equally important, particularly for self-assessment, that there is high trust in the system. If taxpayers don’t trust the authorities to use tax revenue properly, then the level of taxes raised will fall.

Professor Kirchler mapped the overall tax take along these two dimensions as a “slippery slope” that looks like this:




You can see how the ability of a country to raise taxes falls away if the power of the authorities, the trust in authorities or both are reduced.

Voluntary compliance is very a delicate thing, requiring a public understanding of the role of taxes in maintaining society. It’s very difficult to foster, particularly in a post-colonial society. In Ireland, only a few generations ago, to avoid your taxes was seen as a patriotic act of rebellion, and to pay was seen as funding the oppressor. We have an emerging maturity about taxes, visible in the way in which tax evaders are publicly criticised now, but this new understanding is shockingly easy to damage.

In Ireland, the fact that the household charge became the focus of the protest against austerity indicates that it has been damaged here. Since there is no sign that people believe the authorities have less power than before, it follows that trust in the system has been lost somehow, in a way that relates to the austerity measures, and the public discourse around them.

Some questions around this:
- If taxes in Ireland are seen as being used primarily to repay banking debts which are seen as unfair, does this diminish the overall trust people have in the tax system?

- How much does the artificial divide which has been created in the public mind between the public and private sectors degrade this trust?

- If the social norm becomes non-payment, even as part of a protest, will we reach a point on that slippery point beyond which it will be difficult to recover?

by Sheila Killian


Source of graph: Journal of Economic Psychology, Volume 29, Issue 2, April 2008

A 'closer look at Estonia'

Michael Burke: ‘Those who declare with infinite certainty that spending cuts and tax increases cannot work, or that there is no example of an economy cutting its way out of recession should take a closer look at the Baltics.’ So says Dan O’Brien, the Economics Editor of the Irish Times.

When it has been previously pointed out that other European countries, such as Germany and Sweden adopted measures to stimulate the economy, we were told that Ireland is unique. When we pointed that small open economies like Belgium had imposed windfall taxes on banks and energy companies to fund government investment, we were told Ireland is not Belgium. Since tautology cannot be disproved, this seemed to settle matters, at least to our critics’ satisfaction.

But now we are told, Ireland is Estonia, or at least should emulate its ‘success’, which is all that was being asserted in the case of countries which boosted investment to spur recovery. Tom McDonnell’s piece on the Baltic States is very welcome in puncturing this nonsense.

There is just one point worth adding, I think. That is, there is no ‘success’ of the Estonian model via what is euphemistically called internal devaluation, aka severe wage cuts to boost the rate of profit.

Below is a table compiled from the IMF country report that Tom helpfully linked to. It shows 3 things. First is the level of GDP growth. Here the Estonian Finance Ministry has issued an updated forecast for 2012, which is that growth will slow dramatically to 1.7% in 2012. Second is the net contribution from the EU as a proportion of GDP. Third is simply the sum arising from deducting two from one, ie what growth would have been without the EU net contributions. The latter does not include any multiplier effect from the spending of the EU, just its arithmetical total.

Estonia GDP and EU Subventions

Source: calculated from IMF, Estonian Finance Ministry data

Before taking into account EU funds, Estonian GDP is now officially expected to end 2012 still 7.6% below its peak in 2007. The entire EU subvention over the period will be equivalent to 20.6% of GDP. The entire growth over the period, from the low-point is just 11.6%. Without the EU funds the Estonia economy will have contracted over the period by 25.3% (again, taking no account of any multiplier effects arsing from that investment).

As is well-known, the EU is a public body. Insofar as there has been any recovery in Estonia it is entirely a function of state, or supra-state bodies. Equally it is well understood that these subventions come in the form of subsidies to particular sectors, especially agriculture, and in the form of structural and cohesion funds. These investment funds are the larger part of the EU funds provided, equivalent to 16% of GDP over the period. They concentrate on infrastructure, transport and other areas.

The ‘internal devaluation’ model has been a disaster for Estonia. Those who want to rescue profits by reducing wages are searching far and wide to find examples of where this had led to growth. But they are failing. The sole success for Estonia over the period has been investment from state bodies. This is the lesson from the Baltics, and one which does apply to Ireland.

The Baltic Experience

Tom McDonnell: Dan O'Brien recently argued that the Baltic countries provide good examples of the case for front loading austerity. He notes that: "Estonia’s GDP grew by a blistering 7.6 per cent last year, Latvia’s by 5.5 per cent and Lithuania’s by 5.9 per cent. The three were – by a considerable distance – the fastest growing economies in the developed world." He suggests that front loaded austerity and greater competitiveness i.e. internal devaluation, are required to resuscitate the economy.

I would argue that this feel good story needs to be put in context. Unfortunately the recent experience of the Baltic countries has not been a happy one and these countries grew so fast in 2011 in part because they had previously fallen so very far. Table 1 of this paper by Terazi and Sanel shows the scale of the decline in real GDP in 2009 alone. The Baltic countries suffered the largest declines in economic output in the EU despite already being amongst the poorest EU states in terms of GDP per capita.

The Latvian experience has been particularly traumatic. This paper from Weisbrot and Ray of the CEPR provides an overview of the Latvian experience. Latvia's loss of output was 24.1 per cent - even larger than Ireland's (see figure 1 for a comparison with historical downturns).The IMF estimates that Latvia's real GDP will only return to 2007 levels in 2016 (see figure 2). Effectively a lost decade and surely no blue print for 'best practice' in managing downturns. Weisbrot and Ray argue that the data contradicts the notion that Latvia's experience provides an example of successful internal devaluation and they caution that weaker euro zone economies should be wary of becoming locked into pro-cyclical policies.

Unemployment in the three Baltic states also remains above the EU average of 10.2%. Estonia fares best at 11.8% while Latvian unemployment is 14.6% and Lithuanian unemployment is 14.3%. The employment rate in all three countries is also below the EU average. Even these figures don't tell the full story as it is estimated that Latvia's net loss of population in 2009-2011 amounts to as much as 10 per cent of the labour force.

Overall the picture is mixed. Estonia has certainly fared better than Latvia and Lithuania. The IMF country report for Estonia is here. Figure 3 on page 23 of the pdf shows the impact on employment since Q3 2007 with net employment still below 2007 levels. GDP still remains below 2007 levels five years on, although Estonian GDP is forecast by the IMF to pass that threshold in 2012 (see table 1 on page 29 of the pdf).

I guess success is relative.

Agreement and Difference with Minister Howlin

Nat O'Connor: Minister Brendan Howlin’s opinion piece in the Irish Times is to be welcomed. It is valuable to have a Government Minister engaging with the vital arguments put forward in the joint opinion piece of Friday 6th April by 39 economic analysts, many of whom are members of TASC’s Economists’ Network.

There are a number of areas of agreement between both pieces. Both seek to achieve recovery through growth and both acknowledge the important role of achieving productivity and efficiencies in the public service. Most significantly, both agree with the importance of investment, and Minister Howlin’s piece identifies similar sources for investment as those identified in the original article, such as the NPRF and pension funds.

There is potentially a significant difference of opinion in the articles about what would be the role of investment now. Minister Howlin confusingly supports investment yet dismisses stimulus as short-term only. It appears to be on this basis that he claims the Government can go no further in the direction of counter-cyclical policies. The depiction of investment as mere stimulus fails to see the win-win scenario that is possible from targeted investment in specific infrastructure and human capital (such as broadband and education) which will also result in an increase in the economy’s long-term productive capacity. Ireland would in future reap the rewards of these investments, as they create opportunities to create and expand businesses that would not be possible without such investment.

Minister Howlin rightly points to the scale of the problem confronting the State, in terms of the enormous gap between tax revenue and spending. However, he fails to address the options for structuring taxation differently to increase revenue and to balance some of the injustice of regressive tax measures, like the increase in VAT. Likewise, the problem is ultimately not just the State’s finances, but the finances of the country as a whole, including private debt and the crisis of unemployment.

Surprisingly, Minister Howlin does not mention unemployment and job creation, although in fairness, they may be implied by his discussion of increasing investment. However, it is important that growth in sustainable jobs is the measure of success, not just GDP growth statistics. In the context of jobs, Minister Howlin does not explicitly mention the demand-side to job creation (that is, the need for more demand in the economy to permit job creation) but again this may be implicit in his emphasis on investment.

It is unfortunate that Minister Howlin does not address the economic and fiscal costs of social disinvestment. Public service cuts can lead to social costs such as more young people leaving education early, worse educational outcomes overall, less early intervention in health and mental health problems, and so on. These costs have a real effect on the economy, by lowering its long-term productive capacity – the reverse effect of productive investment.

Moreover, social problems have a real effect on the Exchequer, as a euro saved today may result in crime or health issues that cost many more euros tomorrow. If preventing social problems now (through early intervention or education supports) is cheaper than paying to deal with them in future, Ireland’s lenders can accept that this increases rather than diminishes Ireland’s debt sustainability. The 'troika' care more about the debt being repaid than the means used to do so, and they are open to rational cost-benefit calculations such as this.

There is some agreement between the articles on the importance of action at the EU level. However, Minister Howlin only focuses on the role of the European Central Bank, whereas arguably there has been a failure of leadership by both the Council and Commission. The dogmatic pursuit of price stability by the ECB is also unhelpful, and needs to be tempered by an equal focus on employment and sustainable growth in the Euro zone economies. Yet, there is little sign of this kind of thinking at EU level, where there are the resources for an EU-wide programme of productive investment.

Minister Howlin offers a defence of the fiscal compact treaty, which will require Ireland to reduce its structural deficit to less than half of one per cent. From a Keynesian perspective, it is economically correct to have some kind of mechanism that will oblige a Government to save during good economic times. However, Minister Howlin is factually incorrect when he suggests that having the compact would have caused the previous administrations to stow away more savings. This is because major institutions, like the IMF and ECB, claimed that Ireland had a structural surplus during the boom. It was only retrospectively that these calculations were substantially revised to show structural deficits in the last years of the boom. The difficulty in defining and measuring structural deficits – let alone forcing governments to act on them – should not be underestimated.

Minister Howlin acknowledges that he simplifies the argument made by the original contributors. We were certainly not arguing that there is a simple or pain-free way to achieve Ireland’s social and economic recovery. The Fianna Fáil policies of 1977 he dismisses were focused on increasing current spending as a crude stimulus, which is far from what is being proposed by the call for productive and targeted investment through capital spending on infrastructure and human capital.

What is at stake is whether or not there is a viable set of economic policies that would address the jobs crisis and social problems resulting from the current crisis, while also addressing the fiscal crisis that the State faces, as an alternative to the economic approach being taken by the current Government, which in many of its core aspects is a continuation of the policies of the previous administration.

Building on the areas of agreement, such as public service reform and the need for investment, the following arguments (and points of disagreement with Minister Howlin) are reasons to believe the alternative being proposed is viable:
• Productive investment is much more than short-term stimulus because it will increase our economy’s future productive capacity and job creating capacity, which in turn will raise the State’s revenue;
• Much more could be done to restructure taxation to make it more just and to bridge the State’s deficit;
• Social problems through social disinvestment will cost more to solve than they will to prevent – and lenders can be persuaded of that;
• The EU could do much more to solve the crisis, including changing the mandate of the ECB to include maximum employment and sustainable growth.

Responding to the Minister

Michael Taft: The Minister for Public Expenditure and Reform, Brendan Howlin, has responded to the open letter signed by 39 economists, social scientists and analysts. It is welcomed that a Government Minister is willing to engage constructively as this can only improve the public debate. That the Minister claims there is considerable common ground between the contributors and the Government is further welcomed. But ultimately the Minister doesn’t believe the strategy outlined by the contributors is viable. I’d like to address some of the issues the Minister raised in his article. I speak, of course, only for myself and not for any other signatory of the open letter.

The first problem we confront is a disconnect between what the Minister claims and what is actually happening in the economy. He states:

‘The importance of growth is factored into our budgetary figures. Our own economy has returned to modest growth and indeed, the greatest impediment to future growth is the state of the global economy.’

The problem here is that the economy has actually returned to recession – a double-dip recession. The latest quarterly data we have – from the second half of last year – shows GDP in decline. When we turn to the domestic economy, we find the biggest fall since the dark days of 2009. It is difficult to reconcile the statement ‘our own economy has returned to modest growth’ with the fact that we are back in recession.

The second problem is a denial of what the Government is actually doing.

‘Contrary to the view articulated (by the contributors), the Government is not pursuing an “austerity” strategy. The opposite is the case.’

Again, it is hard to reconcile this with what the current Government is doing. In the last budget, the Government engaged in a fiscal contraction equivalent to €4.3 billion (according to the EU Commission, factoring in the carryover from Budget 2011). This was made up of tax increases – primarily regressive VAT increases – and spending cuts, in particular a significant €750 million capital investment cut.
This will have a profound impact, not only on the social fabric, but on economic growth. The Minister for Finance has estimated that for every €1 billion in cuts/tax increases, the GDP falls by €500 million. On this basis, the Government reduced growth by €2.15 billion or over 1 percent off real GDP.

It is worth noting that the Government is now at pains to distance itself from the word ‘austerity’ – such is the low esteem it is now held among people since it is a by-word for low-growth, job losses and rising debt. However, to maintain that you are not pursuing austerity while at the same time doing just that is slightly disingenuous.

From these highly contestable propositions – that the economy has returned to growth and the Government is not actually pursuing austerity – the Minister takes critical aim. But it is not clear exactly who he is aiming at. First, he claims:

‘It is perplexing then to see a problem of this scale (the deficit) effectively dismissed by the suggestion that there is a better, simpler, pain-free way.’

Clearly, this does not refer to the open letter which sets out a very rational approach to fiscal consolidation – ‘smart’ or ‘growth-friendly’ fiscal consolidation:

‘Such an investment programme must be accompanied by “smart” fiscal consolidation, focusing on the least contractionary forms of fiscal adjustment. This requires progressive and equality-proofed taxation targeting high-income groups, property assets, unproductive activity and passive income, as well as environmental measures.’

I doubt there is any Government minister that would disagree with this formulation. And this certainly doesn’t suggest ‘a simpler, pain-free way’ – though it does suggest a ‘better’ way.

Ultimately, the issue is not whether there should be fiscal consolidation or whether it should be pain-free, but what is the most effective and efficient means. According to the ESRI, spending cuts are the least efficient and effective means of deficit reduction for the reason that they most contractionary forms of adjustment. Again, the Minister would be aware of this research – and the common sense behind it.

It also overlooks the fact that investment itself is an effective means of deficit reduction. Putting people back to work, increasing the productive capacity to grow cuts both the general and the structural deficit. In this regard, the Nevin Economic Research Institute’s (NERI) recent report puts the growth potential of investment in perspective.

Second, the Minister claims:

‘The idea that we would use all of our available resources in an all-or-nothing attempt to kick-start the economy strikes me as more Fianna Fáil circa 1977 than John Maynard Keynes, bearing in mind that the sum mentioned, €15 billion, equates to approximately one year’s exchequer borrowing requirement, money borrowed to pay day-to-day costs.’

There is, of course a difference between Fianna Fail’s economic adventurism and the investment-based approach advanced in the open letter. In the late 1970s Fianna Fail gambled that cutting taxation and boosting Government consumption would lead to increased consumer spending. As a result, the indigenous private sector would expand to meet growth among indigenous firms which they assumed would respond with a surge of expansion. This didn’t happen, of course; all we got was the stagflation of the 1980s.

The open letter strategy, however, is to address the economic and social deficits through investment which will grow the productive capacity - a strategy completely at odds with the badly misjudged Fianna Fail strategy of pump-priming consumer expenditure.

In this context, the ‘all or nothing’ reference is curious: it is hardly ‘all or nothing’ to roll out a next generation broadband, to invest in education from pre-primary to lifelong learning, to modernise our water & waste system. This is not about kick-starting, it is about creating new assets that will generate income and reduce spending in the future.

The phrase ‘silver bullet’ only reinforces the notion that the Minister was debating other positions. Even the reference to the ‘€15 billion’: the open letter didn’t propose a €15 billion programme (though NERI has). It merely outlined the sources where investment could commence – the €5 billion in the pension fund, the €15 billion in cash balances, the use of public enterprises’ commercial potential. Regarding the cash balances, even the Government has admitted that using €6 billion of this amount to write-down debt would still leave the balance ‘relatively healthy’. Why not redirect this amount into building our productive capacity?

While it is welcome that the Minister has publicly engaged with the open letter, it is disappointing that he argued from highly contestable premises while failing to address the real and practical propositions that the letter put forward. We are still left with the need for the Government to actually put forward concrete evidence that spending-based fiscal contraction is economically efficient; that privatisation will enhance our net investment position; that an economy that has returned to recession and suffering from rising joblessness and poverty can somehow, at the same time, repair its public finances.

We are still left with the need for the Government to admit that its austerity strategy is not going as planned and, therefore, that it is willing to canvas alternatives.

Response to Mr Howlin

Paul Sweeney: Mr Howlin’s considered response to the letter from the group of economists, of which I was one, is very welcome. His response is serious and measured and set out the case for the Government programme and its actions to date.

It reads far better than the crass headline of the article – which implies the authors of the letter were simply proposing “a silver bullet” to resolve Ireland’s deep and complex economic problems.

First, is it important to acknowledge that Mr Howlin in a government whose hands are tied by the Troika Agreement and the destruction left by the pro-cyclical, tax-cutting, tax-shifting and anti-regulation policies practiced with such vim by the last government. It has had to shift a lot of dung from the Aegean Stables of the Irish State before it can make progress. He is also in a government led by a bigger, deeply conservative party.

To my reading, Brendan Howlin acknowledges in a cautious way – as one would expect from a Minister in a government which is being underwritten by the Troika – that Europe and the ECB is not really dealing effectively with the crisis. We economists and social scientists can say it explicitly and see their repeatedly failure, but it is very difficult to this government to bite the hand. The EU/ECB approaches are partial, piecemeal and doomed to failure and repeated revisions. Further, an EU-wide stimulus would lift many economies from recession, but with 23 of the 27 states being led by conservative parties, this may be wishful thinking, for the moment.

As Minister for Public Service Reform he has had the most difficult task, especially in such a deep crisis, and he pays tribute to the role of public servants in their actions. Ireland is also fortunate that it has a Minister who is committed to public service – notwithstanding the dire circumstances we are in – and this shows in his dealings in the complexity of the reform programme.

His response demonstrates a cautious but welcome commitment to investment and that the government “is open to using the NPRF to leverage investment” in jobs and the economy. I read this as someone who implying that he needs support from progressives to help persuade his conservative colleagues who, over-awed by neoclassical economic view of the dreaded word “leakage” from a small open economy, are afraid of taking action in effecting this investment.

One can debate on whether the government is pursing “austerity” (I’m beginning to dislike the word almost as much as that other abused word, “neo-liberal”) or not. He is correct that they are “borrowing enormous sums of money to sustain the state,” and so are not pursuing austerity, in this sense. But by the end of this year, a staggering €24.4bn will also be taken out of the economy.

I also think that the time period is too short. It was to be 3 years originally and it is clearly not working as we have no green shoots except exports. A puny rise in GDP last year tells more about the activities of MNCs than about the Irish economy where domestic demand continues to collapse – aided and abetted by too high a level of cuts in too short a time period, and with too little in progressive increases in taxes.

Where we can have productive debate is on where the cuts are being made and where taxes are being raised. I, for one, will say that this government has shifted the balance somewhat from cuts to taxes, but the tax mix has not been what is optimum or best needed. For example increasing VAT by 10% is both regressive and deflationary (from 21 to 23%) and not increasing income taxes or introducing wealth taxes or getting a few bob with say a 2.5% increase in the low CT rate from the booming, exporting corporates is not good economics. (I also acknowledge that there have been some good progressive taxes on unearned income). Of course, if there had to be cuts, have they made the right ones? I’ll skip over this debate as it is complex and most people will disagree with each other on the detail.

Mr Howlin ends with the comment like “we would use all of our available resources in an all-or-nothing attempt to kick-start the economy strikes me as more Fianna Fáil circa 1977 than John Maynard Keynes”. Yet did I not hear conservative Mr Noonan on the Politics Programme a few weeks ago go further? He was talking of the possibility of investing the €5.3bn AND leveraging (borrowing) it for more investment, AND New Era AND EIB money.

So maybe the Government will finally work out where it should invest and get moving on it, sooner. But is also needs to re-examine where it is cutting and taxing.

Finally, it is not good enough for the government to simply blame the EU recession for its failure in generating any growth (in GNP and Domestic demand). The role of government in the cuts and taxes to date has had a major negative impact on “growth.”

Constructive criticism is aimed at assisting.

Brendan Howlin responds to open letter on economic policy

Last Friday, the Irish Times published an open letter on economic policy signed by a number of economists, social scientists and economic policy analysts, many of whom are contributors to this blog. In today's Irish Times, Minister for Public Expenditure and Reform Brendan Howlin responds.

Germany in and with and for Europe

Nat O'Connor: As noted in an earlier post, it is useful to see that there is lively debate going on in Germany about Europe and alternatives to austerity. This is an important counterbalance to the 'Austerity Germany' we see presented in much of the media, which creates the illusion that the German people are united in a desire to punish Ireland and other peripheral EU states for our economic and fiscal woes. On the contrary, Helmut Schmidt makes a major contribution to the debate by pointing out Germany's benefit from ensuring solidarity between the centre and periphery of the EU.

Helmut Schmidt was the Social Democratic Chancellor of West Germany from 1974 to 1982. In a key speech to the German Social Democrat party conference in 2011, he outlines the importance of Germany's integration with the other countries of Europe and proposes "radical regulations" for the EU's financial markets as well as the "financing of growth-enhancing projects" to help EU member-states achieve balanced budgets.

The Foundation for European Progressive Studies (FEPS) has recently republished this speech in 15 other European languages in order for Schmidt's message to be widely heard across Europe. An online, English version of the speech is here.

Born in 1918, Schmit takes a long view of the challenges of the 21st Century, as well as the failures of the 20th. He notes that there has been conflict between the centre and periphery of Europe since the Middle Ages - and it most often ended in war. The founders of the European Coal and Steel Community were explicitly motivated to bind Germany into an integrated Europe and to avoid further conflict.

At the same time, Schmidt argues that German strategic interests are also better served by integration into Europe. By 2050, European nations will each constitute "just a fraction of one per cent of the world's population." ... "That is why the European nation states have a long-term strategic interest in their mutual integration."

Schmidt points to recent German budget surpluses as a "very undesirable development". ... "as in reality all our surpluses are the deficits of other countries." (There is a lesson there for those who claim that Ireland can restore its economy on the back of exports alone).

Schmidt supports some sort of fiscal transfer at EU level. In terms of contributions to the EU's budget, he notes: "It is a fact that, for decades now, Germany has been a net contributor. ... And of course Greece, Portugal and Ireland have always been net recipients."

Schmidt identifies the weakness of the EU's institutions in addressing the financial crisis. "Umpteen thousands of financial traders in the USA and Europe, plus a number of ratings agencies, have succeeded in turning the politically responsible governments in Europe into hostages." ... "In 2008/2009, governments the world over managed to rescue the banks with the help of guarantees and the taxpayers' money. Since 2010, however, this herd of highly intelligent, psychosis-prone financial managers has gone back to its old game of profits and bonuses."

He argues that the EU or Eurozone could and should "introduce radical regulations for the common financial market in the euro currency area. These regulations should cover the separation of normal commercial banks from investment and shadow banks; a ban on the short selling of securities at a future date; a ban on trading in derivatives, unless they have been approved by the official stock exchange supervisory body; and the effective limitation of transactions affecting the euro area carried out by the currently unsupervised rating agencies."

Various other policies are also required, including "monitoring mechanisms, a common economic and fiscal policy as well as a series of tax, spending, social and labour market reforms in the different countries." However, despite the need for closer coordination in a range of area, Schmidt argues that the EU will not become a federation any time soon.

"A common debt will be inevitable too. We Germans should not refuse to accept this..."

"We should also avoid advocating an extreme deflationary policy for the whole of Europe. On the contrary, Jacques Delors is quite right to insist that a balancing of the budgets should be accompanied by the introduction and financing of growth-enhancing projects. No country can consolidate its budget without growth and without new jobs. Those who believe that Europe can recover solely by making budgetary savings should take a close look at the fateful effects of Heinrich Brüening's deflationary policy in 1930/32. It triggered depression and intolerable levels of unemployment, thus paving the way for the demise of the first German democracy."

In short, Helmut Schmidt's speech is a reminder that, taking the long view, not only are there alternatives to austerity - but austerity on its own is not a solution at all. Solidarity and leadership are needed to bring about recovery, led by an integrated EU, with centre and periphery working together for their mutual benefit.

Open letter in Irish Times: austerity breeding stagnation

Today's open letter in the Irish Times, signed by many names familiar to PE readers, is available here. Comments?

The clouding effect of international tax avoidance

Sheila Killian: In the Central Bank’s most recent Quarterly Bulletin, released today, Mary Everett does a good analysis of the impact of multinational investment in Ireland. It includes a really useful discussion of the difficulties in extricating the real underlying economic activity from the tax-based money-moving of multinational firms. There’s a particular focus on the Shire effect – the way some multinational firms moved their headquarters here in order to avoid adverse taxes elsewhere.

Everett notes that:
“While these types of companies have large balance sheets, their contribution to the local economy in terms of employment tends to be limited.”

While it’s well worth reading in full, one highlight to ponder is the depressing statistic that 15% of inward direct investment and 21% of outward direct investment moves between Ireland and Bermuda. Hardly a traditional trading partner, this is a strong indication of the sort of aggressive tax planning outlined here, and indicates that for all serious purposes, our GDP is a far less realistic measure of real economic activity than GNP.

Keeping that inflation monster in check

Over on Social Europe Journal, Andrew Watt has a link to a priceless educational video produced by the ECB on the dangers of inflation. As Andrew explains, "Apparently produced about a year ago, the animated video explains (to children?, adults?, heads of state and government?) just how important it is to keep money tight so as to prevent inflation. Otherwise the dreaded ‘inflation monster’ – yes, seriously – might return. Thankfully the kind-but-tough ECB official has tamed the monster and keeps it in a jar on his desk."Click here to watch the video, and here for the rest of Andrew Watt's take on it.

GDP contraction in the crisis Euro area economies

Michael Burke: OECD comparative data for the crisis EU countries highlights the extent of that crisis.

Greece has become a by-word for the effects of ‘austerity’. OECD Greek GDP data has only been published up to Q1 2011. To date Greek GDP has fallen by 9.1% since the final quarter of 2007.

Portugal, whose creditors have also been bailed out by the Troika has seen its GDP fall by 5.1%.

Spain has recently created waves with the Rightist government arguing that it will overshoot the deficit targets set for it externally by the Troika. Formerly, its Socialist government had adopted measures to boost economic activity including increased investment in infrastructure and by increasing the minimum wage. As the chart shows there was a mild economic recovery. Subsequently, ‘austerity’ was imposed and economic activity has begun to contract once more. GDP has fallen by 3.5%.

In Ireland GDP has fallen by 11.6% since the end of 2007. This is a greater contraction than any of the crisis-hit countries in the Euro Area, including Greece. Obviously Greek GDP may have declined even further by the end of 2011. But at the same point of Q1 2011, Irish GDP had fallen by 11.5%- more than Greece. The chart below clearly shows that the total decline in Irish GDP has been much greater than in Greek GDP.

If the final data shows that the Greek economy has contracted by more than the Irish economy, this will owe nothing to any Irish recovery, but solely because the Greek economy has been contracting even faster.

Initially the Greek recession was milder than the EU average, just over2% compared to a decline of just over 4% for the EU as a whole. But no country in the Euro Area has had greater cuts in public spending imposed on it. The result has been an economic slump. But the widely-held belief that public spending cuts in Ireland have been a success is not supported by the facts. It has also produced a slump in Ireland.