Economically damaging and fiscally irrelevant

Michael Burke & Michael Taft: It is often stated that to reduce the fiscal deficit we must cut public spending. There is an assumption, never substantiated, that cuts equal savings. However, the evidence shows otherwise: public spending cuts will not significantly reduce the fiscal deficit and, in some scenarios, may actually increase it.

In April 2009 the ESRI assessed the economic impact of various fiscal measures (tax increases, spending cuts) on a number of variables over a six year period: GDP/GNP growth, consumption, employment, output, wages, borrowing, etc. On the basis of their estimates we will assess the impact of the Government’s current spending cuts on growth and the deficit up to 2014.

Impact on GDP

Since the 2009 budget the Government has announced slightly more than €6 billion in current spending cuts. These include wage cuts, employment reductions, cuts in purchases of goods and services, and social transfer cuts.

Public sector wage cuts: the ESRI estimates that the first year impact of public sector wage cuts on GDP was – 0.335, or -0.2 percent That is, for every €1 billion reduction in public sector wages, the GDP falls by €335 million. This is primarily due to reduced consumer spending (falling by 0.8 percent or approximately €700 million) with a knock-on effect on employment (a loss of 0.1 percent, or approximately 2,000 jobs).

The ESRI also projected that the deflationary effect accelerates – so that by the fifth year the impact on GDP is approximately -0.774, or -0.4 percent of GDP causing further loss in consumer spending and employment.

Other current spending cuts: The ESRI only provides a simulation for employment cuts. Here, they estimate a first year impact of -1.179, or -0.7 percent: for every €1 billion reduction through job losses, the GDP declines by €1,179 million. The driving force behind this impact is the loss of employment – 1 percent, or approximately 19,000 jobs in the first year. There is only a slight easing of the deflationary effect through the years. In the fifth year, the impact is estimated to be approximately -1.165 or -0.6 percent of GDP.

The ESRI does not provide simulations for reduction in government consumption or social transfers. Therefore, we will use the employment reduction multiplier as a proxy. This can be justified on the following grounds:

The fiscal shock from increasing government non-wage consumption was projected by Lane and Benetrix to have a first-year multiplier of in excess of 2.0. While it cannot be assumed the opposite will hold (an equivalent negative multiplier from a cut in consumption), it does show the Irish economy is very sensitive to this type of shock (given that Lane-Benetrix was measuring over a period of 20 years, this impact is likely to be higher during a recession).

While there are no Irish measurements for social transfers, in the US extension of unemployment benefits and transfers to food stamp recipients had higher multipliers (1.64 and 1.73 respectively) than other forms of spending increases or tax reductions. This should not be surprising. The size of the multipliers is directly related to the ‘propensity to consume’; i.e. what proportion of each additional € in income is consumed and what is saved. Transfers to the poor or low-paid are likely to have a stimulative effect since they are obliged to consume a greater proportion of their incomes. Again, while not assuming the opposite is true here, it is expected that such cuts will provoke a significant negative shock among groups with a high propensity to consumer.

Therefore, we find the following (assuming, for the purposes of this exercise, that the cuts of €6 billion took place in 2009 and taking the Government’s growth projection as the base-line):

The first year impact will result in a GDP decline of €4.9 billion, or -3 percent of GDP. In the long-term, the decline accelerates to a decline of €6.4 billion or -3.1 of GDP. These are significantly deflationary.

Impact on Borrowing Requirement

Turning to the impact on the borrowing requirement (EBR), the ESRI simulations estimate that:

(a) A reduction of €1 billion through public sector wage cuts, results in a reduction of 0.3 percent in the EBR in the first year. Because of the acceleration of the deflationary impact, this falls to 0.2 percent in the fifth year.

(b) A reduction of €1 billion through public sector employment losses results in a reduction in the EBR of 0.2 percent in the first year. By the second year, this is reduced to a mere 0.1 percent and continues at this level through to the fifth year.

Therefore, we find the impact on the EBR to be:

The Government’s current spending cuts reduce the EBR by 1.4 percent in the first year; declining to a mere 0.8 percent by the fifth year.

It is important to put this in perspective. The Government intends to reduce the General Government Balance by 8.7 percent of GDP between 2009 and 2014 (a reduction of 7.3 percent in the Exchequer balance).

Yet, the ESRI estimates that current spending cuts will, after factoring in the deflationary impact on the economy, make only the smallest of contributions to that reduction.

However, the ESRI simulations themselves may seriously under-estimate the debilitating impact on the economy and, therefore, over-estimate the reduction in borrowing.

• First, the ESRI simulations are based on long-run average behaviour, which includes both booms and busts. Fiscal tightening in a recession, when there is already spare capacity, will have a greater depressing effect than the same during a boom.

• Second, the ESRI model may assume certain behaviour – ‘crowding in’ of private investment, lower bond yields, increased economic activity, emigration levels – which may not occur. Factors such as the continuing credit crunch, household deleveraging, structural deficits in our infrastructure and indigenous enterprise base may overwhelm such theoretical assumptions.

• Third, the ESRI measures impact in tranches of €1 billion. However, when these tranches are multiplied (e.g. the impact of the April Budget tax/levy increases was €2.8 billion) the cumulative impact may be higher.

• Fourth, the ESRI simulations analyse fiscal measures in isolation. When combinations of these measures are introduced the cumulative impact may be higher.

• Fifth, when access to credit is constrained, the depressing impact on activity arising from fiscal contraction is also likely to be amplified.

In other words, such are the downside risks to the ESRI estimates, that we may experience perverse results: that the fiscal deficit burden may actually rise as a result of public spending cuts.

Conclusion

The Department of Finance is correct: quantifying impacts ‘requires a combination of econometric model simulations and judgement’. Judgement and experience tells us that cutting spending during a recession (a) reduces economic activity and (b) reduces tax revenue and increases unemployment costs. That this occurs is beyond doubt; what we need to do is find the extent.

We have shown that ‘savings’ are minimal and the impact on GDP severe. And such is the fractional impact on borrowing there is a distinct downside possibility that such cuts will increase the deficit burden. This is reinforced when we note the deflationary impact on the domestic economy is even more severe. Whereas GDP will decline by -3.1 percent by 2014 as a result of the current spending cuts, GNP will decline by -3.8 percent. This is what the TASC letter referred to as ‘a low-growth, high debt future’.

Cuts do not equal savings. Cuts degrade economic activity with only a marginal impact on borrowing. The next time a commentator says ‘we’re borrowing €400 million a week’ as a justification for more spending cuts, they can easily be answered: cutting spending won’t affect that ‘€400 million a week’ and it may only make things worse.

To bring the deficit under control we need another alternative – one based on growth and not deflation.

Benchmarking Working Europe

The European Trade Union Institute (Brussels) has recently brought out a publication comparing European countries in areas such as income, unemployment, and social protection, amongst others.

It can be bought or downloaded from here.

Jobs and recovery

Tom O'Connor: The Labour Party are holding a public seminar in Cork tomorrow on solutions to Ireland's economic crisis. The speakers including myself will look at the causes of Ireland’s economic crisis and solutions to it with a particular emphasis on job creation and national recovery.

I will be focusing on jobs and national recovery. My starting position is that to tolerate 430,000 unemployed on the live register is economically disastrous for the economy. Just as importantly, it is morally and socially unacceptable.

Two years ago this June I predicted in the national media that unless the economy received a significant short term stimulation, that it would spiral downwards in to recession.

I said (Summer 2008) on national radio that this would be accompanied by constant increases in unemployment and a resultant falling tax take and widening hole in the public finances. It was obvious two years ago that this perilous situation, in the absence of economic stimulation, would necessitate further cuts, more economic depression, more unemployment, more falls in tax takes, increased deficits and then more cuts......in a spiral downwards.

In the summer of 2008 a huge hole was opening in the government finances: reports at that time were that it was running a deficit of 4 billion. By the start of December, the government stated that it’s deficit for the first 11 months of 2008 was 8 billion. In fact, its end of year deficit for 2008 was 12.7 billion.
The government announced in its October 2008 budget that it expected the end of year deficit for 2009 to be 13.4 billion. In the extra budget in April, the government forecasted and far bigger end of 2009 deficit of 20.35 billion. On the sixth of January 2010, the government announced that the final end of year deficit for 2009 was 24.6 billion.

In May 2008 as the government’s finances started to deteriorate, live register unemployment stood at 201,800 (deficit 4 billion). In February 2009 live register unemployment was 352,453 (deficit of 12.7 billion). In January 2010, this figure was 436,936 (deficit of 24.6 billion) and in February it was 436,956.

That amounts to clear evidence for the cuts- economic depression- unemployment- falling tax takes- ballooning budget deficit prediction. The overall government tax take at end of 2007 amounted to around 47.8 billion (unemployment 198,000 Feb 08). At the end of 2008, with the recession after starting in June, this figure was 41.6 billion (Feb 09 352,000 unemployed). By the end of 2009, the tax take came in at 33 billion (unemployment 437,000 Jan 2010).

So, the government tax take fell by 15 billion over the 24 months in 2008 and 2009 accompanied by a rise in unemployment of 240,000 over the period. Over that period, the budget deficit rose from 1.6 billion to 24.6 billion. In 2009, the government also spend 4 billion out of exchequer funds to recapitalise Anglo Irish Bank. Consequently, 19 billon of the total accumulated deficit from the end of 2007 to 2009 can be accounted for by a huge tax fall, due to untreated unemployment and 4 billion spent on Anglo Irish Bank.

This is a critical observation: it shows that the government’s finances are mostly caused by a fall in aggregate demand due to the recession. Were it not for unemployment and Anglo Irish Bank, our government deficit would have accumulated only to 6 billion over 2 years, which does mean that some tightening is needed, but this is not the main problem. The main problem is unemployment.

The government should have tackled this head on. It still needs to. All the opposition parties and social partners in the past two years have called for the government to stimulate the economy: Fine Gael and Labour proposed stimulus packages in last summer’s local elections worth around 13 and 5 billion respectively. The Greens called for a 2 billion sustainable energy stimulus package last autumn. The Irish Congress of Trades Unions, the Construction Industry Federation and the Irish Small and Medium sized Enterprise associations have all called for similar interventions.

But the Irish government will is ignoring these and the experience of other countries such as the USA, the UK and Australia. It is doing this principally because it wants to ‘correct ‘what it and others perceive as a structural weakness in the economy, living wages. Its solution is to leave unemployment high and with no or negative inflation alongside cuts in social welfare, people will work for a lower minimum wage and wage cuts will become widespread. This will not succeed as countries in Eastern Europe, China and elsewhere will always work for a fraction of even these lower wages.

The solution is not to have very high wages either but living wages. These wages can be maintained by securing a competitive advantage and technological advantage over other countries engaged in lower knowledge work. Productivity and profits for business can be kept up in this way. Significant government investment is needed in high knowledge areas coupled with synchronised up skilling. This is one part of the stimulus package which will be sustainable. The other is the investment in key infrastructural areas which are badly needed: mental health services with the implementation of Vision for Change (700 million); schools building programmes and others.

This can work as follows: There are about 350 incubated companies mainly in the high knowledge area at the moment and the government has been and continues to pour 1 billion a year in to them from exchequer funding. There are over 10,000 researchers, including PhDs working here. The areas which a high proportion of these are researching are new areas for global demand for the next 12 years according to the government’s Expert Strategy Group Report: Ahead of the Curve. Some of the areas identified are:

• Sustainable energy (govt cut SEI budget in April!!)
• Telematics
• Biomedical devices
• Biopharma (govt cut funding for courses!!)
• High quality food exports
• Health and education services for export


Research clusters here need to be mainstreamed or ‘spun out’ in to the Irish economy. Other business ideas should also be considered. There were 13 companies ‘spun out’ as fully fledged trading companies. However, once they are spun out, they are at the mercy of venture capitalists to secure capital. This restricts their growth to employing only about 8 people per company, as they need to grow slowly, resulting from venture and other capital investment in them as businesses, which is far too low. Indigenous small high knowledge companies of this type are kept small or else bought up by huge global companies who can then make handsome gains on the research and development that was paid for by the Irish state.

This then further weakens our indigenous company base and makes us more and more susceptible to global economic shocks where global companies shut down and set up elsewhere. It also involves a knowledge stripping of Irish companies which the Irish taxpayer has paid for which delivers the innovation profits to companies based in New York or elsewhere. This may make a handful of Irish entrepreneurs immensely wealth overnight after the takeover of one of these Irish companies but this delivers poor returns to the country.

Paradoxically, given the recession, we have an opportunity to try to redress this problem to some extent. If the Irish government were to use some or all of the 5 billion left in the National Pension Reserve Fund to spin hundreds of high knowledge companies on the market with sufficient capital to allow them to become large players rather than fledgling ones employing less than 10 people, a significant opportunity for long-term sustainability of Irish owned high knowledge companies could for the first time be created.

Fledgling companies are currently bought out by huge global companies because they are too small to survive despite their excellent business ideas. They do not have the economies of scale to compete seriously. The government now has an opportunity to spin out large companies with a large capital and asset base to allow them to compete on their own on International markets.

These in turn, within a reasonably short period of time, can employ hundreds of workers each at the very least and become internationally sustainable. In turn, his would contribute to an improvement in our balance of payments as these Irish companies would not engage in either transfer pricing or profit repatriation, which most of the large global Trans National Corporations do.

The chain of events needed might look like the following:
• Government needs 5 billion at least stimulus 2010 + 2011
• Companies should be vetted and viable one’s aided within 3 months
• Government should give 50% grants in return for shares to be redeemed over 10 years and 50% in loans
• High quality retraining should happen in parallel through state training agencies to match the skills needs necessary
• Re-training allowance of 330 euros
• Priority should be given to indigenous
• Viable and strong State Owned Enterprises which would pay dividends to state and should be part of this
• A state Development Bank should be set and work alongside higher budgets for Enterprise Ireland.

The alternative of not investing significant resources from the NPRF and significant employment creation is: most of the 10,000 researchers including PhDs will continue to do more post docs as they do now or emigrate; there will still be only a trickle of a dozen or less than 20 most which will be spun out in to the market and because of their small venture capital funding and small size they will employ less than 10 people and then get taken over by TNCS who will reap the benefits of years of Research and Development which will have cost the state up to 3 billion Euros and where the Irish state acts as a nursery for global capital. Once knowledge has been harvested, these companies may then site elsewhere.

A plan of this nature could create thousands of jobs. It would create sustainable employment and start the process of making Ireland a leader and not a follower. It would be attractive to all social partners, benefitting workers and entrepreneurs. It would also give to country an opportunity to start breaking the high risk twin dependence on both construction and global capital

Global companies will always play a huge part in Irish economic development, but we need to start the process of taking control of our own economic affairs and through large Irish companies, in high knowledge areas going forward, such as sustainable energy, biomedical, telematics and food, we can start to insulate the country from the economic shocks which cause recessions. In this way, the current recession can be used as an economic opportunity.

Another take on healthcare

"There is a startling commonality between the root causes and defects of the ongoing banking crisis and those that continue to gain momentum within our health system. There are lessons to be learned." Read the rest of Professor Ray Kinsella's take on our healthcare system - and what can be done to fix it - here.

Ireland still off course on deflationary path to nowhere

Slí Eile: The assessment by the European Commission makes for chilling reading.
It states:

… Despite five consolidation packages adopted since mid-2008, these developments have also produced a dramatic deterioration in the Irish public finances, with the general government balance moving from a surplus position in 2007 to a double-digit deficit ratio in 2009 and government debt exceeding the 60% of GDP reference value in 2009.

The statement goes to confirm the need to reach a Government deficit of less than 3% of GDP by 2014. The Irish authorities are urged to press ahead with measures to raise taxes or cut spending or both. Either way, it is a position of continuing deflation as GDP – and with it tax receipts – are in freefall. Yes, freefall. The real value of GNP in the third quarter of 2009 declined by 15% in real terms compared to the total for the same quarter in 2008 (Deflation can be as great a danger as our surging deficit). With public spending set to rise or hold its own simply due to demographics or social welfare payments arising from increased unemployment Irish macro-economic and fiscal policy is not in a pretty place.
The Commission give an important clue about what we might expect in the next budget (which could be any time between June 2010 and December – I would guess closer to the June end unless there is a general election in the meantime). It states:

With a view to improving the long-term sustainability of public finances, reforming the pension system is another important challenge.

There you have it. Pensioners survived the 2010 Budget relatively intact (OK the Christmas bonus went). Next time it is their turn. Nothing is ruled out including:

• Further cuts in nominal public sector pay
• Further cuts in social welfare payments and tightening of rules
• Further cuts in capital spending and cancellation or postponement of major projects
• Further cuts in programme spending with implications for health care, education, research, local services
• Further ‘levies’ and service charges (water etc)

And yet, all of this may not be enough to placate the market gods. Moreover, all existing projections assume (naively):

• (explicitly) significant early turn round in the world economy(i.e. no double-dip)
• (implicitly) no major recapitalisations of our glorious banks
• (implicitly) emigration as a safety value to contain social discontent (and the high fiscal costs of unemployment and associated social costs)
• (implicitly) widespread social acceptance of this purgatory as a necessary evil to bring us to a better place.

The latter assumption will only hold true as long as most people take the view ‘I don’t agree with it; I don’t like it; but what can we do?; there is no alternative.
TINA
But, when people begin to realise that the strategy – if it could be called that – is not working and is not delivering jobs, remission of debt but is, instead, piling up debt and permanent loss of human skills and dignity – then there will be serious trouble and serious questioning of all that we assumed and relied on up to now.
At some point, someone, somewhere in high authority is going to say ‘this isn’t working’ – the deficit is stuck at such and such a percentage well above the 3% target set of the EU and agreed by the Government, here. Moreover, there will be political realities to address including noisy people on the streets. Large surplus & capital-lending countries will find it near impossible to back down.
I can’t see any chance whatsoever of Government, Unions and EU commission agreeing on an approach to reducing pension liability – which is what the coded quotation, above, is about.
In common with the Dublin consensus, Brussels sees the achievement of competitiveness as the key to recovery. This will be made up of cuts in wages, cuts in public spending (and therefore services) and investment in skills, R&D and new infrastructure (the sugar on the pill).
I am not clear on what is meant by the following sentence: ‘a modest package of stimulus measures to support economic activity of 0.7% of GDP in line with the European Economic Recovery Programme (EERP).’
However, it is clear that given the overall deflationary stance of fiscal policy since late 2008 talk of a stimulus is not in accord with what is going on. Rather, some redirection of spending within the overall total may be viewed as a stimulus. But, I would like to see more transparency around that claim.
The commission estimate that the (negative) impact on GDP arising from fiscal adjustment was 3.25% in 2009 and 2.5% in 2010 (page 7)
The Commission points to lack of appropriate data on many aspects of the consolidation programme. In particular, they go on to point out that the revenue and expenditure projections in the outer years are of an indicative nature and the consolidation efforts in these years are not underpinned by broad measures.

Report of the Innovation Taskforce

An Saoi: I read the Report of the Innovation Taskforce and wept. The Government’s big idea is per Brian Cowan’s piece in Saturday’s Irish Times “We are open for business as a global innovation hub”. I would more accurately describe it as “We are (still) open for business as a global hub of tax planning & scamming”.

There are some reasonable proposals in the document. But when you cut through the waffle, many of the proposals are designed to move Ireland from a low corporate tax environment to a no corporate tax environment, in the hope we get a few jobs as our reward. In Germany or any other sane country a task force with such a remit would be stuffed full of engineers and scientists. Not so in Ireland.

I am a sucker for word searches. It gives you a feel for the document. In this report, the word “tax” is mentioned 127 times, the word “food” eight times and the words “manufacture” or “manufacturing” just 24 times. When “tax” pops up you will always find those three letters “FDI” are not far behind and sure enough they are there 35 times.

Therefore this is a report which pays lip service to Irish SMEs, barely mentions the Public Sector, and almost all of the serious proposals are in relation to tax scamming for multi-nationals. But there are four direct representatives of multi-nationals on the taskforce.

The nub of the Report is contained in Appendix Six, which sets out six tax proposals, which have little to do with the development of innovation in Ireland. I ask for your forgiveness in advance because I am now going to talk tax.

The first proposal relates to IP (intellectual property) and is about “the competitiveness of our tax regime for internationally mobile IP rich businesses.” This is basically a proposal to weaken Section 291A further. This enables multi-nationals to take profits from high tax jurisdictions and move them to a low tax location such as Ireland. You can write off 80% of the “cost” of the IP, i.e. reducing your effective tax rate from 12.5% to 2.5%, before of course deducting any other expenses. Outside of accountancy and legal firms, I can see no jobs here as the real activities will be outside of Ireland.

Proposal number two is in relation to tax credits for R & D, covered by Sections 766 & 766A. This enables a company to deduct the cost of R & D, and also to get an additional tax credit of 25% of the cost incurred. They suggest that the amount of outsourcing be increased and in relation to many SMEs this would make sense. However, again the main concern is multi-nationals “For example, for pharmaceutical companies, clinical trials must be outsourced and they are a significant part of the R&D cost.“ This work would also not be done in Ireland.

Proposal number three is in relation to “Carried Interest”, which is basically a method of senior managers in venture capital firms earning loads and paying no tax.

Proposal number four is in relation to the pooling of foreign tax credits. Credit for foreign tax is specific to that income source, e.g. tax withheld on Spanish income can only be offset against profits from your activities in Spain. The problem arises that the withholding tax payable in some countries exceeds the Irish tax payable on the Irish measure of income. The taskforce want pooling, i.e. you can claim your excess Spanish tax against, say, your profits from Germany. This proposal runs counter to all normal treatment to avoid double taxation.

Proposal number five in relation to withholding tax on payments is just another sop to multi-nationals.

The final proposal is in relation to Patent Income Exemptions, which the 3rd Commission on Taxation, which has recently reported suggested should be terminated. They of course feel it should be retained.

Radical options for EU reform

Slí Eile: In a thoughtful, radical and no doubt controversial assessment of EU economic policy Irish Left Review has cited a report: Eurozone Crisis: Beggar thyself and thy neighbour. The full report can be downloaded here. Perhaps our debates on fiscal, banking, sectoral and macro-economic policy, in Ireland, are too narrowly local without paying more attention to the global and European crisis that is emerging. It is as much a political crisis and a questioning of assumptions and models that were viewed as intact and victorious ever since the triumph of neo-liberalism from the 1980s.

Options for future economic policy in the EU

Slí Eile: I very much agree with Paul Sweeney, writing on this blog site recently

It seems to me that we need more effective EU institutions. We also need EU leadership which is more responsible to its people. Neither are in this plan. But the European people gave the conservatives the majority – even after the collapse of a virulent form of liberalism espoused by those conservatives.

In the new draft strategy for EU2020, as with many EU communications we have a case of all things to all people with something for everyone in the audience – competitiveness, innovation, green technology and of course social inclusion.

While the EU plays an important role as a global player – its institutions and provision for coordination of fiscal and monetary policy across the Union remain weak relative the scale of the challenge, the competition from other world players and the diversity of cultures and levels of economic development within the Union –including the Eurozone.

A major criticism of the draft Strategy is that it speaks of ‘growth’ (growth in GDP) as this is the holy grail and the basis on which various other policy goals can be realised. What about the work of the ‘Sarkozy Commission’ on measuring progress that goes beyond simple GDP?

There are some ideas in the document about addressing unemployment – especially youth unemployment – (e.g. Eures jobs) based on ‘mobility across the EU’ [a slightly ambiguous matter given the history of unemployment and migration in an Irish context]. However, there is a complete lack of how this will be implemented and coordinated and, more to the point, how the devastating increase in unemployment among young Europeans can be reduced as fast as possible. Europe will pay a high price if this problem is not tackled effectively and quickly.

A key question to be asked – just as with the Lisbon Agenda for 2010 – can the EU and its Member States deliver on the multiple goals it can set itself? If the future needs to be very different to the past (pre-recession) modes of production and consumption is the political will there to effect change and to learn the lessons from the catastrophic failure of governance, regulation, trust and market stability witnessed in 2008?

The social dimension of EU2020 is weak and needs to be greatly strengthened.
May be I am missing something – but was there a debate on this draft in the Oireachtas recently? Someone might point to a web link. And has anything replaced the work of the (valuable) National Forum on Europe (axed in line with the Big Snip) in facilitating exchange of information and ‘townhall’ meetings up and down the country?

Social Justice Ireland made a good input during the consultation process towards Europe2020 here.

to quote directly –

The EU 2020 Strategy should therefore speak about values; it must address how the EU proposes to deliver solidarity and a just distribution of resources and well-being; how it proposes to contribute to the development of the impoverished parts of the world as well as fostering a people-centred and green economy.

The document reminds us that

‘80 million people were at risk of poverty prior to the crisis. 19 million of them are children. 8 per cent of people in work do not earn enough to make it above the poverty threshold. Unemployed people are particularly exposed.’

A notable feature of EU2020 is the absence of hard quantitative targets and specification of pathways to achieve particular goals - e.g. ‘Reduce the number of Europeans living below national poverty lines by 25%, lifting 20 million people out of poverty’. Why not just abolish poverty? Important as rolling out ‘ultra-fast’ (‘fast’ isn’t good enough you know) internet connections is – isn’t abolishing poverty more urgent? How about ultra-fast progress on tackling poverty and the causes of poverty to borrow a phrase from another domain.

Really, McCoy?

Michael Burke: In yesterday's Irish Times, IBEC's General Director Danny McCoy said wages increased much more rapidly in Ireland than in other countries in the Euro Area during the period from 2002-2008, precipitating a serious decline in competitiveness.

“As a result, unit labour costs increased by 31 per cent in the period, compared with an increase of 9 per cent in the euro area,” he added. “In a single currency, there is no currency depreciation option to restore lost competitiveness.
“This can only be achieved by unit cost reductions, brought about by a combination of pay reductions and productivity gains.”

Mr McCoy seems to be referring to the EU Commission's Euro Area Report, and its statistical annex, which tends to group data in five-year periods, and does so from 2002 to 2006, while also providing data for later years individually. However, while these do indeed show Ireland's labour cost rising by 30.9% over those years, the average rise for the Euro Area was 13.7%, not 9% as stated. (Perhaps the mistake made was to leave 2008 out of the equation for the Euro Area average, since then the total is 9.9%).

But these are nominal increases in unit labour costs, not real costs. In the table below that one (Table 28) these are also provided. On this measure, real unit labour costs in Ireland (nominal costs divided by the GDP price deflator) rose by 9.7%, nearly all of that coming in 2008 as output plumetted. The cumulative rise in the six prvious years was just 2.8%. And the average real chage in unit labour costs in the Euro Area was -2.7% 2002/08.

However, there was also a difference in the rate of growth in productivity. Irish productivity grew by 11.7% in 2002/08 compared to a rise of 7.4% in the Euro Area as a whole. So, Ireland's productivity rose by 4% compared to the Euro Average over the period (111.7/107.4) while Ireland's real relative unit labour costs rose 5.75% prior to the recession (102.8/0.973). According to EU estimates and forecasts for 2009/10, the overwhelming bulk of this modest relative change is already being corrected, 3.8%.

Of course, none of this tells us anything about the absolute levels of costs, or relative costs. Still less about competitiveness.

But the trends in the external accounts do highlight relative changes in competitiveness. Over the period 2002 to 2008, exports of goods and services grew at exactly the same rate as those from the Euro Area as a whole, while they fell by 3.4% in 2009, compared to a 14.2% fall for the Euro Area. Imports also grew at exactly the same rate as the Euro Area 2002 to 2008 and fell by 8.5% compared to 12.5% for the Euro Area as a whole in 2009. This less pronounced decline in imports is associated with the much stronger export performance; as everyone knows, a large proportion of Ireland's imports are for re-export.

There is nothing in these data to support the IBEC assertions that rising unit labour costs have led to a loss of competitiveness. Despite that, the clamour for lower wages is unabated.

Perhaps, if Mr McCoy remains anxious on the issue of competitiveness, he could suggest to his IBEC members they address its key determinant, namely investment? Investment in equipement has fallen by 37.6% in the last 2 years in Ireland, compared to a 16.6% fall in the Euro Area as a whole.

Tallaght Hospital controversy: An apposite quote

An Saoi: I recently came across the following comment from an interview with Dr. Giovanni Berlinguer, professor of Social Medicine and younger brother of the late Enrico.

I think the esteemed professor has covered exactly why the problems occurred - you cannot have a dual health system operating side by side.

“The health sector is a central actor in eliminating health inequities through universal coverage and by initiating collaboration with other sectors to address social determinants.

Medicine contributed a lot during the 20th century to the benefit of mankind, but the benefits were not equally distributed. There is an old saying: "Medicine is the science that enables the rich to be cured, and says to the poor how they could be cured if they were rich".

Today, the abolition of universal health systems has happened in some countries and it is beginning to happen in others. This trend must be reversed if we are to ensure that poor and marginalised populations have access to the health system.

Universal coverage is important to health, to human rights, but also to social cohesion and stability. Social cohesion is greater when there is not a division in society between those who suffer and those who do not.”

Slash and Burn

Paul Sweeney: Michael Burke is correct in saying that competitive devaluation does not work. It does not matter what so many economists think, or what financial markets think (I find it amusing that some commentators believe that markets think) - the Irish Government is pursuing a slash and burn policy of deflation. Not only is it not working; but it is increasing shop closures, factory closures, joblessness, depressing the state’s tax revenue and will undermine the very foundations of NAMA, some recovery in property values.

It is well known that you cant deflate your way of a recession. There is a difficulty for a small open economy in introducing a stimulus. Indeed, even in the US, the $787bn economic stimulus, the largest in American history, has had its issues. It was not greatly successful, as only 34 per cent of the total was spent in 2009. That partly reflected the large role of infrastructure and its slow spend-out. Yet this stimulus prevented a steeper decline.

There is a delicate balance between the slash and burn cutting of this government and sensitive policies to stimulate domestic demand or, at the very least, not to depress demand further.

Slashing low paid earnings and cutting welfare cheques is the best way prolong the recession. Even the ESRI admitted this when it advocated the deflationary process, admitting that the downside was that it would prolong the recession and add to unemployment and reduced tax revenue. If people have less money in their pockets, they spend less, so shops have less customers, order in less stocks, the owners spend less and so the deflationary spiral continues.

Thus government’s policies of unilaterally cutting wages and welfare are deflationary - throwing more people out of work. Many economists have recently fixated on wages as if thet were the only component of competitiveness. There is no doubt that wages are a large component of that big service industry – the public sector. While a difficult balance has to be struck between the level of cuts, and where they fall, and raising taxes, this government has greatly erred in punishing the poor, low paid public servants and in reducing capital spending when there was an alternative way.

Cutting wages of public sector workers and cutting social welfare cheques for the poorest, while reversing the proposed cut in pay for the very top 700 public servants, reversed undermined any moral authority the government elite had.

Last year €1.3bn was to go into the Pension reserve as in 2008. Instead this vast sum was front-loaded and a total of €7bn was taken from our pension reserve fund and paid out in subsidies to the failed banks. Little of this money is seeping back into the real economy. This action was massively deflationary.

It is said that perhaps a further €10bn more may have to go into the banks in subsidies in the near future. The value of having a banking system is beyond dispute, but why is there no assessment of the deflationary impact of these handouts? Ireland could pay 574,712 people the minimum wage for a year to fill Ireland’s potholes for this €10bn. It would be far less deflationary than putting this cash into the banks, but especially the zombie banks, Anglo and Nationwide.


The indicators of the deflationary impact of the recession combined with government policies are clear. For example, the collapse in imports. These went from €49bn in the first 10 months of 2008 down to just €37bn – by a quarter - in the same 10 months in 2009.

Thus through the collapse in imports, it can be seen how the crisis has hit consumers, businesses and the economy. From the data, it is clear that Irish people do not have money to buy imports. This is partly due to the deflationary policies.

Further, retail sales are plummeting and with a collapse of 14.1% last year. Of this the value of goods fell by 18% in 2009. It is clear that the bottom has not been reached. People are afraid and those with a little are holding on to it - knowing that worse is coming. In 2009, production was at 93% of its 2005 levels. Production was down over 5% in 2009, or 14% in traditional industry, while the modern sector rose by 5% in 2009 (largely exported), compared to large increases in previous years.

Private investment has fallen through the floor. Total investment this year will be €20bn, down from €50bn in 2007. Much of this is construction-related, but the rest is also way down too. For example, machinery and equipment is down by over 40 per cent in 2010 on 2007.

Thus the state should step in. The National Development Plan was ambitious, and in spite of reductions in it, it is still relatively large. However, it could and should be even larger to compensate for the collapse in private investment. There is much to be done in Ireland and the payback is large.

Joseph Stiglitz said: “In a recession, you want to raise (or not decrease) the level of total spending – by households, businesses and government – in the economy. That keeps people employed and buying things, and makes it more likely that businesses will want to invest to serve that consumer demand. However, state spending reductions have the opposite effect: Each dollar less that the state spends generally reduces consumption by the same amount.”

While it is complex and difficult to nurture domestic consumption in an small open economy, we are seeing a precipitous fall in it. So much more should have been done to ensure it did not collapse like this. As domestic demands falls further and more lose their jobs, tax revenue falls further, and things gets worse, maybe a realisation will dawn on our discredited elite. But by then, recovery will be so much more difficult.

The fallacy of competitive deflation

Michael Burke: One of the key planks of government economic policy is the notion of 'competitive deflation'. It has another airing here, where it is argued that, given Ireland's membership of the Euro Area, it is the least worse option available.

The idea of competitive devaluation (or internal devaluation in a single currency area) is a simple one; the local economy is in the mire, there is nothing we can do about monetary policy - interest rates or the exchange rate, and the only way to boost the economy is to increase exports. Of course, this completely ignores the role of fiscal policy. Other countries in the Euro Area have adopted fiscal stimulus and it has brought a far greater degree of stability than Ireland on three key fronts; the economy, the deficit and long-term interest rates. Of course, all these three are linked.

Underlying the notion of competitive devaluation is the idea that the private sector can save its way to prosperity. Saving is currently occurring: the private sector's savings in Ireland will exceed 10% of GDP in 2010, according to the OECD. But there is no sign of prosperity.

This is because there is a faulty assumption at the heart of 'competitive deflation'. It relies on the idea that, if the private sector saves in this way but continues to consume and invest in the same proportions, all that will then happen is that prices will fall, and goods and services will be cheaper at the new, lower level of spending. However, this ignores two trends that tend to occur in crises and are happening currently, most especially in Ireland.

The first is that, in a recession, investment falls much faster than consumption. In Ireland, personal consumption has fallen from its peak by 15.1%, whereas gross fixed capital formation has fallen by 52.5%. Deflation has occurred. But the ratio between consumption and investment has changed markedly for the worse. Accepting the new status quo would be to embed a new, adverse consumption/investment ratio, which actually undermines competitiveness.

The second reason why this new orthodox criticism is invalid is the level of debt. If prices fall, as orthodoxy expects and is currently happening, debt-sevicing becomes more, not less difficult. The real level of the debt only increases - as has happened in Japan since the beginning of the 1990s deflation in that country. Ireland is already currently experiencing deflation, and policy is aimed at actively promoting it. Ireland's policymakers are the only ones in the world who believe that the Japanese experience is worth emulating.

Reply to Dr Constantin Gurdgiev

Nat O'Connor: Dr Constantin Gurdgiev, Adjunct Lecturer in Finance at TCD, posted a lengthly response to TASC’s open letter to the Irish Times. You can read it here. I am a signatory to the letter. In order to have space to deal with his comments in some detail, I am doing so here.

- - -

Dr Gurdgiev, in addition to a series of unsubstantiated characterisations in your post, I identify 14 substantive points which you raise. Feel free to correct me if I’ve taken them up wrong. I deal with them in turn in the order that they appear in the original post.

I am writing from my own perspective as a signatory. Others who signed may have different perspectives and alternative reasons why they were happy to sign.

Before turning to the 14 points, it is good to note that we agree on some things, namely: the need for more value for money from national investment (e.g. a major rethink on Metro North); the need for real public sector reform; some items of capital investment from the ‘Irish Times shopping list’ (e.g. schools); and the need for tax reform. We might disagree on the detail of the above, but at least we can agree that things can’t stay as they are.


1. Construction: “Investment collapse in Ireland is driven foremost by the collapse in construction sector – the sector that accounted for over 70% of total private investment in this country until 2007. So no – the Government has not contributed to this.”

The Government had a major role in fuelling the boom and bust in the construction sector. Hence, they contributed to the collapse. They failed to diversify incentives for investment in order to boost other industries, but allowed the construction sector to become unsustainably large. (Indecon and Goodbody were commissioned by the Department of Finance in 2005 to study the effect of property- and area-based tax breaks. These reports were published as appendices 1 and 2 to the Budget in 2006. Most of these tax breaks have since been discontinued, but too late! There was large-scale deadweight in these schemes, and they contributed to fuelling a ‘boom’ that couldn’t last, followed by the inevitable bust.)

2. NDP allocations: “Investment the authors have in mind is the NDP-related allocations, which are less than 50% about real capital and more than 50% about ‘soft’ investments.”

We would need to target investment into areas with the best multiplier effects for the economy (see also point 9 below), with a mix of short-term (to boost employment) and long-term (infrastructure we need); e.g. using the many available construction workers and cheaper materials post-bust in order to build schools, public transport infrastructure and other ‘hard’ assets. Tapering this investment out over time, as we need to divert the many young people who left school for work on the sites back to education/training.

3. Draconian tax increases: [the open letter authors] “do not mention draconian tax increases here as the contributing factors”.

I’m not exactly clear what your point here is. But tax increases are necessary if Irish people want the same standard of public services as France or Sweden. However, this doesn’t have to be exclusively income tax, it could include taxes on property such as housing tax, which is common to many other countries and is a reliable source of revenue for local government (which often provides primary/secondary education and local primary health care in other countries), as well as other taxes on wealth and a more comprehensive social insurance system. You are complimentary (by implication) about public services in other countries, so presumably there is a reasonable (not ‘draconian’) level of tax than one can be happy to pay, if quality services are delivered.

4. Welfare cuts and deflation: “post-Budget 2010 Ireland’s welfare recipients are still 0.883% better off than they were in December 2008. Is that so deflationary, folks?”

You forgot the effective 2 per cent decrease caused by cutting the Christmas bonus. So, we end up with more than -1 per cent real decrease. You mightn’t agree that it is a regular part of the social insurance that people pay for, but cutting it is still deflationary.

More importantly, we still have a high rate of poverty in Ireland. Behind the inflation figures is the reality that lack of transport makes it more difficult for low income households to avail of falling prices. Plus the marginal benefit of deflation is less; if you were already shopping for the cheapest own-store goods, little difference it makes if brand name goods go down in price. This list goes on, but my point is really that we do a bad job of measuring the reality of poverty and the fact that many people can’t afford all the basics of life (housing, food, heating, etc.). Adjusting welfare payments in line with the CPI or HICP doesn’t add up. A bottom up approach (e.g. minimum income standards) of addressing people’s needs and helping them into education, training and employment would be better for them, and for the economy.

5. Public investment and inequality: “how on earth cuts in public investment are going to make income inequality endemic?”

The original paragraph actually says: “Equally damaging have been the cuts in public investment at a time when private investment has plummeted. This has laid the foundations for a low-growth, high-debt future where unemployment will remain high and inequality endemic.”

That is, the fall of public investment contributes to a low-growth/jobless-growth scenario. That scenario involves high unemployment becoming endemic; and a society where say 1 in 8 people of working age is unemployed (which is the case today) is likely to be an unequal society. Hence, inequality will be made endemic by the Government's failure to put in place a jobs strategy.

6. Private investment: “we should be stimulating productive private investment – that is what creates sustainable jobs and growth. And to do that we need lower taxes, and less borrowing by the Exchequer, so our banks have no Government bonds to roll over at the ECB lending window.”

I agree that we should stimulate productive private investment. For example, we should take away tax incentives for industries that don’t employ many people and use the money saved to fund tax incentives for those that do.

However, low taxes is not the only way to stimulate such investment. For example, we are never going to be able to compete with developing countries for cheap labour. Hence, a well-educated workforce is required, and that requires a significant level of investment in education (funded by tax revenue). Education also protects Ireland from competition by providing our workers with skills that are hard to replicate by low-cost/low-tax economies. We need to build up our comparative advantage in high-tech areas (science and ICT) and move up the value chain; thus making it harder for MNCs to move.

Likewise, we need to invest in transport infrastructure, broadband, etc.

We could raise taxes and still have lower taxes than many continental countries, in order to compensate enough (but not over-compensate) for our geographically peripheral position.

7. Wasteful Exchequer: why “give even more dosh to such a wasteful Exchequer?”

Logically, a government re-directing the economy as we suggest would have changed direction on many things. That must include an end to wasteful behaviour also. I’m all for open decision making and much increased accountability for decisions made by governments and public bodies in order to cut waste.

8. NDP versus the deficit: “To maintain NDP investment at previously planned levels, on top of the current budget deficit we will need some odd €6-7 billion more. To return welfare payments to their 2009 levels, and to reverse pay cuts in the public sector and reductions in employment there, we will need additional €3.4 billion. These are all net of receipts. So the Exchequer will be borrowing some €29 billion this year - 18% of our GDP. What would the Greeks say with their current 12.7% GDP deficit and heading for 10.7%?”

An 18% deficit would of course have detrimental effects on the bond market and the yields Ireland would have to offer, but the proposal of productive investment and job creation leads away from that scenario. Current government policy is taking us there.

For example, the EU's forecasts for Ireland's net general government borrowing deficit are 14.7 per cent of GDP in both 2010 and 2011, up from 12.5 per cent. This is the highest level in the EU. Because of deflationary policies, Ireland now has higher yields than Portugal, Italy and Spain.

I am all for getting the deficit down. But the way to do so, and to lower bond yields, is through fiscal stimulus. (And see point 9 below)

9. Bond yields: “What would the bond markets say?” ... “At what rate would you borrow through these bonds? Current yield is 5%. Greece at 6.3%. To make these bonds attractive to anyone, you’d have to price them around 7%.” ... “Suppose we borrow at 7% for 10 years, invest in new private (not public) enterprises. The rate of survival for start ups in Ireland is, historically, around 25-30% over 5 years. In 10 years – it will be around 15%. To get 10% return on these bonds, the state will need to invest in new ventures that will survive through 10 years slog while yielding over 22% annually! Enterprise Ireland never had this spectacular of a record, even during the boom time.”

The key here is the multiplier effect of productive investment. The various evaluations of the NDP vary as to their multiplier effect, but they are in the order of 2.3-2.6. Let’s take the lower figure (2.3): a €10.5 billion investment programme would yield an economic return of over €24 billion.

A €24 billion increase in activity is about the same as the decline in GDP to date and a bit less than the fall in GNP. Over the course of the recession, taxes fell by €14 billion (even with tax increases). The suggested investment would put most of that back, for an expected tax return of approx. €11.6 billion (to work with the lowerGNP/tax ratio); i.e. more than our initial €10.5 billion investment, thus boosting the economy and reducing the deficit.

10. Private debt: “Most of the non-banking debt – almost 100% of it – in this country is held by private sector firms and ordinary workers. How is paying more in welfare payments going to help deflate this debt? How is public spending on capital projects going to do the job?”

Spending more on capital will employ more people. Not cutting welfare payments will result in less deflation (and hence more employment, e.g. in local businesses). More employment means (a) more tax revenue and (b) less people claiming welfare payments. Hence, although welfare levels may remain higher, less people will be claiming them and so they will cost less as a proportion of the national budget.

And of course, people who are employed will have an easier time paying their debts. So maintaining and boosting employment is crucial to deal with the crisis of private indebtedness.

11. MNCs and exports: Ireland’s “exporting capacity comes from... MNCs, who would flee Ireland” were the open letter’s ideas implemented

I agree that MNCs account for the majority of Ireland’s exports. However, the CSO note that their "sample is heavily reliant upon the large multinational companies especially for exports. The dominance of these companies in our trade statistics may mask the trade performance of indigenous Irish companies." (here, page 9). Nevertheless, 1 in 10 people working in the private sector are employed in an MNC. That’s a lot and they are often ‘good jobs’, with benefits to the local economy through consumption. But it is still a minority. We need a stronger domestic economy too.

In relation to point 6 above, there are many reasons why MNCs invest in Ireland. We need to build on our sustainable strengths to attract long-term, job creating MNCs. They would not all “flee” if Ireland had much improved education, transport infrastructure, broadband, etc. We also have an English-speaking workforce within the eurozone in the European free market. Many other things can attract investment, such as a highly-educated workforce described in point 6 above. Some might flee, others would flock.

12. Low tax, low spend: “I didn’t notice a low tax, low spend economy.” ... “The ... pre-crisis for EU-average level of spending in terms of GNP, and removing the MNCs out of Ireland’s income accounting, leaves the Irish Government in control of over 60% of the entire economy.” ... “Our taxes are now second highest in the EU at the upper margin level. All of this before you factor in some of the highest indirect taxes and charges.”

Re low tax, there are three points one can make. Firstly, The OECD shows that Ireland’s total tax revenue was 31.9 per cent of GDP, compared to an OECD average of 35.9 per cent of GDP. If you just look at the 18 other EU members of the OECD, their average level of tax revenue was 39.1 of GDP. (2006 figures; click on table at end of row showing Irish tax revenue for comparative data).

Secondly, income tax is only part of the equation. The sum effect of consumption taxes and other taxes have to be included too. Ireland may have average or even high levels of income tax, but it has low corporation tax and very little tax on property/wealth. The imbalance of this tax system requires reform to make the overall tax take significant.

Thirdly, the marginal rate of tax is not as important as the actual amount of tax that people pay; i.e. effective tax. The OECD notes (Economic Surveys: Ireland 2009, p. 61) that the value of tax expenditure on income tax in Ireland was three times the average of 22 other EU countries. The marginal rate of income tax may be comparatively high, but anyone earning over 60,000 can avoid a lot of tax through a variety of means, such as generous tax breaks for private pensions.

Re low spending, Eurostat give general government expenditure function (COFOG data here). Ireland’s state spending is 35.6 per cent of GDP compared to an EU average of 45.8 per cent (2007). They don’t give GNP figures, but Ireland’s GNI in 2007 was 86 per cent of GDP (Eurostat figures) – hence Ireland’s 35.6 per cent of GDP spending was around 41.6 per cent of GNP. And was at that relatively lower level the years prior to 2007 as well. Where is your 60 per cent figure coming from? If it is from the current, rather chaotic period, it doesn’t represent a decision by Government to engage in a higher level of public spending... GDP/GNP has fallen greatly, making Government spending look much bigger than its long-term average.

13. Semi-states companies: “does anyone actually believe that our semi-state companies are that good in creating 'new indigenous enterprises’? More CIE? ESB? Bord na Mona? Aer Lingus?”

Semi-states are a mixed bag; some are very efficient, others need real reform. I think we need most of them for the foreseeable future, as I don’t think privatisation would serve the public interest; for example, the privatisation of Eircom seemed to result in asset stripping by a succession of different owners, and weak investment in our telecoms infrastructure. I wouldn’t like to see more of the same with the current semi-states; hence, making them work better is necessary. Changing their governance structures to better serve the public interest would be a good start.

14. Facts and figures: The open letter “established not a single fact” and “provided not a single relevant statistic or estimate” to reinforce its claims.

The open letter (hopefully) reminded readers that there are alternatives, and points out the gaps and flaws in current national economic policy. That’s as much as can be expected in half a page of a newspaper, writing in a style that is hopefully accessible to the general public. You will find plenty of facts and evidence-based arguments on Progressive Economy that deal with many of the above points. And we will be producing more in the weeks and months ahead...

The TASC letter: Fiscally consolidating what?

Michael Taft: The TASC letter raised the prospect of ‘restructuring taxation and expenditure in a progressive and expansionary manner’. This begs two questions – what does this mean for fiscal consolidation; and around what level do we fiscally consolidate. The phrase ‘fiscal consolidation’ is used as if it had some final meaning. It doesn’t. It doesn’t assume any level of tax and spend, just a relationship between the two. Everyone knows we have to achieve the latter. But there has been almost no debate about the former.

The Government has indicated the level they want this re-balancing to occur by 2014 – at the lowest level possible. There is a problem, though. By 2014, we will be paying out a higher level of interest on the debt – nearly four times as much as a percentage of GDP over recent historical levels (by 2014, 3.9 percent of GDP will go on interest payments compared to 1 percent pre-recession). There’s not much that can be done about this in the medium-term. So maintaining a low level of taxation has to factor in this rising cost.

The Government intends to maintain revenue levels pretty much where they have always been. Factor in debt servicing and by 2014 taxation levels will be lower still.

Where does that leave the Government’s spending plans? Little short of slash and burn – despite the Finance Minister’s assertion that the budgetary worst is over. Excluding interest payments, the Government intends to cut public spending and investment in real terms by over €5 billion – or nearly 8 percent – between 2010 and 2014.

The Government’s emphasis on public spending cuts (and the general conflating of ‘fiscal consolidation’ with such cuts) can be seen in a new light – not so much to bring public finances under control, but to maintain a low-tax model whereby spending and investment cuts are inevitable.

Progressives in Ireland have generally argued for a higher tax take – to invest in public services, infrastructure, indigenous enterprise, etc. As the saying goes – you can’t have European-level of services or living standards without paying European levels of taxation. So, what is the optimal level of taxation? The ESRI’s John Fitzgerald has put forward a suggestion that deserves discussion:

‘It is essentially a political question as to what level of public services and investment is likely to be “desired” by the public in the next decade. . . .My own preference would be to target a level of expenditure and revenue in the medium term equivalent to 45 per cent of GDP. However, every government has to make its own mind up on this issue. Whatever that target is should inform the composition of the next budget.’

Fitzgerald’s preference is essentially for an EU norm. If this ‘political’ goal were achieved then it would radically transform the fiscal dynamic.

It would certainly mean higher tax levels – on profits, capital, property, wealth and income. It would also mean a profound debate about what kind of taxation system we want. For instance, as the TASC letter points out - in moving towards a European model, this may mean greater emphasis on social insurance to deliver services and social protection that is now delivered through central funds. It may also mean moving towards higher local taxation – where greater accountability and transparency will hopefully translate into greater efficiencies and higher output.

Nor is it a matter of taking a crude slide-rule approach (a 20 percent increase in tax levels translate into a 4 percent increase on the standard rate). Higher, sustainable growth itself creates higher tax revenues. Even Government acknowledges this when it shows, without raising taxes or introducing new ones, current tax revenue (excluding social insurance and local taxes) will increase by 27 percent – all because of growth.

Even slow progress towards EU norms will give us considerably more resources for investment; a 40 percent tax level would provide an additional €6 billion. To reach Fitzgerald’s preference/EU norms would provide an additional €16 billion. I suspect the higher level will not be possible within four years – after all, restructuring takes time. But anywhere on the way will allow a reversal of spending cuts and a platform for investment.

And this is key – for investment itself will invigorate the economy towards even higher levels of output, which in turn will increase tax revenue. This is the virtuous circle of investment, growth, revenue and lower unemployment costs. And this is before we sit down to the hard work of debating a new taxation architecture.

When the Government says TINA (‘there is no alternative’) they are right: there is no alternative if you want to degrade taxation levels and maintain, despite the economic costs, a low-tax model. But if we move towards European norms, breaking free from a failed model that contributed so significantly to our massive economic and social deficits as outlined in the TASC letter – then more alternatives open up.

The debate begins

Michael Burke: The Open Letter is being discussed over at Irish Economy.

Two interesting counter-thrusts, which are not entirely new. One is that the government's slash and burn approach has stemmed the rise in long-term interest rates. Philip Lane says, "If the government had not undertaken a sizeable fiscal adjustment, the spread on sovereign debt would surely be much higher than the current elevated level and the upward movement in interest rates (influencing the funding costs for the banking system as well as for the government) would have had an even more contractionary impact on the economy.”

But, as previously argued here, this does not accord with the facts. Government austerity policies have widened Ireland’s yield premium over other Euro Area borrowers.

This can be established by comparison with a host of European sovereign borrowers, all of whom adopted reflationary measures in 2009. The most obvious comparator is Belgium, which (by dint of having higher debt and lower deficits) had almost exactly the same 10-year yields as Ireland for well over a year before the crisis occurred. They were within a bps or two of one another.

The Belgian authorities engaged in significant reflationary measures- Ireland had its own unique contractionary experiment. The yield spreads began to part company precisely when Ireland adoped the first of the austerity packages in late 2008. From a zero yield premium over Belgium, this diametrically opposed policy has pushed out the yield premium to 77bps currently, and has been over 100bps. Even in its own terms, the Irish government policy of ‘reassuring the financial markets’ has failed utterly.

The second argument, also familiar to readers of this blog, is that Irealnd's uniquely severe fiscal position ruled out borrowing to invest. But Ireland's fiscal postion wasn't unique, although the response was. It has made matters wose.

The Irish slump was a year earlier than that of the Euro Area as a whole. Ireland’s budget deficit was 7.2% of GDP in 2008 (net general government borrowing). That is not qualitatively different from the Euro Area average the following year, when their recession kicked in. The average deficit that year was 6.4% of GDP, with France a whopping 8.3%. However, the overwhelming bulk of those countries adopted fiscal stimulus packages, with France one of the biggest of all (hence the scale of the short-term blowout in the deficit). So, Ireland's fiscal position did not preclude borrowing to invest, only its polices did.

The EU Commission forecasts French net GGB this year at 8.2% in 2010 and falling to 7.7% in 2011. Similarly, Belgian GGB is expected to be 5.9%, 5.8% and 5.8% (incidentally, one of the reasons that Belgium is a useful comparator, aside from previously identical yields, is to overcome criticisms that the this does not apply to a small open economy, or to lay the yield blowout at the door of Ireland's bank bailout; Belgium is 2nd in the Euro Area behind Ireland for both).

For the Euro Area as a whole, the profile of GGB forecasts is 6.4%, 6.9% and 6.5% out to 2011, whereas Ireland’s is 12.5%, 14.7% and 14.7%. The Euro Area adopted fiscal stimulus; Ireland a Thatcherite slash & burn. The Euro Area is expected to stabilise and lower its deficit. Ireland’s deficit is expected to increase and then ’stabilise’ at that higher level.

The architects of slash & burn need a Plan B, soon, and a little top-up of investment, ‘financed’ by more slash & burn won’t pass muster.

All the wrong options have been pursed: open letter in today's Irish Times

28 economists, social scientists and economic analysts (many of them familiar to PE readers) have written an open letter, published in today's Irish Times, arguing that the Government's economic strategy is failing, and warning that the current approach of spending cuts combined with tax increases on low and average income earners will bring about a low-growth, high-debt future. The result, they say, will be a joyless, jobless recovery. Instead, they argue, we need a reversal of policy and a new investment strategy which can not only address our serious economic and social deficits but can generate employment in the short-term. Investment coupled with a restructuring of taxation and expenditure in a progressive and expansionary manner to ensure a job-rich recovery - this, and not the current deflationary strategy, is the road to prosperity.

Click here to read the full text.

The economics of grade inflation

Slí Eile: An interesting feature of the debate on 'grade inflation' (Leaving Certificate and Higher Education) in recent days is the way in which the story has moved so quickly centre stage following expressions of unease by some industrialists in recent months. Although some had raised concerns - it took comments by a number of key business people to propel the issue to where it is now. Action was take quickly to research the issue. Resolving it will be less easy. First, is grade inflation a fact? A trend towards higher marks does not, of itself, prove the case. A rigorous comparison of scripts and marking schemes would be required. however, there is enough impressionistic evidence to suggest that inflation of grades has been taking place. The fact that economic interests are dictating the agenda should be of concern. All education is to equip learners with the means to grow as humans and as members of society. Development of skills to take play a productive role in the economy is vital but does not constitute the main or sole purpose of education. Ultimately, education is a means for people to relate to others - in caring for others especially the younger and older generations and to behave responsibly towards the coming 7 generations. Its not easy to put a mark on that.

Cáin feabhra

An Saoi: The underlying tax figures for February are dire. Just look at the income tax figures. February is the month when employers send in their forms P35 with any balances due for 2009, and we also get our first feel for 2010 with the January remittances. Despite the income levy, the payments received are down 12% on 2009 and 18% on 2008. They are also €115M below the Dept. of Finance’s figures for February, prepared just four weeks ago. The weather has little to do with income tax.

VAT is slightly over the monthly target. However, as VAT returns are not due in February, this has to be down to technical reasons, for example Revenue staff slowing down refunds or late payments actually due in January. It is unlikely that VAT at point of entry could explain the difference, as customs duties are down. In addition, excise duty is poor and VAT payable on withdrawal from bond would not explain the discrepancy.

All the other payment heads reflect a country mired in the quicksand of depression and going nowhere slowly. Despite the cut in thresholds, CAT is bringing in less tax as assets are devaluing more quickly. VRT for cars continues to decline despite the incentives. With few transactions taking place, stamp duties continue to slide.

The trend for Corporation Tax is unclear since the splitting of preliminary tax payments makes it very difficult to see what is happening yet.

The outlook for March looks even bleaker. The Jan/Feb VAT returns are payable, and that most reliable of predictors - the Central Bank’s credit card figures - shows that January was a complete washout. Credit card purchases were down 14.7% on January 2009, and a massive 29.4% on January 2008. At this stage, we can only presume that February wasn’t much better. Consumer surveys suggest that consumer sentiment is as cold as the weather. The reduction in short-term bank finance or its pricing may also be forcing many smaller businesses to turn to the Collector General as an alternative source of funding.

I am going to stick my hard neck out and estimate the end of year outcome as follows:

I will adjust next month, if necessary.

Mini-budget and further pay cuts in June? Because there will certainly be no pick up!

Public sector labour costs

Over the past year and a half, a number of commentators have claimed that wages in the Irish public sector are high by international comparison. How true is this? Not very, when compared with other European countries. Over at Notes on the Front, Michael Taft examines the data and finds that,Irish public sector labour costs are below European averages. You can read his post here.

EU 2020 Strategy

Paul Sweeney: The European Commission’s Europe 2020 Strategy is an important long term plan. It replaces the Lisbon Agenda, another long term plan. The latter had the ambition of making Europe the most competitive economy in the world. While there was much success, most commentators agree that the Lisbon Agenda did not meet its targets and that new priorities kept being added, deflecting from the achievement.

It is good that the 2020 Strategy is long term: we need to revert to planning to help sweep up the debris of short-termism.

The 2020 Strategy recognises:

- the depth of crisis
- the importance of the state in the economy – if only to bail out the banks
- the Social Market economy
- the need for reduction in unemployment
- environmental issues
- importance of education & technology
- the Green economy
- the need for a Common Vision & agreed priorities in Europe.

It is worth reminding ourselves that this deep crisis throughout the West was caused by economic fundamentalism. This was only challenged by a few, and even Social Democratic Parties fell under the spell of the market fundamentalists, under which many of these parties still find themselves. It was de-regulation, privatisation, and in Ireland’s case, pro-cyclical tax-cutting, tax-shifting and tax-subsidies to wealthy property investors which caused our deep recession.

Ireland had one of the largest falls in GNP in the world. It will fall by a staggering one-fifth or 19.9% this year, on 2007. This is a €32bn cut in national income in just 3 years.

The successful “exit strategy” can only be achieved by a stimulus.
Not by deflationary regressive policies like this Irish government pursuing, i.e.:

- wage cutting,
- welfare cutting,
- public services slashing,
- pouring cash into Zombie banks - which could be used as a stimulus

The speech to the Institute of Taxation by Mr Lenihan on Friday 26th February, in which he claimed that European stimulus packages were failing, was chilling. It was chilling in that he was declaring that he is a true believer in deflationary policies. Below the front page report of his speech in the Irish Times was a report on retail job losses and firm wipe-outs – partly the result of this government’s policies to date.

The proposal in the Strategy to “empower people in inclusive societies” is welcome but flexicurity should mean that workers’ rights must be strengthened, not reduced, especially with regard to precarious work. A Fair Labour Market must mean good wages, stable contracts and good benefits for those unemployed. The reference to Atypical jobs should spell out that they are to be the exception, not the rule, in the EU. Investment in skills and the elimination of poverty and exclusion should be key.

The plan recognises the need to create “a competitive, connected and greener economy, with greater productivity.” However, as most economists on this blog have pointed out, “competitiveness” is not just about short term movements in wages. This is in contrast to the restricted view of the subject of too many influential Irish economists.

Per the 2020 Strategy:

1. Creating value by basing growth on knowledge

- well-resourced European Research Area
- digital economy.
- innovation and creativity

2. Empowering people in inclusive societies

- Flexicurity – but as stated above, workers rights must be strengthened especially around precarious work
- A Fair Labour Market – must mean good wages stable contracts and good benefits for the many out of work.
- Atypical jobs should be the exception not rule in EU
- Skills
- Deals with poverty and exclusion. In my view, there should be a major 'make poverty history' drive by 2020. Why not?

3. Creating a competitive, connected and greener economy

- Productivity
- Competitiveness - not just short term movement in wages
- Broadband: the ideologically driven privatisation of Eircom has been a disaster
- Invest in Public transport
- Energy
- Industrial policy – indigenous industry

4. Fully exploiting the single market

- Does this mean that there will be tax coordination? What are the implications for Ireland’s myopic obsession with its maximum 12.5% CT rate?

Reading the Europe 2020 Strategy plan, I wondered - does it have a major flaw? When it said it was “supporting growth through full use of the Stability and Growth Pact”, I thought - what??

Has not a coach and four been driven through the Stability and Growth Pact by many states, including this one? Will Ireland still meet its 3% target by 2014? Especially with deflationary policies? Have the EU Commission and institutions like the ECB not recognised that, in a deep recession like this, the pact is, in practice, suspended.

Without some form of fiscal union, such as an EU tax body, is monetary union – the euro and ECB - not akin to one hand clapping? The major fiscal crises in the Eurozone, especially the Greek crisis, have exposed this flaw.

Can Monetary Union work if we do not have greater political union? Surely we must now raise much more taxes centrally (to bail out the banks after the next crash, to bail out the odd country and to meet other crises, e.g. climate disasters)? Thus we must go further than mere EU tax coordination. And even that idea causes palpitations in Merrion Street and in Irish corporate boardrooms. Low company taxes represent virtually the only industrial strategy in the cupboard of many Irish conservative policymakers.

We don’t even have a European Bank Regulator. We don’t have “a mechanism to safeguard the financial stability of the Euro area as a whole” as was stated by Ecofin recently. What about a Eurobond for Euro countries?

A major issue in the next decade, the period of the plan, should be radical reform of Corporate Governance. This means a shift from shareholder value to stakeholder interests, in company law, in EU law and in corporate morality - if that is not an oxymoron. This must be sooner rather than later, and must and be in both the private sector (especially), but also in the public sector. Subsidiarity must be the priority in public sector governance, combined with modern management information and people managment systems.

On the issue of governance, there are some hopeful signs. An international agreement on the Transaction Tax is likely at the G20 in June. Further international rule-making and cooperation on finance and banking is on the cards. It is imperative that it is not “back to business as usual” in firms and in Governments, otherwise, we will soon be back to recession.

It seems to me that we need more effective EU institutions. We also need EU leadership which is more responsible to its people. Neither are in this plan. But the European people gave the conservatives the majority – even after the collapse of a virulent form of liberalism espoused by those conservatives.

President Barroso said that “we need a new much stronger focus on the social dimensions in Europe at all levels of government.” This is not, regrettably, reflected in this 2020 vision.