Controversies over speed of fiscal adjustment

Slí Eile: A recent paper by John Fitzgerald of the ESRI (‘Fiscal Policy for Recovery’) indicates the scale of challenge facing public finances in Ireland. His medicine, while conforming to the standard prescription, is greatly more nuanced than the Slash and Burn school of McCarthy/Department of Finance). He outlines six principal Conclusions as follows:

Standard Dublin Consensus Conclusions:
Wages are too high and need to be cut by ‘7% over 3 years’ (in the public and private sectors)
Capital investment should be focussed on producing ‘the maximum impact on the productive capacity of the economy’ but not primarily as generating jobs in the short-run (implicitly the inevitability of continuing high levels of unemployment is accepted pending a larger-scale resumption of outward migration?)
Frontload public spending cuts but in a way that increases efficiency ‘with a minimum impact on services’. ‘Cuts in expenditure now, with an agreed reform package, may well be the only way to achieve long-term reform’. (Fitzgerald rules out a Keynesian stimulus as the scope for borrowing is too constrained by the depth of pro-cyclical squander in the 97-07 period. He also acknowledges that cutting spending and wages will be deflationary and will postpone recovery in 2010 but believes that TINA).
Reform the welfare system to avoid creating ‘poverty traps’ or disincentives to returning to work (when such eventually becomes possible). (This can only mean lower welfare vis-a-vis wages)
Non-Standard Conclusions:
Taxes as a % of GNP should be raised to 45% over a number of years (with an ESRI preference for property and carbon taxes and some shifting in employer PRSI towards employees)
Tax child benefit but no generalised cuts in welfare rates.

Nearly all of the above runs directly contrary to the position taken by the ICTU (see ‘There is Still a Better, Fairer Way’) and by various progressive commentators (see for example
notesonthefront.typepad.com). In essence the disagreement centers on:
* The deflationary impact of pay cuts in general (as against the claim that such cuts will price us back into export markets and boost investor confidence and expectations).
* The need to prioritise job retention and creation through an investment package (as distinct from a lower capital spend suggested by Fitzgerald of around 4% of GNP)
* Prolonging the period of fiscal adjustment (as against a short, sharp snap before the economy bounces back in 2011 or 2012 – hopefully !)
* Defending all families – especially poorer families – in terms of welfare payments and living standards (as against withdrawing net payments to some households and reducing the ‘replacement rate’)
* Raising taxes towards 40-45% more quickly than that envisaged by Fitzgerald.

Fitzgerald makes two further points which should not be overlooked:

My own view is that the 7% public service pay cut in March has made a significant dent in the difference between public and private differentials, while still leaving a substantial public sector premium. The tacit acceptance by the public sector of these cuts was quite a remarkable recognition of the crisis which the economy faces.

Indeed it was remarkable.

Before we can determine the appropriate path of fiscal policy over the next five years we must first decide on what is the long run level of public services that we want. Then the tax level will have to be set at an appropriate level to fund that level of services.

On this last point I must concur 110%.