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.

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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...