A better way

Michael Burke: As the population braces itself for another round of swingeing cuts, the government and the overwhelming majority of the media continue to make this claim: That larger cuts will reassure financial markets, allow NTMA to resume borrowing once more and lead to lower interest rates.

Over at the Irish Economy, Colm McCarthy has been expounding his opinion that the government isn't cutting enough, and that more is needed to actually reassure the financial markets.

However, this market participant actually thinks the cuts are undermining Irish credit-worthiness, so making the situation worse: "Nick Stamenkovic, a fixed-income strategist at the Edinburgh-based RIA Capital Markets, told Bloomberg: "The biggest worry about Ireland is the growth picture. Investors are fretting that the actual growth implication of these fiscal consolidation measures may make it more difficult for budget deficit targets to be achieved".

Meanwhile, Sinn Féin leader in the Dáil Caoimhghín Ó Caoláin said at the launch of that party's pre-Budget submission: "The key to recovery is the provision of stimulus to get the economy moving again by protecting and creating jobs and ensuring that those on lower incomes are not pushed into poverty, thus further depressing the economy."

There you have it. Four competing views of the situation: how is any citizen supposed to arrive at an informed view? Well, perhaps recent history should be our guide.

Through those 5 budgetary packages €14.6bn has been withdrawn from the economy, each package larger than the previous one and increasingly loaded towards spending cuts. We will know soon enough how large the current package will be, and the obligation to report this to the EU means we will know (most of) the detail well before December 7. But it looks like being at least the equivalent of last year's 'last big push' of 4€bn.

Using Exchequer Statements (which are not complete, but widely aired) we know that total tax revenue fell by €7.8bn in 2009, while the deficit excluding bank bailouts and NPRF payments widened by €8.3bn. At the same time GDP fell by €20.3bn.

On this basis, we can test the four propositions. First up, the Government.

Let's call it the Lenihan Claim. It argues that its actions saved the economy from a far worse fate (despite the fact that every other Euro Area economy adopted measures to boost the economy in 2009, and they have been out of recession with deficits falling for over a year). But had they done nothing, this €10.6bn of tightening by 2009 would not have happened. In which case the deficit would have widened to €10.6bn + €8.3bn, which equals €18.9bn. Does anyone, even in the government believe that the government is responsible for nearly the entirety of output in this State? €18.9bn of a total €20.3bn. This is a nonsense.

Secondly, let's look at Mr Stamenkovic's view. We'll call it the Market Reality. His argument is that the markets believe that the fiscal policy are damaging growth to such a degree that it is counterproductive, the decline in activity hits both tax revenues and forces up welfare payments to outweigh the 'saving' made by the cuts. How can we test this? One way would be SF submission there is an annex dealing with precisely this question. It uses Philip Lane's first year multiplier of 1.24 and the DoF's 0.6 estimate of the sensitivity of government finances (that's how much both taxes and outlays are affected by changes in GDP). Now, these are estimates based on long-run behavior; this and the current crisis may push both of these estimates higher. But using these to illustrate the point:- this would mean that a €10.6bn fiscal contraction would lead to a €13.14bn decline in GDP, which in turn makes government finances €7.9bn worse off. The actual 'saving' is just €2.7bn- and the economy is much worse.

Surely, then the third bite-the-bullet option is correct?, to be known as McCarthy's Misconception. This is the advocacy of the ambulance-chasing attorney; Your Honour, my client says multipliers don't exist, even if they exist they are very small, even if they are not small it's too late now to deploy them. Having vociferously argued the first two points over a prolonged period (and brought us the priceless assertion in his cuts Report that the deficit, 'would be eliminated by 2011'), the case rests now on the last proposition: OK, maybe large cuts yield only small savings, but that only shows we need extremely large cuts. But this neglects one small point arising from the Lane (and other models). This is that the negative impact of the cuts accumulates over a prolonged period, 1.61 in Year 2, 1.13 in Year 3 and so on. Therefore the damage to government finances accumulates too over a prolonged period. It only begins to turn positive on a net basis when a decade has nearly passed, by using a series of questionable assumptions about private sector confidence and ‘crowding in’. In that case long after the IMF have been called in.

The fourth option recognises the reality, that cuts don't equal savings because they hurt the economy, which in turn hurts government finances. This is the Sinn Fein Appeal to the poor and the workers of Ireland, but also to all progressives and those who simply care about the plight of their fellow citizens and the country in which they live. It is credible because it is based on analysis of this economy from one of its leading economists and the DoF itself. This shows that investment combined with a tax reform which sees the rich making a greater contribution than the poor to financing recovery is not only fair, but the only practical approach. Michael Taft raised some criticisms here of the submission and they are certainly worthy of debate. But the political framework is the key.

As was the case with TASC's recent proposals for Budget 2011, the starting-point is that the current way of approaching this is unfair, increases unemployment and does nothing to promote recovery. There is a growing conviction that there is a better way.