What goes around the track comes off the track

Michael Taft: Remember a few months ago, when ICTU proposed postponing the target year for Maastricht compliance to 2017? There was a widespread rending of garments and universal condemnation of this most irresponsible and reckless proposition. I recall an interview with our erstwhile Minister O’Dea who went apoplectic at the idea predicting economic Armageddon and the wrath of the Furies (I stepped away from the radio in case he exploded and I got hit by his bodily shrapnel).

Oh, and now the IMF. In their recent report they projected, under current fiscal policy, when the deficit would come into Maastricht compliance. What year? 2016 or 2017. This didn’t get much prominence. I read the newspapers this morning and not one mention (if I’m mistaken, please let me know). Still, when this becomes known, I wonder what the response will be. Condemnation of the IMF? Exhortations to cut even more (Dan O’Brien wants us to have a go at pensioners)? An apology to ICTU? Guess which response is the most likely.

The IMF’s projection shouldn’t surprise us. A few weeks ago, Ernst & Young / Oxford Economics examined the issue and, on current strategy, projected the deficit wouldn’t come into Maastricht compliance until 2018 or 2019. Indeed, I have not met any economist – regardless of their ideological complexion – who, hand on heart, believes that 2014 is a realistic goal.

One merely has to compare Government and IMF growth projections up to 2015 to understand why 2014 is merely aspirational. IMF estimates growth to be substantially less than what the Government is predicting; in particular, the IMF suggests that GNP growth, or domestic activity, will be nearly half what the Government expects. With limited growth comes lower tax revenue and higher unemployment expenditure: hence, a consistently larger deficit.

Why would growth be so understated? The ESRI is ready with an answer (from the full commentary, not available yet on-line).

‘The impact on the wider economy (of the Government’s planned €3 billion fiscal adjustment) is to reduce the growth rate by approximately one percentage point. In addition, the level of employment is lower and emigration flows higher than in the absence of such a package. These are real costs attached to the programme of fiscal consolidation being pursued by the government.’

Of course, the ESRI feels we should proceed with the deflationary fiscal adjustment regardless. Why? Because we have to reduce the deficit. But is it reducing the deficit? Not really; it is resulting in sluggishly high deficits and higher overall debt levels. But we have to cut the deficit . . . and so we are trapped in a vicious circular argument.

So if we proceed with deflationary spending cuts to cut the deficit we will reduce growth which will, in turn, create higher than anticipated deficits. How can we escape this deflationary-deficit trap?

The first step, in any agenda, is to establish a starting point grounded in the real world. Therefore, it is imperative that we scrap any notion that we can, or should, strive to reach Maastricht compliance by 2014. We should abandon any strategies that are premised on bringing the deficit to below -3 percent by that date. A credible strategy cannot, by definition, have a fantasy as an endpoint. And if that bothers some of you budget fundamentalists, get over it.

And while we’re scrapping the fantasy 2014 target date, let’s remember what the real key to repairing the public finances is: as Clinton might have said, ‘It’s the growth, stupid’.

The inter-relationship of it all

Michael Taft: From Ernst & Young’s Economic Eye Summer 2010 forecast, two projections scream out from the report:

First, employment levels won’t return to their pre-recession level until 2022. Yes, 2022. That’s 15 years of a jobs-recession – a decade and a half. That led the report to refer to a ‘ . . . sluggish and largely ‘jobless’ recovery’. The word ‘largely’ is an understatement.

Second, is their projection on the annual deficit. This is equally depressing but, given their employment projections, not surprising. Ernst & Young project that the Government will not only fail to reach the Maastricht deficit target of -3 percent by 2014 – they won’t reach it until 2018 or 2019.

What’s noteworthy about this deficit projection is that it is done against the background of a reasonably optimistic growth rate of 3.5 percent throughout the next decade. However, the E&Y report poses a number of caveats, especially as this growth rate rests largely on the export sector. They raise the real danger of a two-tier economy, with the domestic economy lagging even further behind. If this occurs, we might find that the deficit might (might) eventually come right statistically, but remain an unsustainably high burden for years and years to come.

Of course, this will no doubt give new impetus to the cuts brigade – those who believe you get out of a hole by digging even more. They should be aware of the following. Just after the April 2009 budget, E&Y projected that Ireland would reach the Maastricht deficit target by 2015. Now, after the December budget, they have pushed that back by three to four years. Another round of cuts could see that target pushed back even further.

The key inter-relationship is employment and the deficit. A jobless recovery will continue to impair the public finances. Responding to public finances by more spending cuts will exacerbate employment. And this, in turn, will continue to impair public finances.

Some Governments get it. This one doesn’t.

The future just got worse

Michael Taft: The EU Commission has announced that Ireland will get an extension to the target date for return to Maastricht compliance. Instead of 2013, it will be 2014. But don’t think that feet will be taken off the contractionary pedal. The EU Commission has called for even deeper deflationary measures spread out over a longer period than the Government had intended. The future just got bleaker.

In one sense, the extension was inevitable. The Government’s strategy to reach Maastricht compliance by 2013, outlined in the April budget, was growing more untenable by the day. Back in April, they hoped to hold the deficit at 10.7 percent by the end of 2010. Over the next three years they intended to reduce the deficit by 2.5 percent annually. That, according to the plan, would see the budget home at -3 percent by 2013.

Already, though, this math ahs gotten knocked off-course. The ESRI has projected the deficit will fall to 12.8 percent next year. Further, GDP will be below the Government’s projection. On that basis, the 2.5 percent annual reduction wouldn’t make it. Already, Goodbody Stockbrokers, the NIB and Ernst & Young claimed the Government would fail to reach the 2013 target.

Enter the helpful EU Commission. They are now allowing the Government until 2014 to reach Maastricht compliance. EU Commissioner Almunia tried to put a positive gloss on this – claiming that this extra year was given in acknowledgement that the Government is going down the right course. However, it had little to do with good intentions – it was merely an acknowledgement of cold math.

The bottom-line in all this is not that the Government is being given extra breathing space. Rather, it is that the Government will have to continue its deflationary fiscal strategy – the planned average annual 2 percent contraction up to 2013 – for another year. The economy has not been given a respite – its deflationary sentence has just been lengthened.

How will this play out in the medium term? Despite media reports that the Government is more optimistic about the economic numbers this year (this is in line with all other forecasters), the issue is what are the growth numbers going forward? In April, the Government projected a growth rate of over 10 percent between 2010 and 2013. Some forecasters disagree. IBEC is projecting 6 percent while NIB is slightly more optimistic at 8 percent. Only Ernst & Young, so far, believe growth rates to 2013 will be as strong as the Government projections.

However, extending the deflationary period will only dampen economic growth longer. To put it metaphorically (and much of the debate is played out at this level – ‘take the pain upfront’, etc.), the economy is likely to trough sometime next year. When it hits the bottom of the recessionary sea it will try to swim back up to the surface. However, the Government’s deflationary strategy is acting like an anchor tied around to the economy’s foot, making that upward swim harder and slower.

There are bleaker growth projections. At a recent economic forum organised by Dublin City Council:

‘Jonathan Stenning of Cambridge Econometrics was considerably more downbeat about the prospect of recovery, saying he expected the Irish economy would pick up slowly and grow at an average rate of 1 per cent per annum between now and 2013.’

If Mr. Stenning is correct, the economy will struggle further. It will not be able to generate the necessary tax revenue; it will not be able to generate the jobs to meet the needs of new labour market entrants, never mind those already on the dole; consumer spending and investment will remain depressed; the economy will be mired in a period of low-growth, high-debt.

I really hope the Mr. Stenning is wrong. For if he isn’t, the EU Commission will be coming back to the Irish government again, saying what a good job they are doing, and because of the that they will be giving them another target date extension – to 2015.

But what they will really be doing is lengthening our deflationary sentence. Again.