National Income and Expenditure 2011

Michael Burke: The argument in favour of ‘austerity’ measures is that the overriding objective of policy must be to reduce the government deficit, that this must be done by cutting spending and that there is no alternative to current policies. The release of the latest Irish National Income and Expenditure for 2011 should serve to dispel the several fallacies contained in that argument.

GDP has contracted by €30bn since 2007 in nominal terms, down 6.8 per cent in real terms (Tables 5 and 6). GNP, which excludes the distortions of multi-national corporations who book profits in Ireland to avail of its ultra-low corporate taxes, has fallen by €35bn since 2007 - a contraction of 11.1 per cent in real terms. If the overriding objective of policy were the optimum sustainable prosperity and well-being for all citizens then clearly the current measures would be a spectacular failure.

However, the objective to cut government borrowing on a sustainable basis is also not being met. ‘Austerity’ measures began towards the end of 2008 (unprompted by any international agency, but as a domestic policy choice). From 2008 to 2011 government current receipts have fallen by €6.3bn while current expenditure has risen by just €0.5bn, a total increase in the deficit of a little over €6.8bn despite all the fierce ‘austerity’ measures (Table 21). Worse, in relation to GDP this current deficit (excluding capital spending and receipts) has risen from 2.2 per cent of GDP to 6.7 per cent. Even if debt interest payments are excluded, the ‘primary deficit’ has risen by €4bn.

The only reason supporters of current policy can claim success in deficit-reduction is because the huge one-off payments to rescue the bank bondholders have come to a halt. These ‘grants to enterprises’ have amounted to over €43bn in the 4 years to 2011. But, even if they have now come to an end (which is at least questionable), they cannot be taken as evidence of any underlying improvement in the deficit arising from economic policy. That can only be gauged with reference to the government current income and expenditure, which is deteriorating.

What Is Policy For?

These data are of course well known in the Department of Finance, whose officials advise Ministers. It is improbable that both government and the Troika are unaware of the underlying state of government finances. If current policy even closely matched the success claimed for it, there would hardly be any need for the threatened further ‘austerity measures in the forthcoming Budget.

Yet current policy will be maintained and even deepened. This is because there has been some success, of a kind, for policy. In Fig.1 below data from Table1.1 of the NIE is shown (click to enlarge).

Source: CSO

Even though GDP has been contracting throughout the period, profits have risen in the last two years. At the same time employees’ remuneration has fallen sharply. In a recession the natural tendency is for profits to fall. This is because profits are the surplus after fixed costs and costs of labour and other input costs are deducted. Since fixed costs for firms are often unchanged, the fact the wages do not fall faster than sales means profits decline. This is what happened to profits in both 2008 and 2009. However, after ‘austerity’ measures were introduced in 2008, wages fell in 2009 and have continued to fall since. This has allowed the natural fall in profits to be reversed, at the expense of wages.

To put this in perspective, labour’s share of national income has fallen so far in 2 years that it could be increased by 8.7 per cent over 2011 levels and this would still only have the effect of returning its share of national income to the crisis levels of 2009.

It is argued that the policy measures which have the effect of lowering wages and increasing profits are necessary in order to generate recovery, often described as ‘restoring competitiveness’ even while there is incessant and misplaced boasting about the rise in Irish exports.

But it is impossible to engineer a sustained recovery without an increase in investment. The decline in Gross Fixed Capital Formation (GFCF) is greater than the total decline in GDP, €32bn versus €30bn (Table 5). Yet, from 2009 onwards, when profits rose by €8.6bn, GFCF fell by €9.5bn. The policy of transferring incomes for labour and the poor to capital and the rich, which is the real content of austerity, has been an utter failure in reviving growth.

Policy ought to be aimed at the optimum sustainable growth in prosperity for all citizens. The policy of transferring incomes to capital and the rich does not achieve that, nor does it foster investment, the determinant of all future prosperity. Meanwhile the bluster about an improving deficit position should be recognised for what it is, just bluster.

Is the Irish Economy At a Turning-Point?

Michael Burke: There are a number of curious features of the latest quarterly national accounts data. Statisticians frequently warn that these are preliminary data and subject to revision. It may simply be that these data are likely to be subject to more revision than most. Therefore, identifying long-term trends in the economy may be more useful.

On the data discrepancies, in real terms (Table 6 of the CSO release):

• Net exports surprisingly fell in the quarter by nearly €1.8bn
• Equally, investment (Gross Fixed Capital Formation) rose in the quarter despite virtually unchanged government spending and falling personal consumption
• The price deflators are positive for consumption and government spending, but negative for investment (GFCF) implying renewed deflation in this sector and contributing to the real terms increase in reported investment
• As reported in today’s Irish Times, total domestic demand rose for the first time in 2 years in Q1- except that the totals given by CSO (in Appendix 3A & 3B) do not add up.

As a result the quarterly data may not be very robust. But the longer term trends cannot be invalidated by one quarter’s data. And these remain both stark and grim (all data seasonally adjusted in real terms, from Table 6):

• GDP has been contracting since the 1st quarter of 2007- a 5 year long slump and is now 8.2% below its peak
• GNP, which excludes the profit-booking activities of multi-national firms notionally based in Ireland, shows the Irish economy in a Depression - down 14.2% from its peak 1 year later in the 1st quarter of 2008
• The component of growth which led the slump is investment (Gross Fixed Capital Formation). It peaked in the 1st quarter of 2007 while all other components of the national accounts; personal consumption, government consumption, exports and imports all continued to grow into 2008
• Investment has also driven the slump. From peak, GDP has fallen at an annualised rate of €14.1bn and GNP by €20.7bn. GFCF has fallen by €21.7bn and thus accounts for the entirety of the economic collapse (even including the latest reported quarterly rebound in investment)
• By contrast personal consumption has fallen by €9bn and government spending by €4.6bn (and net exports have risen)
• The increasingly widespread notion that the rise in household savings is the cause of the economic crisis is false. The separate National Income and Expenditure accounts for 2011 (released alongside the quarterly National Accounts) shows that since 2008 profits have risen by 2.5% while wages and salaries have fallen by 16.4%. Profits are rising in an accelerating fashion, up 6.6% in 2011.

Despite all the earlier caveats, what if the data is accurate? It is always unwise simply to dismiss data out of hand. And surely the reported rise in investment is very welcome for those of us who have argued that this is the key to the crisis?

The question of who pays for the crisis bears on how it may be resolved. No-one believes that the economic crisis will last in perpetuity. Ultimately, there is no crisis of capital which cannot be resolved by reducing labour’s share of national income. At a certain point, when profits have recovered then investment may increase. Tentatively, this may be what has already begun to occur in the Irish economy, although the data discrepancies make that proposition doubtful.

Taking the data at face value, there is one reported quarter where investment increased by €1.5bn in nominal terms. This apparently required a rise in profits of €6.3bn over the preceding two years, facilitated by a decline of €5.7bn in the remuneration of employees. The rise in profits is achieved by reducing pay and only a fraction of the profits’ increase has been invested. It is easy to see that any recovery based on this model will at best be very sluggish and require the immiseration of the mass of the population.

The alternative remains state-led investment deploying the growing profits and large savings of the corporate sector. Only state-led investment can ensure a robust recovery which creates jobs and improves living standards, which ought to be the goal of economic policy.

The ESRI Quarterly and 'The Small Open Economy'

Michael Burke: The latest ESRI Quarterly deals very briefly with the issue of economic stimulus.

‘We would be very cautious about a domestic stimulus in Ireland, however funded, as history and experience shows that such a stimulus would have little effect on the domestic economy, but would lead to a worsening of the balance of payments’ (ESRI Summer, QEC, p.41).

Of course, if it were really the case that an Irish stimulus would lead to a worsening of the balance of payments than it would be counter-productive by increasing the overseas indebtedness of the economy, to add to all its other debts.

It should be noted that the ESRI makes no distinction between types of stimulus. Promoting the purchase of goods not at all made in Ireland would be counter-productive, as that could only be met by increased imports. This is what happened with the cut in VRT. But promotion of investment in or purchase of goods wholly or mainly provided in Ireland would not have that effect.

The ESRI also engages in hyperbole when it argues that the experience of the 1950, 1970s and 1980s is that any stimulus measures means a large proportion of stimulus would go to imports. The series of National Development Plans have precisely been a domestic investment stimulus which lifted both the growth rate and the long-term productivity of the economy.

Where Would Stimulus Go?

The assertion that any stimulus would lead to a worsening of the balance of payments is not supported by an analysis of the Input-Output Tables for the Irish economy.

In effect there are distinct categories of sectors in the economy where that would not be the case. The first is comprised of those sectors where the import content of inputs is negligible. This means that any increase in the output of these sectors would require no increase in imports. The second category of sectors includes those where the export output is much higher than the import content. This means that firms based in Ireland are importing lower value goods or services and re-exporting them having added significant value to them. The third category is comprised of those sectors where, even though the import content of inputs are high, the domestic multiplier effect is so large as to produce a significant boost to the domestic economy.

The first category is where import content of inputs is low. As the CSO says (p.10), of 53 sector groups there are 7 which have an import multiplier of less than 0.15, that is for every €1 extra of domestically produced output in these sectors, less than 15 cents is required indirectly in imports. These include wholesale trade, real estate services and education, motor repair, retail trade and repair of household goods. Health services have in import multiplier of just 0.16. Investment in these areas would overwhelmingly boost the domestic economy.

The second category is comprised of those sectors where the export component of output is much greater than import inputs. They are naturally dominated by the sectors in which the overseas multinationals predominate, printed materials, chemical products, office machinery and financial intermediation. But that is not exclusively the case, as the manufacture of food and beverages and the wholesale sectors both export more than they import. Providing services or ancillary inputs to those MNC-dominated sectors, or investment in the two large indigenous exporting sectors would be a positive for the balance of payments, as well as boosting output and employment. Altogether there are 27, of 53, product categories where higher value added means they export more than they import.

In the third category are those sectors where the boost to the economy from increased investment (the ‘multiplier effects’) are so great as to override concerns regarding import content. There are also 7 out of 53 sector groups where the output multiplier is 1.66 or greater (pp. 38-40), implying that the State would have a direct positive return on investment in these areas. These include agriculture, food and beverage manufacturing, water collection and distribution, construction, hotels and restaurants and water transport. The state could either directly invest in these (eg, water distribution and collection, construction/refurbishment of schools) or facilitate investment (eg, through promotion of tourism to benefit hotels and restaurants) and provide a positive return to the Exchequer. Indeed, in the case of tourism promotion, it would make sense for the overwhelming bulk of the investment to be made overseas.

The truisms regarding Ireland’s status as a small, open economy should not obscure the potential for State-led investment in a wide range of product sectors which have little import content, or whose domestic impact is so great as to render the objection that there will e increased import demand meaningless.

In fact, we could go further and argue that the ESRI’s entire framework is wrong. If the aim of policy were to prevent imports then there are numerous examples internationally and in Ireland’s own history where everything from import-substitution to autarky where that has been tried and failed.

27 of the 53 product sectors in the Irish economy export more than they import. Investing in those sectors, either directly or indirectly would boost imports, but exports would grow by a greater amount. Even those sectors which currently export nothing according to the CSO, like education, could become significant exporters by attracting overseas students. There is a vast and growing demand for high value-added education primarily in English and, as coverage of Euro2012 shows, everyone likes the Irish. But that too would require state-led investment and the input of high-value imports, both material and human.

So what do the markets think?

The victory of Francois Hollande in the French Presidential contest provides a further insight into the operation of the bond markets. It is frequently argued that there can be no retreat from ‘austerity’, which in reality is simply the transfer of incomes from labour and the poor to capital and the rich, because the bond markets will recoil and long-term interest rates will soar. This is important as significantly higher long-term interest rates could, unchecked, choke off recovery.

As the new French President has made some gestures in the direction away from ‘austerity’, then it should be expected that at least French long-term interest rates would rise as a result. But French government bond yields have fallen since the Socialist victory, by 18bps (basis points, equivalent to one hundredth of a percentage point, or 0.18 per cent). Ten-year French government bond yields declined to 2.79 per cent1, lower than before the election.
Click here to read the rest of Michael Burke's post.

Are things getting better, or worse?

Michael Burke: The EU Commission Spring 2012 economic forecasts have just been published. It is likely that the downgrading of current growth forecasts will receive some media attention. The EU Commission is now forecasting just 0.5% real GDP growth for Ireland in 2012, followed by 1.9% in 2013. These are significant reductions made from the Autumn 2011 forecasts. Then, growth of 1.1% was projected for this year and 2.3% for 2013.

No doubt, supporters of government policy will point to the fact that there is some growth forecast at all. Even this meagre level of increased activity is better than the average for the Euro Area as a whole, which is expected to contract by 0.3% this year. Surely, this means that the ‘austerity’ medicine is working in Ireland, if, strangely not elsewhere? Well, no.

Back in Spring 2010 the Commission’s initial forecast for Irish GDP in 2011 growth was 3%. It is now estimating that growth was less than one quarter of that level, just 0.7%. Similarly, the initial forecast for 2012 growth was just 1.9% (made in Autumn 2010). Again, it is now expected to be about one quarter of that growth rate, at 0.5%. The outlook for growth is getting worse, not better.

As is well known, the GDP data can be misleading. As Ireland is a weight-station for overseas profits booked to avail of low taxes, other indicators are needed to gauge real activity. In Spring 2010 the Commission was forecasting that both employment and domestic demand would expand, by 0.4% an 2% in 2011. It now expects the latter to have contracted by 3% and to continue to do so over the forecast time horizon (til 2013). Employment was initially expected to grow by 0.4% in 2011. It is now assumed to have contracted by 2.1% and will not expand til 2013, according to these forecasts. Altogether the Commission expects that one in seven jobs will have been lost during the Irish Depression, even if its forecasts do not prove to be overly optimistic once again.

But what of the sole indicator which is now said to be targeted by the government and the Troika, the judge and jury of all economic policy, namely the structural (or cyclically-adjusted) budget deficit? The EU Commission now forecasts that this structural deficit (SD) will rise in 2013 to 7.9% of GDP, from 7.8% in 2012. This compares to a SD of 7.3% of GDP in 2008, when ‘austerity’ began.

In terms of the actual, measured deficit this is now expected to be 7.5% of GDP in 2013, compared to 7.3% in 2008. Even this miserable performance has been achieved by the simple expedient of cutting government investment. In 2008, in the dog days of the previous government the level of state investment was equivalent to 5.2% of GDP. It is now projected to fall to 2.3% of GDP. Without this decline, the actual deficit would be 10.4% of GDP.

The economy is not improving. Domestic activity is contracting and jobs will continue to be lost. Government finances are not improving- they are deteriorating. Apparently, An Taoiseach and others are ‘keen to talk about investment’ with the new French President. But it is only by the disastrous method of cutting investment in Ireland that a new sharp upsurge in the deficit has been temporarily postponed. Even so, both the SD and the actual deficit are rising.

‘Austerity’ isn’t working, even in terms of deficit-reduction.

A 'closer look at Estonia'

Michael Burke: ‘Those who declare with infinite certainty that spending cuts and tax increases cannot work, or that there is no example of an economy cutting its way out of recession should take a closer look at the Baltics.’ So says Dan O’Brien, the Economics Editor of the Irish Times.

When it has been previously pointed out that other European countries, such as Germany and Sweden adopted measures to stimulate the economy, we were told that Ireland is unique. When we pointed that small open economies like Belgium had imposed windfall taxes on banks and energy companies to fund government investment, we were told Ireland is not Belgium. Since tautology cannot be disproved, this seemed to settle matters, at least to our critics’ satisfaction.

But now we are told, Ireland is Estonia, or at least should emulate its ‘success’, which is all that was being asserted in the case of countries which boosted investment to spur recovery. Tom McDonnell’s piece on the Baltic States is very welcome in puncturing this nonsense.

There is just one point worth adding, I think. That is, there is no ‘success’ of the Estonian model via what is euphemistically called internal devaluation, aka severe wage cuts to boost the rate of profit.

Below is a table compiled from the IMF country report that Tom helpfully linked to. It shows 3 things. First is the level of GDP growth. Here the Estonian Finance Ministry has issued an updated forecast for 2012, which is that growth will slow dramatically to 1.7% in 2012. Second is the net contribution from the EU as a proportion of GDP. Third is simply the sum arising from deducting two from one, ie what growth would have been without the EU net contributions. The latter does not include any multiplier effect from the spending of the EU, just its arithmetical total.

Estonia GDP and EU Subventions

Source: calculated from IMF, Estonian Finance Ministry data

Before taking into account EU funds, Estonian GDP is now officially expected to end 2012 still 7.6% below its peak in 2007. The entire EU subvention over the period will be equivalent to 20.6% of GDP. The entire growth over the period, from the low-point is just 11.6%. Without the EU funds the Estonia economy will have contracted over the period by 25.3% (again, taking no account of any multiplier effects arsing from that investment).

As is well-known, the EU is a public body. Insofar as there has been any recovery in Estonia it is entirely a function of state, or supra-state bodies. Equally it is well understood that these subventions come in the form of subsidies to particular sectors, especially agriculture, and in the form of structural and cohesion funds. These investment funds are the larger part of the EU funds provided, equivalent to 16% of GDP over the period. They concentrate on infrastructure, transport and other areas.

The ‘internal devaluation’ model has been a disaster for Estonia. Those who want to rescue profits by reducing wages are searching far and wide to find examples of where this had led to growth. But they are failing. The sole success for Estonia over the period has been investment from state bodies. This is the lesson from the Baltics, and one which does apply to Ireland.

GDP contraction in the crisis Euro area economies

Michael Burke: OECD comparative data for the crisis EU countries highlights the extent of that crisis.

Greece has become a by-word for the effects of ‘austerity’. OECD Greek GDP data has only been published up to Q1 2011. To date Greek GDP has fallen by 9.1% since the final quarter of 2007.

Portugal, whose creditors have also been bailed out by the Troika has seen its GDP fall by 5.1%.

Spain has recently created waves with the Rightist government arguing that it will overshoot the deficit targets set for it externally by the Troika. Formerly, its Socialist government had adopted measures to boost economic activity including increased investment in infrastructure and by increasing the minimum wage. As the chart shows there was a mild economic recovery. Subsequently, ‘austerity’ was imposed and economic activity has begun to contract once more. GDP has fallen by 3.5%.

In Ireland GDP has fallen by 11.6% since the end of 2007. This is a greater contraction than any of the crisis-hit countries in the Euro Area, including Greece. Obviously Greek GDP may have declined even further by the end of 2011. But at the same point of Q1 2011, Irish GDP had fallen by 11.5%- more than Greece. The chart below clearly shows that the total decline in Irish GDP has been much greater than in Greek GDP.

If the final data shows that the Greek economy has contracted by more than the Irish economy, this will owe nothing to any Irish recovery, but solely because the Greek economy has been contracting even faster.

Initially the Greek recession was milder than the EU average, just over2% compared to a decline of just over 4% for the EU as a whole. But no country in the Euro Area has had greater cuts in public spending imposed on it. The result has been an economic slump. But the widely-held belief that public spending cuts in Ireland have been a success is not supported by the facts. It has also produced a slump in Ireland.

Dishonesty and the 'structural deficit'

Michael Burke: An article in the Irish Times by Stephen Collins which asserts that the new Treaty “seeks to do is to put an end to the kind of populist and inept fiscal policies that brought Ireland to the brink of ruin” has already drawn strong rebuttals here and here.

It is an entirely valid argument that fiscal policies brought Ireland ‘to the brink of ruin’- but only because the actual sequence of events was that it was the political decision to bail out the failed private sector banks that fatally undermined the state’s finances.

But there is no legitimacy to any suggestion that the new rules would have required successive Irish governments to act in a significantly different manner, until after the crisis hit. The table below shows that the EU commission assessed there was no structural deficit at all until 2007.

It is worth simply pointing out what the EU Commission has recorded on the Irish ‘structural deficit’.

In fact, even this low ‘structural deficit’ is dishonest. It is an example of what statisticians call ‘data-fitting’; that is, adjusting the data to get the desired outcome. Here’s what the Commission was saying in late 2008, after the crisis and the Irish slump had begun. Somehow a 2008 deficit of 4.9% has become a deficit of 7.2%.

The point of the ‘structural deficit’ is that is exceptionally malleable- it can be made to fit almost any desired level at all. In this article, the impeccably mainstream ‘Investor’s Chronicle’ magazine argues that the ‘structural deficit’ is a myth.

Nor was there a debt problem in Ireland which raised any issue regarding the 60% of GDP limit, not until 2009 for Ireland. As can be seen, it was the so-called ‘core’ countries which were the serial offenders on debt levels before the crisis.

The assertion that the new Treaty would have prevented the crisis in Ireland is groundless.

Government spending policy is deepening the crisis

Michael Burke: The latest national accounts data are worse than they look. The headlines have been about a ‘technical return’ to recession with two quarters of negative growth at the end of 2011. But on two measures, the situation is much worse than the short-term occurrence of a double-dip recession.

• Measured by GDP the economy has been in recession since the end of 2007 and remains €21bn below its peak. This is a decline of 11.6%
• GNP, which excludes the profit flows of overseas multinational corporations, has fallen by €26.3bn, down 17.3%. This takes GNP back to the last century

It remains the case that investment (Gross Fixed Capital Formation, GFCF) is overwhelmingly the source of the slump, having fallen by €23.4bn. This is greater than the decline in GDP and accounts for over 90% of the decline in GNP. Clearly, there can be no recovery without a recovery in investment.

But, acknowledging that all these data are subject to revision, investment is not currently the motor force of the decline. Investment rose in Q4, as did household consumption, according to these initial data. Combined, they added an annualised €2.5bn to growth in the 4th quarter.

The motor force of the slump has become reduced government spending. In the 4th quarter of 2011 government spending fell by €1.9bn in the quarter which is a majority of the total decline of €2.8bn in the period.

The data show the dynamic of the economy. The investment collapse accounts for the slump as a whole. Yet even the tentative increase in investment currently recorded at the end of 2011 is unlikely to persist while there is a contraction in government spending.

The private sector investment strike is the cause of the slump. But government policy is deepening the slump, not alleviating it.

As 'austerity' isn't working, what's the alternative?

Michael Burke: Tom Healey has made some very good points in debunking the myth that ‘austerity’ is working. In general the EU governments that have embraced the ‘austerity’ model – the transfer of incomes from labour and the poor to capital and the rich – are currently engaged in a game of blame the foreigner. The economic argument is that it is the turmoil in the EU which has caused the respective slowdowns. The British government repeats this mantra endlessly, even though British growth in 2011 was half of that both in the Euro Area and in EU as a whole.

The ESRI repeats this misdirected criticism. As the latest quarterly report shows, the growth rate of GDP was 0.9% in 2011. The Euro Area economy and the EU economy growth rates were significantly higher in 2011, at 1.5% and 1.6% respectively. Irish exports grew by 4.4% in 2011, according to ESRI projections. If they are right, exports will have risen by approximately €7bn last year in real terms. Without that rise GDP would have fallen by 3.5% in 2011. Clearly, the idea that the EU is the cause of the renewed Irish contraction is a fiction.

The actual cause of the renewed downturn is the policy of ‘austerity’. Household spending, government spending and investment (Gross Fixed Capital Formation) all reached new lows in the Q3 2011 national accounts data. The biggest single contributor remains the decline in investment. On an annualised basis investment has fallen by €26bn in the course of the recession (although it actually began before GDP ell). This compares to a decline of €17bn in GDP and €23.4bn in GNP. Declining investment accounts for more than the entire downturn.

For most Irish business this is entirely logical. Their two main customers are either the good or services they supply to government, or to the household sector. If both these sectors are cutting their own spending, why would businesses invest?

But this is not to say there is no capacity to invest, or to repeat the foolish mantra that “there is no money left”. In 2010, even as the economy was contracting by 0.4%, the Gross Operating Surplus (akin to profits) of Irish businesses rose to €71.2bn from €69.4bn in 2009 in nominal terms. Yet investment fell from €25.3bn to €19bn. Clearly there is plenty of money left. In fact, the entire contraction in both the economy and in investment could be made good just by accessing a proportion of those profits.

If the logjam of business’ unwillingness to invest is broken by higher growth, they will then willingly invest on their own account. All that is required is to break the logjam, which means the government taking control of some of those profits to invest them.

These temporary measures could be labelled windfall taxes, solidarity taxes, an ‘all in this together levy’ or whatever. But the money is there, and growing. Businesses are refusing to invest the profits they are generating. Government action is needed to reallocate these corporate savings towards investment. None of this contradicts the impositions of the Troika, as the terms Gross Operating Surplus or profits aren’t even mentioned in all the documents, bilateral arrangements, MoUs etc.

This is an Irish solution to the crisis. A national recovery based on the resources that are in this economy, and not beholden to foreign powers.

There's loads of money left

Michael Burke: The FT’s Martin Wolf has an interesting piece in yesterday's paper. He discusses the latest EU summit and highlights the impossibility of achieving the state objective of reducing fiscal deficits using the stated means, further cuts in government spending. This is because the government’s net lending or borrowing is simply the counterpart to all the other net lending or borrowing by the other sectors in the economy.

This point is illustrated in the graphic below (click image to enlarge), which shows three components: the net lending/borrowing of the private sector, the overseas sector and the governments in selected Euro Area economies. These are based on IMF data and projections. These must always sum to zero- there is no other sector that can lend or borrow to/from the rest of the economy. This argument has been made elsewhere.

The situation in relation to the Irish economy is stark. Despite much bluster about corners turned, roads to recovery, etc., Ireland still has the largest fiscal deficit in the whole of the Euro Area economies listed (third graphic on the right). Yet since the external sector is a net borrower Ireland, that is, there is a current account surplus (middle graphic) , along with government, then there must be a large surplus in the private sector. This is exactly what is shown in the first graphic, where Ireland has the largest private sector balance as a proportion of GDP, over 10%.

According to the CSO the gross savings of the domestic sector were over €18bn in 2010, and are €8bn in the first half of 2011. These totals include the government deficits.

But the net lending/borrowing of the private sector can by subdivided as between the corporate sector and the household sector. In any normally functioning market economy the household sectors designated role is as a net saver. The exception was in the run-up to the last bubble when it became a net borrower. The designated role of the corporate sector is as a net borrower, for the purposes of investment. (Banks are supposed to distribute these savings in an efficient manner to the most productive borrowers).

However, only the household sector is performing its role, saving €5.2bn in the first half of this year. The corporate is not performing as it should. It too is saving, €2bn so far this year and nearly €43bn in 2010.

It is this failure of the private sector to borrow to invest which shows up in the national accounts and the investment strike which is the cause of the slump. And, since one sector’s surplus must be recorded as another’s deficit, it is this borrowing and investment strike which leads to the public sector deficit.

The effect of government policy is to transfer incomes for the household sector by cutting benefits and raising taxes (and from the corporate sector by cutting the government’s own investment). This reduces the spending power of both the household sector and the corporate sector and provides an encouragement to the latter to increase its saving, precisely the opposite of what is required.

Instead, government could increase the incomes of both the household and corporate sectors by increasing its own investment (while also stopping any further cuts in their incomes via personal incomes taxes, levies like the USC and benefits cuts). It could take some of those savings from the corporate sector and investment them on its behalf. The consequent increase in economic activity would then oblige the corporate sector to gear up for recovery, by investing and borrowing on its own account. The resulting increase in employment/reduction in the welfare bill would see the public sector deficit decline. The degree to which that occurred would be entirely a function of how much idle savings were transferred into productive investment by government intervention.

It's official - austerity isn't working

Michael Burke: The Department of Finance’s White Paper Estimates for the 2012 Budget make for grim reading. The White Paper can be found here.

What this shows is that, even in the government’s own terms, the policy of imposing ‘austerity’ is a failure. Table 1 of the Estimates is shown below.

Revenues are projected to be effectively flat, €39.9bn in 2012 compared to €39.2bn in 2011. Current receipts (mainly taxation) are expected to increase by just 1.7%. As this is close to the likely inflation rate, it means that official forecasts expect no real increase in receipts at all.

The situation is even worse in terms of expenditure. Total expenditure is expected to fall to €61.5bn from €64.4bn in 2011. Yet this decline of €3bn is more than accounted for by a projected €6.3bn decline in capital expenditure for bailing out failed banks (although, despite repeated promises new bailout funds of €1.3bn will still be required in 2012, on top of €3.1bn in the issuance of promissory notes).

These Estimates, indeed the very name Exchequer, are a relic of colonial history which was to account to for how much Britain was kindly granting this country (and not at all including the private sector looting which was the purpose of the project). A similar process still takes place in the North of this island and it is a mark of how little the official outlook has changed here in the last 90 years that they are still used.

Instead, the EU insists on a definition of the General Government Balance which actually includes all aspects of government finances, not these ‘Estimates’ which are just a part of central government expenditure and income. In particular it includes, where the Estimates do not, the payments and receipts of the Social Insurance Fund, the National Pension Reserve Fund, Local Authorities and other items. The projected outcome for government finances on the GGB measure is shown below. This shows the deficit on the GGB rising in 2012. This was after €6bn was taken out of the economy in fiscal tightening in last year’s Budget, and an entirely new (and regressive) tax introduced in the form of the USC. The verdict is clea: the deficit is rising, not falling. The deficit as a proportion of GDP is projected to stabilise, but only because of a growth forecast which may, or may not be realised.

So, when government Ministers of whichever party confidently assert over the next few days that their particular Budget measures will produce deficit-reduction, the first question should be, why will these measures work when all previous measures have failed?

Perhaps the second question should be, if all the massive cuts that have caused slump, unemployment, immigration, poverty and misery demonstrably fail to produce deficit-reduction, is there actually some other, unstated aim of policy?

Ireland not an austerity role model ...

Michael Burke: This is an interesting piece from Martin Knijbbe on Ireland as a poster-boy for 'austerity' measures. In response to an article from Jurgen Stark extolling Ireland's export-led recovery, he examines that actual trends in the trade balances of key EU economies currently as well as the growth of both imports and exports. Stark remains a member of the board of the ECB for the time being and argues that 'internal devaluation', wage cuts are responsible for Irish export-led growth. This piece, which originarly appeared on Real World Economics, challenges each of those assumptions.

MTFS (III) - Sensitivity of government finances

Michael Burke: Having criticised the government’s talk of improvement in government finances and the economy on the basis of the MTFS forecasts, the document does contain an important step forward. Apart from one small reference in a long-ago SPU, there has never been any official estimate of the sensitivity of government finances to changes in GDP. There is now.

This clearly shows that a 1% increase in GDP leads to a 0.6% improvement in government finances (as a % of GDP) in the first year (2012). An increase of 1% of GDP in the first year leads to a lower deficit from 8.6% of GDP to 8% of GDP. [This was what the earlier SPU said, which was strongly disputed by many, including Karl Whelan here.

But it gets better. The table also shows that for the 1% increase in GDP is an increasing sensitivity of government finances, 1.1% in 2013 rising to 2.1% by 2015. These are in effect the compounding effects of growth on government finances, as the level of GDP grows and both tax revenues and government outlays improve.

At the very least this vindicates the original assertion on the sensitivity of government finances which is crucial to the argument of all those who favour stimulus. That, first, government investment leads to much stronger growth and, second, that this stronger growth leads to much improved government finances (60 cents for every €1 increase in output in the first year, rising to €2.1 over 4 years).

It also points a way to resolving the crisis. Austerity is not only proving hugely damaging but is not delivering deficit-reduction. Growth can.

MTFS (II) - It's official, there is no recovery

Michael Burke: The government is focused on deficit-reduction. But it is failing to reduce the deficit.

There is an extraordinary discrepancy between the dominant ideas about the current state of the economy, the official and widespread ‘narrative’.
The MTFS states that says nominal GDP will be €155.25bn in 2011, with real GDP growth of 1% (Table 3.1, p, 22).

Yet the CSO's latest quarterly national accounts shows that nominal GDP was €39,032mn in Q1 and €39,553mn in Q2 (Table 5, extract below). If growth were zero in Qs 3 & 4 (€39,553mn), then nominal GDP for the year would be €157,691mn, much higher than the €155,250mn Noonan has forecast.

The actual outturn for nominal GDP in 2010 was €155,992. The government forecast is now €155,250. This is a contraction. Yet the whole document talks about a 'shallow recovery gathering momentum'.

Similarly, the forecast is for 1% real GDP growth. But real GDP in Q1 and Q2 was €40,315mn and €40,944mn (Table 1). Again, if growth is zero in Q3 & Q4 (stays at €40,944mn) then the total for 2011 will be €163,147mn. This would be 2% growth over 2010 total €159.906bn. To register a real GDP increase in 2011 of 1%, the economy has to contract sharply in the second half of this year. Alternatively, the Minister already has sight of sharp downward revisions to the recorded growth in the first two quarters of this year.

In either event, talk of a ‘shallow recovery gathering momentum’ is pure fiction, and the MTFS forecasts are rendered entirely without merit.

MTFS (I) - Things are getting worse, not better.

Michael Burke: The forecasts for both the deficit and for the debt level have worsened since April. The government’s Medium Term Fiscal Statement (MTFS) includes a series of forecasts. These show the projections for both the defict and for the debt level. This is despite the fact that the State has found €3.6bn, equivalent to 2.3% of GDP, from an accounting error at the NTMA.

First, here is the main forecast table in April’s Stability and Growth Pact Update (SPU).

Here is the similar section in Friday’s MTFS.

After 2013 all the debt levels are higher. In every year except next year the forecast deficit levels are higher. Importantly, the deficit is now expected to be 10.3% this year, when it was expected to be 10% in April.

The trend is for things to continue to get worse. Less than a year ago, the forecasts were much rosier. The table below is taken from the Information Note on the Economic and Budgetary Outlook 2011-2014 issued by the DoF November 2010.

These forecasts only stretch to 2014. The central forecast for the deficit for 2014 was then 2.8%. In the recent MTFS it is now 5%. A year ago the debt level for 2014 was projected to be 85.5% of GDP. Now it is projected to be 117% of GDP. The very worst debt level was forecast to be 106% of GDP in 2012. In Friday’s MTFS this is now the starting-point for this year’s debt- and the profile is to for increases over three years.

So, after all the misery the forecasts for the deficit are getting worse. And what was the worst-case scenario for the debt is now the starting-point from which the debt is still expected to deteriorate. Even in its own terms, ‘austerity’ isn’t working.

Profits and austerity

Michael Burke: In all the discussion of the economy and the crisis, one word is hardly ever mentioned - profits. This piece looks at the level of profits in one of the crisis-hit countries - Ireland. With domestic activity still contracting and a stubbornly high deficit, maybe the Dublin government remains the poster boy for austerity because profits have begun to recover.

Japanisation

Michael Burke: There is a widespread discussion in the US financial press and beyond on whether the economy is facing a prolonged period of economic stagnation including bouts of deflation. It has been dubbed ‘Japanisation’.

After the stock market and land price bubble burst in Japan in 1989 the economy went into a prolonged depression. In effect it has spent not one but two ‘lost decades’ since, recording miserably low levels of growth.

But it would be a misconception to believe that Japan has recorded no growth at all in the last 20 years. Over that time, real GDP as risen in 15 years and contracted in just 5 years. But the average annual growth over the entire period from 1989 has been just 0.7%. However, even this has been flattered by repeated bouts of deflation, that is, outright falls in prices. If prices fall faster than the fall in nominal growth, real growth will be recorded as positive.

It is not at all given that the US will experience Japanisation, most importantly because the starting-point for the level of debt in the corporate sector is not comparable to that of Japan at the end of the 1980s. As a result there is no financial compulsion to reduce private sector investment in the US, a key factor in the economic stagnation.

Irish Deflation

Why is this relevant to Ireland? Simply put, this economy is currently experiencing more severe deflation than Japan. In the table below we set out the pace of price changes (GDP price deflator) in Japan and Ireland and useful comparators.

Change In GDP Price Deflator (annual % change)

Source: World Bank

According to World Bank data deflation has been worse in Ireland than in Japan over the last 4years, prices falling by 6.8% versus 4.5% price declines in Japan. This is also very different to the experience of the OECD and the Euro Area as a whole, who have not experience deflation.

This is important in light of the recent GDP and GNP data for Q2, which have widely been described as a turning-point for the Irish economy and proof that ‘expansionary fiscal contraction’ is at work. In terms of GDP growth in the first half of this year, real GDP grew by 2.1% in H1 2011 compared to H2 2010. But nominal GDP rose by just 1.3%. This implies a GDP deflator of -0.8%, or -1.6% for the year as whole. This is not very different from the World Bank’s forecast for deflation in 2011 as a whole.

But the situation is even more pronounced in relation GNP. Given that the export sector is artificially inflated by (mainly) US MNCs booking profits in this jurisdiction to avail of low taxes, then GNP is decisive in terms of measuring the growth of the domestic economy and its ability to service government debts. In real terms GNP fell 4.7% in H1 from H2 2010, highlighting the extremely divergent paths of the domestic and export sectors. But nominal GNP fell by 6.5% over the same period, implying that the price deflator fell by 1.8% in the first 6 months of this year.

Price falls are not unequivocally bad news. For those fixed incomes, such as pensioners, real incomes rise. But if the majority of incomes also fall in the household, corporate and government sectors, then the effect is to increase the real burden of existing debts. Given that the economy is facing a debt crisis, as Japan did before it, deflation exacerbates the key problem facing the economy as a whole.

The latest data show that Ireland has not broken the deflationary cycle it entered in 2008. There can be no serious talk of turning-points unless it does.

Wiping Clean the Anglo/INBS Debt Slate

Tom McDonnell, Michael Burke and Michael Taft: The Anglo Irish and Irish Nationwide debt must become a major political issue. The Anglo/INBS debt-burden is an unjust and unwarranted charge which the Irish people ought have no responsibility for, a charge which will continue to drain the productive economy for years to come. In the following we discuss how we can expunge this debt based on (a) renegotiating the promissory note, (b) renegotiating a new repayment schedule (if any are needed), (c) writing down bondholder debt, and (d) political strategies to strengthen the Government’s negotiating position. The starting point should be a Government announcement this autumn that it does not intend to continue with the current promissory note payment schedule and will enter into renegotiation with the affected parties.

Many people are not aware that the vast majority of the Anglo/INBS debt has yet to be repaid. While the full amount has been placed on our general government debt, this was an accounting exercise. Under the current promissory note of €31 billion, of which Anglo Irish comprises €25 billion, the Department of Finance estimates the total cost to the state to be in the order of €65 billion, including interest on the promissory note, interest on borrowing and the capital payment made to Anglo Irish in 2009 (though this total could vary depending on future interest rates). This averages out to an annual bill of €4.2 billion over the next 14 years.

• In the next four years the cost of Anglo/INBS debt will make up almost a third of all state borrowing.;
• The annual repayments will exceed the entire budget for the nation’s primary school system;
• The average annual repayment for just one year exceeds the entire cost for a next generation broadband network;
• The total cost is equivalent in scale to half of our GNP this year.

The absorption of Anglo/INBS debt has currently added over 15 percent to total Government debt. Were it to be removed or substantially written down, Ireland’s debt levels would fall back towards the Eurozone average which stands at 87 percent of GDP. Even with the recent Anglo Irish interim report and the anticipated reduction in losses, the scale of future borrowing will be substantial.
In dealing with Anglo/INBS debt we have advantages. First, the promissory notes are not part of the EU-IMF Memorandum of Understanding. Therefore, further payments under the IMF-EU bail-out deal are not contingent upon maintaining the current promissory note schedule. Second, Anglo/INBS is for the most part detached from the European financial system; the issue of contagion to other financial institutions is extremely limited.

Bondholder debt makes up only a small part of Anglo/INBS liabilities – less than 10 percent. The major liabilities are made up of loans from central banks (€40.8 billion) of which the promissory note (€23.8 billion) makes up over half.

Renegotiating the Promissory Note

While the Central Bank of Ireland (CBI) is part of the Euro system of central banks (and, therefore, cannot act unilaterally), the promissory note is the CBI’s responsibility. The loans from other central banks look set to be covered by the non-promissory note assets on Anglo’s books (over €30 billion). Therefore, the renegotiation will, in the first instance, commence with our own Central Bank.

In a renegotiation, the Government should be seeking a complete write-down of the promissory note. This would require an innovative response from the CBI. We believe this will be done as the CBI has already accepted its critical role in the Anglo/INBS debacle.

In early January 2009, the Minister for Finance relied on advice from the CBI and the Financial Regulator when nationalising Anglo Irish. This led the Department of Finance at the time to state that Anglo Irish was ‘solvent’ and ‘open for business’. Subsequently, however, the CBI admitted they had been profoundly mistaken, stating that months before nationalisation and the bank guarantee both Anglo Irish and INBS ‘were well on the road towards insolvency’. Shortly after the Anglo Irish nationalisation, the CBI was compelled to notify the Gardaí and the Office of the Director of Corporate Enforcement (ODCE) of ‘certain matters’. These admissions are signals of a potentially positive response from the CBI to rectify some of the damage its mistakes have inflicted on the Irish public.

The crucial issue is the extent to which CBI can unwind its position without risking balance-sheet insolvency (through write-downs and other strategies). Anything short of that risk should be explored and negotiated. A Government announcement that it does not intend to proceed with the current repayment schedule would provide the incentive to parties to explore all the options.

Such a course would of course require sanction or, at least, tolerance from the ECB. However, it is a matter of debate as to what extent the ECB was aware of Anglo/INBS insolvency when negotiating with the Government over the fate of these banks. In this respect, it would be helpful in terms of accountability, transparency and clarification if the Government published all communication between itself, the CBI and the ECB regarding Anglo/INBS since the run-up to the bank guarantee starting in early 2008. Such publicly-released information can help progress the debate by establishing where different responsibilities lie for propping up insolvent banks with Irish taxpayer money and central bank loans.

A New Repayment Schedule

If, at the end of this process, an agreement is negotiated which imposes a debt on the Exchequer, the next issue is the repayment schedule. There are two approaches.

(a) Reschedule with the CBI

The debt could be repaid over a greatly extended period of time (e.g. 30/50 years) via a similar instrument to the existing one. The goal would be to significantly reduce borrowing in the short/medium term with either a repayment holiday for the period that we are reliant upon EU-IMF funding and/or a payment restructuring so as to back-load the annual liability. This also leaves open the possibility of revisiting the issue in the future with a view to further write-downs. This approach may provide the CBI with more flexibility than actually writing down the promissory note itself and could constitute an effective write-down via future inflation.

(b) Reschedule with the EFSF

Alternatively, the Government could seek to transfer the promissory note to the European Financial Stability Facility (EFSF) with whom the Government could then negotiate a greatly extended loan. As the EFSF can now lend to recapitalise banks, this would simply be taking advantage of a new opportunity. Even this option, on the basis of repayment of the Anglo Irish debt, would greatly reduce borrowing in the medium-term.

Restructuring the repayment schedule, even if there is no write-down of the promissory note, would provide the Irish economy with considerable breathing space. A further option would be to substitute a ‘bullet bond’ (similar to a normal Government bond) whereby only interest would be paid annually with the full amount redeemed after a greatly extended period (e.g. a 30-year bond). At the least, we could expect annual costs to fall by a minimum of two-thirds, saving the taxpayer €2 billion a year over the next 14 years and postpone the payment of the principle to a longer-term horizon where it would be easier and cheaper to roll-over the debt.

Bondholder Debt

Bondholder debt, estimated to be approximately €6 billion, would be the subject of separate negotiation/actions. There is a clear argument in equity, as mooted by the Minister for Finance, to unilaterally write-down the unguaranteed debt. The ECB is reported to be opposed to this strategy because of contagion fears. However, the markets have already distinguished between the debts of viable banks and those of the dead banks Anglo and INBS. Financial analysts continue to criticise and express bemusement that the Government is continuing to honour unguaranteed debt: ‘because the two banks are effectively in the process of being liquidated, burden sharing by senior unsecured bondholders does not constitute a threat to financial stability’.

As for the guaranteed bondholders, it would be argued that not honouring this debt would undermine the credibility of similar guarantees underpinning the pillar banks, with implications for their ability to access the market. That is why this debt should be negotiated.

A Political Debate – in Ireland and Europe

The Government has a strong opportunity to strike a new deal on the Anglo/INBS debt. We have outlined a series of approaches which can provide the Government an opportunity to expunge this unjust debt. By opening up renegotiations on the entire amount of Anglo/INBS debt, the Government would give itself (and other parties) more flexibility across a range of issues (the promissory note, restructuring the payment schedule, and bondholder debt). This could allow for more give-and-take than focussing on one issue such as the unguaranteed senior debt.

It is important the Government keep the Irish public abreast of its goal and strategies and that this be done in an open and transparent manner (hence the publication of communications between the Government and the CBI/ECB regarding Anglo/INBS). For this is essentially a political project – to reverse the decision by the previous Government to place the private debt of dead banks on to the public balance sheet. That the new Government had no part in this vast transfer of resources (over €14,000 per person living in the State) gives it clean hands and greater moral capital.

But this is a Eurozone issue as well and it is necessary for the European public to become aware of the immense burden Ireland is carrying for non-existent banks. For instance, how would the German public react if they had to repay an equivalent dead-bank debt of over €700 billion, with annual repayments of around €50 billion for over a decade? Or if the French had to pay over €550 billion with annual repayments of around €40 billion (nearly four times the amount of the recently announced austerity package)? The appropriate Government Ministers could launch a Eurozone-wide information campaign – informing the public, commentators and policy makers of the immense debt burden that is Anglo/INBS. We believe this would elicit considerable sympathy (and not a little bit of shock), thus strengthening the Government’s negotiating position.

There are reasons why the ECB, under a new President, would be open to such a renegotiation. The Anglo/INBS debt is relatively small in comparison to the amount that the viable banks (e.g. AIB, Bank of Ireland) owe the ECB. The elimination or write-down of Anglo/INBS debt would reduce the burden on the economy. A strengthening economy, in itself, will increase the chances that the viable banks can return to private funding and that the ECB will be repaid in full.

This debate must be taken up by all sections of society – by individuals, civil society organisations, political parties; for the Anglo/INBS debt is a key component of the economic and fiscal crisis. While we cannot pre-empt or predict the ultimate outcome, we can call for the Government to suspend the current repayment schedule for the promissory notes (which requires a further €3.1 billion payment in March of next year) and enter into a renegotiation.

And if there are other, better alternatives than the ones outlined here, we welcome that. For we are only concerned here with starting the debate, not writing the last word. But that debate must start now before we spend one more cent on this invidious debt.

This time, it's different

Michael Burke: The ESRI’s latest research paper, ’Irish Government Debt and Implied Debt Dynamics: 2011-2015’ has received much coverage. Commentary has focused on the projected stabilisation of the overall debt in relation to the economy; the debt/GDP ratio or the debt/GNP ratio. From this, some more excitable commentary has suggested that this is a vindication of the broad-based attack on living standards, increased taxes on working people (but not on corporates) and public spending cuts euphemistically known as ‘austerity’ policies.

However, this last contention, that ‘austerity works’, is not supported by the authors’ findings themselves. To quote their own summary of their paper, ‘[Our projected debt ratios are] much lower than had been projected in official figures earlier in the year, partly because the cost of the bank recapitalisation was much lower than anticipated and also because of the reduction in EU interest rates’.

So, the lower projections are based on the lower level of bank recapitalisation and lower rates for bailout funds for those recapitalisations. According to the authors’ abstract of their own findings, none of the projected improvement is attributable to ‘austerity’ measures.

Quality of Forecasts

But how ‘good’ are these forecasts, in both senses? First, what is the quantum of improvement that is being forecast by the ESRI? Secondly, how likely is it that these forecasts will prove correct? The debt ratios forecast by the ESRI are set out in the table below:

Debt Ratios, % GDP

Source: ESRI, Eurostat, IMF databank, Euro Area Spring Forecasts

The first point to note is that the ESRI is not projecting any reduction in the level of government debt over the period 2010 to 2015. Over that period, debt will rise from 94.9% of GDP to a projected 106.2%. It is in effect projecting a deterioration in the debt level to next year, then stabilisation and then a reduction. Both the IMF and Eurostat forecasts are much worse.

This disparity is a function of two factors. First, the Eurostat and IMF forecasts were made before the reduction in interest rates and before the lower projections for the level of the bank bailout were made. Secondly, the ESRI has stronger real growth projections than either Eurostat or the IMF.

Before dealing with the substantial point of how large the bailout and interest rate savings are, it is worth highlighting the main source of the discrepancy in growth forecasts. In effect, ESRI has a much larger growth forecast of +1.8% real GDP in 2010 than either Eurostat (+0.6%) or the IMF (+0.5%). The difference arises because whereas the IMF and Eurostat both have prices rising by 0.6% in 2010 to reduce real GDP by that degree, the ESRI projects falling prices of 1.1% (implied from the gap between real and nominal GDP (Table 7). Given that deflation both reduces the nominal level of taxation revenues while also increasing the ratio of existing debt to nominal GDP, there can be little argument that this ‘stronger’ growth forecast is responsible for the ESRI’s more optimistic debt/GDP forecasts.

Instead, it is the combination of lower interest rates and a lower projected bank bailout cost which is responsible for the projections of a substantially improved debt outlook. On the former, the consensus appears to be that the annual saving will be in the order of €1bn per annum, perhaps slightly more. Implicitly the ESRI authors assume a saving of €1.125bn per annum, on the basis of a former interest rate of 6% (p.20, point 2.). Compounded, this saving over a 5 year period amounts to €8.5bn or approximately 4.6% of the GDP level projected for 2015.

On the lower bank bailout costs, the international bailout of creditors to Irish banks in November 2010 included €10bn of immediate bank recapitalisation plus another contingency amount of €20bn. To date, of this a total of €17bn has been provided by the State (banks funding €7bn themselves in the financial markets for a total of €24bn). The ESRI authors expect €3bn to be repaid to the State by 2014. This ‘saving’ of €13bn also incurs interest. However, the authors now argue that funding from the Troika will be needed in 2014, even though the terms of the original bailout were that the government would return to the financial markets in 2013. Therefore, there will be no net interest saving, based on the authors’ projections. Instead, there will be an additional cost of approximately €0.5bn (based on the 3.5% interest rate, rather than a projected interest rate of 6% in the financial market borrowings that are also assumed in the ESRI paper). As a result, the projected saving from a less onerous bank bailout is a net €12.5bn.

Taken together the actual interest rate saving of €8.5bn and projected saving on the bank bailout of €12.5bn combine for a total €21bn. This is equivalent to 11.4% of projected 2015 GDP.

Without these actual and projected windfalls, the ESRI forecast would otherwise have been 117.6% of GDP in 2015. This compares to a debt/GDP ratio of 94.9% in 2010.

Debt Dynamics

The idea that there will be no more bank bailouts has firmly taken hold and is largely responsible for the specific rally in Irish government debt in recent weeks. This is despite the fact that the EBA’s stress tests were widely discredited by the failure of two small Spanish banks shortly after publication, with total losses exceeding the EBA’s estimate of EU-wide recapitalisation requirements.

It may be the case that further losses do not require further recapitalisations. But the key exposure of the Irish banks is to the domestic economy, which continues to deteriorate on all forecasts, including those of the ESRI. This has an impact on the banking sector. Currently, this is most evident in the rise in the rate of mortgage defaults.

This highlights a key misconception regarding the relationship between the banking sector, government finances and the real economy. It is assumed that, if the banking sector is stabilised to the extent that it requires no further taxpayer funds, this will restore government finances to health, as long as public spending is reduced towards the level of taxation revenues (sufficient to provide a ‘primary surplus’, that is before interest payments are included). It is argued that, if all three occur, bank stabilisation, no more bailouts, a swing toward a primary surplus, then the crisis ‘will be over in 3 years’.

This is the premise that underlies a section of the ESRI paper dealing with debt dynamics. It is not denied that significant remedial action was required to resolve the crisis in the banking sector, even while many argue that a bailout of all their creditors was one of the least effective means of doing so. But, ever-greater contraction of the domestic economy can only be fatal to any ambitions to remove the banking sector from the life support it has been given by taxpayers. In effect, the ESRI and many others look through the world through the wrong end of the telescope. Neither banks’ balance sheets nor government finances can be restored to health until and unless there is an economic recovery.

The authors argue that, absent any further negative ‘shocks’, the debt/GDP ratio will begin to fall from 2013 onwards. The horizon for an imminent improvement never seems to alter. It is always 18 months hence. But the Irish economy received no external shocks in the way that economists use the term. The recession began here nearly a year before it began in the world economy, the slump in investment also a year earlier (which preceded the recession in both cases).

Three years ago in the Autumn 2008 Quarterly Economic Commentary the ESRI was forecasting a general government debt of 47.5% of GDP in 2009 and was fully supportive of government efforts to cut the deficit, in particular urging cuts in public sector pay. But this contractionary fiscal policy was a shock to the economy and the effect was slower growth, rising unemployment and falling tax revenues.

In the event, the debt/GDP ratio was 65.6% of GDP, not 47.5% in 2009, even while the government implemented ‘austerity’ measures equivalent to 9.1% of GDP. In effect the ESRI was forecasting a near-term deterioration in the debt level followed by stabilisation and then reduction, based on ‘austerity’. In fact a trawl through the QECs since 2008 shows that this debt profile is what the ESRI has been forecasting since 2008.

The authors clearly haven’t asked themselves the key question, so we must: Why will it be different this time?