Good News on the Economy from Europe but a Warning?

Paul Sweeney: There is some good news on the Irish economy from Eurostat. But hidden in the text is a warning to another member state, Luxembourg, that may threaten us in the next quarter, if the European statistical police, based in Luxembourg, find out how lavish and spendthrift the government has been, and intends to continue to be, with certain public assets.

Comparison of EU Bank Bailouts

Michael Taft uses Eurostat data here to compare the 'direct' impacts on General Government Deficits caused by the EU's numerous bank bailouts. In some cases these figures dont even capture the full cost of the bailouts as, for example, in the case of Ireland the €20 billion taken from the National Pension Reserve Fund is not included in the Eurostat figures.

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.

The structural deficit just got worse

Michael Taft: The latest EU Commission projections are out and, if anything, they show an even higher structural deficit than what the Government is projecting. This provides a perspective on what additional austerity might be in store for us under the Fiscal Treaty.

The EU Commission’s Spring Economic forecasts shows Ireland‘s structural budget balance to be far and away the highest in the Eurozone – at 7.9 percent for 2013. The Eurozone average is 1.8. We are much higher than Greece (4.5 percent), Spain (4.8 percent) and Portugal (4.6 percent).

The EU projection compares unfavourably to the Government’s own projection of 6.9 percent for 2013. In nominal terms, the EU is projecting a structural deficit over €1.6 billion higher than the Government for next year.

What is particularly noteworthy is how sluggishly the deficit is falling. Between 2011 and 2013, factoring in €7 billion worth of fiscal adjustments, the structural deficit falls by a mere 0.5 percent. The Government is hoping for a fall of 1 percent.

The EU doesn’t make projections outward to 2015. However, if we were to take 2013 as the starting point and use the Government’s pace of deficit reduction, we’d find a structural deficit of 4.5 percent for 2015. If this holds, the structural deficit has deteriorated and the gap between the EU projection and the Fiscal Treaty target has now widened to €7.2 billion. The Government estimated that it would be €5.4 billion.

To date, the Government has refused to engage with this issue. Instead, it insists that increased investment and micro-economic reforms will raise our productive capacity and that this will be enough to close the structural deficit gap without any further fiscal adjustments. However, whatever about the talk of growth and investment, the Government is doing the exact opposite as discussed here.

This is, of course, all a bit speculative as we don’t have EU projections out to 2015. But, with the new EU projections, we could now be facing into a higher structural deficit than that projected by the Government with a much slower decline. All things remaining the same, this means that the gap between the structural deficit and the Fiscal Treaty target just got larger. And, potentially, the amount of austerity needed just got greater.

The referendum - what to do?

Jim Stewart: The Treaty on Stability, Coordination and Governance is flawed in many respects. Martin Wolf, writing in the Financial Times on 6th March, itemises some of these flaws. The obvious one is the requirement in clause 1b limiting the ‘structural deficit to 0.5% of GDP’. Countries must adjust rapidly to this position as agreed by the European Commission. In addition if the ratio of government debt to GDP is greater than 60%, article 4 requires the excess amount to be reduced over a twenty year period. So that a country where a debt/GDP ratio is currently 100% is required to reduce this amount by 2% per annum. In effect this means running a budget surplus of 1.5%. This is impossible to achieve, without debt writedowns. In the absence of debt writedowns attempting to achieve this target would deepen the current recession in Ireland and other countries, and prevent any economic recovery.

The Treaty states that the rule will be deemed to have been “respected if the annual structural balance of the general government is at its country-specific medium-term objective”. The problem is how can this be known? Both Ireland and Spain would have satisfied this budget criteria before the economic crisis. The key question was whether government finances were stable over time? This means that (1) the financial crisis would have to be forecast, (2) policy responses would have to be forecast, and (3) the effect of both the financial crisis and policy responses on government finances would have to be forecast. Some economists got point (1) right. Official Ireland was spectacularly wrong. No economist forecast all three nor would this be possible. The proposal from Philip Lane (Irish Times Feb. 7) for Ireland to develop a capacity (funded by the State) for “independent, high quality assessments of structural trends in the economy and the public finances” will have the effect of creating jobs for economists but little else.

Further issues arises in relation to the measure of debt. For example, activities transferred to a commercial State owned company, such as the proposed Water Authority, would also have associated debts transferred. Current measures of GDP are favorable to Ireland because GDP is inflated by profit switching transfer pricing by foreign owned firms. This may not always be the case. How can rational economic policy be based on a ratio, in which both the numerator and denominator are subject to revision, especially in the case of GDP?

This does not mean that over a period of time Government expenditure and government revenue, should not be sustainable. Being sustainable does not mean expenditure should be almost identical with revenue. An economy that is growing strongly can have both government deficits and maintain a stable debt/GDP ratio. Successful economies can have widely varying ratios of debt to GDP over long periods of time, for example Japan.

The fiscal treaty can be added to the list of flawed policy making that has helped turn an economic crisis (largely of our own making) into a national catastrophe. It is particularly dangerous because it will be incorporated in the constitution making change very difficult and incorporates the right of another one of the signatories to the treaty to bring a case to the European Court of Justice (article 8.1) and face financial sanctions in the event of non-compliance. It is the same thinking that initially set penal interest rates on Irelands borrowing under the EU/IMF Programme.

Hence the question arises why would rational people vote in favour of a Treaty which has so many flaws. John O’Hagen (Irish Times, 8th March) asks of those opposing ratification to explain “how day-to-day State expenditure will be funded from 2013”. The simple answer is that according to the Government, after the current programme has ended, (that is at the end of 2013, not ‘from 2013’ see EU/IMF Programme, p. 16 ) Ireland will turn to the bond markets for financing (Minister of State Brian Hayes quoted in Irish Times 6 March, 2012), and a point also made by Jean-Claude Juncker, chairman of the Eurozone finance ministers, to the European parliament on Feb 29.

But the point has been made unless the Treaty is ratified financial assistance will not be granted from the European Stability Mechanism at the end of 2013 should it be needed. So the question is how likely is a second bailout and to what extent will it be required? The answer to this question is uncertain. Funding is in place from the existing programme until the end of 2013. While bond redemptions amount to €11 billion in 2014, they will be zero in 2015 (NTMA annual Report 2010, p. 15). In addition, national savings contributed about €4.3 billion in 2011, and could rise further.

A further uncertainty arises from the stated intention of Francois Hollande, the front runner in the French Presidential election to renegotiate the treaty (Hugh Carnegy and Quentin peel, Financial Times, March 4, 2012). At the same time the main architect of the treaty Merkel, has lost credibility in Germany with the resignation of the candidate she supported as President. Because of this and other issues, Der Spiegel (2/21/2012) reports difficulties within the coalition government and states “many are now asking how much longer it can survive”. The second bail out package for Greece required the support of the opposition Social Democrats and Greens (Der Spiegel 2/27/2012). Opposition parties and likely participants in a successor government espouse policies such as emphasising growth rather than austerity to balance budgets, a Eurobond and a Financial Transaction Tax.

Spain recently announced a new higher target for the budget deficit of 5.8% compared with 4.4% agreed with the Commission, some hours after signing the new Treaty. Furthermore the Spanish Prime Minister announced that the budget deficit was a matter for the Spanish Government and not the Commission. It is also interesting to note that there was very little change in yields on Spanish government bonds (benchmark 10 year yields rose from 4.91% to 4.96%) on the first day of trading after this announcement and the signing of the Stability Treaty, indicating, perhaps that markets recognise that increased austerity is bad for economic growth and bad for bond markets. Further budget cutbacks in the Netherlands could result in a general election in which political parties opposed to budgetary cuts would make large gains (Financial Times, March 1, 2012). It is likely that government policy in relation to the financial and economic crisis will change in key EU countries as a result of political change.

The strategy to adopt in the face of this uncertainty is to delay holding a referendum for as long as possible. At government level we in Ireland have ‘world class skills’ in delay. The Department of Justice is especially skilled in this regard. A delay is likely to mean that political change in EU countries, such as France, will result in change to the Stability Treaty. Peripheral countries (Greece, Ireland, Portugal, Italy, Spain) will thus have an opportunity to influence treaty change to their benefit. Writing detailed fiscal stability rules into a constitution is flawed reasoning, and treaty change could remove this threat. Delay will help clarify if and to what extent a second bail out is needed.

What about the promissory notes? If as some have suggested there is an agreement to reduce the cost of the promissory notes, should this influence or decision? On this An Taoiseach is correct: there is no linkage. The cost of the promissory notes can and should be reduced under existing rules and should have no influence on voting intentions on the Treaty for stability.

It is difficult but vital that economic policy is taken from those without any democratic mandate, and without any economic policy other than a dogmatic adherence to the imposition of austerity. It is indeed unfortunate for Ireland and the EU that we have a Commissioner for Economic and Financial Affairs who is bereft of ideas. It is doubly unfortunate for Ireland that those directly responsible for implementing the programme (Mr. Székely, Director and European Commission mission chief to Ireland) are unable to produce a single idea that is growth enhancing (see for example the recently published review of the economic programme for Ireland).

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.

Facing up to reality: Austerity is an obstacle to deficit reduction

This is the first part of a two-part post.

Michael Taft: On Sunday, Colm McCarthy wrote:

‘ . . .the programme for budgetary correction needs to be accelerated. There is one, and only one, policy instrument available to Government which will improve confidence quickly and that is the pace of deficit reduction.’

Couldn’t agree more (though equally important is to prevent private banking debt from being absorbed into Government debt). We need to reduce the deficit in a sustainable manner. Therefore, the first thing the new Government should do in its review of public spending is to consign the Report of the Special Group on Public Service Numbers and Expenditure Programmes (aka An Bord Snip Nua) to the rubbish heap. Not only is it so methodologically flawed that it tells us almost nothing about generating savings for Exchequer, the strategy which it promotes (austerity, deflation) has been a failure. Indeed, that strategy may actually be adding to the deficit and debt burden. It is time to junk the report and start a real deficit reduction programme.

Hasn’t Worked So Far

In 2009 the Special Group report called for €5.3 billion in public spending cuts, almost all current expenditure. But in the three budgets in 2009 the Government did a few billion better. They cut current spending by €6.3 billion. In addition they cut €1.5 billion from the capital budget while increasing taxation by €2.8 billion – an overall contraction of €10.6 billion.

What happened next was predictable and predicted. The Finance Minister called in the Opposition Finance spokespersons in the autumn of 2010 to tell them the deficit was still rising.

The last budget cut approximately €2.1 billion in current spending and €1.8 billion in capital; all this to try to get the deficit down to below -10 percent. What’s the prognosis? Not good.

According to newly released papers, the Department of Finance is already expecting the deficit to be higher than last budget’s projections. They were hoping for an Exchequer balance of €17.7 billion; now they project a balance of €17.9 billion – and that’s after only two months of Exchequer returns.

According to the Department:

‘Income tax will be a key determining factor in the achievement or otherwise of the overall tax revenue tax target for 2011’.

If this is the case, there should be cause for worry. The briefing paper stated income tax was down €45 million on the end-February target. The recently released March Exchequer statement showed income tax falling €125 million behind target. This ‘key’ category is weakening. So is VAT, which is down €179 on target.

But this shouldn’t be too surprising. The last Government estimated that for every 1 percent of GDP in fiscal contraction, economic growth falls by half that amount (though the IMF suggests the fall in GDP could be between twice and four times what the Government estimates). This results in falling tax revenue and rising unemployment costs, which in turn adds to the deficit burden.

Already, based on current growth projections, the deficit target has slipped by nearly ½ percent in the first three months. In other words, the Government is not likely to break the -10 percent deficit threshold. And according to the Sunday Business Post (link not available yet), the Government, along with the EU and IMF, are preparing to revise future growth downwards. This will lead to a deterioration of the deficit target.

So what have we got? The Special Group report called for €5.3 billion in spending cuts. The Government responded by cutting public spending by €11.7 billion – more than twice as much as the Report’s recommendations (and this doesn’t count the cuts in the 2009 budget). And yet the deficit still remains stubbornly high, only slight below the deficit level at the time the Report was published.

The pro-austerity camp has only one response to this running-in-quicksand scenario: more austerity. But it is austerity itself that is the obstacle to sustainable deficit reduction. How much deeper down the hole do we have to dig until we realise that it is the digging itself that is the problem?

When do we start facing reality?

Next post: why the methodological flaws in the An Bord Snip report require it to be junked.

Ireland's forgotten deficit

Rory O'Farrell: What is the bottom line for the Irish economy?

It is well known that the economic bubble was inflated by borrowed money, largely in the private sector. What is largely being ignored is that the total economy, public and private sector, is still being financed from abroad.

Ireland has successfully managed a trade surplus in our recent history, exporting more than we import. We have had a steady income. However, for most of the 21st Century we have shown a Current Account deficit. But why is this important? The Current Account in the National Accounts in many ways is similar to the current account a private citizen has in a bank (it is complicated in that it measures flows rather than stocks). It measures the day to day items of the national economy. It includes our trade balance, but crucially for Ireland, it includes some of our day to day expenses in the global economy. Each quarter the Irish economy must send money abroad to pay interest bills and the profits to multinationals. Given our liabilities, Ireland has to run very fast to stay still. Even having a trade surplus of €10 billion may not be enough push us back in the black.

Though the fiscal deficit is important, the Current Account serves as the bottom line for the economy as a whole. If we want to pay back our private sector debt (such as in Anglo or AIB) without just lumping it onto the National Debt, we must show a Current Account surplus.


What can be done?

It is inevitable that our debt overhang will resolve itself eventually, but as with everything in economics there are choice as to how to deal with the issue. Continuing with government policy will lead to debts being resolved through bankruptcy.

The most obvious way to reduce out international liabilities would have been to allow private sector debt stay private, and allow the bank bondholders take a hit. This would have been the correct thing to do. Unfortunately this is getting more and more difficult to do as the Government added private debt to the public debt.

We can increase exports. Unfortunately this is difficult, though not impossible. We cannot change demand from abroad but we can make ourselves more competitive.
One suggested way is to lower wages. However how would this benefit the current account? It might increase inward investment in the medium term, but as wage rates are already competitive it is unlikely it would have much of an effect. Also, as our export sector is dominated by multinationals cutting wages would simply increase the profits that are sent abroad, so a wage cut could actually harm our Current Account position. Alternatively we could try reduce non-wage costs by investing in public infrastructure.

We can reduce imports. This is something we have far more control over. One possible way is through massive Government cut backs to kill off domestic demand for imports. This is a strategy that was pursued by the IMF in South America, but they have moved away from this. The social consequences are too severe. Also a social wasteland does not make for a good export platform, so such a tactic could also reduce exports, and not improve the Current Account balance. As most government spending is done domenstically. There is some leakage abroad, but government spending can be targetted in a way to minimise this.

The government could look at which income groups spend the most on imports and increase their income tax rather than that of other groups. Also Ireland imports a disproportionate amount of goods, mainly due to our dependence on foreign energy. Investing in alternative energy is a good substitute, but also the simpler solution of public transport and cycle lanes would reduce the amount of fuel we import.

Finally we can reduce capital outflows and have one big inflow. Repatriating the National Pension Reserve Fund would be the obvious inflow. But what of outflows? Saving does not always equal investment. We should look at which income groups save their money abroad and tax them more. This will help to keep money in the domestic economy, and reduce our external liabilities.

It may be argued that this policy is protectionist, but we simply cannot afford to keep importing at the rate we have been.

2011, 2014, the Bond Markets and Growth

Nat O'Connor: It seems to me that there is some confusion in the way in which international factors on Ireland's deficit are presented to the general public in the media. In particular, the 'requirement' that Ireland's deficit is reduced to three per cent of GDP by 2014 seems to be confused with the issue of whether it may be too expensive for us to borrow from the bond markets early next year. The financial institutions that lend money to countries (i.e. the 'bond markets') do not care whether Ireland reaches three per cent of GDP by 2014, provided we can show evidence of an ability to repay our borrowings. But in terms of providing this evidence, the deadline for satisfying these lenders may well be early 2011, not end-2014.

Those who are offering to lend money to Ireland at the moment (at high rates of nearly eight per cent) are taking a chance on making big money on these loans; balanced against a heightened risk that this or the next Irish Government will decide not to pay back the loan - or only pay back a portion of it. However, they are not crazy. They would not lend to Ireland (except at extortionate, short-term rates) if they thought that it was highly likely that we would default on the loans. So, we are still in a position where some of these large - and coldly calculating - financial institutions think that they can make money. (That is, they are confident that we will pay back the loans, or at least enough years of interest, to make it worth their while taking the risk). Unfortunately, not enough of them are interested in lending to Ireland, hence we would have to borrow at nearly eight per cent from the small pool of risk-takers who are willing to lend.

However, the institutions that might consider lending to Ireland at lower rates are not necessarily the same financial institutions that would lend at higher rates. Some institutions make more conservative lending decisions, while others go for more risky investments. This is an oversimplification, perhaps, as most will have balanced portfolios, but it hopefully illustrates the point that not all participants in the international bond markets are clones.

The more conservative institutions operating in the bond markets want to see more evidence of ability to pay. That is, they want evidence that Ireland has moved into a period of economic growth that can be sustained. And they want evidence that tax revenue is stable. And they certainly want to see public expenditure reduced over time to what the state can afford, based on its revenue. However, as long as there is evidence that the state is on a sustainable path, it doesn't matter whether it is 2014, 2016 or 2020. All that matters is that Ireland is on a stable growth trajectory and can show that it will be able to pay back the money.

Meanwhile, there is another part of the bond market that Ireland must also satisfy. That is those institutions that have already - in better times - lent money to Ireland. (Much of our borrowing is at 3 or 4 per cent interest). Like the conservative financial institutions that will not currently lend to Ireland, those who have already lent to us very urgently want to see evidence of ability to pay! They want to see a credible growth plan, because they are not even benefitting from especially high interest rates on what have become risky loans. Some of these institutions may be the same ones that might lend more money to Ireland in future, but only if presented with evidence of growth.

Finally, there is the EU dimension to all of this. The EU Stability and Growth Pact is a political agreement made between all Eurozone countries. Our Government have pledged to return our deficit to 3 per cent by 2014. This is a political decision. It was perhaps a necessary decision in order to persuade the European Central Bank to assist Ireland by buying some of our bonds, and accepting the IOUs we gave our banks to cash in. But it is only one of the many political compromises we make in Europe all of the time. Much EU business is done by consensus within the Council of Ministers. There is certainly scope for Ireland to gain compromise on this target, with the support of other Eurozone countries who are also in danger of missing the target.

However - and this is where the more immediate bond market question gets mixed up with the EU 2014 question - if we think that our economic strategies are not going to deliver growth, and therefore the international bond markets will not lend to us at a reasonable rate, we have to remain on reasonably good terms with the ECB, so that they will buy our bonds and, ultimately, bail us out with the EU-IMF fund, if the worst comes to pass.

Ironically, the effort to satisfy the EU by aiming for a deficit of 3 per cent by 2014 - in case we need EU help - is likely to make it more likely that we will need to avail of emergency assistance! That is because our sequence of severely contractionary budgets (and a further €6 billion in cuts and taxes planned for December) is shrinking the economy, cutting or even killing growth, and making it less likely that the more risk-averse parts of the bond market will lend to us.

How do we get out of this bind? The answer is simply that we need to deal with 2011 before we deal with 2014. The issue in 2011 is whether Ireland has a credible growth strategy, which will persuade more international lenders to lend us money at a more reasonable rate. The only way that this can be achieved is by a smart combination of tax changes, expenditure changes and measures to foster growth and jobs.

Crucially, Budget 2011 is effectively Ireland's last chance to change direction. The Government has the option of spending sufficient money from the national pensions reserve fund (NPRF) to offset some - or maybe even all - of the contractionary effects of increased taxation and reduced expenditure in 2011. We do still need to lower the deficit by a combination of tax and spending changes. But we also need to boost jobs, boost aggregate demand, and boost economic growth.

At this stage, a number of commentators have made the same observation and a range of bodies have put forward credible options for boosting growth in the economy. Without getting into the pros and cons of the different approaches - and there are profound differences - there are many options that Government could take:

- TASC proposes a €3 billion Economic Recovery Fund in 2011 including a credit guarantee scheme for small businesses and rollout of next generation broadband (which would be labour intensive);

-ICTU calls for a minimum investment of €2 billion per annum, over three years, to be spent on a new water and waste network, retrofitting energy inefficient buildings, educational buildings and broadband (with options to bring in private finance, as well as using NPRF money);

- Fine Gael propose a major state-led investment of €18 billion through their NewERA proposals, funded through selling state assets;

- Labour wants to create a Strategic Investment Bank to invest €2 billion (initially) in SMEs and raise finance for infrastructure;

- Sinn Féin proposes a 3.5 year stimulus, using €7 billion from the NPRF (€2 billion in 2011) to invest in a revised National Development Plan, including remediating the water network, extending and rolling out broadband. Also a 'cash stimulus' through welfare, which would boost aggregate demand in local areas;

- IBEC have stated that only growth will solve the fiscal crisis. They call for limiting cuts to capital investment, reviews to ensure all new government policy and legislative initiatives support employment, a radical overhaul of the public employment service, an ambitious national internship programme and the continued PRSI reduction for employing people who are long-term employed;

- ISME "warns of Government complacency on jobs". They claim that businesses are "handicapped by a reduction in consumer demand exacerbated by exorbitant costs, late payments and a difficulty in accessing bank credit";

There is a broad and growing consensus on the economy. That consensus is on the need to change direction, and focus on jobs and growth.

And this is recognised internationally. Paul Krugman notes the 'experiment' (and here also) that Ireland's austerity resulted in a worse result than Spain's attempts at stimulus. Joseph Stiglitz has claimed that Europe "made a wrong bet with austerity". In particular, Ireland’s struggle to revitalize its economy after the country’s worst recession on record shows the risks of focusing on deficits. "The belief that markets will get new confidence has been shown wrong" by Ireland’s austerity drive, Stiglitz said.

If the Government continues to monomaniacally focus on cuts and taxes, and refuse to present a credible growth strategy, it will bring us much closer to requiring an EU-IMF bailout, allow further collapse in the economy and cause unnecessary hardship for many people.

Abandon the deflationary ship

Michael Taft: The Minister for Finance when announcing his €4 billion spending cuts in the last budget, stated confidently:

‘Further corrections will be needed in the coming years, but none as big as today’s. . . A Cheann Comhairle, the worst is over.’

Well, the worst has gotten worster. We are now told we will need another €4 billion or €5 billion in ‘adjustment’ (read: contraction) on top of the €7.5 billion the Government intends. We are told the reason for this is that growth projections are lower. Nobody has copped it that deflationary policies themselves are suppressing growth, the main reason why we known apparently need . . more deflationary policies. But won’t more deflationary policies produce ever lower growth which in turn will maintain unsustainably high levels of deficit? Silence all around.

Let’s be clear: the issue is not the balance between spending cuts and tax increases. The issue is the deflationary model itself. As long as policy is determined within the parameters of that model, it will fail to repair the public finances.

Using the ESRI fiscal multipliers and their growth rates contained in their Recovery Scenarios Update, let’s see where additional contraction will get us. These figures are provisional insofar as there is some extrapolation and, therefore, are intended to be indicative only. But they show the scale of the failure that is the deflationary model.

The ESRI was the first to signal that the Government’s strategy will fail. The €7.5 billion would not only fail to reach Maastricht compliance by 2014, it would fail to do so by 2020. As a percentage of GDP, (with an additional €1.5 billion added due to increased interest payments and revising growth downwards by a third, which seems to be consensus projection) this is what the deficit would look like:

As can be seen, even with an additional contraction of €4 billion, on top of the current €7.5 billion, public finances cannot be brought into Maastricht compliance by 2020. It would flat-line between -4 and -5 percent. And each additional €1 billion contraction would only lower the deficit by between -0.1 and -0.2 percent.

However, there are problems with even these projections. The ESRI model assumes an interest rate risk premium of 2 percent. We are now double that position. With projections showing that even with additional contraction, we won’t repair public finances we should expect that risk premium to remain high (that is, if we are still in the market).

Nor does the above take account of the probability that growth and deficit-reduction are reacting to the deflationary impact on the GNP (where most tax revenue is generated) – an impact which is 20 percent to 30 percent more negative than on GDP. If we tried to factor that in, we’d flat-lining at above -6 percent or so.

Nor does it include the extra interest payments arising from higher deficits. With additional fiscal contraction we’d still be adding €10 billion to €15 billion on our overall debt by 2105, putting cumulative pressure on the deficit.

And what it doesn’t take into account the spectre of what can be described as a deflationary cascade.

Something darker may be hiding in the Government’s fiscal cupboard. Michael Burke referred to this when highlighting the findings of the IMF. In short, for economies that have hit an interest rate floor and where other countries are pursuing fiscal consolidation, a 1 percent budgetary contraction could produce a decline in the GDP of 2 percent.

To put this in perspective, current policies are closely following the rule of thumb – a 1 percent contraction is producing a fall of 1 percent in GDP (marginally more). However, if we start entering more sustained deflation, we could really be in trouble. Even if the IMF is only half right (I emphasise half right), we could find ourselves in this ugly situation:

The deficit would fall to only –8 to -9 percent of GDP by 2014 and then flat-line for the rest of the decade.

The more we engage in fiscal contraction, the more we would be entrenching high deficits in the economy. The economy would literally be spinning its wheels with all the consequences this would have for unemployment, growth, debt and interest payments.

Additional fiscal contraction will not repair public finances but will drive the debt ever upwards (the ESRI already estimates the debt to be 130 percent of GNP by 2015 on current policies, but that’s not even counting the additional Anglo-Irish/INWB bail-out which will add another €10 billion minimum to that debt pile).

If we accept the fiscal contraction coming down the line and content ourselves to debating the relationship between spending cuts and tax increases, then we will be debating on the Titanic. For the real problem is not how much cuts or taxes, but the Government’s deflationary model itself. It can’t change direction.

And we’re heading for a big iceberg.

How not to reduce the fiscal deficit

Slí Eile: Today's opinion poll in the Irish Times is odd. One of the questions is: 'Asked if the Government should stick by its target of reducing the budget deficit by €3 billion or doing more as suggested by Mr Lenihan, 54 per cent opted for the €3 billion target, while 26 per cent accepted that it should be more.' According to the print version of the newspaper, the question is introduced as follows: 'The Government has signalled that the gap between national income and expenditure will be reduced by €3billion...'.
Clearly, someone is confused about:
the difference between national accounts and public finances
reducing spending, increasing taxes and reducing deficits.
The story says that 20% didn't know, 54% said same reduction and 26% said more is needed.
Well, I belong to the 'make reduction' of more than €3bn in the deficit by not cutting spending and directing some of the cash in NTMA to job creation in new green tech industries.
Put another way, cuts do not equal savings due to the dynamics and interactions between domestic demand, investment and tax receipt flows. The empirical evidence reviewed on this site and elsewhere suggests that the underlying deficit remains stuck not because the Government has not cut enough but because the economy is in a prolonged recession and, to some extent, domestic fiscal policy has made the situation worse.
The best way to embed the deficit is to continue cutting - especially on the capital side. That is exactly what Fianna Fáil and inter-party Governments did in the 1950s and they reaped a whirlwind of rising emigration, unemployment, poverty and stagnation.

Lessons from abroad

Michael Burke: There is an imminent danger with regard to government finances. The government and its supporters have repeatedly argued that their policy would have the following effects:- revive growth, correct government finances, bring down borrowing costs and prevent a disaster such as being excluded from financial markets like Greece/the IMF being called in.

In turn, each of the negative consequences they have warned of has come to pass, as a consequences of their policies. GNP growth (the bit that policy, not world trade, directly influences) continues to contract. Government finances continue to deteriorate. Borrowing costs continue to soar, so much that there is genuine concern about NTMA's forthcoming bond auction.

In a previous post, Michael Taft used the analogy of the Titanic heading for the iceberg http://www.progressive-economy.ie/2010/09/debating-on-titanic.html . The government can see the iceberg, like the rest of us and its response? Full steam ahead....stoke the boilers with another €3bn. Mr Honohan says it should be more, as if concerned the iceberg should slip out of our course before we reach it.

What would be the result if the engines were thrown into reverse: instead of cuts there was increased spending? How would the economy, government finances and international markets look then? European experience might be useful.

One thing economies do have in common with large ships is that that they take time to respond to changes in direction. In particular, on the whole taxation revenues are a lagging indicator of activity- they are paid after the event, sometimes a long time afterwards. But we know that in Europe, or more accurately the Euro Area most governments increased their spending in response to the recession (many also increased their minimum wage too, just like the older textbooks said they should). The fruits of that policy can be seen in the 2nd half of last year and this.

Take the case of Spain. It had a sizeable fiscal stimulus in 2009 equivalent to 2.3% of GDP. This ECB publication details the bailouts in the EU. This was before it was strong-armed by the EU, the financial markets, the ratings agencies and the banking interests these both represent into cutting public spending. A very modest improvement in the economy has since taken place, but this contrasts with Ireland's continued contraction in GNP. Spain's central government deficit has almost halved in the first 7 months of this year as tax revenues have rebounded sharply. Because of this improvement, bond yields are falling in Spain even while they are rising here. 10yr yields in Spain are now more than 2% low than Irish yields having been the same earlier in the year, half that change having taken place in the last 4 weeks. Bond investors respond to those tax and deficit data.

Or France, where the stimulus was equivalent to 1% of GDP and the growth rebound has been more robust (partly because the measures have not yet been undone, as they have in Spain). The budget deficit is ¤100bn lower in the first 7 months of this year than last, a decline of 22.8%. And of course, yields are less than half of Irish yields.

Germany is the same, a fiscal stimulus of 1.4% of GDP and record growth in Q2. The Federal structure means that the time la for the improvement in government finances will be greater- both the spending was delayed as much of it devolved to regional Laender and the tax revenues will also be delayed. In any event the deficit is on course to widen to just 3.5% of GDP this year.

The same pattern is true all across those Euro Area economies where government spending was increased (as well as being the case in the US and Britain; the deficit is lower as a result of increased spending).

Now, whenever there is an attempt to draw lessons from international experience, the cry goes up that 'N is not Ireland'. Well of, course. Every concrete situation is a unique combination of general circumstances. Not two phenomenon are exactly alike- otherwise they would not be separate phenomenon. The objection usually boils down to two points. First is the issue of 'leakage', this economy's propensity to import. This has already been dealt with elsewhere, and 90% of Ireland's imports are inputs for production, and the value created from that is what accounts for its wealth-creation, including overwhelmingly its exports. The other objection as that Ireland's position in the markets is a function of its uniquely large bank bailout.

But this does not explain its unique status as remaining in (domestic) recession nor the fact that tax revenues continues to contract. The fact is, the bank bailout, which is a millstone, is not much correlated to yields either, since Greece had no bank bailout to speak of and Belgium- which had the next biggest bank bailout- has not come under any market pressure at all. Instead, it is the disastrous impact of fiscal policy on the economy and the effect that this has had on government finances which is the driving force behind the ongoing risis in Ireland.

It is indeed time to reverse course.

Debating on the Titanic

Michael Taft: The confusion between fiscal contraction (i.e. public spending cuts) and reducing the fiscal deficit continues apace. On Morning Ireland, Caoimhghín Ó Caoláin, Sinn Féin’s Dáil leader was being interviewed on the budgetary options facing the Government. The very first question began like this:

RTE: ‘We know the Government is going to cut the deficit this year by around €3 billion ... some doubt about whether it will be a little more than that . . . ‘

This encapsulates all that is wrong with the debate over fiscal policy. For the Government is not seeking to reduce borrowing or the fiscal deficit by this amount or anything like it.

Leaving aside the impact of bank bail-outs – which should be treated as an ‘extra-ordinary’ (with special emphasis on ‘extra-ordinary’) – the Government estimates that net borrowing of central government will be:

2009: - €16,857 million
2010: - €17,346 million
2011: - €16,831 million

At best, if the Government hits its budgetary targets, central government borrowing will fall by €515 million – not €3 billion.

When we turn to the General Government Deficit (the instrument used to measure Maastricht compliance) we find the deficit falling from -€18,720 million to -€17,030. This is a fall of nearly €1.7 billion. Why the discrepancy then with the above figures? And doesn’t this show the Government is at least making some progress? Answer to the second question – no. Let’s answer the first.

The discrepancy is due to the treatment of the deficit in the Social Insurance Fund. In 2010, the Government expects the Fund to be in deficit by nearly €1.2 billion. This is factored into the General Government Deficit. In 2011, the Government expects the Fund to be in surplus again – largely because those on Jobseekers’ Benefit will have exhausted their benefit (they receive it for only nine months).

When we remove the Fund deficit, we find the difference to be approximately €500 million – the same as the Central Government borrowing.

Let’s cut to the chase: if cutting public spending resulted in an equivalent cut in the fiscal deficit we wouldn’t be having a public finance crisis. The Government has already cut nearly €9 billion from public spending. They intend to cut €2 billion plus in the next budget. If all these cuts equalled cuts in fiscal deficit, we wouldn’t be having these discussions about public finances – we’d be in clover.

The ESRI has already assessed the Government’s fiscal strategy and found it incapable of either repairing public finances (at least in this decade) or preventing the debt from spiralling out of control.

Debating a future of public spending cuts is like holding a debate on the decks of the Titanic. Equating public spending cuts with cuts in the fiscal deficit will do nothing to change the course of the ship or melt the iceberg waiting for us. There is only one option – change the captain and, for goodness sake, turn the wheel.

Out of the traps and into the abyss

Michael Burke: A piece in today's Guardian reports on the downgrade by Moody's, and expresses some surprise that there wasn't much of a reaction in Ireland.

The journalist goes onto to argue that the downgrade was subsumed by the latest twist in the saga of NAMA, the banks and the property speculators- who want to be bailed out but to keep all their assets too.

But the muted reaction may also have something to do with self-delusion. Mark Fielding of ISME is quoted in the piece as saying that the government is going in the right direction. And there is this quote from the financial journalist Simon Carswell, "The main story here is our problems are huge, but we are doing the right things to fix them. What Ireland has done better than any other country is that it was the first out of the traps to try and fix things. Darling and Brown went in the completely opposite way. They thought they could spend their way out of the recession."

Yet, the British economy did indeed come out of recession, and it was entirely due to increased government spending. The domestic economy expressed by GNP recovered in Q4 2009, at the same time as GDP rebounded. Government current spending and government investment rose by a combined £10.36bn during the British recession, which is greater than the £9.65bn in the recovery to date. Apart from declining imports demand, it was the only category of the national accounts which made a positive contribution to growth in 2009.

Surely, though, spending like this would have produced a huge widening of an already large deficit? By happy coincidence the British ONS also published today the June report on Public Sector Finances. And the short answer is No. In the period since the beginning of the Financial Year, the April-June 2010 public sector net borrowing is £4.6bn lower than in the same period a year ago. And the reason is that taxes are higher, up £9bn. The rolling 12-month borrowing total is down to £143bn. That's just 6 months after the Pre-Budget Report projected a £178bn for this Financial Year.

How can that happen? How can increased government spending lead to a declining public sector deficit? It's actually based on a simple lesson, painfully learnt in the 1930s, after a prolonged period of austerity measures failed to close the deficits. In a slump increased government spending increases total demand, thereby increasing taxation revenues and decreasing welfare expenditures. In short, government spending more than pays for itself- it provides a positive net return to the exchequer. And the opposite is the case; decreased government spending in a slump depresses total demand and so lowers tax revenues and increases welfare payments (even when welfare entitlements are cut).

Irish government policy was first out of the traps- and headed straight for disaster. The British, being relatively slow learners, are now emulating Dublin's policy and will reap the same dubious rewards.

What's €4 billion here or there?

Michael Taft: In all the discussion over the CSO’s recent National Accounts release for the first quarter this year – the one that shows that the Irish economy is ‘emerging from recession’ – one critical figure was over looked: the substantial revision downwards of GDP for 2009.

The CSO had previously estimated 2009 GDP to be €163.5 billion in current terms. This was slightly better than the ESRI’s estimate but slightly down on the Government’s own projection. However, the CSO’s projection earlier this year was preliminary. When they produced their final figures for 2009, GDP was down substantially – by nearly €4 billion. The final outcome is €159.6 billion.

The downward revision is due to exports. Previously, the CSO projected exports to be €148.5 billion. Now its €144.8 billion (there were slight downward revisions for investment and Government consumption). In other words, the CSO had previously estimated exports to be higher last year than what they actually were.

Why should this be of concern? First, it means we must be guarded about reading too much into quarterly figures. The CSO, of necessity, is dependent upon less reliable data when they produce quarterly figures – data that is open to large variations, particularly in multi-national export figures. It is only when the National Income and Expenditure report is published that we get solid numbers.

Second, it shows up our deficit and debt figures in even a worse light. The Department of Finance informed Eurostat that our General Government Balance (our deficit for the purposes of Maastricht calculations) for 2009 was €19.3 billion. Using their own GDP projections, our ‘underlying’ GGB was -11.8 percent (with the Anglo bail-out it was -14.3 percent).

Overnight, our deficit has worsened. For 2009 our ‘underlying’ deficit is now -12.1 percent. This, too, went unreported in the wave of green-shoot journalism and the Government spinners desperate to show their policies are working. Our GDP fell by €4 billion and our deficit increased but none of this was, apparently, worth commenting on.

This is about par – especially in terms of the new deficit numbers. Over the last year, the Government has missed every deficit target they set for themselves. At every turn, the Government got it wrong. This is called ‘getting public finances under control’. In most other lexicons, this would be called a failure.

To highlight this failure all one needs to do is refer to the Finance Minister’s own warnings when he proposed the April emergency budget. He was concerned that the deficit would exceed -12 percent and even head towards -12.7 percent. Therefore, he had no choice but to increase income and health levies (cutting disposable income and, so, demand) and slash current expenditure (social welfare for young people, the Christmas bonus, etc.) by nearly €1 billion in the year. And so he did. What happened? The deficit exceeded -12 percent. Cutting spending and people’s disposable income during a recession is like running in quicksand.

But there is another unnerving statistic that went unremarked. While 2009 GNP figures were not significantly revised in the latest CSO release, there was a substantial drop in nominal GNP for the first quarter this year. Again, we have to be careful: not only are quarterly projections open to wide variations; GNP numbers are highly sensitive to multi-national repatriation activities.

Nonetheless, the drop is significant. While in real terms, the quarterly GNP fall was -0.5 percent, the nominal fall was nearly -7 percent. Is this a case of multi-national activities; or is the CSO picking up the first impact of the highly deflationary measures in the 2010 Budget. We can’t be definitive at this stage – especially as we don’t have deflators. But following the last budget, forecasters revised downwards their GNP projections for this year.

Deflation comes with a very high price – one of them is that it increases the deficit and debt burden. A comparison of the Exchequer Balance in the first quarters of 2009 and 2010 highlights this:

• Q1 2009: -11.2 percent of GNP
• Q1 2010: -13 percent of GNP

The reason for the deterioration is not the amount of deficit but rather the falling value of GNP. If GNP nominal value remains sluggish throughout the year, we may find an ever increasing deficit and debt burden, especially as GDP growth will not be, as the Department of Finance describes it, ‘tax-rich’ due to low corporate tax.

This is not what a real recovery is supposed to look like.

Irish debt ... finally, some healthy scepticism

Michael Taft: Just because some people don’t get it – that shouldn’t stop us from getting it. Colm ‘Digger’ McCarthy was at it again, calling upon the nation to dig an even deeper hole. We have engaged in deflationary policies in order to please the markets. This obviously isn’t working. What’s the solution? More deflationary policies.

‘ . . . the government needs to re-state as forcefully as possible its commitment to fiscal consolidation, and to ignore the irresponsible cacophony of demands for additional spending. We will be lucky if we can borrow enough to keep the show on the road.’

Along the way, certain facts have to be ignored and unsubstantiated assertions repeated. For instance, the deflationary interventions last year produced benefit to Irish borrowing costs. It didn’t – as shown here. Borrowing costs increased after each ‘budget’ the Government introduced (February pension levy/spending cuts, April emergency budget, 2010 budget).

Then we got the ‘We’re not Spain, Italy or Portugal’. No, we were worse, despite some commentators’ determination not to read the indices. Of course, they had to say this because admitting things were going south would beg questions about the efficacy of deflationary policies.

Now we’re getting a ‘We were doing the right thing, the markets knew we are doing the right thing but the Euro crisis was outside our control and we unfortunately got swept into the maelstrom.’

Under this narrative, Irish debt was improving up to April – proof that the markets were satisfied. The problem for this narrative is that all EU-15 countries debt was improving (save for Greece and Portugal); but Ireland was improving less than most other nations. And some of those countries whose debt didn’t improve as much in percentage terms as Ireland’s (e.g. Belgium and France) – well, their borrowing costs were much, much lower than ours to start with.

Still, the spin continues. Only this morning we have this gem from the Irish Independent:

‘ASIDE from bond yields that aren't as high as others in the eurozone, the rewards for Ireland's early frugality have been slow to come.’

What index could they possible be referring to? Excluding Greece (who’s not in the market), Irish 10-Year spreads are the worst in the EU-15. According to the Irish Times Saturday index Irish 10-spread came in at 2.53. Next in line is Portugal at 2.51. Every other country is well below.

False narrative, missed facts, bad prescriptions; at least some commentators are starting to express reservations. Peter Bacon said:

‘It is unclear if Europe can sustain fiscal consolidation in the medium term without a growth strategy running in parallel.’

Alan McQuaid said:

‘The 5% interest rate is going too high. My view is that the markets are not buying into the austerity strategy. Telling everybody to get to 3% in two or three years risks knocking the stuffing out of the economy.’

In addition, the Sunday Tribune reports:

‘Ben May, a European economist at Capital Economics in London, warned it would be tough for Ireland to meet the 3% target by 2014 because economic growth rates would unlikely rise back up to historical levels.’

And in the Sunday Business Post, David McWilliams posed the issue this way in arguing for an immediate close down of Anglo Irish:

‘The reason the markets will support closing down Anglo is that markets have no interest in an Ireland that turns itself into a debt-servicing machine to pay for the mistakes of yesterday . . The financial markets are investors who want growth, who want to invest in the real wealth of Ireland and the real wealth of this country . . No investor minds a government spending €20 billion on education and infrastructure because it means the balance sheet will have an asset opposite the debt. But on our national balance sheet opposite the €20 billion is Anglo, with its treasure chest of worthless land and sites. This simple accounting identity scares people.’

At least, in a few quarters, scepticism over deflationary policies is being raised.

We may not be reaching a consensus on a new macro-economic framework – one which emphasises investment, growth, employment, and tax-driven fiscal consolidation. But more and more are starting to ask the difficult questions.

That’s a start.

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.

Get thee to a calculator

Michael Taft: ‘One and one is what I’m telling you / get a pocket computer’

So sang Blondie. Deborah Harry might have been singing to whoever penned the latest Back Room article in the Sunday Business Post. Arguing that economic policy under a Fine Gael / Labour government would not be significantly different, the author goes on to write:

‘According to the Government’s own figures, the exchequer deficit will this year amount to €18.8 billion. Had the Government not already taken harsh budgetary steps, equivalent in total to €15.9 billion, our exchequer deficit would be a staggering €34.7 billion this year, or 27 percent of national income.’

Just when you think you’ve read it all, along comes someone to present us with a statement so devoid of understanding that all you can do is be amazed that this stuff actually gets published. If the government had not taken harsh steps would our deficit have risen to nearly €35 billion? Of course not; but don’t take my word for it – here’s what the Department of Finance had to say about the matter.

In their 2010 Pre-Budget Outlook, Finance projected the annual deficit for 2010 to 2013 in the absence of any fiscal correction from Budget 2010 onwards; in other words, if there were no tax increases and no spending cuts. This is what they came up with, as a percentage of GDP:

2010: - 14 percent (‘around’ as Finance puts it)
2011: - 13.7 percent
2012: - 12.2 percent
2013 - 10.5 percent

Finance was attempting to assess the deficit without €11 billion worth spending cuts and / or tax increases. You might have noticed that the deficit goes down. Indeed, if one extrapolates from the figures to estimate 2014 (Finance didn’t do 2014 because the EU Commission had yet to postpone the Maastricht target date), the deficit would be less than - 9 percent.

Amazing. Doing nothing would actually cut the deficit by nearly 40 percent. Yet our Back Room whiz has our deficit ballooning to 27 percent of GNP. To readjust the above figures, the deficit would fall from – 17.4 percent of GNP in 2010 to – 11.3 percent in 2014.

If anything, Finance under-estimates the decline in the deficit because they took a ‘static’ approach, which means they didn’t assess the impact of withdrawing the cuts and tax increases on the GDP. I discussed some of this here at the time of the publication.

So how did Back Room get a €35 billion figure? She/he merely totted up the amount of fiscal correction to date and added it to the current deficit. Of course, this ignores the deflationary and, at times, self-defeating impact of such correction.

First, tax increases reduce tax revenue in other streams (e.g. if you increase income levies, people have less money to spend and, consequently indirect taxes fall). In addition, tax increases reduce demand which leads to higher spending (unemployment costs) and reduced tax revenue through less business profits and tax on labour which has been cut.

Second, spending cuts act in the same way but as the ESRI has shown, they are even more damaging to the economy – spending cuts reduce tax revenue and increase unemployment costs more than tax increases.

Third, given that the GDP is reduced, the resulting deficit still remains high.

This is not an argument for doing nothing. Indeed, if one were forensic in tax increases (only on high income earners) and spending cuts (in areas that benefit high income earners), there would be less deflationary impact. And if that were combined with stimulus measures to generate employment and growth it would mean a faster falling deficit and overall debt. Faster than what the Government is trying to attempt.

But that these arguments are difficult to get across is evident when one has to read the type of stuff that Back Room churned out. For that is where our debate is at – an absolute inability to read the economy. And if you can’t read the economy, how are you going to fix it?

Pain, but no gain

Michael Burke: In a recent piece in The Guardian, Dean Baker argues that politicians are ignoring Keynes "at their peril".

Arguing that it would be reasonable if deficit-reduction easures produced positive results, but they do not, Baker says, this is a case of "pain, but no gain."

"Ostensibly, there will be a lower interest-rate burden in future years, but even this is questionable. First, the contractionary policy being pursued by the deficit hawks will slow growth and lead to lower inflation or possibly even deflation. It is entirely possible that the debt-to-GDP ratio may actually end up higher by following their policies than by pursuing more expansionary policy."

This is exactly what has happened. The Fianna Fail-led government has had a fiscal contraction totalling 8.9% of GDP (€14.6bn in fiscal tightening compared to 2009 GDP of €163.5bn).

This is the profile of Ireland's general government borrowing as a proportion of GDP, according to the EU Commission's data and forecasts (click to enlarge). Those for the Euro Area are shown alongside (Euro Area Report, Spring 2010, Table 37)

By contrast, the Euro Area had an average fiscal stimulus of 4.4% of GDP, according to the EU Commission, European Economic Forecast, Autumn 2009, although since that was written both Germany and France announced further significant stimulus at end-2009, pushing the average over 6%.

If we take 2009 as the major year of fiscal stimulus in the Euro Area and of fiscal contraction by the Dublin government, then we have a startling conclusion. It seems that the EU average GGB deficit is barely more than the fiscal stimulus itself, at approximately 6% of GDP. Yet at the same time government policy has saved Irish taxpayers from a far worse fate. If it hadn't been for 'tough decisisons to reassure the markets', by taking 8.9% out of the economy, the deficit would be 21% of GDP in 2011 (8.9% + 12.1%, not including Anglo).

Advocates of fiscal stimulus are accused of believing in the tooth fairy. But this is a tale out of the Brothers Grimm.

The advocates of slash&burn can neither explain the semi-magical way in which the Euro Area's deficit is no greater than the stimulus measures, and is now falling. And they invite us to believe in a horror story, where a gargantuan deficit, unique to Ireland has been averted, leaving just a monstrously-sized one in its stead, which is forecast to rise again in 2011.

But there is another explanation, one which would incorporate the hugely divergent trends in Euro Area government finances. It can be summarised as follows: Stimulus works. Slash-and-burn doesn't.

Money for some, just not us

Michael Taft: ‘Folks, the money ain’t there. There is no untaxed honey-pot of rich people to be taxed. Put top rate taxes up to where they were in the 1980s (we are more than halfway there already, by the way) and see how much money we raise. It won’t make a material difference and might just make things worse. Explain to the public sector that they were hired, with the best of intentions, on a premise that proved to be false. The money to pay them just doesn’t exist. That does not mean they are not valued or that they are not doing a superb job in a dedicated way.

The ‘no cash’ constraint is, unfortunately, absolute and binding.’

No wonder the debate over the economy is so degraded - if this is the quality of commentary we are getting from our broadsheet media. Let’s examine this ‘no-cookies-in the-cookie-jar’ argument that Chris Johns, chief executive of Bank of Ireland Asset Management, put forward in the Sunday Business Post.

First, there are cookies for Anglo-Irish - up to €20 billion cookies that will never be repaid.

Second, we will pay (and it is we – through Government guarantee) approximately €50 billion for largely under-performing, if not downright worthless, assets from the banks.

One may argue these expenditures are necessary; or that we could have achieved the same thing for less cost (the Government is already reconsidering the option of closing down Anglo-Irish over the long-term – an option they initially dismissed). One may argue that we had to clean up the banks’ balance sheet (but we could have paid a lot less if we were willing to take larger a stake in the banks). One may argue a number of things – but one thing is certain: the ‘no-cash’ constraint is, in these cases, neither absolute nor binding.

Third, the ESRI estimates the Government will have nearly 30 percent of GDP – or nearly €50 billion – in Exchequer cash balances and National Pension Reserve Fund assets. Yes, we need a large liquid buffer, especially as the Government’s deflationary policies have failed to protect the integrity of Irish sovereign debt. And, yes, some of this money is tied up in bank recapitalisation. And, no, this is not an argument for raiding the cookie jar. What it shows, however, is that there are some free-floating cookies that could be put to use: investing in the economy, generating jobs and growth, increasing tax revenue, reducing unemployment costs and, so, reducing the deficit. We may debate how much; but the ‘absolute and binding’ argument is not so absolute when we lift the cookie jar lid.

Let’s look at the ‘honey-pot’ assertion. The Commission on Taxation, to take just one small example, stated that of the €700 million spent on mortgage interest relief expenditure (in essence, a cash subsidy), nearly half went to the top two income deciles which, according to the EU Survey on Income and Living Conditions, averaged €140,000 in gross income. A question arises: if ‘the money ain’t there’, why are we subsidising high-earning households to the tune of over €300 million a year?

Or take the current exemption from the Health Contribution Levy enjoyed by rental and dividend income; Fine Gael estimates this subsidy costs €89 million. This, again, is likely to benefit the top income deciles – at a time when the ‘money ain’t there’.

Or take Labour’s proposals to limit the tax relief for pension contributions for high income groups. They estimate this subsidy costs €350 million – a lot of money to be paying those on high incomes there ain’t no money.

So the money is there – through these subsidies – for certain folk. It just depends on one’s priorities.

Probably the most disturbing thing about this analysis is its rejection of investment as a tool for growth and revenue generation. For instance, the Irish Times reported on an internal HEA report:

‘The HEA report says an investment of over €4 billion will be required to upgrade dilapidated buildings and provide space for a 30 per cent surge in student numbers.’

Clearly, this would be a wise investment – not only in our future knowledge capital but in getting people back to work now on productive activity. What if we were to take that money in just those three examples I’ve used (there are lots, lots more – see TASC’s report on tax expenditures) and redirected it into upgrading our third-level institutions? A back-of-the-envelope multiplier calculation indicates that it would boost tax revenue by nearly €900 million over a six year period while employing thousands of workers directly and creating thousands more jobs downstream. It gets even better when one factors in reduced unemployment expenditure.

From just this one small example, building on small examples, we see how redirecting money that is being foolishly spent (and subsidising high-income groups in a recession is about as daft as you can get) into productive investments exposes arguments based on ‘no cookies in the cookie jar’.

The fact is that money is there. It depends on priorities. We can argue the toss over how much and how best it should e spent. I’m sure Mr. Johns would agree that state investment in Bank of Ireland is a good investment based on the probability of return and the protection of our banking system. Clearly, Mr. Johns would say that the ‘no-cash constraint’ is not absolute and binding in this case.

If so, then how much more the case for the economy and growth and employment.