Tom McDonnell: The debate about the fiscal compact is likely to continue for some time. Much has been made of the 'one twentieth' rule but in practice it is adherence to the rules around the structural balance which will really matter in terms of the fiscal stance post 2015.
Ireland is currently working its way through an Excessive Deficit Procedure (EDP) which requires the general government deficit to be no worse than 3% of GDP in 2015. At that point Ireland will be expected to improve its structural budget balance by converging to a medium term objective of a deficit no larger than 0.5% of GDP. The Department of Finance estimates that the structural deficit will be 3.7% in 2015. If one generously accepts this figure as accurate then the government will be obliged to adopt a fiscal stance consistent with 'correcting' the remaining gap. This will trigger additional discretionary fiscal consolidation equivalent to circa 3.2% of GDP - about €5 billion in 2012 terms (though not necessarily all in the same year). This suggests that the programme of continuous austerity will continue out to 2017/2018. A bleak prospect.
This continuous fiscal tightening combined with the huge private debt overhang will drag on the economy's capacity to generate increases in real GDP. Debt sustainability in the absence of higher inflation (anathema to the ECB) or low interest rates on government borrowings (perhaps by extending the official programme past 2013) will be challenging. The Treaty does refer to an ability to deviate from the medium term objective under 'exceptional circumstances'. It will be interesting to see how this is interpreted in practice and it is possible there may be scope for wriggle room.
The fiscal compact is certainly no panacea for the current crisis though it might ameliorate the severity of the next one. The answers to the current crisis lie elsewhere.
Showing posts with label fiscal consolidation. Show all posts
Showing posts with label fiscal consolidation. Show all posts
Tuesday, 7 February 2012
Saturday, 24 September 2011
Is (Government) austerity working?
Slí Eile: Much has been made of the latest quarterly national accounts data issued by the Central Statistics Office last Thursday here. First the good news: Gross Domestic Product (GDP) is estimated to have increased by 2.3% - in real terms - between the second quarter of 2011 and the second quarter of 2010 (Table 1). Hurray. Next, GDP has increased for two consecutive quarters. So, the recession is over? And Government contractionary policies are having a positive impact? I think not. A number of caveats are in order:
1 Quarterly national accounts represent 'latest best estimate'. If you scrutinise a succession of Quarterly accounts as they are released you will spot significant adjustments to older estimates. CSO is obliged to publish Quarterly data within three months of the end of a given Quarter. Many components of estimated GDP (and GNP) are volatile and subject to change as new information become available later on.
2 The components of growth in GDP have been performing very differently (see below).
3 Discretionary hikes in tax rates and cuts in expenditure programmes have impacted but not in a way that stopped 'initial estimates' (CSO's own description) of an increase in GDP.
In relation to quarterly data, many variables need to be considered including seasonal adjustments (which can make a big difference from Quarter to Quarter), swings in the value of physical changes in stocks of goods, estimations of price changes in deflating current price estimates and estimations from balance of payments.
The latest CSO data show two emerging trends:
* a healthy recovery in the estimate of exports; and
* continuing contraction in domestic demand - especially investment
In volume terms exports were up by an estimated 4.9% between Q2 of 2011 and Q2 of 2010 (Table 3). It does appear that much of this was - curiously - in the services area (Table Annex 1 last line) where the year-on-year increase in the volume of services was 7.3% to Q2 of 2011. The other side of the story is what is happening on all the 'domestic' components of GDP. Personal consumption was down by 2.4% of this period while net expenditure by Government was down by 3.3%. Investment was down by a huge 14.3% (much of this is related to building and construction). As a result final domestic demand was down by 4.6% (Table Annex 3A). When adjusted for changes in the value of physical changes in stocks the fall in total domestic demand was 2.2%. Combining data from different tables in the CSO release it is possible to estimate that the total gain in GDP between Q1 of 2011 and Q2 of 2011 (quarter-on-quarter changes) was in the order of 900 million Euro. Other things equal, exports net of imports would have increased GDP by 1.9 billion. However, the components of domestic demand sliced one billion off GDP just in the space of three months. Set against a gain of 1.9 billion, the domestic demand side took it toll of close to one billion. So, we are looking at a twin-track economy - and - unemployment continues to inch up while the real value of consumption falls as more people are made redundant and incomes are still contracting. Its a strange kind of recovery.
Yet, one should be positive about the growth in exports. It would be interesting to have more data on how this growth breaks down - which sectors, what markets and how. Changes in commodity prices, currency shifts and changing cost structures as well as new product lines and services are relevant considerations. It is little wonder that Ireland inc is prepared to fight to the bitter end for our 12.5% corporate tax. Sentiment, confidence about the future and sticking to low corporate taxes is seen as a sine-qua non for securing continuing growth in the foreign direct investment sector and its export performance. But is it sustainable morally (as a form of tax-cheating and avoidance to the detriment of developing countries), politically (EU) and economically (as the BRIC countries rise and rise)? Somehow Ireland inc needs to discover and invent a wider range of tactics going forward. Of course, a huge unknown going forward is what is going to happen to world trade and, therefore, exports from Ireland. All the best current downwardly revised GDP growth plans may yet come to ruin if the world is faced with a double-dip slump.
And what of Government contraction here in Ireland? All the evidence to date indicates that cumulative fiscal austerity since the Autumn of 2008 has added to contraction in domestic demand, rising unemployment and a continuing investment slump. The latest CSO release provides no evidence that this is not still the case. If the theory and practice of such austerity is expansionary fiscal contraction, recovery in consumer and investor confidence and higher levels of competitive performance on world and domestic markets there is little to prove that slash and burn has delivered anything other than further contraction leading to further slash and burn.
Readers might find the following IMF working paper of interest here. IMF is not a monolith and the authors of this paper (Ball, Leigh and Loungani) propose a more prudent, measured and timely approach to fiscal consolidation linked to more growth-friendly and jobs-friendly strategies. They also point to the deep equity impacts on wage-earners of fiscal contraction with reference to empirical studies over 173 episodes in 17 advanced economies over 30 years.
Wednesday, 2 February 2011
Where did it all go wrong?
Michael Burke: The Central Bank’s latest Quarterly Bulletin contains a sharp reduction in its growth forecasts.
It is now forecasting 1.0% GDP in 2011 and -0.3% GNP. Previous forecasts were 2.4% GDP and 1.7% GNP. The media coverage of the downward revision almost completely neglected the reason for the increased pessimism, and over at the Irish Economy blog there has also been a discussion of the Bulletin without ever referring to the cause of the lower forecasts.
So, here is the Central Bank’s own rationale for lowering its forecasts:
"These projections represent a significant downward revision to those published in the last Quarterly Bulletin, which were compiled on the basis of a much smaller €3bn fiscal consolidation in 2011 than the one currently budgeted, and on the basis of continued market access to funding on reasonable terms.”
The point on reasonable funding terms seems misplaced. The average interest rate on the EU/IMF debt to bail out Europe’s banks is no greater than market rates that obtained when he prior Bulletin was published. On 1 October 2010 Irish 10yr yields were 6.6% and 4yr yields were 5.25%.
Therefore, the real change in circumstances is the much larger ‘fiscal consolidation’ in 2011; €6bn in spending cuts and tax increases rather than the anticipated €3bn. This is a rare explicit official admission that the cuts’ policy has a depressing effect on activity, with obvious implications for the entire logic of the policy. If an extra €3bn in fiscal measures can depress GDP by 1.4% and GNP by 2%, what will be the impact of a €15.8bn ‘fiscal consolidation’? In reality, as the central bank points out €700mn of the 2011 measures are non-recurring asset sales and similar (p.29) - which will not affect growth.
Therefore the additional measures affecting growth amount to €2.3bn. And the impact on the economy? GNP will be €2.6bn lower than previously forecast (Table 1).
Now, of course this doesn’t mean that the central bank has joined the investment, not cuts camp. The intellectual contortions required to accept that cuts are necessary even while identifying the damage arising from them is not confined to the central bank.
But what is the fiscal impact?It is commonplace to assert that lower growth will lower taxes by 30%, as that is the proportion of tax revenues relative to GDP. This nonsense is recycled by many who should know better. First, total government revenues (including social security and other items not in the Exchequer Statements) are overwhelmingly derived from GNP and in 2010 were 43.8% of it. Secondly, the sensitivity of taxation revenues is greater still. Sensitivity is not taxation/output but the change in taxation revenues/change in output.
Some leading commentators – advocates of ‘fiscal consolidation’ – seem wholly unaware of this sensitivity of taxation, which the DoF puts at 0.6. Thirdly, the sensitivity of government finances also includes outlays, ie of output falls and unemployment rises social welfare outlays will rise even if welfare entitlements are cut. Usually, these are neglected in the debate but they are about half the size of the tax impact.
So, we reach a situation where, according to Central Bank analysis, a €2.3bn fiscal tightening leads to a fall of €2.6bn in output. According to DoF analysis this will lead to a €1.56bn in fall in tax revenues. Standard assessments of the impact on government outlays would suggest a rise of €780mn, for a total deterioration in government finances (combining falling taxes and rising outlays) of €2.34mn. That’s €4mn more than the ‘fiscal consolidation’.
So, the deficit is being entrenched and consolidated, along with Depression and unemployment. That’s how we got here. Getting somewhere else still requires a different path.
It is now forecasting 1.0% GDP in 2011 and -0.3% GNP. Previous forecasts were 2.4% GDP and 1.7% GNP. The media coverage of the downward revision almost completely neglected the reason for the increased pessimism, and over at the Irish Economy blog there has also been a discussion of the Bulletin without ever referring to the cause of the lower forecasts.
So, here is the Central Bank’s own rationale for lowering its forecasts:
"These projections represent a significant downward revision to those published in the last Quarterly Bulletin, which were compiled on the basis of a much smaller €3bn fiscal consolidation in 2011 than the one currently budgeted, and on the basis of continued market access to funding on reasonable terms.”
The point on reasonable funding terms seems misplaced. The average interest rate on the EU/IMF debt to bail out Europe’s banks is no greater than market rates that obtained when he prior Bulletin was published. On 1 October 2010 Irish 10yr yields were 6.6% and 4yr yields were 5.25%.
Therefore, the real change in circumstances is the much larger ‘fiscal consolidation’ in 2011; €6bn in spending cuts and tax increases rather than the anticipated €3bn. This is a rare explicit official admission that the cuts’ policy has a depressing effect on activity, with obvious implications for the entire logic of the policy. If an extra €3bn in fiscal measures can depress GDP by 1.4% and GNP by 2%, what will be the impact of a €15.8bn ‘fiscal consolidation’? In reality, as the central bank points out €700mn of the 2011 measures are non-recurring asset sales and similar (p.29) - which will not affect growth.
Therefore the additional measures affecting growth amount to €2.3bn. And the impact on the economy? GNP will be €2.6bn lower than previously forecast (Table 1).
Now, of course this doesn’t mean that the central bank has joined the investment, not cuts camp. The intellectual contortions required to accept that cuts are necessary even while identifying the damage arising from them is not confined to the central bank.
But what is the fiscal impact?It is commonplace to assert that lower growth will lower taxes by 30%, as that is the proportion of tax revenues relative to GDP. This nonsense is recycled by many who should know better. First, total government revenues (including social security and other items not in the Exchequer Statements) are overwhelmingly derived from GNP and in 2010 were 43.8% of it. Secondly, the sensitivity of taxation revenues is greater still. Sensitivity is not taxation/output but the change in taxation revenues/change in output.
Some leading commentators – advocates of ‘fiscal consolidation’ – seem wholly unaware of this sensitivity of taxation, which the DoF puts at 0.6. Thirdly, the sensitivity of government finances also includes outlays, ie of output falls and unemployment rises social welfare outlays will rise even if welfare entitlements are cut. Usually, these are neglected in the debate but they are about half the size of the tax impact.
So, we reach a situation where, according to Central Bank analysis, a €2.3bn fiscal tightening leads to a fall of €2.6bn in output. According to DoF analysis this will lead to a €1.56bn in fall in tax revenues. Standard assessments of the impact on government outlays would suggest a rise of €780mn, for a total deterioration in government finances (combining falling taxes and rising outlays) of €2.34mn. That’s €4mn more than the ‘fiscal consolidation’.
So, the deficit is being entrenched and consolidated, along with Depression and unemployment. That’s how we got here. Getting somewhere else still requires a different path.
Tuesday, 19 October 2010
Fine Gael's 3:1 Ratio
Nat O'Connor: Fine Gael has given some useful clarity on their fiscal policy position with the declaration that they would seek €1 billion in tax increases for every €3 billion in cuts (Irish Examiner). Across the period of the four-year plan, this suggests that they would seek to close the deficit while making Ireland an even lower tax economy than it was before the boom; which can only mean the wholesale removal or reduction of public services, and significant cuts to public pay and/or numbers.
The implications of the 3:1 ratio can be spelled out in more detail once we establish just how much needs to be cut in the four-year plan.
The Opposition finance spokespersons were given access to data by the Department of Finance today. Is it just political theatre, or did the spokepersons really not know that the adjustment needs to be more than €7.5 billion over the four-year plan?
Consider, we have known for some time that the deficit is c.€19 billion (not including the banks), although it now seems that it might come closer to €20 billion. In July, the IMF's most recent report on Ireland suggests that the structural deficit is eight and a half per cent of GDP (i.e. the bit that won't go away when the economy recovers, welfare payment decrease, tax increases, etc.); which is €13.6 billion (8.5% of 2010's estimated GDP of c.€160 billion). So, it should have been obvious to them for some time that the four-year plan will have to make adjustments of c. €12-14 billion to meet the target of 3 per cent of GDP by 2014.
Note, I'm assuming that the economy will not have moved to the height of another economic cycle, so we would need to clear the entire structural deficit by 2014, assuming that at least €5 billion of a cyclical deficit remains, which will diminish with further economic growth. (€5 billion in today's money is the 3 per cent of GDP requirement under the Eurozone SGP). Arguably, the target for cutting the structural deficit could be slightly less, if the economy recovers faster and helps closes the gap. Hence, my use of the range €12-14 billion.
If we seek a €12 billion adjustment, Fine Gael's 3:1 ratio equates to €3 billion in taxation and €9 billion in cuts; €14 billion would imply €3.5 billion in tax and €10.5 billion in cuts.
A more moderate approach would be a 1:1 ratio, with an equal balance of tax and spending reductions; for €6-7 billion of each.
Patrick Honahan, before he became Governor of the Central Bank, suggested that Ireland's tax take could increase by 3 per cent of GDP (i.e. €4.8 billion) (e.g. quoted here). And that level of tax increase is just to return us to the same type of low tax economy we had before the boom. Nonetheless, if €4.8 billion was taken as an ideal level of tax increases, that would imply €7.2 billion to €9.2 billion in cuts. That is a ratio of 2:3 or almost 1:2 (depending on whether we adjust by €12 or €14 billion). Hence, Fine Gael, with only €3 or €3.5 billion in taxes, would not even reach the €4.8 billion that Patrick Honahan suggests is a credible target.
And once we have established what levels of tax and spending cuts each party wants in the four-year plan, the next question is timing; that is, should we frontload the adjustment? Or keep a more even pace? Or should be push out the deadline for fiscal adjustment by a few years? Leo Varadker of Fine Gael is on record calling for more adjustment sooner. TASC argues for a slower pace (€3 billion adjustment in 2010) to avoid damaging the economy too much in one year.
Of course, we will have to deal with more than the structural part of the deficit if we don't foster recovery in the economy!
TASC's budget proposals argue that we need to foster economic growth through targetted investment to build up human capital and intellectual capital (education, training, R&D) as well as physical infrastructure (broadband, schools, renewable energy). Speaking at the Kenmare economics conference, Leo Varadker emphasised his disagreement with the TASC proposals and signaled Fine Gael's intention to focus all investment on infrastructure (including broadband and renewable energy, but also forestry and other areas).
It would be nice if every political party could state what ratio they would choose between tax and cuts, as it would be a useful rule-of-thumb for the broad implications of their fiscal policy. Likewise, we'd need to see their timescale and what they would do to foster economic recovery.
More importantly, from TASC's perspective, it will be essential to see how each party's four-year plan would change the distribution of income and level of economic equality in Ireland. Tax change and cuts to public services affect different segments of the society differently. Whatever package of fiscal policy decisions are taken in these four-year plans will shape our society, as well as the economy, for quite some time.
The implications of the 3:1 ratio can be spelled out in more detail once we establish just how much needs to be cut in the four-year plan.
The Opposition finance spokespersons were given access to data by the Department of Finance today. Is it just political theatre, or did the spokepersons really not know that the adjustment needs to be more than €7.5 billion over the four-year plan?
Consider, we have known for some time that the deficit is c.€19 billion (not including the banks), although it now seems that it might come closer to €20 billion. In July, the IMF's most recent report on Ireland suggests that the structural deficit is eight and a half per cent of GDP (i.e. the bit that won't go away when the economy recovers, welfare payment decrease, tax increases, etc.); which is €13.6 billion (8.5% of 2010's estimated GDP of c.€160 billion). So, it should have been obvious to them for some time that the four-year plan will have to make adjustments of c. €12-14 billion to meet the target of 3 per cent of GDP by 2014.
Note, I'm assuming that the economy will not have moved to the height of another economic cycle, so we would need to clear the entire structural deficit by 2014, assuming that at least €5 billion of a cyclical deficit remains, which will diminish with further economic growth. (€5 billion in today's money is the 3 per cent of GDP requirement under the Eurozone SGP). Arguably, the target for cutting the structural deficit could be slightly less, if the economy recovers faster and helps closes the gap. Hence, my use of the range €12-14 billion.
If we seek a €12 billion adjustment, Fine Gael's 3:1 ratio equates to €3 billion in taxation and €9 billion in cuts; €14 billion would imply €3.5 billion in tax and €10.5 billion in cuts.
A more moderate approach would be a 1:1 ratio, with an equal balance of tax and spending reductions; for €6-7 billion of each.
Patrick Honahan, before he became Governor of the Central Bank, suggested that Ireland's tax take could increase by 3 per cent of GDP (i.e. €4.8 billion) (e.g. quoted here). And that level of tax increase is just to return us to the same type of low tax economy we had before the boom. Nonetheless, if €4.8 billion was taken as an ideal level of tax increases, that would imply €7.2 billion to €9.2 billion in cuts. That is a ratio of 2:3 or almost 1:2 (depending on whether we adjust by €12 or €14 billion). Hence, Fine Gael, with only €3 or €3.5 billion in taxes, would not even reach the €4.8 billion that Patrick Honahan suggests is a credible target.
And once we have established what levels of tax and spending cuts each party wants in the four-year plan, the next question is timing; that is, should we frontload the adjustment? Or keep a more even pace? Or should be push out the deadline for fiscal adjustment by a few years? Leo Varadker of Fine Gael is on record calling for more adjustment sooner. TASC argues for a slower pace (€3 billion adjustment in 2010) to avoid damaging the economy too much in one year.
Of course, we will have to deal with more than the structural part of the deficit if we don't foster recovery in the economy!
TASC's budget proposals argue that we need to foster economic growth through targetted investment to build up human capital and intellectual capital (education, training, R&D) as well as physical infrastructure (broadband, schools, renewable energy). Speaking at the Kenmare economics conference, Leo Varadker emphasised his disagreement with the TASC proposals and signaled Fine Gael's intention to focus all investment on infrastructure (including broadband and renewable energy, but also forestry and other areas).
It would be nice if every political party could state what ratio they would choose between tax and cuts, as it would be a useful rule-of-thumb for the broad implications of their fiscal policy. Likewise, we'd need to see their timescale and what they would do to foster economic recovery.
More importantly, from TASC's perspective, it will be essential to see how each party's four-year plan would change the distribution of income and level of economic equality in Ireland. Tax change and cuts to public services affect different segments of the society differently. Whatever package of fiscal policy decisions are taken in these four-year plans will shape our society, as well as the economy, for quite some time.
Monday, 19 July 2010
Between the rocks
Slí Eile: Here we go again. Softening-up time. The summer schools, the rain, the Dáil holidays and…. exclusive inside news stories on what the Government might be thinking about. (strategic investment gosh not in your life) …..Somehow it reminds one of the summer of 2009 and the summer of 2008….Now, sir, would you like your leg amputated or your right arm? Good, lad, you have taken so much tough pain as a result of tough choices in the last 18 months that things are beginning to look up. The markets say so (really?). Now, the public finances are beginning to stabilise as the underlying indicators have stopped getting worse (well except for unemployment and emigration but who really cares about that ….).
Never before have statistics been so cruelly tortured to find inflection points and decelerations in the rate of decrease and positive signals from one Quarter’s data or one month’s data as if trends were linear and smooth (note that the statistical requirement arbitrarily used by some analysts to see two consecutive quarters of growth to announce a recovery has been left aside as GDP growth in Q1 of 2010 was enough to spin the story).
One of the aspects of being caught between a rocky hard place and a hard place is that the rocks have been arranged and the thinking arteries hardened so as to avoid any consideration of alternatives. Instead, we have the delusional recovery by a 1,000 cuts. But, the cuts agenda is running into trouble on three counts:
The underlying parameters (leaving aside Anglo which is a mighty big elephant in the fiscal parlour) are not shifting south rendering the 2014 SGP looking like the Emperor without a leaf.
Rising unemployment and contracting income are driving up some of the fiscal stabilisers such as eligibility for medical cards, unemployment welfare and other ‘automatic’ payments.
The politics of cutting again by some €3bn and then again by some equal amount in Election Year minus one look increasingly problematic.
Here’s the story:
1 Public sector pay bill (around 30% of total public spending) is pretty much pegged for the next three years unless there is some ‘unexpected deterioration’ in public finances.
2 Government is moving at snails pace to reform taxation especially in those areas where the rich gain the most (property, tax breaks and financial transactions). The promise of economies through changes in work practices doesn’t translate into lower public spending. Such changes in practices and greater flexibility might enable – over time – a better quality and quantity of public service (however measurable) for a given input of persons or money. It might even enable Government to – eventually – reduce spending by employing less staff in the key sectors (health, education and central/local government for a given outcome of public service). My bet is that:
* Numbers employed will grow in some areas and stagnate or fall a little in others
* The (nominal) pay bill will rise very slightly due to automatic increases (e.g. increments) as well a structural changes arising from the shedding of low-paid and low-skill jobs over time (just watch which vacancies are being filled).
* ‘quality’ improvements in service will be glacial
* Grass-root pressure will build up to revisit the terms of the nominal pay freeze especially as GDP starts to grow and prices erode real wages.
3 The Greens have – for now – taken ‘free fees’ and further changes to the staff-student schedule at primary and secondary level education off the agenda. That’s a lot of cash.
4 The banking tragedy (farce?) looks fearsome – with a roll over of debt bunched to maturity at end of September 2010 and with continuing pressures on the banks a fresh round of recapitalisations cannot be ruled out (thus pushing the measured General Government deficit to over 20% in 2010 and possibly 15% plus in 2011).
The counter-factual of ‘doing nothing’ – i.e. not following the deflationary line since 2009 is adduced as reason to stay the course and continue cutting more. Yet, nobody has shown, empirically, what would have happened if Government had adopted a different growth strategy and made different choices. Everything is predicated on static zero-sum analysis.
The choice of deflation (and it is a choice) leaves Government with some pretty stark new choices within its medium-range deflationary strategy:
- More cuts to an already crisis-ridden health system
- Amputations to significant public service programmes in local authorities and central government (you can guess which)
- Larger deflationary measures than those spoken of to date.
- Revisiting the Croke Park deal
- Further cuts in social welfare targeting this time older folk and children (so much for the fine sentiments behind the proposed Childrens’ Rights referendum)
- An IMF-EU rescue plan later on
- An early election
Take your pick.
Fancy being in the opposition benches? – supporting the broad parameters of the fiscal contraction and yet hedging bets on just how these cuts would be implemented and which taxes would be raised if one were in Government.
Some day, the case for a sane, investment strategy to grow our way out of this fiscal, banking and human skills utilisation hole will become inescapable.
Never before have statistics been so cruelly tortured to find inflection points and decelerations in the rate of decrease and positive signals from one Quarter’s data or one month’s data as if trends were linear and smooth (note that the statistical requirement arbitrarily used by some analysts to see two consecutive quarters of growth to announce a recovery has been left aside as GDP growth in Q1 of 2010 was enough to spin the story).
One of the aspects of being caught between a rocky hard place and a hard place is that the rocks have been arranged and the thinking arteries hardened so as to avoid any consideration of alternatives. Instead, we have the delusional recovery by a 1,000 cuts. But, the cuts agenda is running into trouble on three counts:
The underlying parameters (leaving aside Anglo which is a mighty big elephant in the fiscal parlour) are not shifting south rendering the 2014 SGP looking like the Emperor without a leaf.
Rising unemployment and contracting income are driving up some of the fiscal stabilisers such as eligibility for medical cards, unemployment welfare and other ‘automatic’ payments.
The politics of cutting again by some €3bn and then again by some equal amount in Election Year minus one look increasingly problematic.
Here’s the story:
1 Public sector pay bill (around 30% of total public spending) is pretty much pegged for the next three years unless there is some ‘unexpected deterioration’ in public finances.
2 Government is moving at snails pace to reform taxation especially in those areas where the rich gain the most (property, tax breaks and financial transactions). The promise of economies through changes in work practices doesn’t translate into lower public spending. Such changes in practices and greater flexibility might enable – over time – a better quality and quantity of public service (however measurable) for a given input of persons or money. It might even enable Government to – eventually – reduce spending by employing less staff in the key sectors (health, education and central/local government for a given outcome of public service). My bet is that:
* Numbers employed will grow in some areas and stagnate or fall a little in others
* The (nominal) pay bill will rise very slightly due to automatic increases (e.g. increments) as well a structural changes arising from the shedding of low-paid and low-skill jobs over time (just watch which vacancies are being filled).
* ‘quality’ improvements in service will be glacial
* Grass-root pressure will build up to revisit the terms of the nominal pay freeze especially as GDP starts to grow and prices erode real wages.
3 The Greens have – for now – taken ‘free fees’ and further changes to the staff-student schedule at primary and secondary level education off the agenda. That’s a lot of cash.
4 The banking tragedy (farce?) looks fearsome – with a roll over of debt bunched to maturity at end of September 2010 and with continuing pressures on the banks a fresh round of recapitalisations cannot be ruled out (thus pushing the measured General Government deficit to over 20% in 2010 and possibly 15% plus in 2011).
The counter-factual of ‘doing nothing’ – i.e. not following the deflationary line since 2009 is adduced as reason to stay the course and continue cutting more. Yet, nobody has shown, empirically, what would have happened if Government had adopted a different growth strategy and made different choices. Everything is predicated on static zero-sum analysis.
The choice of deflation (and it is a choice) leaves Government with some pretty stark new choices within its medium-range deflationary strategy:
- More cuts to an already crisis-ridden health system
- Amputations to significant public service programmes in local authorities and central government (you can guess which)
- Larger deflationary measures than those spoken of to date.
- Revisiting the Croke Park deal
- Further cuts in social welfare targeting this time older folk and children (so much for the fine sentiments behind the proposed Childrens’ Rights referendum)
- An IMF-EU rescue plan later on
- An early election
Take your pick.
Fancy being in the opposition benches? – supporting the broad parameters of the fiscal contraction and yet hedging bets on just how these cuts would be implemented and which taxes would be raised if one were in Government.
Some day, the case for a sane, investment strategy to grow our way out of this fiscal, banking and human skills utilisation hole will become inescapable.
Tuesday, 29 June 2010
More of the same
Michael Burke: There has been much discussion about the ESRI's view that Ireland will eventually recover to have a stronger growth rate than most other EU economies. The interest was sparked because some took it to be a vindication of government policy. But the ESRI forcasts are not exceptional; they're very much in line with those of the OECD, IMF and, in the short-run, the EU Commission.
But neither are they a vindication of government policy.
To take just one of the assessments, that of the IMF, in its recent annual assessmnent of the economy there were lots of encouraging words on policy. 'Assertive', 'credibility', 'resolve', 'appropriately ambitious fiscal consolidation' all get an airing in the first two paragraphs, so you get the picture.
But, just as you wouldn't ask Seamus Heaney for a inflation forecast, no-one ever reads the IMF publications for the beauty of their writing. It's the numbers we care about. Here is a summary of some the key numbers
* GDP falling by 0.5% this year
* A gradual rise in GDP growth to 3.5% in 2015
* Unemployment peaking at 13.5% this year
* But structural unemployment keeping the rate at 9% in 2015
There's one more shocking number to come, but let's deal with these first. The recession here began at the start of 2008, for the Euro Area as a whole it began one year later. The Euro Area began to recover in mid-2009 while all the official foreasts have the economy here contracting again in the first half of this year. Therefore the Irish recession will be precisely two-and-a-half years long, compared to 6 months for the Euro Area as a whole.
The forecast increase in GDP growth to 3.5% provides little cause for celebration. The last time this economy had a lower growth rate than that was in 1993, recovering from the strait-jacket of the European Exchange Rate Mechanism and an overvalued punt. In addtion, as all the forecasts agree, the recovery will be a statistical one only as net exports pick-up on the back of rising global demand (but, incidentally, nailing the nonsense about 'lack of competitiveness').
But, since the export sector relies heavily on foreign imports, because it is not especially labour-intensive and, above all, because it is so lowly-taxed, none of this statistical improvement will be reflected in domestic ativity or create jobs (or narrow the deficit). So, shockingly, unemployment is still expected to be 9% in 2015. And although the IMF does not state it, given that employment prospects are so poor, the declining unemployment rate must arise overwhelmingly from continued mass emigration.
This might be of little concern to the IMF, which states that "[Government] actions have reassured the global policy community and international financial markets." We won't dwell on the fact that Irish 10yr government bond yields were 5.6% yesterday, having started the crisis at 4.1%, nor that most other yields have fallen since that time. But at least the 'global policy community' is reassured, by which the IMF means, well, the IMF and others.
Yet the only other number of significance is the most shocking of all. The IMF arguments that prior measures are on a track 'leading towards' deficit-reduction. But not on the track itself, as they argue for further fiscal consolidation measures equivalent to 4.5% of GDP. And, if growth is not as robust as the government foecasts 'a clear possibility' the IMF says, the measures will need to be even larger.
To put this in context, the €3bn in further measures the government is talking about is 1.8% of GDP, on top of the 2008 ad 2009 budgets, emergency budget and measures which amounted to 8.9% of GDP. So, rather than the government's €3bn measures, the IMF reckons they should be at least €7.35bn, probably more. That's at least half the fiscal tightening already seen to date.
It is to repeat a fiscal tightening which led to wider, not norrower deficits (7.3% of GDP to 14.3%),and the longest, deepest recession in the Euro Area, as well as a surge in both unemployment and emigration. Repeating the same experiment and expecting a different outcome is madness.
But neither are they a vindication of government policy.
To take just one of the assessments, that of the IMF, in its recent annual assessmnent of the economy there were lots of encouraging words on policy. 'Assertive', 'credibility', 'resolve', 'appropriately ambitious fiscal consolidation' all get an airing in the first two paragraphs, so you get the picture.
But, just as you wouldn't ask Seamus Heaney for a inflation forecast, no-one ever reads the IMF publications for the beauty of their writing. It's the numbers we care about. Here is a summary of some the key numbers
* GDP falling by 0.5% this year
* A gradual rise in GDP growth to 3.5% in 2015
* Unemployment peaking at 13.5% this year
* But structural unemployment keeping the rate at 9% in 2015
There's one more shocking number to come, but let's deal with these first. The recession here began at the start of 2008, for the Euro Area as a whole it began one year later. The Euro Area began to recover in mid-2009 while all the official foreasts have the economy here contracting again in the first half of this year. Therefore the Irish recession will be precisely two-and-a-half years long, compared to 6 months for the Euro Area as a whole.
The forecast increase in GDP growth to 3.5% provides little cause for celebration. The last time this economy had a lower growth rate than that was in 1993, recovering from the strait-jacket of the European Exchange Rate Mechanism and an overvalued punt. In addtion, as all the forecasts agree, the recovery will be a statistical one only as net exports pick-up on the back of rising global demand (but, incidentally, nailing the nonsense about 'lack of competitiveness').
But, since the export sector relies heavily on foreign imports, because it is not especially labour-intensive and, above all, because it is so lowly-taxed, none of this statistical improvement will be reflected in domestic ativity or create jobs (or narrow the deficit). So, shockingly, unemployment is still expected to be 9% in 2015. And although the IMF does not state it, given that employment prospects are so poor, the declining unemployment rate must arise overwhelmingly from continued mass emigration.
This might be of little concern to the IMF, which states that "[Government] actions have reassured the global policy community and international financial markets." We won't dwell on the fact that Irish 10yr government bond yields were 5.6% yesterday, having started the crisis at 4.1%, nor that most other yields have fallen since that time. But at least the 'global policy community' is reassured, by which the IMF means, well, the IMF and others.
Yet the only other number of significance is the most shocking of all. The IMF arguments that prior measures are on a track 'leading towards' deficit-reduction. But not on the track itself, as they argue for further fiscal consolidation measures equivalent to 4.5% of GDP. And, if growth is not as robust as the government foecasts 'a clear possibility' the IMF says, the measures will need to be even larger.
To put this in context, the €3bn in further measures the government is talking about is 1.8% of GDP, on top of the 2008 ad 2009 budgets, emergency budget and measures which amounted to 8.9% of GDP. So, rather than the government's €3bn measures, the IMF reckons they should be at least €7.35bn, probably more. That's at least half the fiscal tightening already seen to date.
It is to repeat a fiscal tightening which led to wider, not norrower deficits (7.3% of GDP to 14.3%),and the longest, deepest recession in the Euro Area, as well as a surge in both unemployment and emigration. Repeating the same experiment and expecting a different outcome is madness.
Wednesday, 10 March 2010
The TASC letter: Fiscally consolidating what?
Michael Taft: The TASC letter raised the prospect of ‘restructuring taxation and expenditure in a progressive and expansionary manner’. This begs two questions – what does this mean for fiscal consolidation; and around what level do we fiscally consolidate. The phrase ‘fiscal consolidation’ is used as if it had some final meaning. It doesn’t. It doesn’t assume any level of tax and spend, just a relationship between the two. Everyone knows we have to achieve the latter. But there has been almost no debate about the former.
The Government has indicated the level they want this re-balancing to occur by 2014 – at the lowest level possible. There is a problem, though. By 2014, we will be paying out a higher level of interest on the debt – nearly four times as much as a percentage of GDP over recent historical levels (by 2014, 3.9 percent of GDP will go on interest payments compared to 1 percent pre-recession). There’s not much that can be done about this in the medium-term. So maintaining a low level of taxation has to factor in this rising cost.
The Government intends to maintain revenue levels pretty much where they have always been. Factor in debt servicing and by 2014 taxation levels will be lower still.
Where does that leave the Government’s spending plans? Little short of slash and burn – despite the Finance Minister’s assertion that the budgetary worst is over. Excluding interest payments, the Government intends to cut public spending and investment in real terms by over €5 billion – or nearly 8 percent – between 2010 and 2014.
The Government’s emphasis on public spending cuts (and the general conflating of ‘fiscal consolidation’ with such cuts) can be seen in a new light – not so much to bring public finances under control, but to maintain a low-tax model whereby spending and investment cuts are inevitable.
Progressives in Ireland have generally argued for a higher tax take – to invest in public services, infrastructure, indigenous enterprise, etc. As the saying goes – you can’t have European-level of services or living standards without paying European levels of taxation. So, what is the optimal level of taxation? The ESRI’s John Fitzgerald has put forward a suggestion that deserves discussion:
‘It is essentially a political question as to what level of public services and investment is likely to be “desired” by the public in the next decade. . . .My own preference would be to target a level of expenditure and revenue in the medium term equivalent to 45 per cent of GDP. However, every government has to make its own mind up on this issue. Whatever that target is should inform the composition of the next budget.’
Fitzgerald’s preference is essentially for an EU norm. If this ‘political’ goal were achieved then it would radically transform the fiscal dynamic.
It would certainly mean higher tax levels – on profits, capital, property, wealth and income. It would also mean a profound debate about what kind of taxation system we want. For instance, as the TASC letter points out - in moving towards a European model, this may mean greater emphasis on social insurance to deliver services and social protection that is now delivered through central funds. It may also mean moving towards higher local taxation – where greater accountability and transparency will hopefully translate into greater efficiencies and higher output.
Nor is it a matter of taking a crude slide-rule approach (a 20 percent increase in tax levels translate into a 4 percent increase on the standard rate). Higher, sustainable growth itself creates higher tax revenues. Even Government acknowledges this when it shows, without raising taxes or introducing new ones, current tax revenue (excluding social insurance and local taxes) will increase by 27 percent – all because of growth.
Even slow progress towards EU norms will give us considerably more resources for investment; a 40 percent tax level would provide an additional €6 billion. To reach Fitzgerald’s preference/EU norms would provide an additional €16 billion. I suspect the higher level will not be possible within four years – after all, restructuring takes time. But anywhere on the way will allow a reversal of spending cuts and a platform for investment.
And this is key – for investment itself will invigorate the economy towards even higher levels of output, which in turn will increase tax revenue. This is the virtuous circle of investment, growth, revenue and lower unemployment costs. And this is before we sit down to the hard work of debating a new taxation architecture.
When the Government says TINA (‘there is no alternative’) they are right: there is no alternative if you want to degrade taxation levels and maintain, despite the economic costs, a low-tax model. But if we move towards European norms, breaking free from a failed model that contributed so significantly to our massive economic and social deficits as outlined in the TASC letter – then more alternatives open up.
The Government has indicated the level they want this re-balancing to occur by 2014 – at the lowest level possible. There is a problem, though. By 2014, we will be paying out a higher level of interest on the debt – nearly four times as much as a percentage of GDP over recent historical levels (by 2014, 3.9 percent of GDP will go on interest payments compared to 1 percent pre-recession). There’s not much that can be done about this in the medium-term. So maintaining a low level of taxation has to factor in this rising cost.
The Government intends to maintain revenue levels pretty much where they have always been. Factor in debt servicing and by 2014 taxation levels will be lower still.
Where does that leave the Government’s spending plans? Little short of slash and burn – despite the Finance Minister’s assertion that the budgetary worst is over. Excluding interest payments, the Government intends to cut public spending and investment in real terms by over €5 billion – or nearly 8 percent – between 2010 and 2014.
The Government’s emphasis on public spending cuts (and the general conflating of ‘fiscal consolidation’ with such cuts) can be seen in a new light – not so much to bring public finances under control, but to maintain a low-tax model whereby spending and investment cuts are inevitable.
Progressives in Ireland have generally argued for a higher tax take – to invest in public services, infrastructure, indigenous enterprise, etc. As the saying goes – you can’t have European-level of services or living standards without paying European levels of taxation. So, what is the optimal level of taxation? The ESRI’s John Fitzgerald has put forward a suggestion that deserves discussion:
‘It is essentially a political question as to what level of public services and investment is likely to be “desired” by the public in the next decade. . . .My own preference would be to target a level of expenditure and revenue in the medium term equivalent to 45 per cent of GDP. However, every government has to make its own mind up on this issue. Whatever that target is should inform the composition of the next budget.’
Fitzgerald’s preference is essentially for an EU norm. If this ‘political’ goal were achieved then it would radically transform the fiscal dynamic.
It would certainly mean higher tax levels – on profits, capital, property, wealth and income. It would also mean a profound debate about what kind of taxation system we want. For instance, as the TASC letter points out - in moving towards a European model, this may mean greater emphasis on social insurance to deliver services and social protection that is now delivered through central funds. It may also mean moving towards higher local taxation – where greater accountability and transparency will hopefully translate into greater efficiencies and higher output.
Nor is it a matter of taking a crude slide-rule approach (a 20 percent increase in tax levels translate into a 4 percent increase on the standard rate). Higher, sustainable growth itself creates higher tax revenues. Even Government acknowledges this when it shows, without raising taxes or introducing new ones, current tax revenue (excluding social insurance and local taxes) will increase by 27 percent – all because of growth.
Even slow progress towards EU norms will give us considerably more resources for investment; a 40 percent tax level would provide an additional €6 billion. To reach Fitzgerald’s preference/EU norms would provide an additional €16 billion. I suspect the higher level will not be possible within four years – after all, restructuring takes time. But anywhere on the way will allow a reversal of spending cuts and a platform for investment.
And this is key – for investment itself will invigorate the economy towards even higher levels of output, which in turn will increase tax revenue. This is the virtuous circle of investment, growth, revenue and lower unemployment costs. And this is before we sit down to the hard work of debating a new taxation architecture.
When the Government says TINA (‘there is no alternative’) they are right: there is no alternative if you want to degrade taxation levels and maintain, despite the economic costs, a low-tax model. But if we move towards European norms, breaking free from a failed model that contributed so significantly to our massive economic and social deficits as outlined in the TASC letter – then more alternatives open up.
Tuesday, 2 February 2010
McCarthy on fiscal correction - advice to Scotland
Slí Eile: Never shy to expound, economist Colm McCarthy, of Bord Snip fame imparted wit and neo-liberal orthodoxy last week in Edinburgh. See an account of his address here. (Does anyone have the full text somewhere?) He declared:
It’s getting public opinion and the opposition parties and the broadsheet media on board and getting them to accept and understand that we’re not doing this for fun, that we’re in a hole and that the quicker we start dealing with it the better and that there has to be a fiscal consolidation and all this kind of stuff.Looks as if this approach had a large measure of success in 2009 - except that the fiscal deficit is still hanging where it is and the prospect of more deflation, more unemployment and more spending cuts will see to a continuing debt trap.
Thursday, 5 November 2009
'There is a better way than cuts'
Slí Eile: In the interest of balance and with due regard for many economists, it is necessary to point out that not all economists believe that we must cut our way out of the Great Irish Recession. Dissent comes from Professor Ray Kinsella, reported from the annual Céifin conference in yesterday's Irish Times as follows:
Tomorrow, Friday 6th November, is an opportunity to begin a fight-back. But, we also need a solid intellectual counter-position backed by detailed analysis and facts and not just slogans. The ICTU Ten point plan is a good start.
"Ray Kinsella, professor of banking and financial services at UCD, said he rejected the idea that cuts were the way forward in healthcare. “It’s certainly leading to extraordinary incidents of psychosocial stress,” he said. Many people taking their own lives in recent times had no record of psychiatric illness but they were desperate and could find no way out.He said he wanted to challenge the orthodoxy that cuts were the only solution: “There is a better way than cuts.” Prof Kinsella said we were unable to get out of this crisis because our existing political framework was obsolete and incapable of reform; our banking system was “malign”; and we could not build a new economic order on a failed political paralysis."
While one may not concur with every pronouncement by the said Professor, the Award for Honest Straight Talking must be given. With the battle lines clearly drawn - OECD economists prescribe cuts in social welfare for the unemployed, old and sick in Ireland and reductions in the minimum wage - unions, community organisations and parties of the left must stand together to defend the poor, the low-paid and those excluded from decision-making.Tomorrow, Friday 6th November, is an opportunity to begin a fight-back. But, we also need a solid intellectual counter-position backed by detailed analysis and facts and not just slogans. The ICTU Ten point plan is a good start.
Thursday, 29 October 2009
Its OK to borrow off-sheet when it comes to NAMA
Slí eile: When it comes to sorting out banking and keeping risk to under 5% for bondholders, there is nothing to beat a bit of creative accounting and re-labelling. The creation of SPV - Special Purpose Vehicle involving a 51% private (big) investor holdings to get around the EU Stability and Growth Pact guidelines is intriguing. We are talking about big money here - over 30% of annual GDP in 2009. I am not complaining except to wonder if this latest wizardry will not give rise to more questions, delays and problems.
In a letter to Eurostat regarding September Maastricht Return, the Department of Finance projected a General Government Balance (GGB) for 2009 of -€19,982 million or -12.0% of GDP, 'which shows a worsening of €1,569 million on the April 2009 forecast deficit of -€18,413 million, or 10.7% of GDP'. In other words, as everyone knows and accepts by now the exchequer is miles off course and the wind of collapsing tax receipts continues to blow the ship north by north west where we are warned of some nasty IMF rocks (although Michael Casey doesn't regard this as the worse thing that could happen).
The Department of Finance acknowledge that the 'principal causes of the dis-improvement in this level of the GGB' includes a further collapse in tax revenue of €2.1 bn
Would anyone in Merrion Street, the ESRI or among academia care to estimate what proportion of this tax shortfall (and rising spending resulting from more unemployment) is a direct consequence of:
pay cuts
collapse in consumer confidence
businesses going to the wall because of lack of credit
How long will the GGB increase or remain at about 12% until the truth emerges? I suspect that some people are thinking to themselves that an international recovery allied to resumed emigration will relieve the pressure and pull us - eventually - out the present impossible bind.
Eventually things will come around - no matter how incompetent and self-defeating fiscal policy is. However, we have choices. If we cut too much and too quickly allied to measures which target low pay and welfare then the recovery will be slower, longer and more painful with pain multiplied for those at the bottom.
A national unemployment emergency should be declared and every initiative, cut or allocation job-proofed. The consequences of a lost generation to unemployment, despair and ill-health are incalculable.
In a letter to Eurostat regarding September Maastricht Return, the Department of Finance projected a General Government Balance (GGB) for 2009 of -€19,982 million or -12.0% of GDP, 'which shows a worsening of €1,569 million on the April 2009 forecast deficit of -€18,413 million, or 10.7% of GDP'. In other words, as everyone knows and accepts by now the exchequer is miles off course and the wind of collapsing tax receipts continues to blow the ship north by north west where we are warned of some nasty IMF rocks (although Michael Casey doesn't regard this as the worse thing that could happen).
The Department of Finance acknowledge that the 'principal causes of the dis-improvement in this level of the GGB' includes a further collapse in tax revenue of €2.1 bn
Would anyone in Merrion Street, the ESRI or among academia care to estimate what proportion of this tax shortfall (and rising spending resulting from more unemployment) is a direct consequence of:
pay cuts
collapse in consumer confidence
businesses going to the wall because of lack of credit
How long will the GGB increase or remain at about 12% until the truth emerges? I suspect that some people are thinking to themselves that an international recovery allied to resumed emigration will relieve the pressure and pull us - eventually - out the present impossible bind.
Eventually things will come around - no matter how incompetent and self-defeating fiscal policy is. However, we have choices. If we cut too much and too quickly allied to measures which target low pay and welfare then the recovery will be slower, longer and more painful with pain multiplied for those at the bottom.
A national unemployment emergency should be declared and every initiative, cut or allocation job-proofed. The consequences of a lost generation to unemployment, despair and ill-health are incalculable.
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