Ireland’s New Capital Investment Plan and its New Industrial Strategy

Paul Sweeney: A major speech made by the Taoiseach last Thursday 16^th February on proposed changes in Irish economic policy was lost in the chatter about his departure.  

The Taoiseach set out two major economic plans: a ten year capital investment programme and the development of a new industrial strategy. 

Taoiseach appears to seek Increased Public Investment, as does OECD.

Paul Sweeney: The leak in the Irish Times (13^th June 2016) that the Taoiseach has written to Mr Juncker, President of the EU Commisson, on the need for greater investment in Ireland is welcome, but appears somewhat disingenuous. 

His letter appears to quote the report published by TASC last December which pointed out that Ireland’s level of investment was at its lowest level ever and was the lowest in the Union. Mr Kenny said investment in infrastructure in Ireland was at its “lowest level for many years, and also represents the lowest level of any member state at present” – the two points emphasised by TASC.

National Income and Expenditure 2011

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

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

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

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

What Is Policy For?

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

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

Source: CSO

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

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

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

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

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

The effects of an investment stimulus

Rory O'Farrell: The idea of an investment stimulus got a boost this week. Though people may disagree over the extent to which this is 'new money', it shows that at the very least, the government want to be seen to be pro-investment stimulus.

Coincidentally, this week I presented a working paper which uses the HERMIN model (used by the EU to measure the effects of cohesion funding) to assess the effect of an investment stimulus.

Two interesting things stand out about the announced stimulus. First is the involvement of the European Investment Bank (EIB). Not only do they bring money to the table, but perhaps more importantly they bring their expertise in assessing projects and an independent pair of eyes. They won't be funding any vanity projects.

The second is the off-the books nature of the funding. With traditional financing, the net cost to Government of an investment is considerably less than the headline cost, about 57%. This is as multiplier effects lead to increased tax revenue. Then over the medium term, the supply side effects of higher GDP and tax revenue more than offset interest payments on a project. However, as the projects are 'off the books' and the tax revenue is 'on the books' there will be an immediate decrease in the reported Government deficit. Though this is playing with accounting rules, it means that the government will about €400 million more room to manoeuvre and staying within Troika limits.

Overall, we can expect 17,000 jobs to be created per €1bn invested in a year, and there is a multiplier of 1.6. When designing a stimulus, it is important to front load the investment, and then phase it out. This allows the export cavalry enough time to come over the hill and save us from long term unemployment and stagnation.

Is the Irish Economy At a Turning-Point?

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

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

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

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

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

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

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

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

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

Investment strategies and economic recovery

TASC hosted its third lunchtime seminar yesterday. Tom Healy, Director of the Nevin Economic Research Institute, gave an interesting presentation on 'Investment Strategies and Economic Recovery', which is available for download here. Comments?

Splashing the water

Michael Taft: First there was Claiming our Future with its bold but common-sensical proposals to promote growth and equity in the economy. Now we have the Nevin Economic Research Institute (NERI) laying down a new fiscal framework to pursue such an alternative economic strategy. And it poses a real challenge to all progressives.

Some of us have just been working at the edges of the pond. For instance, some of us have argued for a freezing of current public expenditure at current levels up to 2015, substituting tax increases in place of spending cuts, and relying on an investment programme (mostly paid out of own resources) to increase our productive capacity in the medium-term. Of course, this approach accepts real cuts in the overall spending package (after inflation) but the argument is that savings on unemployment costs can be redirected into other areas of current spending. It still represents an expansionary fiscal platform, but a tight one.

NERI, however, runs past us all, jumps into the pond with both feet and starts splashing the water all around – including all over us. They, too, propose an expansionary programme but instead of freezing public spending, they want to increase it – increasing it to EU averages in the long-term. This would be combined with increasing government revenue to similar EU levels.

Let’s look at the differences – comparing Government projections, a ‘freeze-spending’ scenario, and NERI’s proposals. The following looks at overall spending minus interest payments – that is, primary expenditure.

As seen, while freezing spending would provide an additional €4.3 billion for current and capital spending above the Government’s projections, NERI’s proposals would provide an additional €9.8 billion. That’s a mighty sum.

The objections will be loud and voluminous – you’re adding to debt, you’re avoiding tough decisions (no one ever mentions avoiding bad decisions), you’re padding an already wasteful and inefficient public sector, etc. etc. and more etc.

But let’s briefly looks at some of the issues NERI’s proposals raise.

The first is whether you use GDP or GNP (or more properly GNI – which is GNP plus net EU payments) to measure spending. This is one of those bottom-less pit debates where consensus is almost impossible. I don’t intend to re-run the arguments here. However, it is worth noting that while Irish GDP per capita exceeds the EU-15 average, owing to the froth of multi-national accounting, Irish GNI per capita is about average. Average income, average spend – that’s NERI’s approach.

This suggests another approach to looking at expenditure. The following looks at Government spending on public services per capita. This is useful category given that overall spending can be skewered by pension expenditure in EU countries with a much older demographic.

Ireland would have to increase its spending on public services by €7.5 billion just to reach the average EU-levels. There’s doing more with less as the mantra goes; then there’s doing less with a lot less.

Second, NERI’s proposes to increase Government revenue to EU-15 averages. This would be a substantial sum. By 2017 it would mean €13 billion extra. I can hear a big gulp. But the important point here is that this doesn’t mean that this amount must be met by increasing current tax levels. Increasing growth and employment will make up a large part of this gap.

For instance, the Government intends to increase tax by €3 billion over the next three years. However, they project government revenue will increase by €7.5 billion. Growth will increase government revenue by nearly two-thirds; the fiscal adjustments will only account for a third. And that’s in a scenario where the Government is cutting investment and domestic demand. Imagine the increase in government revenue in a scenario where investment and domestic demand is increasing.

Third, the idea that public spending is a drain on public finances has been firmly established in the public debate by the austerity orthodoxy. NERI’s programme challenges this view.

For instance, the ESRI shows that increasing spending on public services by €1 billion (a combination of increased employment and wages) would mean an increase in the borrowing requirement of €580 million in the first year. Increasing income tax by €1 billion would reduce the borrowing requirement by €744 million. In other words, a straight one-for-one increase in income tax and spending on public services would result in a net reduction in the borrowing requirement.

This is not an argument that we can spend our way out of a recession. We can’t, we must invest. But it is an argument for a more sophisticated fiscal approach which uses a number of instruments in a carefully calibrated way. Increasing taxation beyond the economy’s capacity to absorb it (such as happened in the last few years) while increasing public spending without regard to productivity (which happened under Fianna Fail’s failed programme in the late 1970s) is a recipe for a real mess.
However, increased spending combined with similar increases in taxation can be a net boost to the economy and public finances. Imagine if we introduce a wealth tax and took the proceeds to roll-out an early childhood education network – that would be a boost in the short and long-term.

None of the above constitutes a ‘model’. There is still considerable work to be carried out. But there is considerable evidence to show that NERI’s programme would work, that Claiming our Future’s vision is achievable.

NERI has jumped into the pond and is splashing the water all around. I suggest we all follow suit. I have dipped my toe in. And the waters of an expansionary economic strategy are just fine.

Invest and do no further harm

The Nevin Economic Research Institute will be publishing its second Quarterly Economic Observer later today. Click here to download the full document. Commenting on the report, NERI Director Tom Healy called for a more gradual approach to fiscal adjustment that allows space for domestic demand to recover as well for investment to have a positive impact on employment and output. He stated that a stimulus through investment and holding to the current level of public spending could help restore confidence and improve revenue buoyancy in the short term while taxes on high-income and high-wealth households would begin to move Ireland towards European norms of taxation.

Government spending policy is deepening the crisis

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The false economy of selling state assets to fund job creation

Sinéad Pentony: Today’s announcement provides us with some more details on the government’s thinking in relation to the role of state assets in our economy. The position has become more nuanced in some regards, as the sale of the ESB appears to the off the table (with the exception of some power generators) along with the sale of Bord Gais’s transmission and distribution systems. However, privatisation remains a clear policy focus for the government and a bitter pill is being sweetened with the promise of the proceeds of privatisation being used to fund job creation. But this is false economy.

We are hearing a lot about supporting job creation at the moment. Last week it was the Action Plan for Jobs, this week the sale of state assets will be used to support job creation and tomorrow the government will launch its Pathways to Work - the Government Policy Statement on Labour Market Activation.

Last week's TASC report on the Strategic Role of State Assets, along with today’s statement, clearly articulate the trade-off between short term and longer term investment priorities, with the latter increasing the capacity of the economy to grow and compete with other advanced knowledge-based economies. So the sale of strategic assets is a critical issue because it could actually cost us jobs in the medium-long term if we don’t have the infrastructure that facilitates and supports the functions of a dynamic advanced economy competing globally.

Last week the Action Plan for Jobs was announced. Any initiative aimed at promoting job creation is to be welcomed, and the focus of the Plan is on improving the conditions for doing business in Ireland. While ‘bold ambitions’ are to be admired, it’s difficult to see how the target of increasing the number of people in work by 100,000 – from 1.8 million to 1.9 million jobs by 2016 - can be realised, when the next three budgets are expected to take a further €9 billion out of the economy by 2016. One can only imagine the sorry state that the country will be in, in three years time - if we continue on the current path of austerity piled on top of more austerity.

On Monday night the Frontline programme was devoted to discussing the Action Plan. One of the panellists was businesswoman Glenna Lynch whose business has been struggling since the onset of the crisis and she has been forced to let people go. When asked what she thought about the Action Plan, she said that there was very little in it for her and that the problems she faces relate to the fact that successive austerity budgets are sucking money, demand and confidence out of the economy.

Pathways to Work is being launched tomorrow, the objective of which is to “drive the introduction of measures to improve the conditions for job creation across the economy and to ensure that the creation of these jobs feeds into a reduction in unemployment”. Our labour market activation policies have long been in need of reform, and they must reflect the complexities of the labour market in a modern economy.

In general the Action Plan for Jobs and Pathways to Work can be described as ‘supply-side’ measures, aimed at creating the conditions for businesses to create jobs and for people to be in a position to the take up jobs.

But how can businesses create jobs when the demand for their goods and services is static or shrinking because of budgetary measures?

What’s needed are a series of ‘demand-side’ measures aimed at creating demand for labour, and this requires investment. But this investment should not be financed from the sale of state assets, which should rather be used to support investment in the medium term. Instead, much needed short-term investment should be financed through the €4.7billion remaining in the NPRF, along with an initiative that allows part of the €5.3 billion held by Irish pension funds to be invested in infrastructural projects.

Time for Plan B

Nat O'Connor: Austerity policies are not working. I was one of 59 signatories of a letter in today's Irish Times calling for Plan B.

Plan B must include productive investment in infrastructure, education and labour skills. There is some money available to spearhead this, in the remainder of the National Pension Reserve Fund and in cash balances held by the Government. Rather than using this money to further capitalise the banks and/or pay off debt, it would be more effective and more socially just for the Government to boost productive investment. Ireland's economy is operating far below its productive capacity and capital spending as a proportion of GDP is now the lowest in Europe. Therefore there is ample absorptive capacity to increase investment in areas such as the provision of next generation broadband infrastructure, retraining etc., as well as other areas that will boost employment in the short term and increase productive and innovative capacity in the medium and long term.

The private sector is not currently investing, therefore the State needs to get the ball rolling. This can be funded from part of the €15 billion or more the Government currently holds in cash and assets, as well as from tax increases on wealth and higher incomes. The Government's announcement that it is looking at the Anglo promissory notes is very welcome, and could also release some money for investment that is currently earmarked as part of the €3.1 billion to be paid on promissory notes this year.

Stiglitz and Job Creation

Nat O'Connor: Joseph Stiglitz has an interesting three-page article in Vanity Fair where he reassesses the causes of, and therefore necessary solutions to, the current "Long Slump" in the USA, comparing it with the Great Depression.

In addition to the massive damage caused by the banking system and financial speculation, there were social and technological changes underpinning the Great Depression and (Stiglitz argues) similar changes in employment patterns underpin the current Long Slump.

Before the Great Depression, one in five Americans worked on a farm. Today, it is one in fifty. Before the Great Depression took hold, agriculture in the USA was already in difficulty. Technological improvements in machines, seeds, etc had lead to much higher production. While this might seem good for one farmer, when all farmers have higher production, prices fall due to the surplus supply. Part of the long-term solution, Stiglitz argues, was the painful move of many Americans away from farming to working in manufacturing. The main driver of this was World War 2, which led to massive Government spending on war industry, which laid the basis for a massive shift towards industrial production post-war. Combined with the GI Bill, which gave veterns access to university education, the nature of employment was transformed.

Obviously, Ireland had a quite different history of development. Movement away from the land was slower and we have maintained small farms, whereas the US has moved to large-scale industrial agriculture. Alhough Ireland had some earlier industrialisation (Lemass/Whitaker), only in the 1980s and 1990s did Ireland see employment rise in newer industries like IT, pharmaceuticals, etc. Nevertheless, Ireland experienced the same technological shifts in agriculture that have resulted in far less people working in farming now than was the case in the 1930s. Unlike the USA, mass emigration out of Ireland disguises the extent to which there was an exodus from the land to other areas of employment.

Stiglitz then goes on to argue that similar improvements in production (largely) combined with global competition from low wage countries (but perhaps to a lesser extent) mean that machinisation is now dominant in US manufacturing, rather than mass employment. Hence, there is a need to shift the expectations (and skills) of a great number of people from industry to services.

Sitlitz has two conclusions about how to bring about the transformation from manufacturing to service industries. His second conclusion is that banking reform is still necessary and that little has been done to date in the USA. We need to put much more regulation on the banking system to ensure that it serves society and lends money to the job creating small and medium enterprises in the real economy. (This point seems equally relevant to the Irish case.)

His first conclusion is more challenging. Stiglitz argues that the only way to resolve the crisis in jobs is for the State to engage in a massive programme of productive investment; preferably without another war. We know what the long-term drivers of economic development are: education, technological innovation and infrastructure. The State needs to borrow to invest heavily in these - reversing decades of declining investment - in order to do no less than transform employment patterns.

It's a big challenge to the failed strategy of austerity, which has seen cutbacks and job losses combined with an unreformed banking sector that continues to pay bonuses and engage in financial speculation, with public money.

It is obviously more difficult for the State to engage in major productive investment in Ireland because of the difficulty in borrowing money. Nevertheless, there needs to be much more discussion of the development path we are on. What is the future for jobs in Ireland? We know we can't go back to 12 per cent of the work force employed in construction. Half of that level would be a long-term norm. So just where are the jobs going to come from in 2016 and 2021? Even if resources for investment are limited, we still need to focus on education, technological development and the hundreds of different supports needed to retrain workers and build the capacity of Ireland's businesses to create jobs. And it seems likely that the State needs to lead the way towards increasing productive investment in every way it can.

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.

State Investment Bank

Sean O Riain: Michael O’Sullivan and I have an article in today’s Irish Times arguing for a state investment bank. Some links to supporting materials are below.

Allocation of bank lending by sector and poor investment record is discussed here

Role of the state and the weakness of private sector in providing ‘productive investment’ from 2000-8 is documented by Rossa White of Davys here

Patrick Honohan's QEC article on the limited role of finance in Ireland’s economic success of the 1990s is here

Research on the effectiveness of grant aid:
Manufacturing in the 1980s:
O’Malley, E., K.A. Kennedy, and R. O’Donnell. 1992. Report to the Industrial Policy Review Group on the Impact of the Industrial Development Agencies Dublin, Stationery Office (not available online)

Software in the 1990s:
Ó Riain, S. 2004. The Politics of High Tech Growth: Developmental Network States in the Global Economy (Structural Analysis in the Social Sciences 23) New York/ Cambridge: Cambridge University Press. (this link to the most relevant parts vis google books may work)

Manufacturing in the 1990s:
Girma, S., H. Gorg, E. Strobl, F. Walsh, 2008. “Creating jobs through public subsidies: An empirical analysis” Labour Economics 15, 6, 1179-1199

Already noted above, this piece provides data on how state funding stimulated private investment funding in the late 1990s and after the dot.com bubble.

Investment denial and the new road map

Michael Taft: Colm McCarthy’s post on Irish Economy takes a sceptical look at ‘productive investment’, or more precisely, the Government’s claim that the New ERA proposals – can create up to 100,000 jobs. This leads him to state that:

‘The spectre of politicians seeking to create 100,000 jobs through extra public spending is every economist’s nightmare.’

One could quip that not creating 100,000 jobs should be every economist’s nightmare. However, let’s examine what exactly a public investment-led recovery programme is intended to do. For the last thing we need in the debate is a series of assertions that sheds little light on means to kick-start recovery. You can read the rest of this post here.

Social Impact Bonds - Thinking Outside the Box

Sinéad Pentony: At a time when public and private investment is badly needed it’s important to think outside the box and look at different investment vehicles and the outcomes we want to achieve.

Investment tends to be equated with upgrading and improving our physical infrastructure - such as better roads, school buildings, health centres, and energy and communications infrastructure. Investment in human capital is also essential because economic growth in the 21st century is likely to be built on the exploitation of new knowledge and technology.

While investment in physical and human capital is essential for a sustainable and job-rich recovery, it’s important that investment which is ring-fenced for better social outcomes also forms part of the mix of investment. Social impact bonds (SIBs) have the potential to provide much needed investment in the areas of unemployment, health, housing, etc.

A SIB is a defined as “a contract with the public sector in which the public sector entity commits to pay when significant improvements in social outcomes for a defined population are achieved.” Private capital is raised to fund interventions that aim to deliver these improved social outcomes. Financial returns to investors are dependent on the degree to which these interventions improve the target social outcomes. If the interventions fail, the investors may lose their money. If the intervention succeeds, the public sector pays the investors a return financed from a share of the public sector benefit and/or exchequer savings made as a result of the improved social outcomes.

Further details on how the SIB works is provided by Clann Credo, which is a social investment fund and they have recently put out a call for ideas to identify social issues and interventions that may fit the criteria for SIBs in Ireland. The UK has taken the lead in this area and Social Finance, a non-profit organisation, launched the first SIB in 2010, to reduce re-offending among short-sentence offenders. Social Finance is developing SIBs across a number of other areas including children’s services, drug rehabilitation and health. SIBs are also being developed in the USA and Australia.

At a time when the community and voluntary sector has been decimated by cuts and our public services are being starved of investment, creative responses to financing initiatives that focus on social outcomes are more important than ever.

A long malaise

Michael Taft: With years of austerity ahead, resulting in weak growth and high unemployment, freezing interest rates and another round of quantitative easing in the US will do little to solve the crisis, writes Joseph Stiglitz.

We need more investment, more bank lending to SMEs and a determination to use all the fiscal tools at our disposal to create jobs. Without this, all we will have to look forward to is a long malaise.

Google and the case for broadband investment

Tom McDonnell: It is too easy in these days of high drama on the European stage to forget the fundamentals that will drive our eventual economic recovery. And we will recover provided we make the right strategic decisions.

It was welcome therefore to see this intervention by Google's executive chairman Eric Schmidt. He stated yesterday:
“The thing the Government can actually do that’s hard is [to] work with the telecommunications providers to get more broadband. It’s very difficult for small businesses to do,”

“There are very few things that are better use of your money than long-term infrastructure in information technology that serves the interests of the citizens of the country.”

My own doctoral research has focussed on the development of telecommunications infrastructure in Ireland and there is a wide body of theoretical literature and empirical evidence that backs up Schmidt's claim that 'broadband' matters for a country's growth prospects.

The rate of knowledge acquisition in an economy plays an important role in the long term growth rate of that economy. Broadband internet reduces the costs associated with learning and is a facilitator of knowledge acquisition and diffusion par excellence.

It is what is known as a General Purpose Technology. That is a transformative technology like the steam engine and electricity which affects the entire economy.

And Ireland is a broadband laggard.We are at the bottom of the class with Portugal and Greece.

Fixed (wired) broadband subscriptions per 100 inhabitants in the EU15 and Norway, Iceland and Switzerland (June 2010)
Rank Country Total
1 Netherlands 37.8
2 Denmark 37.3
3 Switzerland 37.1
4 Norway 34.2
5 Luxembourg 34.1
6 Iceland 33.3
7 Sweden 31.8
8 France 31.4
9 Germany 31.3
10 United Kingdom 30.5
11 Belgium 30.0
12 Finland 26.4
13 Austria 23.0
14 Spain 22.2
15 Italy 21.3
16 Ireland 20.3
17 Portugal 18.9
18 Greece 18.7
Source: OECD

A number of factors have hampered broadband development in Ireland, for example, low population density and a geographically dispersed population.

A lack of infrastructural investment by Eircom has also contributed negatively to broadband development in this country. One reason for the lack of investment is that the company was loaded with debt in the years after privatisation. Eircom now has debt levels approaching €4 billion. This was a legacy of Leveraged Buy Outs which the state had made itself powerless to stop.

Eircom's troubled finances will prevent it from investing sufficiently in the future. Although the Government's finances are perilous, the case for state investment in broadband is strong.

Headline growth

Michael Burke: Irish Economy Grows Fastest In Three Years, runs one headline on the Blooomberg news agency. It would be great to think that after all the sacrifices to date, their truly was a corner being turned at last.

But a closer inspection of the CSO report reveals a much less rosy picture. GDP rose by precisely €500mn in the Q1 (in real, seasonally-adjusted terms). Bu this was more than accounted by the rise in exports of €1,471mn. In addition, imports fell, as households are too impoverished and business too unwilling to invest. They fell by €106mn so that net exports rose by €1,577mn, or more than three times the recorded rise in GDP.

As we know, the export sector is an ‘enclave’ in this economy, employing relatively few workers and requiring even fewer inputs from the domestic sector of the economy. Indeed, some of the activity recorded as exports is not real economic activity undertaken here at all but simply foreign (usually US) Multi-National Corporations booking activity in Ireland t avail of the ultra-low taxes.
The domestic economy remains deeply in the mire. This is the sector that both employs the vast majority of workers and is responsible for nearly all the taxation revenues. GNP contracted by 4.3% in Q1 and is now 15.4% below its peak level.

Nearly all categories of the economy continue to contract. Household consumption and government expenditure both fell by 1.9% in Q1 and now stand 12% and 11.2% below their respective cyclical peaks. Inventories continued their decline.
The sole recorded rise was in investment (gross fixed capital formation), up €46mn in the quarter. That this now amounts to a 1.1% rise shows just how far investment has fallen. Even so the decline in investment still accounts for a total annualised loss of over €22.3bn in the course of the recession and is 59.2% below its peak. This is more than the entire recorded fall in GDP (because exports have risen) and 95% of the entire fall in GNP.

There can be no idea of a sustained recovery without a rise in investment. The latest tiny pick-up in investment makes barely a dent in that huge shortfall. If investment were to return to its pre-recession peak (which was a full one year before the recession began) then at this pace it would take 34 years to achieve it.
As this economy is gripped ever tighter in the ‘austerity’ vice it is perhaps worth recalling that the core countries of the Euro Area did not respond to their own economic and fiscal crises with the same medicine. Their strong growth at the beginning of this year is not the accounting tricks of US MNCs but real activity by their own producers, with the result that recorded growth has been accompanied by job-creation and a lower deficit.

Perhaps the Bloomberg headline should have read: US Accountants Create First Appearance of Irish Growth For Three Years.