May 28th Lunchtime: The Recession Diaries

Over at Cedar Lounge Revolution, WBS is doing a good job tracking the ongoing campaign against Ireland’s borrowing capacity and, in particular, the performance of the National Treasury Management Agency. On a recent post, I agreed but received this challenge from barratree

Michael, - I’ve yet to see you addressing the point that most people are concerned about. Its the medium to long run ability to finance the country not right now in the present. If we undertook a massive stimulus plan in would completely undermine any trend towards a sustainable budget. After 2 years we would be looking at laying off all those people taken on by the state to build railway lines etc and there still being no jobs for them. And the deficit would be sky high. B

I accept that, in arguing for an expansionary investment approach, I might not have comprehensively addressed the issue of fiscal sustainability. However, I question whether ‘most people’are concerned about long-term budgetary issues. People I come across are more worried about losing their jobs, or getting a job, or losing their business or their pension, etc. Nonetheless, barratree has asked legitimate questions. So here goes.

We first have to acknowledge that currently there is no strategy – being pursued or articulated – capable of leading us towards a sustainable budget. The Government’s April budget was introduced for one reason and one reason only – to bring a 12 ¾ percent fiscal deficit (which they claimed was unsustainable) down to 10 ¾ percent. This was intended as one more step in bringing the deficit below – 3 percent by 2013. They had, broadly speaking, two options:

• Attack the deficit by raising taxes and cutting government consumption and investment  
• Attack the deficit by increasing economic activity through investment and job creation

They chose the former; a disastrous choice. To pursue deflationary strategies in a rapidly deflating economy is to pour fuel on the flames. With consumer spending falling, with jobs being lost, with investment collapsing – the Government has done all the wrong things.

This is not some mere deduction (though history tells us that the last time Governments pursued these kind of strategies, the Great Depression resulted; which is why no other government is doing what Fianna Fail is doing, regardless of their ideological hue). In their respective projections, the ESRI and the EU Commission have given current policy a thumbs down. Remember that Government’s goal in raising taxes and cutting spending was to reduce this year’s deficit to 10 ¾ percent. What’s the verdict?

• The ESRI projects the deficit to run to 12 percent  
• The EU Commission projects the deficit to go out of control: 15.5 percent

To make matters worse, the NTMA’s Michael Somers suggests that our overall debt could exceed 100 percent of GDP shortly.

So the question is not whether we should borrow more – we will, under any scenario. The key question is what do we borrow for? If we continue down the Government’s road, we will be borrowing to sustain ever higher levels of unemployment benefit, ever lower levels of tax revenue.

There is another option – to borrow for investment. I have made a number of suggestions in this regard. But what is needed is a new budgetary arithmetic based on investment. We know that the current arithmetic based on deflation will fail. Can an investment one succeed?

Let’s say a progressive government was determined to invest up to 3 percent of GDP annually into an economic investment programme over the next four years, or between €5 billion and €6 billion each year. If we use an extremely conservative multiplier effect – given Ireland’s open economy – we could expect the GDP to be approximately €16 billion higher than under the Government’s projections. I’ve used a 0.75 multiplier effect – the US Government uses much higher estimates, up to 1.65, but then they have a large, less open economy than we have (Fine Gael uses higher multipliers, which I am somewhat sceptical).

GDP growth is higher but it will come at a cost – an extra €21.5 billion borrowing for an investment programme over the next four years. However, the net extra borrowing will be much less because the investment programme is designed to put people back to work (that’s why President Obama, Prime Ministers Rudd and Brown, Chancellor Merkel describe their stimulus programmes in terms of jobs created/saved – not in terms of expenditure or debt). In effect, a stimulus programme widens the tax base by creating new taxpayers. Compare this to the Government’s deflationary strategy, which narrows the tax base, by letting people fall into unemployment.

Again, let’s use the Government’s tax projections (they project tax revenue will be 21.2 percent of GDP next year, rising to 22.3 percent by 2013 – yes, they are intent on maintaining a low-tax economy). By applying these minimal percentages, we find that tax revenue under a new investment strategy increases by €8.7 billion over the four-year period. That would reduce the fiscal deficit in each year, leading to an overall net debt increase of €12.8 billion. Where would this leave us by 2013?

Pretty much in the same place as where we might be under the Government’s strategy. That’s because while the debt will rise, so will the GDP – so the proportion remains the same. Moreover, this doesn’t count the savings on social welfare expenditure – so we might expect the annual fiscal deficits and, so, the overall debt burden to be lower still.

But there is one big, significant, enormous difference – under a new investment strategy, the economy will be in a stronger position to pay off its debt.

To take one example of this: employment. How many more people can we expect to be employed as a result of an investment strategy? This, of course, depends on the type of programmes pursued. For instance, there is a strong argument to postpone the North Metro; it is more capital and import intensive and less labour intensive. Instead, for the next couple of years we could expand the Government’s insulation programme; this is more labour intensive and more of the materials would be supplied by domestic enterprises. Both are necessary, but it’s about prioritising necessary investment in a more strategic way (in any event, the North Metro still has a lot of preparatory work to do before the ground is broken).

At a conservative estimate, we could expect between 15 and 25 percent of the extra stimulus to find itself into wages, depending on the labour intensity of the programmes. This would translate into between 81,000 and 134,000 average industrial wage equivalents. This corresponds to Fine Gael’s own job creation estimation (100,000 jobs arising from a €18 billion investment over four years). An economy with that many more people at work is in a much, much stronger position to absorb the debt burden than one with all those people unemployed and on the dole (less tax, more government expenditure).

In addition – and, again, this depends on focused and strategic government policy – if the investment is primarily invested into our infrastructural base, the economy will perform stronger. One example of this is a programme to roll out Next Generation Broadband. This is a necessary component of the new economy. If we have it on the other side of the recession, we will be more competitive. Seaport infrastructure, green energy, early childhood education, primary health care-team network, a proper spatial/regional strategy – if these are not in place, we will fall further behind our trading partners.

Barratree raises the issue of what happens to all those people employed as a result of the stimulus investment – will they be made redundant once the stimulus is ended? This poses a down-the-line challenge to government policy. Let’s remember – a stimulus is intended to raise the productive base to a level that it could be achieving were it not for the downturn.

For instance, the ESRI assumes higher growth rates by mid-next decade. If this is the case – because of the eventual recovery in global demand – then the trick will be to ease an economy out of stimulus and into this increased growth. Particular jobs may be lost, but the supply of jobs – as current and new enterprises increase output – will grow. Managing this rise in supply will be no easy task.

For instance, a greatly expanded insulation programme – targeting construction workers with few skills (SIPTU estimates that nearly 40 percent of such workers only have a junior certificate level of education) – would combine work with training/education opportunities for employees on the job. Hopefully, this would mean that as the insulation programme is reduced, many of the construction workers would now have marketable skills for the new jobs coming on stream.

Of course, many of the new enterprises established as part of the stimulus programme would remain in place – for the simple reason they are profitable and reduce economic and social costs. Green initiatives are one example. Establishing an early childhood education system and primary healthcare teams are others.

I won’t attempt to graph or chart this phenomenon – it is too speculative; it is hard to project to next year, never mind 2015. The ESRI makes an attempt – over-optimistic in my view. They assume an unemployment rate of 6.4 percent by mid next decade. Therefore, we have two choices:

Wait (hope) for this to come true, leaving people on the dole in the meantime (with all the social dangers that entails).

Or, put the unemployed into work now and ease them out of any artificially stimulated employment into the new jobs the ESRI comes on stream. The former course, means amassing incredible debt levels as we borrow to pay for people on the dole; the latter, reduces this debt by creating ‘new taxpayers’ while at the same time investing into our productive base so that the ESRI’s projections have a better chance of coming true.

There is nothing given about any of this. There are no certainties. We may be facing into an extended period of low-intensity growth (as the World Bank has warned) once we come out of technical recession. An L shaped recession but may be long on both ends. There will be difficult, painful decisions to make – considerable economic and social demands with scarce resources, no matter how much is borrowed.

But we start from a more certain premise. On every measurement, with every new projection coming out – the Government’s strategy will not work. It was never going to work.

What is needed is a new government that understands that the economy is not ledger but a dynamic process, that employment and investment is the key, that a recession can only be overcome by growth strategies; a government courageous enough to defy the orthodoxy that is starving the current debate and offering us little else but more unemployment, more poverty, more debt – more of the same.

A politically brave government with considerable management skills.

The only question is: does such a government exist within the current set of political parties?

Comments

[Dr. X]

>>>does such a government exist within the current set of political parties?

My sources say no. Thanks for the above post btw.

[t g macamhloaibh]

I tend to agree with barratree. Given the prevailing notion of both FG and FF that labour is almost an evil cost to business, can we really expect the labour expended on any public project to be more than temporary and disposable?

[t g macamhloaibh]

I should also add that your insights ring true and seem constructive.

However, a Keynesian solution requires a commitment by the govt instituting the program to have the lont-term concerns of the entire population as the ultimate focus. Our present and future govts do not. Not because they are stupid or evil. They know we will not be generating national supluses of wealth. They know we operate in a very mature Western economy where no new block-buster industry has emerged in over 3 decades. They know it is easy to buy from the East but very hard to sell to the East. They know that technological advances are reducing the amount of jobs available. They know multinational can game national tax regimes (we depend upon this ourselves) and fully utilize vertical integration to disburse knowledge and constrain wages.

Therefore, as politicians who cannot offer all wage earners a decent income nor future prospects for growth, they plan to cater for those who can operate in the new knowledge economy. These jobs tend to be sparse but well paid. The can build a sub-structure around these jobs and opportunties. Hopefully enough to win the majority of seats in any future Dáil.

And they will probably succeed. The only alternative in town, Socialism, continues to pursue unpopular natioanlisation schemes and doesn't offer an alternative and viable economic structure or policy.

The sad part is that there are plenty of talented socialists in Ireland with the economic acumen to create the altenative, popularly supported and viable economic policies.

They seem to be looking for a political party. Instead why don't they gather their thoughts and energies into a central location and provide the leadership our politicians lack. Socialist politicans certainly have the passion. Isn't it time to provide them with the policies to go along with the passion?

[Mack]

t g macamhloaibh -

They know we operate in a very mature Western economy where no new block-buster industry has emerged in over 3 decades.

Personal computers (hardware, software, gaming), mobile phones, the internet (advertising, e-commerce, VoIP etc), advanced biotechnology, advanced finance (e.g. derivatives), advanced electronics (digital cameras / videocameras) - all absolutely huge industries and much more too..

[t g macamhloaibh]

mack -

many of which are all relatively mature technologies with well established companies whose economies of scale do not present surplus wealth creation on a broad economic scale. As I already stated, many other cited techs are not scalable but are niche opporunities and will be exploited by knowledge leaders and often not generate broad labour returns.

You might want to do a quick cost benefit analysis of advanced finanical products. These products create huge returns for a small percentage of players and have added systemic economic risk (the results which we are currently living with)which call into question their utility to society at large.

[Mack]

t g macamhloaibh

Fair point re derivatives.

They're all new technologies from the past 30 years though. There's been no shortage of innovation in that period, Western economies have grown by large amounts throughout the period. Certainly Ireland has changed enormously. My guess is we'll see continued innovation over the next 30 years, who knows in what? I bought a robot that vacuums our house for us last week (works pretty well too).

[t g macamhloaibh]

Well mack, I don't disagree with your points per say. I hope that Ireland does develop some of these technologies (the talent is there) and that the economy prospers; although I'd argue that much of the polity and civility of Ireland was lost during the economic transformation.

Maybe it's the degree to which technological changes, and the industries or businesses created, and will impact on everyone that really matters. If the majority of the wealth created goes into very few pockets, while the masses enjoy the often questionable utility value of the production (often alot of gadgets), to what end is society served or advanced?

[Mack]

t g macamhloaibh -

If that's what happened, then I think we'd need a rethink. I'm not convinced that is what happened though. Go back slightly further, say 40 years, and most houses didn't central heating. Go back only 20 years and holidays outside of Ireland were rare. Go back 50 or 60 years and most toilets were outside, a little further and a lot of households didn't have electricity. Today most households have a car, a television (often big and with huge numbers of cable or satellite channels), mobile phones, computers, a holiday once a year (more in many cases) and even the most basic (undilabated) housing in Ireland today would seem luxurious to the aristocracy of centuries past, on the basis of improvements previously listed. Average life expectancy has increased massively, while infant mortality has collapsed.

I take your point about some of the polity and civility being lost in the south - I don't know as I didn't grow up here, and for me the changes in the north have been massively and overwhelmingly positive. At least one positive from the recession is the frenetic pace has slowed and it might open opportunities to save some of what has been lost, before it goes forever. And once we reach a decent standard of living for all, maybe we should look at accumulating time rather than money...

[t g macamhloaibh]

mack

Interesting point about the relationships between time and money. Society may be better served by using some leisure time in the raring of children etc. rather than chasing every consumer good or appearance of affluence.

I too hail from the North but have lived in the South for some time. I also agree that the changes in the six have been for the better and hope that the old sectarian divide eventually meets a bitter end. However, it's time to build a better society - not just a society based solely on material accomplishments alone.

I'd say by our posts that we'd eventually agree on too many points! No fun! :-(
good luck