Economic Shunning: July 6th The Recession Diaries

During the Great Depression, the British King announced he was cancelling the purchase of a royal yacht as a gesture of sympathy towards his beleaguered subjects. John Maynard Keynes claimed this was misguided. Instead of cancelling the order for his yacht, Keynes said the King should have purchased two yachts. His line of reasoning was that these orders would increase employment in the shipbuilding yards, would generate employment in the businesses that serviced the yards and, with the extra wages, would increase demand which would save jobs in local shops and businesses.

In other words, those individuals and businesses that can afford to do so, should circulate money into the economy to generate jobs and enhance incomes which, in turn, ‘enhances’ the initial injection; hence, the multiplier effect.

This is important to remember as the construction industry ends its first day of industrial action. I’m not going to comment on the particulars of the dispute. Those of us not involved hope that a resolution that can be found, that agreements are honoured and that economic justice is done.

However, I am struck by a particular line that is emerging from this dispute which, if universally acted upon, will do considerable harm to the prospects of economic recovery. On Morning Ireland this line emerged three times. First, in an interview with Jack O’Connor, SIPTU President:

Interviewer: ‘Do you anticipate any problems in explaining to your own members why they should support action for more money for one group of workers when so many workers are not getting more money they’re actually getting less if they’re not unemployed?’

And again, with O’Connor.

Interviewer:  ‘There’s no question of more money for these people (i.e. other workers). They’re either getting the same if they’re lucky or their pay is being cut and yet you’re advocating more support for a group of workers who are looking for more pay.’

And once more, this time with a striking worker:

Interviewer: Do you think you have the general public’s support? It’s a tough time to be going on a strike and a lot of people losing their jobs and take pay cuts.'

This ‘line’ – striking for increased pay while others are losing pay and even their jobs – could be applied to any dispute anywhere, from electricians to retail and hotel workers, to factory and office workers, anywhere in the economy. It could be applied to any request for higher income – whether it be pay, social transfer or in-kind increases through the reduced costs of public services. The effect is to ‘guilt-trip’ anyone making such requests/demands, never mind anyone acting on this – either industrially or politically. Such people looking for higher pay are selfish, having no sympathy with those who don’t have jobs. They should be shunned:

'You want more pay?! You should be grateful to have a job. Now get back to work.’

This ‘line’ is exactly what the economy doesn’t need. Higher wages and disposable incomes are a necessary element for economic recovery and, therefore, should be supported; it should be supported by those who want to see us get control of the fiscal deficit and the unemployment crisis; most of all, it should be supported by other businesses who are reliant upon increased domestic demand. Let’s go through the arguments.

On the fiscal level, a pay increase is of more value to the Exchequer than that same money retained by an enterprise. For each extra €100 in pay results in an increase in Exchequer / Social Insurance Fund revenue €40.75 at the standard rate and €61.75 at the top rate (this combines income and PRSI from employees and employers). That’s quite a kick. You would think, therefore, that the Government would be quite anxious to see pay increases in the private sector where affordable. Multiply that €100 and extend it to a few hundred thousand workers, and the money will be flowing in – and all that without unpopular tax increases.

Just as importantly, though, increases in disposable incomes can be translated into higher demand. Quite simply, people with more money in their pockets (either because they got a job, got a pay increase or got a tax cut) are more likely to spend it on goods and services produced by domestic enterprises than people with less money. This is, of course, not a straight equation. People may well take the increased income and save it; or start paying off debts; personally rational, economically inefficient. That is why tax cuts can be hit and miss – with potentially debilitating consequences for the Exchequer.

However, this is not the case with a pay rise. Even without the extra consumer spending, the Exchequer gains. In turn, the Government could use that extra revenue to increase demand (e.g. engage in job-creating investment). Further, there is little doubt that generalised wage increases for average income earners will ‘leak’ into the domestic economy, to a greater or lesser extent depending on circumstances. To the extent that it does, the economy has the potential to get a double benefit.

Where does that leave ‘inability to pay’? It can become a pivotal point in increasing Exchequer revenue and domestic demand. This clause has been used in the past as a defensive weapon for companies to postpone/suspend pay increases agreed at national level. Now it can be turned into a positive weapon for economic recovery.

There is no doubt there are companies that cannot afford to pay wage increases – and therefore, cannot contribute to increased demand. This, in turn, harms other companies – those that sell goods and services into the domestic economy. They receive less sales revenue and experience a decline in turnover, resulting in payroll cuts in wages and/or employment.

Therefore, it is all the more imperative that those companies that can afford to pay, do so. In effect, these companies subsidise those enterprises that cannot afford to pay. This subsidisation increases demand and tax revenue which helps weaker companies in two ways – it increases the prospect of higher sales revenue and increases tax revenue with which the state can promote increased demand.

Of course, this is not how IBEC sees it. They tore up the current wage agreement earlier this year. The only beneficiaries of this act were companies that could afford to pay. It amounted to nothing less than fiscal and economic sabotage. The losers were not just the employees affected; the Exchequer loses out on the extra revenue and businesses reliant on domestic demand lose out – since workers have less money in their pockets. To the extent that this feeds into lower consumer confidence, domestic businesses take a double hit.

When workers engage in industrial action in pursuit of higher pay, there may be many points of legitimate debate. However, the generic allegation that higher wages – and taking either political or industrial action in pursuit of that – is somehow damaging to the economy, and that anyone who engages in it should feel ashamed, only serves to justify deflation.

Hopefully, one day we’ll hear a question on a current affairs programme being put to a company owner:

Interviewer: 'You have a profitable company. Yet you’re refusing to pay your employees a wage increase. How can you justify such an action that depresses demand, short-changes the Exchequer, and contributes to reduced economic activity?'

I’d sure like to hear the answer to that one.

[And, yes, by the way – I support the electricians.]

Comments

[Fergal]

Great post.I can't wait for the day when a union rep comes on the radio and tells Pat Kenny or Jos Duffy that their equivalents in Portugal or Lithuania earn only a fracrion of their pay!

[Barry]

You may have dealt with this before Michael, but I was wondering where you stand on the assertion that fiscal stimulus in Ireland would leak.

In the example you gave above regarding the King's yaucht, the would be beneficiaries of the King's decision to buy two yauchts were British based workers and companies.

The leakage argument states that in Ireland's case, most of the stimulus money would be spent on imported goods which would be of little benefit to the domestic economy.

[t g macamhloaibh]

Great article. You've put the arguments together logically and in a simple to understand manner. [I like simple :-)]

No doubt a pursuit of positive economic policies, as outlined in the article, would reap some cummulative benefits in the years ahead; though I really doubt that employers in Ireland will readily give an inch when it comes to wages. The current system is geared to short term gain at the expense of long term stability.

When a worker is made to feel ashamed to ask for a wage increase while bankers are bailed out, the wealthy pursue legal tax havens, and wealth becomes ever more concentrated, the prognostication for the economy isn't too good. The MSM and most opposition parties heartily agree with this position.

[Note that 'savings' should theoretically be used as an investment expense and thereby generate more capital structural formation. This is the rub; especially in light of increased competition for scarce resources. We have loads of money but very few areas in which to invest in creative capital asset formation (machinery, factories, etc.) This is the real dilemna for left-of-centre economic strategists. It's less of a dilemna for the right wing. Trickle down economics works a treat for this cohort.]

[CMK]

Barry, this has occured to me as well. One possible answer would be to focus on the numbers of Irish companies who are distributors and agents for non-Irish companies. So that, for instance, if X piece of capital equipment has to be purchased it may well be manufactured by a German firm, but the ordering etc would be done through an Irish agent and/or distributor. Therefore, spending that money would shore up Irish jobs in the latter companies, even if the ultimate benefit went to a German company. Conversely, if the German government decided as part of a stimulus package to upgrade security on their software - this may leak to the many Irish companies who can provide expertise in this area. Just my five cents....

[dealga]

I like the piece, but the first thing that strikes me about it is what would the king do with two yachts if he only *needs* one? And what happens after the second yacht is built, haven't you just postponed the inevitable? Does the king go back and buy a third yacht?

There might be a multiplier effect but, on that basis, it's a pyramid scheme. Eventually either the king will run out of money or he will realise he just doesn't need another yacht.

Furthermore, if he has no obligation to the shipbuilders (be it moral or legal), but a duty to his subjects, he might decide to keep buying yachts, but buy them elsewhere if he thinks he can get them built cheaper.

It's rarely mentioned and maybe doesn't stand up to rigorous analysis but a lot of what's happening in Ireland makes me think of how the Fascists bankrupted Italy in the '20s and '30s:

http://www.mises.org/story/1935

obviously without the invading Ethiopia part.

[Michael Taft]

Barry, it's a difficult issue - ensuring that public investment remains in the economy as much as possible. It's important to remember that the vast proportion of our imports are for use in production - 70%. Even for private consumption - over 30% of the recent increase in non-housing consumption went on personal services: a high-job content category. There's no doubt that as the business sector revives, we will see an increase in imports. There are three things to focus on. First, the indigenous sector which sources over 65% of their materials domestically (only about 30% of multinational sourcing is domestic). Second, those sectors with low import-density. For instance, an invstment strategy would target early eduation. Education has a low import-content (8%) while it can create thousands of jobs. Third, to focus on low-average income groups. Not only do these groups have a high propensity to spend, their expenditure has less import content (they buy fewer jacuzzis and foreigh properties than the wealthy). CMK's point is well taken. Even in the retail sector importing goods for sale - those goods have to be landed on shore, transported, stocked and sold - all by domestic workers and enterprises. This is not to say that keeping leakage low will be easy - it won't. That's why an investment stimulus programme must be forensic and prioritise those sectors with higher domestic multiplier outputs. I will do some more work on this issue of imports and leakage as you have raised an important point.

dealga, I wouldn't push the yacht example too far - I just mentioned it as an example of the necessity for those who can do so (like the state) to spend. Personally, I wouldn't know why anyone would want two yachts. Maybe one for each side of the island. Ultimately, Keynes was concerned with demand management in order to even out the business cycles - spend in down periods but retrench in up periods. From that we can see why it was such a disaster for the Government to promote pro-cyclical policies at the turn of the century - pump-priming an already over-heated property sector for instance. Of course, there are considerable limitations with demand management in a small open economy. That's why I've concentrated on spending on our productive capacity - those areas which will need to invest into anyway (telecommunications, energy, insulation, education and health, etc.). We will need a much stronger physical and social infrastructure on the other side of the recession if we are to hope to take advantage of the global upturn. This investment will produce returns for decades - and create jobs in the short-term. Win-win.