Stabilising on the Ocean Floor. The Recession Diaries - September 23rd

Today on News at One the Minister for Finance mentioned ‘stabilisation’ and ‘stabilise’ a number of times to explain away the 2nd quarter National Accounts report which showed the GDP returning to dive mode. It’s like the captain of sa ubmarine that has just sunk to the ocean floor trying to put a brave face on it by announcing to his crew ‘we’ve stabilised our descent’.

Let’s cut to the real nonsense in the interview, though – dangerous nonsense.

RTE: ‘But do you accept the if you go as far some analysts are advising you . . .in regard to cutting public spending, you may actually make a bad situation worse.’

Minister: ;Well, that is always the danger. But it has to be said that last year after a decline of 10 percent in GNP, a very rigorous budget which removed €4 billion of public expenditure still left the economy stabilised.

If the Minister said this because he had to say something in a tight spot, you’d just regard it as another bit of spin. But if he (and this goes for anyone else) actually believes this, we are in deeper trouble than we can imagine. For it is simply not true.

Don’t take my word for it. Here’s what the ESRI said before the last budget:

'There is now much discussion of the nature of these measures (i.e. the proposed budgetary measures for 2010) which are equivalent to almost 3 per cent of GDP on a full year basis. The consequences of such a further sharp correction are, by our estimation, significantly deflationary. Were there to be a neutral budget in 2010, then our estimates would suggest that the recovery in GDP would occur much earlier in the year leading to positive growth in GDP for the year as a whole.'

In discussing the upcoming 2011 budget, the ESRI had this to say:

'We estimate that such a budget package would reduce the General Government Deficit by between 1½ and 2 percentage points of GDP. The impact on the wider economy is to reduce the growth rate by approximately one percentage point. In addition, the level of employment is lower and emigration flows higher than in the absence of such a package. These are real costs attached to the programme of fiscal consolidation being pursued by the government.'

In short, the economy would have grown this year by a higher amount if the anchor of these deflationary cuts had not been tied around legs. How much? Using the ESRI multipliers, the Government’s budget last year depressed economic growth by about 1.7 to 1.9 percent. Were it not for the spending cuts, we’d be well back into growth or at least a lot better off than we are now.

This is basic economics – spending cuts (and tax increases, especially on low and average income earners) cut growth. That’s its function. At certain points in the economic cycle it is a valid instrument. If the Government had cut tax expenditures to the property market a few years it would have taken some heat out of the asset bubble – in other words, it would have cut the growth in an over-heated property market.

I’ll repeat it again: cutting public spending cuts growth.

Had the captain not aimed the submarine full speed towards the bottom of the ocean, the crew might not be back at the surface; but they wouldn’t be on the ocean floor, listening to the sound of the hull crushing.

Comments

[Chris]

If 3 Billion in cuts will undermine growth then why is Gilmore ignoring even the ESRI and rolling in behind Cowens Strategy

[Michael Taft]

Chris - we have to clarify some of the terms. Terms like 'fiscal adjustment' and 'fiscal consolidation' are neutral in terms of spending cuts or tax increases. The can also refer to any process that 'adjusts' or 'consolidates' the fiscal balance. For instance, an expansionary budget which might imply a higher expenditure on the ‘sheet’ may end up with a positive adjustment in terms of revenue increase and lower unemployment costs arising from investment. In the real world, however, these terms are taken to mean 'spending cuts'.

Labour has argued in the past for a strong mix of tax increases and spending cuts. In the last budget, they proposed that 40 percent of the adjustment come via taxation though that still left €3.5 billion in spending cuts with €1.4 billion reinvested via a Jobs Fund and Christmas Bonus.

Adjustments through taxation are better than spending cuts. But it should be remembered that any such adjustment is deflationary, though tax being less (depending on where it impacts – water charges would be particularly deflationary because it is so regressive). That is why the overwhelming need to promote growth and, in particular, job creation. This is now starting to come into the debate.

It would be helpful if Labour (a) dropped its commitment to reducing the deficit to -3% of GDP by 2014 (Maastricht guidelines). Nobody believes it will happen, it won’t happen and any attempts to do so will be unsustainable and only end up driving long-term debt; and (b) outlined an expansionary programme of investment; this would still retain a strong ‘consolidation’ element – but in the first instance it should impact on high-income earners as this is less deflationary. To date, Labour’s programme has addressed some elements of this – but not a full programme, yet.