Monday, 20 July 2009

Here's to economic recovery

Michael Taft: Maybe Colm McCarthy doesn’t drink Carlsberg. He certainly has not taken on board their recent ad campaign which suggests:

‘It’s not just A or B. There’s probably always a C.’

On News at One, McCarthy gave us the A and the B:

‘We have to get the borrowing down. There’s only two ways of doing it. One is by increasing taxes . . and the other is by controlling expenditure far better that we have been doing in recent years.’

Of course, there are problems with A and B. Increasing general taxation on low and average income earners and cutting public expenditure, especially social transfers, are deflationary and potentially self-defeating. What’s more, seemingly substantial tax increases and cuts may have little impact on the fiscal deficit – the very reason for income levies and An Bord Snips. Indeed, the piece de resistance of the McCarthy Committee – reducing public sector employment by 17,000 – will deepen the recession, cut consumption and increase unemployment; but it will only reduce the fiscal deficit by 0.2 percent.

So is there a C? Yes – and here it is in shorthand. According to the ESRI’s latest quarterly report, Ireland will have a gross/debt ratio of 74 percent in 2010 (this doesn’t include provisions for NAMA) while the net/debt ratio will be a mere 58 percent after Pension Fund assets and the NTMA’s free cash balances are included. Compare this ratio to the Eurozone’s which is expected to average 84 percent according to the EU Commission’s Spring Forecast.

So just at the gross level – Ireland could borrow €16 billion over the two years and still be ‘average’ in terms of debt. With this sum, Ireland could invest it into physical and social infrastructural modernisation and enterprise development measures. This would not only stimulate growth and improve our productivity – it would create thousands of jobs in the process. This would increase tax revenue, lower social welfare costs and stimulate consumption – assisting enterprises reliant upon domestic demand. We could turn a vicious cycle into a virtuous one.

This is admittedly a simplified version of an investment stimulus programme (but no more simplified than McCarthy’s A and B options) and it would also face problems – chief of which is, could we ensure that such investment would be efficiently and forensically spent with minimal leakage and maximum benefit?

But it does constitute a third option – one that almost all other industrialised countries are pursuing in one form or another. However, not to refer to it, even if only to dismiss it; to ignore it, to pretend it doesn’t exist as an option – and to continually insist there is only A and B is to do the public debate a grave disservice.

There is an alternative to what, essentially, are pro-cyclical policies – raising taxes and cutting expenditure in a desperate and ever failing attempt to close the fiscal deficit in the middle of the biggest contraction of economic output of any EU country since the war.

At least take a taste.


Proposition Joe said...

Are you forgetting that our ability to borrow at a reasonable rate is predicated on the perceived risk of our sovereign debt, not on whether we are below or above the European average? A country can be highly indebted and still be seen as very low risk (say the US) or less heavily encumbered but still very high risk (that's us). It all about the outlook, and the outlook for our debt is very bleak, with NAMA and several heavy deficit-heavy budgets still to come. Even in the best case scenario we're unlikely to get out of this recession without a GDP-to-debt ration well north of 100%. Not to mention another 100 billion in accrued public sector pension liabilities. This puts your proposed 16 billion stimulus (approaching 10% of GDP) in perspective. Unless we offer public servants a share in a wind turbine in lieu of their pension, it hard to see how a stimulus could be afforded.

Slí Eile said...


In case you missed it see 'ESB borrows €365m in US bond sale' recently:
The fundraising was oversubscribed and attracted interest “from a wide range of US institutional investors”, the ESB added.

this might be termed off balance sheet debt counting and is an example of how state companies have potential to borrow for productive, job-creating, environment-enhancing purposes.

Tomaltach said...

Does the ESB annual revenue fall 33% short of covering its costs? You equate the ESB with the Irish economy. It cannot be that simple.

I take your point that the government could use its ownwership of state or semi-state companies to push through what amount to stimulus packages. But none of that would mean we wouldn't have to address our national fiscal crisis.

Michael and Slí - if I understand it you are saying that it doesn't matter if we push towards or over 100% debt to GDP, that we can afford it, that it will not in fact be a crippling burden in the medium term, and that P Joe's point on the difference between Ireland and other nations in the current debt market is irrelevant?

I remain to be convinced.

Pavement Trauma said...

Here are the ERSI figures and projections up to 2010; they already take into account certain tax increases and expenditure cuts.

In 2007 our net debt was 23 billion euro.
In 2008 our net debt was 40 billion euro.
In 2009 it is projected to be 60 billion euro.
In 2010 it is projected to be 94 billion euro.

These figures are net - i.e. include the NPRF and other balances. Are gross debt is a good bit higher. It does not include the projected pension liabilities.

Our absolute level of debt has quadrupled between 2007 and 2010. Does anyone expect us not to require any additional borrowing after 2010? Adding additional debt now is economic lunacy.

Brian Woods said...

Getting out of debt requires real income - not some sort of 'funny money'. That is, you need a sufficient surplus to pay down your debt and its exponentially increasing interest. The exponential term is the killer. Need exponential 'growth'.

Problem is, growth requires energy - and apparently we have peaked on fossil fuel production. So we had better locate a cheap-ish form of liquid fuel or ... ... ungrowth! Debt increases!!! Boom!!!

We need a Debt Jubilee - difficult and all as this may be. You cannot stimulate those that either do not want to stimul (sic) or those that cannot.

We are not a (major) manufacturing economy. We are predominantly a FIRE* (or were!)economy. This paradigm is on life-support. Resuscitation is no longer possible for reasons (partly) stated above.
We have a choice: (a) glide to the 'bottom' or, (b) fall over the precipice. Seems that (b) is the selected option!!!

A few years back I read an article that predicted the Ireland would, within a generation, drop to the 'poorest' country in Europe. I thought the guy was daft. Some research showed he had a good argument.

BdSp is monoline thinking. We deserve better. Don't expect it from the Status Quo - yet. Wait until energy and food prices start to increase again: 12 -> 18 months perhaps. Good book to pass the time: Debt and Delusion: Peter Warburton. ISBN.0-9770793-3-3. Cheers.

Brian P

* Finance, Insurance, Real Estate.

Michael Taft said...

The key point, Tomaltach, is that bringing the fiscal deficit under control is inextricably intertwined with restoring growth to the economy. As I have tried to show on other posts - here and elsewhere - the ESRI has produced the multiplier tables showing the limited impact on the fiscal deficit arising from a range of taxation and public cut measures. That is not to rule these out - they can form part of a comprehensive strategy. However, on their own, they will not do the trick. In using taxation and expenditure 'control' measures it is imperative that select carefully - namely, those measures that are the least deflationary. If Proposition Joe is correct - that even in the best-case scenario we are heading towards 100% GDP/debt ratio (I wouldn't be so pessimistic but it is a possibility under the current strategy) then we must ensure that we an economic base capable of generating the growth and wealth to pay that debt off. Allowing unemployment to rise, allowing our infrastructure to further 'rust' is hardly the way to do that.

As to the cost of borrowing - it shows how bond markets are influenced and manipulated by forces beyond supply, demand and risk assessment. For clearly, there is no chance of Ireland defaulting on its debt. So why the risk premium? To argue that we are a higher risk than Portugal or Greece just doesn't stand up to objective analysis.

Pavement Trauma - using the EU Commission's projections, Eurozone average equivalent in Ireland would be €135 billion. That leaves us some space between our own and the Eurozone average.

That every other country is increasing its debt to combat recession should be noted. That they are being encouraged by the EU Commission itself, the IMF, the World Bank, etc. should also be noted. To describe all this as lunacy is a bit harsh. It is, after all, the natural and rational response to recession - that is, to pursue counter-cyclical policies. We could, however, limit our need to borrow for investment purposes, if we applied taxes on capital and wealth while reforming regressive tax expenditures.

Pavement Trauma said...

A 135 billion debt @ long term interest rate of say 3% (which is very low, it is already higher) will see us spend more on servicing the debt than we spend on education. If interest rates go to 5.2% - debt interest costs will be more than the health budget.

We are more risky than Portugal or Greece because the rate at which we are ramping up debt is much higher than them. Plus we have the spectre of NAMA & the bank guarantee hanging over us. We are very unlikely to default this year or next. But a lot of sovereign bond holdings tend to be for the long term, can anyone honestly say that the chance of default in three or more years out is impossible?

If you look at the components of the projected collapse in our GDP/GNP, the majority is down to a fall in 'fixed capital formation' (i.e. investment incl in property) from 49 billion to 20 billion in 2010. The projected fall in public and private consumption by comparison is from 119 to 109. Investment is not going to go back to that level any time soon. Consumption is not going to raise anywhere near enough to fill that gap. The size of our economy will be reduced for the foreseeable future. Publich expenditure based on a 2007 sized economy but paid for by a 2009 (or 2010 or 2011) sized economy is just not feasible.

Adding additional debt now so that we don't have to cut expenditure only delays the inevitable and make it a lot worse when we do have to do it.

There is no realistic alternative 'Option C' only 'Option D' - for default. And if we don't act, it won't be an option.