Thursday, 16 July 2009

The Report (or, it really is the economy, stupid)

Michael Taft: No one should be too surprised about the broad thrust of the report of the Special Group on Public Service Numbers and Expenditure Programmes (here referred to as The Report, best said aloud in deep, sombre terms). We knew there would be cuts of €5 billion, cuts in social welfare, health and education, cuts in public employment, cuts in programmes in every Department – an orgy of cuts to satisfy even the most insatiable deflationist gourmand. Okay, now we know the details. Now comes the concern, even outrage.

With over 300 pages to pore and sweat over, how do we get an initial handle on The Report without getting lost in the considerable detail contained therein? Can we take a step back and view – much as we might examine the dark cloud from afar, to get a more comprehensive sense of the oncoming storm.

First, let’s deal with a political issue – and this is not down to The Report and its Authors. There is nothing in this – and I emphasis nothing – that could not have been drawn up by Ministers, their appointed advisors and civil service staff. Indeed, as the section under Methodology points out, many (most?) of these proposals came from the Departments themselves. No doubt, many of these proposals have been hanging around for a while – if only in shorthand.

Fianna Fail is cynically using The Report as a kind of good-cop, bad-cop pantomime. The Report recommends cuts of €5.3 billion. But the Government is only looking for €2.5 billion in current expenditure cuts next year. So when people get all wound up by this or that proposal in The Report, the Government will step forward with a reassuring tone: ‘Yes, citizen, that is awful. We won’t go there.’ See how it works? And, then we’re supposed to be grateful that Fianna Fail is only cutting off one finger rather than our whole hand.

But back to The Report proper. We are, in effect, being sold tainted goods. And the Authors are completely aware of this. The Terms of Reference state

‘Review the scope for reducing or discontinuing Expenditure Programmes with a view to eliminating the current budget deficit by 2011.’

This was written in November 2008. Events have overtaken this term – the Government’s strategy, revised in April, doesn’t envisage the current deficit being eliminated until 2014 or later. Nonetheless, the work of the committee was instrumental – to provide a sustainable basis for eliminating the current deficit.

Here, The Report employs an obvious sleight-of-hand. It talks about ‘savings’ of €5.3 billion but the Authors know full well that this ‘headline’ figure is disingenuous. It is not the same as reducing the current deficit or reducing the borrowing requirement by that amount. Indeed, they know that the fiscal effect of these cuts will fall short of €5.3 billion. The Report calls these cuts ‘savings’, all the while knowing that we will not save the amount they claim. It is misleading – knowingly misleading.

Let’s take a look at two areas. First, the Report suggests reducing public sector employment by over 17,000. Interestingly, the ESRI ran a simulation of reducing public sector employment by this same amount (they culled these numbers from the educational and health sectors; in The Report these sectors accounted for over 75 percent of overall employment cuts). What did the ESRI conclude?

• A drop in the GNP of nearly 1 percent (boy, we need that)
• A drop in consumption of half a percent (more domestic businesses going to the wall)
• Unemployment rising by nearly 1 percent (or an extra 20,000 on the dole queues)

And the fiscal effect? The reduction of 17,000 in public sector employment would reduce government expenditure by €1 billion (headline figure) but would only ‘save’ the government €492 million – less than half the headline figure.

Why is that? Because when you calculate the effect of the reduction on the economy (it is, after all, the economy, stupid) – the drop in output and consumption, the rise in unemployment – you don’t maximise the ‘benefit’ of the cut. In fact, you don’t even get half the ‘benefit’.

The second issue is the attack on the living standards of those on the lowest incomes. This is largely but not confined to the income of social welfare recipients; however, they take the brunt. A cut of 5 percent is only the start but let’s stay with that. The Report claims a ‘saving’ of €850 million. But would it actually ‘save’ the Exchequer this amount? Hardly – and the Authors know this.

Unfortunately, the ERSI did not calculate the effect of reducing social transfers. But we can make logical deductions. Given that those on low incomes have the highest propensity to spend, any reduction in that expenditure will

• Reduce spending tax revenue
• Lower consumption (purchasing goods and services from domestic businesses) which will,
• Decrease business profits tax revenue, and lead to
• Either wage freezes in the business or even job losses

The €850 million is therefore a misleading ‘saving’ figure.

However, the Report is full of deflationary attacks on people’s living standards – beyond just reducing social welfare rates:

• Reducing the numbers on the medical card schemes and requiring those with one to make payments for prescription medicine
• Increasing thresholds for the Drug Repayment Scheme (which will impact most on low/average income groups)
• Reducing childcare subsidies to low-income families
• Means-test the elderly’ Homecare Packages
• Increase school transport charges

All these will have a deflationary impact.

Could the Committee have made an economic impact assessment of all their recommendations? You bet. The ESRI has the computers, the software and the trained personnel to do so. Would it have been conclusive? Not necessarily. But they would have been indicative and given us some parameters to asses the impact.

So why didn’t the Committee do this? Quite simply, because it would have undermined their whole approach and opened it to general public ridicule. Here’s why.

If, say, that the entire cuts package actually only produced savings of 60 percent of their headline figures, then the €5.3 billion ‘savings’ would have melted away. We would be talking about €3 billion. And the simulations would have clearly shown what we intuitively know.

That The Report’s proposals, if implemented, will lengthen and deepen the recession, will cause further job losses, will further reduce consumption and spending.

And after all the pain, what would be the fiscal effect of implementing every one of The Report’s proposals?

It will reduce this year’s Exchequer borrowing requirement from nearly €26 billion to €23 billion – maybe, if we’re lucky, if the combined effects of the cuts are not greater than their individual parts.

Can anyone claim that this is anything more than rearranging the deck chairs on the good ship Ireland?

That is why The Report should be metaphorically placed in a large manila envelope, sealed and stamped with ‘Return to Sender’.


Ronan L said...

Michael, quick question:
If you were in charge, what would be the number at which you would want to settle our taxes and expenditure (currently in the low 30s and high 50s)? I presume you wouldn't go along with my €42-45bn, as that would mean cutting expenditure by up to €15bn, but I'd be interested in seeing what you think is Ireland's magic number (at least in ballpark terms).

Michael Taft said...

Ronan, thanks for the challenge. I don't see the issue initially in budgetary terms (and I hope you don't think I'm avoiding your question). Indeed, I don't think it is possible to address the larger fiscal issues, in the short-term, through budgetary contraction. But I do have a kind of magic number in mind. I’d take UNITE’s ‘Growing the Economy’ as a starting point and argue for a sustained investment programme of somewhere in the order of 3 percent of GDP annually over a four year period (approximately €5 billion per year). This investment would be sourced through a number of instruments: (a) increased borrowing (the recent ESRI projection for debt suggests we could borrow an extra €15 - €20 billion over the next two years and still below the Eurozone average; and that’s not counting the Pension Reserve Fund’s assets and the NTMA’s free cash balances); (b) front-load the winding down of the NTMA’s free cash balance – this would release a considerable amount now; (c) increases taxes on high incomes and wealth (especially the latter) which would have the least deflationary impact; (d) reform, reduce and/or abolish regressive tax expenditures; (e) issue Economic Recovery Bonds for the domestic household market to take advantage of the growing savings ratio – and this could be a cheaper product than that necessitated in the current international bond market.

This investment would be spent through both temporary and permanent increases in public expenditure – capital and current – along with expenditure through a new state industrial holding company (ICTU’s original proposal which Fine Gael based their NewERA proposals on). This borrowing would be off-the-books. This investment in our physical and social infrastructure is needed in any event; all the more so if we want to take advantage of the eventual recovery in global demand. Of course, the investment package would have to be carefully constructed to minimise leakage.

The effect of this in the short term would be to increase expenditure and widen the fiscal deficit. However, the strategy would be to, in the medium term, shift the annual fiscal deficit into the overall debt. This can be done as a consequence of direct state investment and job creation, increase in domestic demand and a rise in economic activity: more taxpayers, less expenditure on social welfare, more consumption, growing activity in the private sector, etc.

This, to my mind, is the best way to deal with the annual deficit. Of course, this only deals with the cyclical deficit – but that is the part that is running away. Once the economy has returned to sustainable growth, the tax base should be expanded consistent with that growth, to overcome the structural deficit. Of course, this means we won’t be able to come into Growth and Stability Pact-compliance for some years but we’re not going to anyway; certainly not with the Government’s deflationary strategy. This also means moving the economy to a higher-spend, higher-tax model, breaking with the Anglo-American model, adopting more European norms.

To recap – 3 percent is the magic number; 3 percent of GDP. Spend and borrow. Tax and cut in a non-deflationary manner. In this respect, the McCarthy Committee does have some common sense proposals to save money (cutting subsidies to private fee-paying schools, generic drugs, etc. But I would transfer these efficiencies into investment (which would reduce our need to borrow). I wouldn’t blow it on deflationary strategies.

Now, if only someone would put me in charge.

You can have a read of the UNITE document here:

I’d like to hear your thoughts on it.

Aidan said...

I get the uneasy feeling that Colm Mc Carthy (Economist) is being used by both the FF/PD government and the Department of Finance (the permanent government) to lend his name to a review and recomendations that should never have been necessary if they had not let public expenditure get out of hand on the back of an unsustainable housing bubble in the first place

This report is really a product of Department of Finance thinking. The Second Secretary General, Department of Finance and a former senior
official in the Department of Finance are part of the small group. Other members seem to be from the Ireland’s elite business/administrative cadre.

This group’s first acknowledgement in the report is to ” the excellent assistance and support provided by officials in the Sectoral Policy Division of the Department of Finance. Officials provided the Group’s Secretariat, as well preparing detailed papers for the Group on each Ministerial Vote Group and papers and notes on a significant number of policy areas.”

Enough said!

Anonymous said...

I'd like to hear your thoughts on it

I'm not a member of Unite, so it is a tad cheky of me to make this suggestion about how they should spend their money... but I will anyway:

Michael Taft (and Paul Sweeney) sholuld write opionion pieces for the national papers on the damage to the economy (as against the pain for particular groups). And if the editors of the op-ed pages don't accept them, then Unite (and Congress and others) should buy advertising space to publish the articles.

Tomaltach said...

I haven't got around to reading the report in full as yet, but from the bits I've gleaned and what I've read about it, it strikes me as almost embarassingly amateur or incomplete. What I mean is that it comes across like a naive post on website - you know the "I'd cut this, I'd halve that, I'd merge A with B" without thinking through any of the complex consequences of these proposals (even economically).

I think it demonstrates one think very clearly. That you cannot simply sit down with a list of government expenditures and take a red pen to strike out inefficiencies. It suggests that the only way to make credible proposals for improvement and reform is to take each organisation or small groups of related organisations and work through in detail the theoretical and practical implications of any revision of how they operate.

McCarthy's exercise is simplistic, naive, unworkable, and unfair.

Desmond O'Toole (PES activists Dublin) said...

Speaking on 'Prime Time' last night, Jack O'Connor made the point that this report was little more than "fantasy" and would never make it into government policy in whole or in any significant part.

I think Jack's comments reinforce your statement about Fianna Fáil's intentions with this report. However, by targetting pretty much every section of Irish society (except the powerful and wealthy) but ultimately not having any serious interest in adopting any of the report's measures, Fianna Fáil are demonstrating themselves to be just a touch too clever by half.

With this unproductive posturing a myopic and clueless Taoiseach and Minister for Finance have demonstrated yet again just how unfit to lead they are.

Socialism or Barbarism! said...

Firstly, to agree with your analysis that this represents another step towards reducing further domestic consumption and, thereby, will result in further deflation and a further weakening in fiscal receipts. That much is undeniable and reflects the neo-liberalism of the authors and the government.

However, it is far from clear that this report will not be implemented or substantially implemented. While the cuts identified in current expenditure to be achieved over the two years 2010-11 amount to €3 billion (not €2.5 billion as you state), it does not follow that the €5.3 billion of cuts will not be implemented.

For a start, as you say yourself the actual savings will not amount to the headline figures quoted in all cases (the figures you provide on gross savings arising from sacking 17,000 workers would point to 50% of headline figures - yet the figure of €3 billion represents just under 60% of that total cuts identified). In addition, €275 million of the cuts are in capital expenditure and will go towards the separate €1.75 billion identified for cuts to be achieved over the two year period 2010-11.

Of course the government may will be using this report as an opening gambit in implementing these cuts but it would be unwise to underestimate the its intent. If the goal is to achieve a 3% budget deficit by 2013 (as they state) then further cuts of a similar nature again may have to be implemented by that date. This is only the first step in a drastic reduction in social provision within the state. The consequences of a neo-liberalist economic development policy grounded on a race-to-the-bottom with the third world.

It is natural to be stunned into disbelief by the scale and scope of the cuts identified but that cannot allow complacency. If anything the situation is likely to be worse than identified by the Government given the likelihood that losses in asset portfolios within the banks will rise as the recession extends and the deflationary vicious cycle deepens. To compound it all then when the rest of the world escapes this recession/depression and faces up to its long-term inflationary costs we will remain saddled with debt as euro-denominated interest rates rise and remain unable to devalue relative to our trading partners!

While you have been steadfast in suggesting a stimulative response to the downturn (to your credit) the reality is that the state will not be able to finance that without spiralling into a default brought on by rising interest premiums on sovereign debt.

As such it is our analysis that short of revolutionary change in our society, massive cutbacks *and* tax increases are inevitable; especially given the open-ended commitment to bail out the banks. The only option for the left must be to mobilise to prevent this agenda of austerity!

Ronan L said...

Hi Michael,

Thanks for that detailed response, I'll give the UNITE document a read too and come back with my thoughts... honest!


Barry said...

Question for Michael? What are your qualifications and experience? Im Just curious. Secondly-can we realistically borrow 20 plus billion per year for next few years? We are told the Bond markets will turn on us.Is not the ECB bailing us out at moment by buying bonds for us. Im very confused. Please help!

Michael Taft said...

Barry, First, I am research officer for UNITE the union. I held that position previously in the ATGWU prior to the merger. Second, we will be borrowing €45 billion over this year and next, though some of that won’t feature on the General Government Balance since its for bank recapitalisation. Yes, we are told the bond markets will turn on us. We’ve been hearing this mantra since January. Yet, the last two bond auctions issued by the NTMA were over-subscribed by three to four times. We’re actually turning investors away. Don’t forget – we’re a low debt economy. By the end of 2010, the ESRI projects our gross debt/GDP ratio to be 74% with a net debt/GDP ratio to be 57%. That compares to a Eurozone average projected to be 84% by the EU Commission. In other words, we could borrow €15 billion more – above and beyond what Government targets – and still be below average. Further, the NTMA has already borrowed pretty much all we need this year – and that’s with a €20 billion cash cushion in the bank.

I’m not suggesting we be blasé about all this – but it does give us some scope to change direction, to reject deflationary policies and promote investment stimulus measures. This will drive up the overall debt to Eurozone averages – but by getting people back into work and increasing economic activity, we will be closing the annual deficit (more taxpayers, more taxes, less social welfare expenditure).

Slí Eile said...

"What are your qualifications and experience?"

I find it truly amazing how so many people bow to the supposed superior expertise knowledge of some mainstream economists. If the number of publications and accolades from the media were a measure of the wisdom, compassion and common sense allied to good analysis of data and understanding of how markets, institutions and people actually work then we would be a better position economically now. I am afraid such is not the case.

Sometimes, it takes a few voices to state the obvious and not so obvious and question assumptions, claims and prognosis.

Many economists should be on a penitential course for some time following the lack of common sense appraisal of data staring us for some years now. Many of us were blaze. Only a few spoke up. 2008/09 was the watershed.

We need to go back to the drawing board now. The old world and its model and assumptions is not working.

Anonymous said...

Is it naive of me to think that opening NAMA to foreign banks (headline on IT website this morning) is a bid to get ACC to stop rocking the boat? And is Brian Lenihan's comment last night - " it is not inevitable that the Nama process would result in the State taking a majority share position in the two largest banks, AIB and Bank of Ireland" - the clearest indication yet that the haircut won't be too severe and therefore they won't have to pump further money in to recapitalise the banks?

Who is supposed to be scrutinising these actions? I don't hear too much noise on that front.

Sorry about the anon. Couldn't sign in. Joseph