Tuesday, 24 November 2009

The hall of mirrors

Michael Taft: A number of commentators have referred to the fact that Irish public expenditure is ‘rising faster’ than almost any other European country; that it now gobbles up over 50 percent of our GNP. In stating this, the assumption is that to rectify the deficit we should cut public expenditure. However, when we subject this to closer inspection we find ourselves in a hall of distorting mirrors, seeing reflections of a reality that is so distorted we are in danger of losing perspective.

Yes, public expenditure, as a proportion of GNP, is rising to over 50 percent though to what extent depends on how you calculate the numbers. The following excludes payments to the Pension Reserve Fund (including the payment for this year slightly exaggerates the level of spending as it includes the 2010 payment as well). How much of the GNP does total government spending make up?

2007: 37.8 percent
2009: 51.2 percent

That is a big jump – an increase of well over a third. But what are the numbers behind the numbers – what is the real image that is potentially being distorted by this spend/GNP ratio? There are two sides to this ratio.

Side One: between 2007 and 2009, total government spending increased by €8.8 billion, or 14 percent. What are accounted for this increase? 66 percent was due to the rise in the Social Affairs budget, while 21 percent was due to the extra cost of debt service. All the rest of the Government’s budget (including public sector pay) made up only 11 percent. In other words, the increase in public expenditure is mainly recession-driven.

Side Two: and what a recession. Between 2007 and 2009, GNP has contracted by a massive €25 billion, or -13.6 percent. Compare that to a Eurozone average contraction of -3.5 percent. With the economy falling that fast and that far, public expenditure, even if it remained static, would still be rising at a relentless pace.

So let’s break down all the contributing factors to this rising GNP/debt ratio.

Nearly half the rise in the public expenditure/GNP ratio is down to the contraction in the GNP itself. Social welfare and debt servicing – both recession driven – make up another 46 percent. Public expenditure increases in all other areas make up only 6 percent.

Now here’s the kicker – the deflationary impact of public expenditure cuts mean that the actual cut actually contributes little to reduced the spending/GNP ratio. While spending may be reduced somewhat, GNP is also reduced (e.g. cutting public employment by 5 percent will save €488 million but will come at a cost of a decline in the GNP of €1.1 billion).

What we have to do is step out of this distorting hall of mirrors. The proposition that you can cut your way out of recession means we will be trapped staring at mirrors only to see shapes so distorted that they bear no resemblance to the real world.

1 comment:

Mack said...

Michael -

I agree there is a a lot of smoke and mirrors going on here - including paying for bank recapitalisations out of the National Pension Reserve Fund and keeping NAMA entirely off balance sheet. One off charges - if we're lucky, if not ...