Monday, 9 November 2009

'O make me a Keynesian (but not yet)' ?

Slí Eile: The entry by UK economist David Blanchflower into the domestic economic debate (re-flation versus deflation) created a stir last week. For a moment, it took us away from the narrow, Irish insular debate of ‘public sector versus private sector’, ‘job cuts versus pay cuts’, ‘public spending cuts versus tax hikes’, ‘your grandmother versus your job’ and ‘your left arm versus your right hand’ – all false dichotomies and enforced choices thrown on a public already anxious and dispirited. When you hear the Prime Minister of a country saying that he has a vision for the future and that vision is a smaller public service then you know we have a vision-crisis as well as a values-crises. Blanchflower’s message is simply that we cannot afford to condemn a generation of young people to long-term unemployment with all the devastating consequences that this entrails.

Blanchflower’s talk can be podcasted here.

and his talk can be downloaded here.

(as can all the papers for the Dublin Economics Workshop here)

Blanchflower’s main policy conclusion is
“The time to act is now. The young must be the priority.” (his words)
He also warns that Recovery may not be V-shaped but W-shaped. (IMF and other bodies are cautioning against a premature withdrawal of stimulus measures).
Before considering his menu of policy options, some of the key points he makes at the outset are that:
* The costs of unemployment will vary across countries and between groups within populations. * The young will be hit hard.
* The duration of the slump may be much more prolonged than most people are expecting and … * Much will be changed both in our ideas and in our methods before we emerge.
* During a long period of unemployment, workers can lose their skills.
* Unemployment increases susceptibility to malnutrition, illness, mental stress, and loss of self-esteem, leading to depression and in a few cases suicide.
* The long-term unemployed are at a particular disadvantage trying to find work. People's morale sinks as duration rises.
* As unemployment rates increase, crime rates tend to rise, especially property crime.
* Increases in the unemployment rate, lowers the happiness of the population, not just the unemployed. The fear of becoming unemployed in the future lowers a person’s subjective wellbeing
* Unemployment while young, especially of long duration, causes permanent scars rather than temporary blemishes. He cites solid UK longitudinal evidence to back this up.

His policy prescription is decidedly Keynesian:
1) Maintain or even increase aggregate demand through stimulative fiscal policy
2) Target assistance on the young through active labour market programs and continuing training and expansion of education, wage and employment subsidies for the young, incentives for hiring the young in public sector organisations such as in education and health and ‘lowering the minimum wage for the young’

Blanchflower argues that ‘moves to cut public expenditure or public sector wages or employment’ in the depths of a recession are ‘a mistake and may turn a recession into depression’

Little wonder that there was such a lively and adverse reaction from the economics mainstream here

In that thread Michael Burke asks:

A challenge to all the slash and burn advocates: Name another advanced economy which intends to pursue a course of slashing public spending currently in the way that Ireland intends.

One detects a severe case of Augustinian Keynesianism among the Irish economics confraternity (while we would love to stimulate fiscally we will not because.....):

O Lord make me a counter-cyclical Keynesian - but not yet.


Mack said...

"2) Target assistance on the young through active labour market programs and continuing training..."


Surely it would be better to cut salaries on the condition that employment is increased - even if only on temporary contracts (until there are private sector jobs)? The social welfare budget doesn't seem to be far off the size of the deficit, if we could get people off welfare while keeping the spend elsewhere could we make up the €4bn cost savings in a non-deflationary manner, without sacrificing a generation?

Proposition Joe said...

"O Lord make me a counter-cyclical Keynesian - but not yet."

A similar observation could have been applied to the social partners during the boom. Had they advocated some hoarding of the surplus during the boom instead of falling over themselves to grab as big as possible a share of the spoils for their members, then we would have the means to fund a stimulus now that we need it.

Proposition Joe said...


"Surely it would be better to cut salaries on the condition that employment is increased - even if only on temporary contracts "

The opposite is by far the more likely outcome ... employment of outsiders will be sacrificed to protect income levels of insiders.

There's an implicit point zero in ICTU's ten-point plan, that easily trumps their point #1 "Protecting Employment".

Michael Burke said...

@ Mack & Proposition Joe

The idea of cutting public sector wages to create jobs is far-fetched, both practically and theoretically.

Practically, because no-one in government circles has the slightest intention of creating a single new hire from the 'savings' created by their pro-cyclical fiscal policy. To suggest otherwise is untenable.

Theoretically, because the deflationary effects of the wage cuts will only depress activity further, and employment with it. As a result, the 'savings' will be nothing of the sort as the deficit will continue to rise.

Otherwise there would be a close correlation between low unemployment rates and low pay rates. There isn't. Bangladesh has the lowest pay rates in the world and still has massive underemployment, and starvation. (IMF's World Economic Outlook Database, April 2009 Edition).

Marise said...

At the risk of seeming quite dense, I must say that I've yet to be convinced that we need to cut 4 billion euro this year. How was this figure arrived at? I ask because even those against cuts seem stuck on it. I would like to study the rationale and see for myself whether it's a given.

Mack said...

Michael -

You are right politically, but then we have two sets of orthodoxies in which such thinking does not figure.

"Theoretically, because the deflationary effects of the wage cuts will only depress activity further, and employment with it."

Really? That's surprising.

I'll outline my understanding -

We could take a public servant on €90k and reduce their salary (perhaps temporarily) to €50k and hire, on temporary rolling contracts, two graduate interns at €20k to work on internal infrastructure projects (that will reduce overheads long-term). Because the marginal propensity to consume is greater for a worker on €20k or €50k is greater than for a worker on €90k proportionally much more money would be spent in the Irish economy.

As I understand it, cutting the salary of a higher earner and employing two extra workers should give a boost to the economy (if we presume the reduction in the income tax take is balanced by both a reduced pension liability and increased VAT take), rather than be deflationary. Unless I'm missing something?

Marise said...


The reason that would not happen is that salary is only one portion of compensation. Behind the salaries reside pensions, OT, training, other benefits. And rules surrounding contractors (hiring, duration, security, etc.). And there are not that many workers making 90K and above.

Mack said...

Marise - I agree it's not going to happen, but cuts probably will. It would be better than cuts alone, right?

Michael Burke said...

@ Mack

You are not wrong in principle. My argument relates to the proposed cuts as they stand. They are cuts, pure and simple, not, as some self-styled champions of the unemployed would have it, job-creation schemes. That is; no job substitution and outright cuts in wages. The text-book effect of that is deflationary.

@ Marise

You pose a very good question re the €4bn cuts, since Mr Lenihan simultaneously announced that the government stood ready to bail out BoI shareholders, again, to the tune of €5bn. That also places his comment that, "We are in a war situation", in an interesting light.

Martin O'Dea said...

Regarding the long-running inflate/deflate or cut/spend argument. I just polished off a long rant in that I would like to post here;
I feel that it is too long for the accepted word count here, but I will post in two posts if I can beg patience


I believe there may be an element of this debate that requires consideration by those advocating cuts as realignment of public spending with government revenue.
My understanding is that this argument is best supported by the idea that the government income was unsustainably high and caused by the property bubble, therefore simply enough, with that bubble now deflated and stamp duty etc. almost absent from the coffers we simply must cut public spending accordingly.
Conversely there is an argument that suggests that public spending improves conditions of economic activity and as an example the money given to the IDA and its use to attract foreign investment would be an indirect and clearly beneficial result of public spending, plus the argument that cutting people’s income and welfare will depress the economy further and so the income take from consumption and indeed employment taxation (unemployment) will further reduce requiring further cuts to meet the new deficit and lead to further reduction in government income. A deflationary spiral.
Countering this is the fact that once this adjustment is made people will return to spending and earning at a more sustainable level i.e. without the artificially high levels of activity in the housing market.

What would seem crucial then in deciding which of these interpretations you prefer and which resulting course of action you espouse is whether you believe the economic activity which depended on this misplaced emphasis in one sector, can, in fact, be replaced by other areas of development. Considering that if income was to magically increase by 20% next year we would not be advocating cuts, reform, sure, but not cuts. Therefore this is not a question of whether the public spend should come down but whether it has to because the income to government cannot come up to meet it. The debate of public pay and private pay is for another forum entirely - perhaps a new benchmarking process, and is, in fact, irrelevant to this whole debate.

So, can we replace the economic activity allowed in the past by the housing boom; well while we can’t predict the future it would surely be worthwhile to attempt to project from what we know and have experienced?

Martin O'Dea said...


In this regard I feel that economics can be brought down to - stuff! That is to say that I would consider myself better off than the someone in the top 1% of wealth in 1800 AD (by the way I’m a long way from that percentile now!) Why am I better off, well; food, medicine, healthcare, longevity, transport, leisure time activities, communication and information technologies enablers, access to support and advice, (housing), etc. or in short ’stuff’
I simply have more stuff than he does.
Stuff, of course, that arises from enterprise, innovation, research and development, and economic activity, or people working - productivity.
The financial economy can be seen then as the background enabler for the productive effort to take place in. Certainly, as risk and enterprise requires rewarding, there is a downside of money making money without any real contribution other than speculation; and left unchecked this can, clearly, have negative impacts, but, ideally the capital is merely an enabler, and Michael Burke’s argument that we need to replace private investment with public investment therefore stands up, unless we feel that there is no more stuff that can replace housing; nothing else that will employ people and entice employees to part with their earnings for other items and services provided by other employees.

This is the key difference between, say, an oil crises, where there is, in fact, a problem with the ‘real economy’ i.e. an essential element of the economic activity is not available in sufficient amounts; and this financial economy difficulty - if we can agree that there are alternatives to housing for our activity.

So, the answer is - a monumental yes. The worlds of technology, nano-tech, robotics, genetics, pharmaceutics, bio-tech, communication and information technology, will allow for increases in the level of ’stuff’ unlike anything seen before - why? Because technology does not grow linearly, it grows exponentially, see as a very simple example Moore’s Law. In fact, it is difficult to be aware of this revolution of opportunity when being immersed in it - but almost all, understand that it is there and it is gaining in significance; watch any film or show from five years ago (see how old fashioned it seems and why), and you will appreciate why someone like Ray Kurzweil suggests that the patterns are undeniable that the rate of change shows us that things moved as much in the last five as the previous ten, and in the previous fifty as the proceeding two hundred years.

And yet, we cut. We suggest that we cannot increase our productivity and economic activity sufficiently and to resist taking our borrowings up to a higher -though not from a comparably currently high level - we must cut, and dampen public investment and indeed public confidence.
One must accept then that this is potentially a massive mistake.
Firstly, because there is so much potential awaiting finance, secondly because the vast majority of our peers are at least trying to stimulate, and thirdly, because there are plenty of nations who will seek the means by which to chase down this new activity in a positive and confident mood, which may ultimately see us relinquishing our position in the global market place to so many particular countries who will invest again and again in education and enterprise.

Having said all of this, I cannot see how the current minister for Finance or the current government can retrace their footsteps thus far, and so it would seem essential that we have a general election and that someone puts a confident hand high up in the air to lead us in a positive and assured manner.