Thursday, 10 December 2009

Budget 2010: Multipliers not banished from Ireland

Michael Burke: The Budget contained no estimate as to the real cost, in terms of human misery, of the effects of the crisis to date and the government's own role in exacerbating both. That is a scandal, but perhaps an expected one. From the opposition parties, the case was made that, in addition to being an attack on the poor and low-paid, women and youth would bear the brunt of the cuts. The case was also well made by Sinn Fein that there is a viable an alternative of reflation.

On a smaller scale, it is also a scandal how the government treats estimates of the fiscal effects of its own policies. In the Pre-Budget Outlook, there was no account taken of the contractionary effects of their policy, so a €4bn cut was assumed to be a €4bn saving. Now, in the Budget documentation itself, there is at least a recognition that is not the case and €897mn is estimated as the impact of this Budget's measures on the fiscal position, that is a €4bn cut is now expected to be a €3.1bn saving.

This is a modest step forward. But where does this €897mn estimate come from? There is no explanation beyond "quantifying the impact of these measures is an inherently uncertain exercise". Agreed. But does this estimate correspond to experience? On the face of it, it is no more than the direct losses to the Exchequer from reduced expenditure, with no account taken of the contractionary effects on the wider economy and the further negative impact on both revenues and expenditure.

These are widely known as 'multiplier effects' and they have achieved a certain notoriety in Ireland as many commentators and even economists here doubt there existence, or argue they are so small in the Irish context that they can be disregarded. However, that is not now the view of the government.

In terms of a change in Ireland's growth resulting from a change in interest rates, the DoF calculation (using the ESRI's econometric model) is that a 1% increase in GDP could reduce the General Government Borrowing (GGB) by up to 2.2% over a 5-year period (Table 6). So, multipliers have not been banished from Irish soil after all. A similar exercise was conducted where the improvement in growth arises from export performance, with more modest results, up to 1.5%. Why the same exercise was not conducted for a 1% change in growth arising from a change government spending is not at all clear.

There is no reason to suppose that the impact on government finances from a change in spending would be any lower than from a change in interest rates. Most econometric models assume that government spending, especially government investment has the higher multiplier effects. But, using only the results arrived at for growth arising from changing interest rates, a 1% change in GDP could lead to a change of up to 2.2% in the GGB over 5 years. Now a €4bn cut in in government spending is equivalent to approximately 2.3% of GDP. But, even if all the €4bn is regarded as a 'saving', this multiplier means that the net impact is a deterioration in the GGB over 5 years of up to 2.75% of GDP.

And this is precisely what has been happening. Table 7 shows that both the debt and deficit positions have been getting worse than government forecasts. This is not because of growth undershooting. In fact, the current projection for GDP in 2009 of -7.5% is a slight improvement over April’s forecast of -7.7%. Yet the GGB is expected to have deteriorated, from an initial estimate of 10.7% of GDP to now 11.7% of GDP. At the same time the level of general government gross debt is expected to be startlingly worse, equivalent to 64.5% of GDP compared to 59% as recently as April. This pattern is repeated in official forecasts out to 2013; growth is everywhere expected to be better (indeed very strong in 2012 and 2013), but the deficit and debt levels are worse than previously expected.

This is because the government, the DoF and their supporters take insufficient account of their own negative impact on government finances arising from fiscal contraction. If the assumption was that all previous cuts were going to deliver commensurate savings, the actual outcome would a be a shock. If, as in the latest Budget document, there is a partial acknowledgement that cuts are not savings, then the impact on government finances is still an unpleasant surprise. But, from a perspective in which fiscal contraction is economically disastrous and entirely counter-productive even in its own terms, then the outcome was entirely predictable, and predicted.


paul sweeney said...

This is a very important point and DOF really needs to take into account the social impact of its Minister's decsions. It would be in its own interest as a Dept as the officials have been regarded by many as uncaring, which I am sure, is totally untrue.

Michael Burke said...

@ Paul Sweeney

Paul, if they did they might also make some estimate of other 'costs' which have a huge personal, societal and economic impact, such as increased crime, drug and other addictions, violent crimes including domestic violence, family break-up and of course emigration.

Martin O'Dea said...

Lads, what you're saying here is all high-fallutenated stuff, with mulitpliers and calculators and what have you, you can reach any conclusions you want. Emigration is a good thing, and it will do no harm to the youngsters to go abroad for a while or permanently, or we can certainly let the foreigners return - there's hardly any jobs left after the housing thing. This is why we are hitting Welfare, we are also contemplating running cheaper buses to the airports as a stimulus package.
Speaking of fiscal stimulus we haven't got any money. We export everything, and so all we can concentrate on is to be cheap when the yanks pick up.
The public service can moan all they want, but that's all they can do.
The car owners and pub owners are the backbone of Ireland and deserve help to get out of this tough time.
Look I know fellas in my own constituency who are on the welfare and they are down in the pub all day, now that can't be right, if they were given less they might get up off their backsides.
Thats the realities for you fellas, but you keep on with your econometrics or whatever it is your having yourselves.
Cllr. Take your pick T.D.

p.s. fair play to jackie healy rae -wha?

Things are this bad, we can no longer blame our politicians for thier underdeveloped, ignorant and immature approach to governing this country. We have got to change the political landscape. Progressive Economics and/or Tasc need to politicise now. If there is not a political option with which to allign then one should be created. There is an immediate urgency, opportunities are slipping by and the bad is worsening the longer we as a group/and in the wider sense as a country stall.

Damian Tobin said...

Michael - very interesting points.

Unfortunately the use of statistical indicators that might warn of policy failure or economic difficulties whether it is in banking regulation or public services has never been a strong point of this government. Not only did it fail to realise the severity of banking problems in Ireland, but now it seems to lack the type of detailed statistical information that underpins good budgeting. It is really unfortunate, but not surprising, that more weight has been attached to an unquestioned "statistical" exercise comparing public and private wage levels, than a cost benefit analysis of public sector cuts.

The pre-budget report even points to an inability to gauge private sector wage trends thought is seems to imply that reductions in public wages will be matched by the private sector - yet it does not appear to have an assessment of the likely affect that this would have on the economy, let alone its effect on the provision of front line public services or society in general.