Monday, 8 February 2010

Government policies

Tom O'Connor: The exchequer figures published last week show that government tax revenues have fallen by €700 million from €3.7 billion in January 2009 to €3 billion in January 2010. Also, the CSO published figures this week showing unemployment had risen sharply by 13,341 in one month. We are also now led to believe that NAMA may result in very little lending by the banks, according to media reports on a leaked memo by the IMF to Brian Lenihan at the NAMA instigation stage.

These results and revelations are very bad. However, a new spin has been put on them by government to show the opposite. Brian Lenihan has said that the fall in tax revenues is in line with the government’s expectations, and the sharp rise in unemployment was also what they expected. He assured the public on the media that there isn’t any problem simply because he expected it!

It would seem that the 436, 936 workers signing on the live register at the moment needn’t worry because Brian Lenihan expects them to be there. Because he expected unemployment to rise, he obviously expected tax receipts to be down, which may mean that more cutbacks will be necessary. But that would seem to be o.k. Why? Because Brian Lenihan expected it.

This type of economic reasoning will do nothing to reduce unemployment and will leave poverty-stricken families, many on the verges of having their homes repossessed; exasperated, frustrated, angry and fearful for the future of their families. It sends a clear message to them that the government doesn’t care.

However, there is a very clearly discernible economic policy at work here: Brian Lenihan is content because he knows that the draconian cutbacks for this year may still help stabilise the economy, despite the fall in tax receipts. He has clearly chosen to ignore making any serious efforts to solve unemployment and get tax receipts up, simply because he is implementing enough cutbacks in the coming year.
Why would a government not prioritise reducing unemployment, virtually give up on tax receipts and instead go for a one-dimensional solution of cutting back government expenditure? The answer is well-known in economic models: Lenihan is implementing a classical monetarist, expectations-augmented Phillips Curve solution to the Irish economy.

These fancy words mean that: the government is taking the view that,, with huge unemployment workers expectations will be very modest and they will feel they are lucky to have a job at all. In fact, they will be softened up in to accepting wage cuts.

This softening-up exercise was confirmed last Monday with Colm Mc Carthy stating that his ‘Mc Carthy Report’ was simply a ‘political exercise’. For those whose jobs have been lost due to the government accepting the veracity of Mc Carthy, they now know that it was a political exercise to soften up the population for cuts in all directions.

In order to shock the population in to accepting lower wages, you will need the recession and a huge army of unemployed people to carry this through, with workers expecting pay cuts to stay in a job. The next stage in this reasoning is that, once workers have become more ‘competitive’, than the conditions will be ripe to hire more of them.

In addition, severe cutbacks in public services allow the government to stay in a strong bargaining position by not relying on increased tax receipts due to cutback savings. It further increases the supply of nurses, speech and language therapists and special needs assistants so that they will accept lower wages if they are lucky enough to be re-employed in the future.

Then, with workers wages significantly reduced in both the public and private sectors, sufficient economic incentives will be restored to employers who may then employ some workers to produce increased amounts of goods and services. At this stage, economic growth, employment and tax receipts grow again and this has the knock-on effect of improving the government’s finances.

There are huge problems with this approach: firstly, it is in effect an IMF type structural adjustment programme and has no respect for the social hardship it creates. The fact that speech and language therapists, occupational therapists, nurses, special needs assistants and other personnel are being laid off is seen as a necessary part of the plan, even though thousands of children and sick adults urgently need them. In some cases, it is a matter of life and death.

Secondly, once the plan is complete and some workers are re-hired, they will have to accept wages which may be so low as to force them in to poverty. They may also have to work more hours to make the same wages they made previously, either with their old employer or with an added part-time job just to pay the mortgage. This is exactly what has happened in the USA in the past 20 years, where low-skilled workers have to work two minimum wage jobs to afford the cost of living in a trailer.

The third point is that it is economically unsustainable. This approach is not really about inventing any new, highly productive and highly skilled well paid jobs. It is about making the economy competitive without moving towards the knowledge economy. The problem here is that with 50% of taxpayers earning less than 30,000, and 25% who haven’t completed a leaving cert, the government is trying to force these to accept less by competing for wages in an increasingly low cost environment.

These workers will not be able to compete with low cost countries. Instead, they need to be re-trained and redeployed in high skilled areas where wages can still remain at the level of the economically developed countries of the EU. This requires state investment in both retraining and productive capacity.Wages can be reasonably good if the worker has increased productivity and skills gains to give her a competitive advantage over workers in cheaper, low skilled countries. To achieve this, the government needs to invest in technologically advanced infrastructure, high skilled industries and in high grade services areas. Increased productivity levels for those at the higher end of the income distribution also need to happen in both the public and private sectors.

Fourthly, by leaving unemployment to rise, to achieve, what is in effect, a rather merciless agenda, the government will almost certainly cause unemployment to stay stubbornly high for at least five years after 2010, and will cause the emigration of tens of thousands of workers whom the government itself has spend thousands training. It also continues to ignore 30,000 families whose homes are in danger of being re-possessed, many of whom are out of work.

Fifthly, these policies are the antithesis to investing in the productive and competitive capacity of the economy to stay competitive and allow for decent wages. For example, the government’s huge investment in research, if not mainstreamed, will result in hundreds of incubated companies being bought out by huge global high knowledge companies who will subsequently reap the rewards of billions of state money. They will also take hard earned ideas, technological advances and associated personnel of the Irish universities and Institutes of Technology.

Sixthly, even though social partnership has been pronounced dead, the current policies do little for any of the social partners. Several businesses are closing every day, banks are not lending, the government has reined in its investment in the economy. Businesses are suffering. Workers are suffering. Community groups are suffering. Farmers are suffering from lower prices on the grounds of depressed consumer demand. In addition to the opposition parties, large numbers of FF TDs do not favour the current agenda. We are left with the cabinet and less than a half dozen academic advisors pushing this agenda. So much for democracy Irish style.

In short, Brian Lenihan’s approach is economically and socially retrograde and will serve the economy and society very badly unless changed. To make matters even worse, in the light of noises coming from the banking sector itself in recent months and the news of the IMF memo to Brian Lenihan on NAMA, there is a clear need to reverse the irresponsible policy of structural adjustment and the associated complacency on the part of the government in running down of the economy and accepting continued increases unemployment.

If not, any growth in the second half of the year will be too little, too late to avoid misery for hundreds of thousands of people, and the skills/productivity weaknesses in the economy will persist for many years afterwards. In doing nothing right now, the government is burying its head in the sand.


Joseph said...

So, IMF told the government last April did they?

It can't possibly be true because in a post made by Minister Lenihan on.....

....posted on 14th October 2009 he said "The establishment of NAMA removes the riskiest assets from the banks balance sheets which frees the banks to restore the flow of credit to the real economy."

So that's alright then. These documents are obviously wrong.

LOL ..... well I would be laughing if it wasn't so serious.

Rory O'Farrell said...

The banks exist to make a profit, and if they think a business is viable they will loan to it.

NAMA will increase the money banks have to loan, so I expect it will increase lending.

Unfortunately, as finance is internationally mobile the increased lending wont happen in Ireland. AIB will loan the money to British and Polish borrowers as they can give a better return for the risk, or else invest in things such as German bonds. The money will leave the country.

If the government wants to inject money into the economy, why not invest in the infrastructure that we will need when the economy recovers? Infrastructure such as trams, school buildings etc.

Barry said...

Wages deflation in the private sector surely has little to do with current government policy and everything to do with the collapse of the construction industry. Less jobs, more people equals fall in price of labour.

Leaving the reprehensible NAMA aside for one minute, the fundamental problem we have here is that our spending levels were based on tax receipts that no longer exist and that can only be replaced-in the short term at least- by borrowing.

So like almost every other contributor to this blog you are asking governement to keep borrowing to pay a public sector wage bill that will eventually have to be cut anyway.

Id love to keep borrowing too but is that really sustainable? Thats what I want you to answer please.

Tom O'Connor said...

@Barry: I'm not saying more borrowing. I believe that several billion has to to come from the National Pension Reserve Fund. Wage deflation has everything to do with government policy: there are calls from the business groups to bring down the minimum wage for example. Also, given that the banks are not lending, the failure of the government to invest in the economy slows down economic activity drastically. In this case, there is an over supply of labour, thousands of whom are unemployed. At that stage it is an employer's market and they can offer lower wages. The workers being offered the lower wages will be forced to take them to stay in a job. One might also argue that the government's tax breaks to an already booming construction industry in the late 1990s fuelled the speculator driven construction boom which given that construction workers were in high demand, allowed those construction workers to ask and recieve higher wages which is part of what happened here in Ireland. Construction workers pay increased significantly, masons demanded more prices per block all because of the construction boom which drove up wage inflation in that sector. Bertie Aherne's government was a one trick pony. It gave away 11 billion in tax avoidance breaks from 1999 to 2005, the biggest portion of which went to construction. Indeed the Bacon report highlighted the fact that the government's tax breaks whereby the interest on borrowings for property could be set off rental income of property developers for tax purposes fuelled the building and building of more properties. The boom continued as long as credit flowed and demand wasn't exhausted. However, eventually the over supply and credit clampdown forced the bubble to burst which had been fuelled also by land re-zoning and other decisions which were very much influenced by politics as the Flood and Mahon tribunals revealed. The over heated construction sector in turn lead to higher wages for the workers in that sector. Ergo, the government fuelled the creation of higher wages.

Barry Doyle said...

Tom. Thanks for that. A littlbe bit short of time at the moment for a long response but a couple of points in reply.

1. Im not sure you have fully refuted my point about market forces being the main driver of wage rates. Yes, government/ IBEC want drops in the minimum wage but above that level surely its just a case of an employers market as you put it leading to inexorable downward pressure on wage expectaion among workers? You describe how wages rose during the boom,fuelled by reckless governemnt policy, surely we are witnessing this process in reverse, albeit with less influence from government?

2. Krugman's latest piece on Spain is just as relevant for Ireland. Although, Im not sure if there fiscal crisis is as bad as ours.He seems to be advocating or rather saying it is inevitable that deflation is the only way that Spain can regain the competitiveness it last as a result of its property boom and being part of the euro. Are we not in exactly the same boat? Full piece here

Michael Burke said...

@ Barry Doyle

No, before and during the crisis Ireland has enjoyed sizeable trade surpluses, whereas Spain suffered very large deficits; +10.4% of GDP in 2007 versus Spain's -8.6% of GDP.

In any event, Krugman is wrong in principle. If the economies of the Euro Area with large trade deficits, France, Spain, Greece, Slovenia and Slovakia, all deflate their way to increased competitivness, where does this leave the remainder, who will therby have suffered a loss of competitiveness? They too have to emabark on a similar course. Or the entire Euro Area does because of the strength of the Euro, and on.

This is a new form of the beggar-my-neighbour policy which was a contributory factor in the Great Depression. They are one-offs, which depress demand in two economies not just one (the domestic and foreign exporter). The sustainable way to improve competitiveness is via investment.

James Conran said...

Michael Burke said: "If the economies of the Euro Area with large trade deficits, France, Spain, Greece, Slovenia and Slovakia, all deflate their way to increased competitivness, where does this leave the remainder, who will therby have suffered a loss of competitiveness? They too have to emabark on a similar course."

No, countries with large trade surpluses (I'm looking at you Germany) need to reorientate their economy towards domestic demand, especially consumption. Thus will trade surpluses and deficits be reduced to sustainable levels and the universe be brought back into balance...

Michael Burke said...

@ James Conran

If all the countires with large trade surpluses need to boost domestic demand that would include Ireland too, which has far large trade surpluses than Germany.

I'm all in favour boosting Irish consumption, Germany too come to that.

James Conran said...

But more important is the current account, which has been in substantial deficit since 2005 (though I think it moved significantly towards balance in 2009 as imports declined quicker than exports).