Friday, 12 February 2010

How fortunate to have avoided such disaster

Michael Taft: Pat McArdle celebrates the fact that the Fianna Fail government has taken up the austerity cudgels:

‘With hindsight, we were fortunate to have gone down the road we did. The alternative of job creation schemes or expansionary measures would have been disastrous.’

Let’s run through some comparative data to see just how ‘fortunate’ we have been and how we avoided ‘disaster’. These cover the years 2007-2010 – three years of recession (for Ireland, anyway). The Euro zone data and estimates come from the EU Statistical Annex. Irish data and estimates come from the recent ESRI Quarterly Report (except for Irish domestic demand which comes from the EU estimates).

• Euro zone GDP is estimated to fall by -2.7 percent. Irish GNP is estimated to contract by -13.3 percent.

• Euro zone GDP per capita is estimated to fall by -4 percent. Irish GNP (for the domestic economy) per capita is estimated to fall by -16.1 percent.

• Euro zone domestic demand is expected to fall by -2.3 percent. In Ireland it is expected to fall by -19.3 percent

• Euro zone consumer spending will hardly fall at all: -0.4. In Ireland, consumer spending will fall by -8.8 percent.

• Total investment in the Euro zone is projected to fall by -12.8 percent. In Ireland, the fall is projected to by -51.7 percent.

• Non-property investment is estimated to all by -17.7 percent in the Euro zone. It is estimated to fall by -38.9 percent.

• In the Euro zone, employment is projected to fall by -3 percent. In Ireland it is projected to fall by -12.7 percent.

Pity those other Euro zone countries with their ‘job creation schemes and expansionary measures’. We’re just ‘fortunate’ that Fianna Fail is in power.

13 comments:

Oliver Vandt said...

@Michael Taft
I think you are being unfair in not allowing for the possibility that he was expecting a rebounding of house construction generating significant new employment. He believed house construction had bottomed out a year and seven months ago so he may well have been expecting a recovery in the latter half of 2009.

Ulster Bank chief economist Pat McArdle said: "The record low in employment mirrors weak new orders, indicating a poor outlook for construction activity in the coming months."

However, despite a sense of pessimism in the industry about the prospects for future work, Mr McArdle added that there would be no major new deterioration in the housing sector.

"We maintain the view that, while housing will remain in contraction for some time, any significant worsening is unlikely."

http://www.irishtimes.com/newspaper/finance/2008/0609/1212947706225.html

Aidan R said...

I was thinking of writing a post/reponse to this article on my own blog.

The first paragraph speaks volumes but it is not central to the substantial issue being addressed.Either way, it states:

"The ball started rolling with the ECB.....Government action in the form of Nama and the April emergency budget did the rest. With hindsight, we were fortunate to have gone down the road we did. The alternative of job creation schemes or expansionary measures would have been disastrous"

This is an absurd argument. Firstly it claims that there was a direct choice between NAMA, the emergency budget and opting for job creation schemes. I had to read this opening paragrpah several times to try figure out if it was a typo or bad editing. But, I have concluded it is poor reasoning. Without getting into the fact that NAMA is funded by taxpayer backed ECB bonds, it is reasoning that the government had to 'choose' between saving the banking system and creating policies to protect jobs.

Secondly, it ignores that the government did create a job protection scheme, minimal as it is. Thirdly, and most importantly, the argument is based on a hypothetical counter-factual. Useful in deductive mathemathic models but a completely invalid form of reasoning about real-exisitng policy choices. He could have given case examples of countries where job protection measures were chosen over protecting the banks. But, there are no examples of this across the EU. He could have also chosen to examine countries that have opted for job creation measures and expansionary polices that failed. But again, there are not many examples.

He later goes on to quote Paul Krugman; the biggest advocate of job creation measures to prtect existing employment. And this is the fundamental point of the article (and reveals its normative foundation): it makes no reference to unemployment or jobs because it assumes that once growth picks up, the private market will start creating jobs.

One only has to look back 20 years into Irish history to acknowledge this is not the case for small open economies. 'Growth without jobs' was what occured from 87' through to 95'. It required active labour market 'supply' measures' by both government and organised economic interests to really embed employment creation. Furthermore, the state is always involved in job creation by virtue of its heavy involvement in education and training. These are particularly important for small open economies with a weak industrial base.

So, again, it is the normative difference between those who think employment and jobs require active state involvement and those who think it does not. The former is based upon empirical-historical evidence, the latter based upon hypothetical market models.

But, more importantly, it does not contextualise the different political conditions that underpin the differing capacity and choices facing the Greek and Irish government. Something I talk about over on my own blog.

karl deeter said...

as devils advocate: do you have any estimations on where we would be if we spent lots of money on expansionary job schemes? I wouldn't automatically accept that we'd be equal to the eu averages as our economy was more out of balance (weighted toward construction/property) than many others. Is this not a comparison to an outcome that cannot be quantified and therefore is neither better or worse?

Michael Burke said...

@ Karl Deeter

This I think is the decisive question; where would Ireland be with reflation rather than contraction?

I think we can safely leave aside the idea that all the other European governments bar Greece have been reflating simply to buy off their electorate, which is often the implication of mainstremam commentary in Ireland. Mrs Merkel won an election on the platform of fiscal rectitude and, only once elected, chose the reflationary route.

Therefore the European governments and the rest of the G20, must be engaged in reflation not for electoral reasons, still less for reasons of Leftwing ideology, not least because the are generally of the Right.

They are reflating because it works.

Estimates of how effective reflation is in the Irish context vary from the Lane/Benetrix models to the estimates of the NDP evaluations, and all points in between. But they are effective, with fiscal multipliers ranging from 1.4 to 2.8.

Decisively, these multipliers also work in reverse; if you withdraw government spending the economic tailspin depresses taxation revenues and the deficit actually rises. Which is what has happened here.

And these are only averages, and so are themselves underestimates in relation to crises, especially the current one.

This is not simply an exercise in macroeconomic stimulus, as welcome as that should be. But, in the narrow terms of deficit-reduction, multipliers at either end of this scale are effective in reducing government borrowing, since the boost to economic activity produces its own tax revenue reward.

There are no guarantees as to precise output and deficit implications of any reflationary package, not least because the composition of any package is crucial.

However, Ireland has uniquely engaged in a contractioary fiscal policy and the deficit is still rising. All the major economies which have reflated have seen their deficits stabilise or start to fall.

A tale of 3 countries and their deficits, Ireland, Greece and Germany: In 2008 their net government borrowing was as a percent of GDP 7.2, 7.7 and 0. Ireland cut spending by 6.4% of GDP, Greece did nothing and Germany reflated equivalent to 4%. The EU Commission's forecasts (made before the latest measures adopted in Greece) are deficits for 2011 of 14.7% in Ireland, 12.8% Greece and 4.6% Germany.

Clearly, all deficits have risen under the impact ofthe recession. But the policy response was decisive, the best option was to reflate, the next best was to do nothing and the worst was Ireland's slash and burn.

This is because the mutipliers are real, are objectively verified (by Irish research, examining even solely Irish conditions) and operate both positively (reflation) and negatively (deflation/contraction).

Rory O'Farrell said...

@Karl Deeter

I think the question should be, where would we be if instead of putting 1 billion into investments in foreign countries through the pension reserve fund, we put that money into a school building programme or some other productive investment? These investments reduce the structural deficit by reducing rental payments on prefabs. It gives an immediate 'social return' through jobs, and a financial payback also that would outperform foreign investments (as we would save on dole money, unemployed people could pay mortgages to soon to be nationalised banks and so on).

Stashing away money by investing in foreign countries makes sense when the economy is running at full capacity, but we would get a better return through investing at home now.

Joseph said...

FF? Austerity? Doing nothing about unemployment (they aren't). Somebody please pass the sick bucket.

Anonymous said...

Mr McArdle is partisan in his comments. He is deeply conservative and orthodox. As befitting a bank economist. The trouble is that he is writing his "comments" in the Irish Times which up until recently had the excellent and critical analysis of Paul Tansey. It seems that Mr McArdle is very supportive of the Government's deflationary policies and of NAMA.
Casual readers would not know that there is another view. Many would think that Mr McArdle is a critical journalist.

Michael Taft said...

Karl, the effect of both an expansionary and a neutral fiscal policy can be measured - as can the Government's deflationary approach. For example, the effect of cutting 17,000 public sector jobs - as measured in the ESRI simulation in its working paper 287 - is fiscally irrelevant but economically damaging. By the 4th year, the borrowing requirement falls by only 0.1% of GDP but the GDP falls by 0.7% (the effect on the domestic economy is even worse - at 1%). However, the effect on consumer spending (-1.1%) and employment (-0.8% or about -15,000 jobs) makes the cut extremely damaging. Therefore, in this case, to do nothing (not to proceed with this cut) would be highly preferable for sound social and economic reasons.

In effect, spending cuts do not equate into savings. Indeed, there is an insidious effect: the cut is not embedded in the public finances but rather in the economy, resulting in lower growth and, consequently, continuing high debt levels.

Measuring increased output and the benefits from increased tax revenue and reduced unemployment expeniture using, as Michael Burke refers to, the Lane-Benetrix multipliers shows not only a positive effect (a 1.6 ratio in the second year of a capital investment) there is a long-term supply side benefit as measured by the ESRI in their ex-ante evaluation of the current NDP progrmmae which means a permament rise in output. In this sense, an investment approach to our economic and fiscal crisis ensures embeds growth and not cuts into the economy going forward.

There will be some concrete examples of this to be published soon so when this is done we can compare the effects of an expansionary as opposed to a deflationary approach.

James Conran said...

Both Michaels, Taft and Burke, seem to argue that we are on the right hand side of some kind of left-wing Laffer Curve - fiscal stimulus (tax cuts and/or increased spending) will reduce the deficit.

M. Burke says:

"...in the narrow terms of deficit-reduction, multipliers at either end of this scale [i.e. 1.4 to 2.8] are effective in reducing government borrowing, since the boost to economic activity produces its own tax revenue reward."

Assume a multiplier of 2 (many would dispute this). A stimulus costing 1% of GDP adds 2% to GDP. But if each 1% added to GDP yields .35% of GDP in additional tax revenues (given that the Irish tax/GDP ratio is about 35%) then such a stimulus would still increase the deficit by .3% of old GDP or .1% of the newly increased GDP. It's not much but it's still an increase and would be more if the multiplier is less than 2.

Plus we also have to consider the effect on bond markets. Right or wrong the bond markets seem to think austerity (at least in Ireland and Greece) is in fact the way to go in terms of keeping sovereign debt manageable. Even if they're wrong in principle, in practice what are the chances that an announcement of an Irish stimulus plan would cause a sharp spike in interest rates, and what effect would this have on the effectiveness of the stimulus itself (since increased interest payments to foreign creditors obviously has a deflationary effect).

Michael Taft said...

James - investment certainly does have the potential to pay for itself. If we use the Lane-Benetrix multipliers, a once-off capital investment of €2 billion should expect to raise GDP in two ways: (a) the demand-side (short-term, temporary) effect should expect to raise the GDP over by about €7.5 billion over a 4-6 year period before being spent. During this period, with a 35% tax ratio, we would recoup the original investment, the interest and have some left over; and (b) the supply-side (long-term, permanent) effect should provide a €400 million boost to GDP according to the ESRI. This would mean a permanent tax-revenue increase of €140 million long after the demand-side effect is spent.

Of course, much depends on the quality of the investment. If we build houses that no one will ever live in (sound familiar) the long-term cost will be negative. However, investing in NG Broadband, public transport, early childhood education, quicker access to seaports, electricity grid in the West to abosrb greater wind power, off-shore wind farms, home conservation, a modern water & waste network (this latter would also reduce maintenance costs on Vitorian age pipes bring additional benefits) - all these would have real short-term and long-term benefits and have the capacity to increase productivity and competitiveness.

Some fiscal stimulus wouldn't have, in my opinion, the desired effect. For instance, Fine Gael's proposal to reduce employers' PRSI could have enormous dead-weight and not achive the multiplier level needed to recoup the cost (but I'm prepared to be wrong on this). Similarly, general tax cuts may end up as savings and defeat the purpose. Nor would adding people to the public sector payroll for make-work purposes, though employing thousands of teachers/assistants in early chilhood centres would be a strong investment.

So, if the quality is right and targeted at modernising our economic and social infrastructure, the nubmbers are there to show that investment pays for itself.

Michael Burke said...

I don't need to add much to Michael's reply except to say that all these estimates of the multipliers are based on long run avearges, not the current crisis.

To give a concrete example from recent experience, the DoF assumed the tax mutiplier would be 1.1(that is a 1% fall in output would lead to a 1.1% decline in taxation revenues), but the actual multiplier was 2.46, a 13% decline in output led to a 32% decline in taxation revenues.

Rory O'Farrell said...

@ Michael Burke

The multiplier effect should be larger (than long term averages) in a recession (as there is plenty of slack, and less crowding out by government) which would help to explain your figures.

Michael Burke said...

Rory

Your are absolutely right.

the 3 conditions which most analysis suggest boost the multipliers above their (differing) long-run average estimates are:

large spare capacity

low rates

constraints on access to credit

All of these currently apply. Therefore it is no surprise to find that in the crisis, the multipliers turn out to be much higher than estimates of the average, both positively (reflation) and negatively (contraction)