Sunday, 30 May 2010

Get thee to a calculator

Michael Taft: ‘One and one is what I’m telling you / get a pocket computer’

So sang Blondie. Deborah Harry might have been singing to whoever penned the latest Back Room article in the Sunday Business Post. Arguing that economic policy under a Fine Gael / Labour government would not be significantly different, the author goes on to write:

‘According to the Government’s own figures, the exchequer deficit will this year amount to €18.8 billion. Had the Government not already taken harsh budgetary steps, equivalent in total to €15.9 billion, our exchequer deficit would be a staggering €34.7 billion this year, or 27 percent of national income.’

Just when you think you’ve read it all, along comes someone to present us with a statement so devoid of understanding that all you can do is be amazed that this stuff actually gets published. If the government had not taken harsh steps would our deficit have risen to nearly €35 billion? Of course not; but don’t take my word for it – here’s what the Department of Finance had to say about the matter.

In their 2010 Pre-Budget Outlook, Finance projected the annual deficit for 2010 to 2013 in the absence of any fiscal correction from Budget 2010 onwards; in other words, if there were no tax increases and no spending cuts. This is what they came up with, as a percentage of GDP:

2010: - 14 percent (‘around’ as Finance puts it)
2011: - 13.7 percent
2012: - 12.2 percent
2013 - 10.5 percent

Finance was attempting to assess the deficit without €11 billion worth spending cuts and / or tax increases. You might have noticed that the deficit goes down. Indeed, if one extrapolates from the figures to estimate 2014 (Finance didn’t do 2014 because the EU Commission had yet to postpone the Maastricht target date), the deficit would be less than - 9 percent.

Amazing. Doing nothing would actually cut the deficit by nearly 40 percent. Yet our Back Room whiz has our deficit ballooning to 27 percent of GNP. To readjust the above figures, the deficit would fall from – 17.4 percent of GNP in 2010 to – 11.3 percent in 2014.

If anything, Finance under-estimates the decline in the deficit because they took a ‘static’ approach, which means they didn’t assess the impact of withdrawing the cuts and tax increases on the GDP. I discussed some of this here at the time of the publication.

So how did Back Room get a €35 billion figure? She/he merely totted up the amount of fiscal correction to date and added it to the current deficit. Of course, this ignores the deflationary and, at times, self-defeating impact of such correction.

First, tax increases reduce tax revenue in other streams (e.g. if you increase income levies, people have less money to spend and, consequently indirect taxes fall). In addition, tax increases reduce demand which leads to higher spending (unemployment costs) and reduced tax revenue through less business profits and tax on labour which has been cut.

Second, spending cuts act in the same way but as the ESRI has shown, they are even more damaging to the economy – spending cuts reduce tax revenue and increase unemployment costs more than tax increases.

Third, given that the GDP is reduced, the resulting deficit still remains high.

This is not an argument for doing nothing. Indeed, if one were forensic in tax increases (only on high income earners) and spending cuts (in areas that benefit high income earners), there would be less deflationary impact. And if that were combined with stimulus measures to generate employment and growth it would mean a faster falling deficit and overall debt. Faster than what the Government is trying to attempt.

But that these arguments are difficult to get across is evident when one has to read the type of stuff that Back Room churned out. For that is where our debate is at – an absolute inability to read the economy. And if you can’t read the economy, how are you going to fix it?


Donagh said...

It's not only the Dept of Finance and the ERSI that agree with you, and show the SBP backroom person to be talking rot. Finches does too:

"LONDON — Fitch Ratings cut Spain's credit rating on Friday, saying the government's efforts to reduce debt will weigh on economic growth in coming months — another blow to Prime Minister Jose Luis Rodriguez Zapatero's efforts to shore up confidence in state finances.

The ratings agency cut the country's rating one notch from AAA to AA plus, saying Zapatero's efforts to close the budget deficit "will materially reduce the rate of growth of the Spanish economy over the medium term."

The ratings agency decision echoes concerns from economists that efforts to cut state debt will also withdraw stimulus from the economy and hinder growth. Lower growth in turn means gathering less in tax revenues."

Anonymous said...

Pat Leahy is hack. His book 'Boomtime' is an absolute mess. Like his journalism, he makes stuff up, add quotes, keeps them anynomous and then expects everyone to believe him. He has a bee in his bonnet about anything resembling 'left wing ideology' and blind to the fact that he is, as Keynes would put it "the slave of many defunct economists" For Leahy, anything 'left' is ideology and anything McCreevy or the PDs did 'the choice of the electorate'. Hard to fathom why an excellent paper like the SBP keeps him on their accounts.

Michael Burke said...

If cuts = savings then the government has indeed prevented a far worse fate on the deficit.

But then a €35bn deficit would be equivalent to 125% of GDP (which has fallen by €28bn (or, as the govt.'s preferred measure, equivalent to 117% of GNP, which is down €30bn).

Not even Kim Il Jong can create an economy where the State accounts for 125% of GDP.

This is fantasy economics.

Any serious assessment of the government's fiscal policy would begin with its impact on the economy and only from that move on to assessment of both tax revenues and other government spending (eg. increased payments to the unemployed as you're creating more of them).

The back room is where dodgy businesses often cook the books. But this type of accounting wouldn't pass even the most distracted of tax inspectors.