Wednesday, 14 July 2010

The future looks like the past

Michael Burke: The latest ESRI Quartely Report is just published. Coincidentally, it follows hard on the heels of a piece by Paul Krugman in the New York Times arguing that, with inflation below the Fed's target and policymakers passive, there is a danger of debt/deflation.

In this economy, there is no criticism that policymakers have been passive. They have been hyper-active in withdrawing demand from the economy during a recession, four budget packages and more threatened, just as they were responsible for stoking demand in the midst of a boom. As a result, now there isn't a danger of deflation - there is the reality.

In the ESRI Report, the data and forecasts provide a sharp warning about the dangers of debt/deflation. According to the ESRI analysts, the GDP price deflator fell by 4% in 2009 (p.8, Table A) and is forecast to fall by 0.75% again in 2010 (p.9 Table A). But the problems go deeper than that.

The export sector is largely untaxed, and in any event provides few jobs. We therefore have to look to GNP for both. But GNP is expected to decline once more, despite the much-vaunted recovery by 0.6% (p.10 Table A), leading to a further cntraction in employment in both this year and next. Worse, because of continuing deflation, the value of GNP is forecast to fall by 2.6%.

Why does this matter? The importance of these deflationary trends concentrated in the domestic economy is clear if we consider the amount of ¤ produced. In 2008 the monetary value of GNP was €154.7bn but by the end of this year it will under ESRI forecasts have contracted to €128.7bn. In 2007 it was €162.9bn. That is a cumulative fall of 21%. A Depression.


This highlights the risk of debt/deflation: anyone, individual, business or government, that borrowed an existing debt in 2007 or before still has to service the same debt and at some point repay it. Only, on average, the current incomes to service that, and the income to repay it, have fallen by 21%. The debt burden is getting much heavier.

The entirety of government policy is said to be focused on cutting its own deficit. But because of the policy-induced Depression, it is actually rising. In terms of the General Governemtn Balance (the Maastricht definition of the deficit) the ESRI forecasts that the deficit will widen to €31.3bn this year, or 19.75% of GDP. That's up from €13.2bn as recently as 2008, and a small surplus in 2007.

The ESRI does say it expects the deficit to fall in 2011. There is an assumption that there will be no further bank bailouts, so the the 'underlying deficit' will decline from 11.5% of GDP to 10.5%. However, this last forecast is premised on the idea that a 'full package of €3bn in austerity measures' is implemented in full.

But we have been here before with the ESRI. They assumed as much in the Spring 2009 Report, argung for the full implementation of €4bn spending cuts and tax increases, plus €750mn in capital spending cuts. And what was the verdict? If we take only the Exchequer budget balance, leaving aside all the bailouts, the ESRI assumed then that the deficits would be €25.7bn and €19.3bn in 2009 and 2010 respectively. The oututurn and forecast for those two years is now estmated and forecast by the ESRI to be ¤24.6bn and ¤17.6bn respectively. That is a 'saving' of €1.1bn and €1.7bn, versus total Budget measures equivalent to €17.6bn once this year's measures are included (which ESRI does). It only 'works' at all because of resumed mass emigration lightening the welfare bill, at a cost of the long-term capacity of the economy and an increased dependency age of its poplation.

And the stock of debt keeps rising as the deficit remains stubbornly high, interestpayments mount and the GDP denominator declines, from 25.1% in 2007 to a forecast of 93.5% in 2011.


The main problem in the economy remains the slump in investment. Gross fixed capital formation has fallen by €31.7bn from its peak. This accounts for more than either the decline in GDP or GNP during the recession. It is down for 12 consecutive quarters, falling again in Q1, down 30% from Q1 2009. The ESRI is forecasting that it will fall by a further 24% in 2010 (p.10, Table A). This would leave investment at just 12.5% of GDP. By comparison, even with the slump in investment elsewhere, the OECD average investment rate in Q4 2009 was 18.4% of GDP, and is expected to pick up somewhat later in the course of this year. At this rate, the genuine MNCs based here might have to reconsider their position.

If the ruling ideology bore any relation to reality, this could not be happening. 'Expansonary Fiscal Contractions', 'crowding in' and similar nonsense are premised on the idea that, as government withdraws from economic activity, the private sector would fill the gap, and more efficiently. It is doing neither. It is further argued that cutting government spending, both current spending and capital spending will reduce the deficit and the debt. But the decline in the deficit still remains next year's forecast away and the debt continues to climb. Meanwhile hundreds of thousands of Irish women and men are not working.

Neither is policy.

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