Monday, 20 September 2010

Lessons from abroad

Michael Burke: There is an imminent danger with regard to government finances. The government and its supporters have repeatedly argued that their policy would have the following effects:- revive growth, correct government finances, bring down borrowing costs and prevent a disaster such as being excluded from financial markets like Greece/the IMF being called in.

In turn, each of the negative consequences they have warned of has come to pass, as a consequences of their policies. GNP growth (the bit that policy, not world trade, directly influences) continues to contract. Government finances continue to deteriorate. Borrowing costs continue to soar, so much that there is genuine concern about NTMA's forthcoming bond auction.

In a previous post, Michael Taft used the analogy of the Titanic heading for the iceberg . The government can see the iceberg, like the rest of us and its response? Full steam ahead....stoke the boilers with another €3bn. Mr Honohan says it should be more, as if concerned the iceberg should slip out of our course before we reach it.

What would be the result if the engines were thrown into reverse: instead of cuts there was increased spending? How would the economy, government finances and international markets look then? European experience might be useful.

One thing economies do have in common with large ships is that that they take time to respond to changes in direction. In particular, on the whole taxation revenues are a lagging indicator of activity- they are paid after the event, sometimes a long time afterwards. But we know that in Europe, or more accurately the Euro Area most governments increased their spending in response to the recession (many also increased their minimum wage too, just like the older textbooks said they should). The fruits of that policy can be seen in the 2nd half of last year and this.

Take the case of Spain. It had a sizeable fiscal stimulus in 2009 equivalent to 2.3% of GDP. This ECB publication details the bailouts in the EU. This was before it was strong-armed by the EU, the financial markets, the ratings agencies and the banking interests these both represent into cutting public spending. A very modest improvement in the economy has since taken place, but this contrasts with Ireland's continued contraction in GNP. Spain's central government deficit has almost halved in the first 7 months of this year as tax revenues have rebounded sharply. Because of this improvement, bond yields are falling in Spain even while they are rising here. 10yr yields in Spain are now more than 2% low than Irish yields having been the same earlier in the year, half that change having taken place in the last 4 weeks. Bond investors respond to those tax and deficit data.

Or France, where the stimulus was equivalent to 1% of GDP and the growth rebound has been more robust (partly because the measures have not yet been undone, as they have in Spain). The budget deficit is ¤100bn lower in the first 7 months of this year than last, a decline of 22.8%. And of course, yields are less than half of Irish yields.

Germany is the same, a fiscal stimulus of 1.4% of GDP and record growth in Q2. The Federal structure means that the time la for the improvement in government finances will be greater- both the spending was delayed as much of it devolved to regional Laender and the tax revenues will also be delayed. In any event the deficit is on course to widen to just 3.5% of GDP this year.

The same pattern is true all across those Euro Area economies where government spending was increased (as well as being the case in the US and Britain; the deficit is lower as a result of increased spending).

Now, whenever there is an attempt to draw lessons from international experience, the cry goes up that 'N is not Ireland'. Well of, course. Every concrete situation is a unique combination of general circumstances. Not two phenomenon are exactly alike- otherwise they would not be separate phenomenon. The objection usually boils down to two points. First is the issue of 'leakage', this economy's propensity to import. This has already been dealt with elsewhere, and 90% of Ireland's imports are inputs for production, and the value created from that is what accounts for its wealth-creation, including overwhelmingly its exports. The other objection as that Ireland's position in the markets is a function of its uniquely large bank bailout.

But this does not explain its unique status as remaining in (domestic) recession nor the fact that tax revenues continues to contract. The fact is, the bank bailout, which is a millstone, is not much correlated to yields either, since Greece had no bank bailout to speak of and Belgium- which had the next biggest bank bailout- has not come under any market pressure at all. Instead, it is the disastrous impact of fiscal policy on the economy and the effect that this has had on government finances which is the driving force behind the ongoing risis in Ireland.

It is indeed time to reverse course.


tom said...

Thanks for that Michael.

Interestingly it's notable how over the last few days, the mainstream media is increasingly making something approximating these very points.

I heard Emmet Oliver (of the indo) this morning make the point that it was the decreasing tax take that was the problem, and that you couldn't reduce the deficit by reducing the size of the economy and tax take.

Having spent two years cheering on austerity, could it be possible that they are now beginning to see that - whatever ideology says - the current scheme is simply not working.

Not that I have any hope they'll follow their own logic to any reasonable conclusion.

Antoin O Lachtnain said...

Reducing costs *can* reduce the gap between spending and income. It doesn't necessarily have that result though.

Much the same can be said about increasing taxation. You can't necessarily reduce the gap by increasing the taxation. You could just push more people into a welfare trap.

Borrowing will reduce the gap, but it just pushes the problem into the future. With the rate of growth likely to be half, or at best three-quarters of the cost of borrowing, any extra borrowing is going to be a major burden for the next generation to carry.

Ultimately, the thing that reduces the deficit is productivity and competitiveness.

SlĂ­ Eile said...

The line that for every 5 euro spent on say social welfare 2 euro is borrowed and 3 euros is brought in through tax misses the point: for every 3 euros brought in throught tax as % of GDP in Ireland 5 euros are raised as % of GDP on average across the EU27. It is possible to close the fiscal gap entirely through moving from a low-tax country to a mid-EU level one by (i) closing off tax reliefs and raising taxes on property and wealth and (ii) kick starting the economy thru a stimulus package paid for from the enormous case reserves in the NPRF and NTNMA holdings. AFter all we are assured that there is plenty of liquidity to avoid borrowing to recapitalise the zombie bank.

Michael Burke said...


Increasing the productive capacity of the economy is the function of investment - an is impossible withoutit. The problem is that in the OECD as a whole and in Ireland especially, investment continues to decline, down 8.1% in Q1. In fact the peak-to-trough decline in gross fixed capital formation more than accounts for the entire recession, €31.7bn in a GDP contraction of €24.6bn, and a GNP fall of €31.3bn.

Therefore what is required is a significant increase in government-directed investment, the private sector being unwillng to invest on its own account.

Your objection that the growth rate will be below the borrowing rate would be unanswerable- if it were true. But Fitzgerald et al show in their evaluation of the NDP that the returns to govt. investment vary between 14% to 18%, some way above the current austerity-induced borrowing rates.In addition tax revenues are elastic, they don't rise (or fall) in parallel to activity but at a far faster rate in both directions.

Sli Eile,

That line is indeed a complete distortion. More accurate to say that for ever €10 borrowed €5 is directly attributable to government austerity policy (the deficit was 7.2% of GDP before they started slash&burn and is now 14.3%). As European experience shows, they could have revived the economy and cut the deficit by increasing government spending. The failure to act in this way makes the responsibility of policy overwhelming.

Antoin O Lachtnain said...

It is news to me that the private sector is unwilling to invest in projects that can return 14-18 percent returns. I can assure you that they are.

I would be surprised to see a study showing that NDP projects 2007-2013 and planned projects beyond that are currently expected to return 14-18 percent returns.

You are suggesting centrally planned investment. You are almost unique in advocating this. Fidel Castro, not a man known for his neoliberal credentials says that system doesn't work, even in Cuba (

Even if there were any possibility of success, we do not have a civil service in place that would have the capacity to be able to plan and administer such a thing. How would the government ever practically go about actually picking the projects and executing them?

Michael Burke said...


your surprise might be lessened by reading the suggested analysis.

Antoin O Lachtnain said...

Are you referring to FitzGerald and Morgenroth's magnum opus "Ex-ante Evaluation of the Investment Priorities for the National Development Plan 2007-2013" or one of the others?

This was written four years ago and was predicated on completely different economic conditions. (See for instance Figure 4.7)

Even in that, I cannot find mention of the rate of return you suggest.

The report also strongly emphasises the importance of carrying out studies of the return from individual projects. This report is not a substitute for such investigations.

Michael Burke said...


pp.66-70 of the Mid-Term Evaluation shows that the returns vary between 14% and 18%.

You are right. The economic conditions now are now 'different'- much worse. But all serious research suggests that the returns to government investment are higher when the 'output gap' (spare capacity) is higher- government investment does not draw away from the private sector but boosts it. So too with low interest rates and constrained access to credit. All of which apply currently.

Antoin O Lachtnain said...


You are referring to a report about a Development plan and a set of projects which ended almost five years ago. The report itself was finalized almost seven years ago. It is completely out of date. We cannot relive the noughties.

I really do not think you understand what has happened. The world is a radically different place to what it was three years ago. The old Keynesian model of growth-at-all costs and relentless construction is over. We need to start considering the well-being of our people, rather than headlessly chasing the growth-god and amassing enormous, high-priced debt to foreign banks and corporations and dumping it on our children.

Michael Burke said...


Fitzgerald is not a 'Keynesian', still less Morgenroth, I think.

But the evidence of their evaluation is there for all to see.

As previously stated , the impact of investment increases in recessions, not decreases.