Wednesday, 13 October 2010

Leo Varadkar and Capital Programme Stimulus

Leo Varadkar has an interesting piece in the Sunday Business Post, available here.

Basically he suggests that we get the fiscal changes over quickly (basically in one or two budgets), and he proposes almost all the changes come about through cuts, rather than tax increases. With everything done people would supposedly have something to look forward to.

What is interesting is that he makes a clear distinction between capital and current spending (something that I think has been missing from the debate). To offset the damaging effects of contracting current spending, he proposes increasing capital spending.

I disagree with Leo Varadkar in putting all the changes on the expenditure side (I would put most of the emphasis on taxation, and increase inheritance tax significantly), but I do agree with the idea of distinguishing between current and capital expenditure and using capital spending to boost the economy while getting current spending back on track.

I suppose it is important to further refine the idea, by getting the structural deficit, rather than current deficit, back on track. This would mean that for the next few years we would still run a deficit on the current side as unemployment is above the structural norm, so we would pay higher levels of unemployment benefit, and also receive a lower tax take. This would be just the normal reaction of the 'automatic stabilisers'. A problem with targeting the structural deficit is that it is hard to calculate, and it is affected by the actions we take today. If we allow long term unemployment to fester, then we will have larger structural unemployment resulting in a need to have higher taxes, or lower spending over the long run. But if we improve our infrastructure and long term growth potential this means we can afford higher current spending today. But in debating our fiscal plans I think its important to clearly differential between the overall fiscal deficit, the current deficit and the structural deficit, and be patient in explaining to people their differences.

So overall I think it would be feasible to create a plan that:
1) Gets our structural deficit back on track in one or two budgets
2) Achieves this mainly through adjusting taxes (really I mean increases, but I may as well get in on the political jargon)
3) Offsets the negative effects by increased capital spending
4) Allow the citizens to vote on the plan so its implementation gains credibility with the bond markets.


Antoin O Lachtnain said...


What capital projects do you propose that we aren't already doing? It is really hard in practice to identify new capital projects that will provide a return proportionate to the cost of capital.What is the benefit of doing capital projects without a return if it requires cutting back on (say) mental health services or administrative staff in schools?

Rory O'Farrell said...

@ Antoin O Lachtnain

I specifically said I wouldn't target cutting current expenditure (such as mental health services or school budgets), but try close that gap through tax increases. The gap due to cyclical factors such as social welfare would be left to close automatically (but the speed would be boosted by the infrastructural spending).

There would be no point in substituting current expenditure for non-productive infrastructure. Luckily however the National Development Plan gives a menu of infrastructure projects to choose from.

I would simply accelerate this programme (but omit projects that we now think are unnecessary due to lower population growth and prioritise labour intensive projects). This would last at least two years, and give some time to think of other projects. When it comes to building infrastructure should we do it now when we are paying out dole money to builders, or wait for an economic recovery when such projects will add to inflation?

So far the government hasn't even spent the money that they committed to in the last budget on schools. Some of this is due to better value for projects, but much is just down to the government being overly tight.

Antoin O Lachtnain said...

I accept your point re cutting services, I misunderstood you a bit, or mixed your views up with the other guy.

But you are not taking into account the deflationary effect of tax increases. Tax cuts will make it harder for people to find money to invest in new ventures. Everybody says that small, innovative companies are where the growth has to come from. Do you think they are wrong, or how would you fund these small ventures?

I still can't see, and you haven't pointed out any significant project that could be added to the NDP which would provide a return on investment, even if we had a return to a medium level of growth. Even some of the projects in the NDP at the moment have a very questionable impact in the current situation as you rightly point out.

The government could and should spend money on schools a bit faster, and probably it should (though I haven't done the analysis myself). But I think we are getting to the core of the problem - the system of central control that we have is incapable of rapidly rolling out cost-efficient projects - . If you increase the money available, you won't necessarily improve the central control.

We seem to have become quite good at rolling out mega-projects like coast-to-coast motorway systems, but we have not figured out quite simple, pedestrian things like school capacity planning, and how to put new roofs on schools and replace leaky portacabins.

The following is not a comment on the rightness or wrongness of it, but if you put any proposal to the electorate which involved increasing taxes, whilst maintaining the same level of services, would absolutely fail to get any endorsement.

We actually have masses of 'hard' infrastructure now. I think we have to start making smarter use of them to improve quality of life and make life better. This requires intellectual expenditure rather than fiscal expenditure. I do not think we should expect to be able to resolve our problems using the economic levers alone.

Rory O'Farrell said...

I suppose the main projects that come to mind are transport, broadband, and buildings such as schools.

RE transport, I am living in Brussels and can basically get anywhere in the city within half an hour. If this were to be the case in Dublin it would surely boost productivity. Instead of being stressed after spending an hour driving to work, workers would arrive fresh and productive. I think the benefits of broadband are straight forward, and for school the financial return is not renting prefabs, which are expensive.

I think the main criticism of the capital stimulus plan is that there aren't enough projects ready to go (and I can blame the govt for not planning them back in '08, but 'we are where we are'). However I'm sure there must be €20bn of projects in the NDP that we can accelerate to do over the next two years.

You have a good point about centralising decision making. The most labour intensive projects (and best ones for a stimulus) are probably local level jobs like repairs to schools and hospitals (which also have a financial reward in terms of a stitch in time saves nine) rather than megaprojects. Perhaps create a small projects fund lodged in the Central Bank and allow schools borrow 'mortgages' from this government fund. I remember seeing how if schools were allowed take out a commercial mortgage they would actually save on paying for prefabs. Also I am happy with how Waterford City Council have used what little powers they have to create the short term jobs that will keep people ticking over during the recession.

Regarding innovation, I don't think most taxes are a problem as they are only taxed on the profits when they are successful. A bigger issue are government charges like stamp duty, and costs of lawyers when setting up a business. I think reducing the cost of advice of a lawyer is crucial, but the government won't move on that given the top 3 in government are lawyers. I would reduce most transaction taxes on real things like property, though not on things like financial shares.
Finally to help small businesses that do things for government I would reduce the credit period to under 2 weeks. This should boost their cashflow in a more effective way than the bank bailouts. Tax increases are deflationary, but I would argue that euro for euro they are less deflationary than spending cuts. But the increased capital spending would help offset the negative effects.

"harder for people to find money to invest in new ventures"
To be honest I have no confidence in the governments banking measure to increase lending. Maybe one thing the trade unions could do is to coordinate laid off workers, with help from local credit unions, pool their redundancy money to invest in their own companies. A few ex-Waterford Crystal people did this to continue producing crystal for tourists to Waterford, and in the past redundancy money was often the seed capital for small local businesses.

Antoin O Lachtnain said...

I agree that transport is a good thing to sort out. The problem is that our transport system is already grossly overcapitalized and more capital isn't really going to help. I have been going through the figures today for something else. (All the following are in 2009 money:

Capital employed in CIE (2002): EUR 1.3 billion
Capital employed in CIE (2009): EUR 2.8 billion

Number of passenger journeys (2002): 271.4m
Number of passenger journeys (2009): 251.7m

The problem is that we are essentially wasting money by investing it in the way we are currently doing. We have plenty of equipment and so on as it is, and we are getting no benefit out of it. The problem is that we aren't applying the capital correctly. That's an intellectual deficit, not a money deficit.

The problem isn't financial capital, it's intellectual capital.

Much the same goes for broadband, although it certainly needs money to come from somewhere to roll the thing out. it's still only EUR 2bn all-in though. And although it has taken a long time, private enterprise, in the form of UPC is putting in the money now. The Singapore sovreign wealth fund appears to be planning to put money into eircom to roll out a fiber infrastructure.

You are quite right about the seed capital issue in reference to banks. As a result, this seed capital has to come from ordinary people. Redundancy money is fine for the case you mentioned, but innovation businesses in general are unlikely to be in a situation to avail of this. Redundancy payments in high-tech industries are generally very low, because the years served is rarely more than 5 or 6. Trade unions have no relevance in these companies.

You are saying that tax-and-spend is less deflationary than keeping tax low. Can you really prove this or show this as a general case?

Ultimately you are saying that the government's civil servants know better how to invest money and extract a return than people do themselves. In the case of Ireland today, this is simply not true. This is not a generalized statement. It may well be true in Singapore, or in Brussels or somewhere else. But it is not true here and now in Dublin, Ireland, and that is part of our problem.

Rory O'Farrell said...

Regarding overcapitalisation/ bad use of capital, I suppose at least if we improve the tram network in Dublin we can sell off a lot of the buses. Relatively low tech solutions like off road bike paths would be fairly labour intensive, not need many imports and can be planned quickly. The government could tell each local authority they have X amount to spend on bike paths if they do it by 2011. As a general rule I'm more inclined towards these small projects than the megaprojects.

Regarding tax and spend, if I can find some good papers I'll post them. But I'll give a demonstration. If you give someone (or not take from someone) €1 in cash they will spend 25% on imports (I'm just making up the number, I've no idea the percentage of imports in consumer spending, but its less than the aggregate level anyway) so you get 75c of activity. However, if you pay someone €1 you first get that €1 worth of activity, and then they spend 25% of that on imports, so you get €1.75 worth of activity. An the multiplier continues for a bit. Also there is the distributional effect. Rich people save more, and a chunk of those savings are invested abroad, taking money from the Irish economy. Also, what richer people buy tends to be imported (e.g. a BMW versus a monthly bus ticket, or Champagne instead of Guinness).

As for govt knowing where to invest money. I think the government has a role to play in where to put the infrastructure, and though they missed out on broadband, they can get in on the next generation. But I wouldn't think they know where to invest money on the broad mass of investments that make up the economy (unfortunately it doesn't seem like the banks knew either). I would like to see a type of mutual bank for businesses, that is owned by its customers (the borrowers would all be businesses). I don't want to derail things by complaining about bank policy, but we have private banks and political involvement without responsibility, probably the worst combination.

A final point on the broad economy is that as a country we must export more or import less to pay off our public and private debts. Any stimulus measures the government takes shouldn't directly encourage importing more, like the car scrappage scheme did.

Antoin O Lachtnain said...

You cannot replace trams with buses. It won't work, because the density is too low in our cities. On the other hand, you could sell off the buses without building trams. All you have to do is improve the design and operation of the network. However, the public sector just doesn't have the capacity to do that. They have gotten consultants involved to replan the network, and still they are making a mess of it.

You can put all the budget you like for off-road bike tracks, but you cannot build one that is any way useful in 16 months, because there is too much consultation required and land may need to be taken. I am involved with getting a bus lane rolled out in Dublin at the moment, and even though it has been through public consultation and has been planned out, bureaucracy is not letting it get built. Anyway, the amount of money you can put into one of these projects is minimal. At 50,000 a mile, you could build 2000 miles of cycle lanes for 100m euros.

how could you structure a mutual bank for businesses? You would need at least 100m euros in capital to start at all. Where would you get that for a fairly risky venture?
it would be more accurate to say that wealthier people invest more, which is different from saving. The issue is how to get them to invest here, rather than elsewhere. Why not do this with tax incentives?

To follow through with your multiplier theory, when an Irish person spends money, they don't necessarily spend it on Bollie and Beemers. They might spend it on their children's education, or on medical care or countless other labour-intensive things. They might use it as equity to raise more money for a business project. Do these activities not create their own multipliers?

Tax on medium-high incomes in Ireland is not particularly low. The KPMG study mentioned recently on irish economy suggests that Ireland is in the middle quartiles on this score.

What we need is innovation and clever ideas - intellectual capital if you like. How will more building work stimulate that?

Michael Taft said...

On the narrow issue of tax increases vs. spending cuts, I would refer readers to the ESRI study (the 2nd in 18 months) that shows that tax increases are less deflationary and more effective at reducing the deficit. For every €1 billion tranches, income/property/carbon taxes deflate GNP by -0.1 to -0.3%. Cutting public wages/government consumption/capital spending deflates GNP by -0.4 to -1.0%. As a consequence, tax measures reduce the deficit by 0.4 to 0.6% while the numbers for deficit reduction ranges from 0.2 to 0.3%. Tax measures win out on this score (taxes on high income groups would be even less deflationary and more effective at reducing the deficit).

On the issue of investment, clearly there are problems with planning strucutres, processing and delivery, etc. It is a fairly opaque area of government spending. However, the necessity to invest remains. Ireland's infrastructural capacity is poor as ranked by a number of international bodies (which the National Competitiveness Council highlights). I would hold out three main projects: rolling out next generation broadband, a state-of-the-art waste and water system, and retrofitting energy deficient buildings to the highest possible rating. This involves acquiring new assets, replacing creaky ones, and upgradding current ones. All these would have very high demand-side impacts and positive long-term supply side impacts.

But Rory point is well taken. We tend to think in silver bullet mega progjects whereas wealth generation is, similiar to many private markets, a series of micro, small and medium-sized endeavours. This would be prime for local and regional authorities (I suspect, Rory, that much of what you may be referring to comes under the remit of sub-central government). Unfortunately, we have considerable institutional and planning deficieneis at local level. This suggests, just as Antoin refers to intellectual capital, that we need substantial reform in our institutional capital.

The ESRI paper can be found here:

IBEC has a number of good suggestions here:$file/Revisiting%20the%20NDP%20May%202010.pdf

Comhar has published a provacative paper here:

The CIC/RIAI submission is also worth a look:

And Fine Gael's NewERA also has some ideas:

These are just a sample of many of the ideas that are out there to get the economy moving again.

Antoin O Lachtnain said...

Thanks for the list of submissions, I will look at them later.

The building retrofit is by its nature a large number of small projects. As a matter of practicality, surely a tax break of some sort is the way to get this done fast,inexpensively and without bureaucracy? It could be monitored and certified in conjunction with the property tax survey, perhaps? We are lucky that we now have a gross oversupply of uniformly qualified BER surveyors ready and in place.

For broadband, a 300 euro tax credit for a private investor (or even householder) for every building connected to a fiber network, maybe more for rural premises? That would be 600m euros all-in. The private sector could provide the rest of the cost. It could be done through soviets, workers cooperatives, community partnerships, PLCs, local authorities or whatever body takes the initiative, just as long as it gets done to a sufficient standard.

For waste and water, it is more complicated, but not that much more complicated. I do not think megaprojects are the way to go (such as the one to bring water from the Shannon to Dublin). It seems clear to me that a large proportion of the yearly water needs in the cities could be met through rainwater and greywater harvesting. Properly coordinated, the harvesting tanks would also form a buffer for floods. Again, the way to do this is through tax breaks and rates remission. Again, the cost of doing this should not really be that much. Say the 5,000 largest premises in the country, spend 200,000 euros each per premises, you should get the result for 1 billion euros. By its nature, this kind of expenditure will be spread over five or so years.

No doubt some upgrading of the pipework is also needed, but this really isn't that expensive either now that labour and professional services are becoming reasonably priced. You could have a long and interesting debate about how the whole thing should be structured. But at the end of the day, you should be able to renew an awful lot of water pipe for a billion euros (that's a thousand euros per house for a million houses).

A tax break is still expenditure, just a different type of expenditure. You still have to tax someone else to get the money. But at least the government isn't in it alone.

Antoin O Lachtnain said...

This is the sort of business that fits well for Ireland

No amount of money invested will stimulate businesses like this. It's a matter of intellectual capital, which is obviously ephemeral and hard to understand.

Michael Brke said...


there is no reason to mystify the relationship between government spending and private business.

A. Govt. builds extension to school = private sector jobs, output, profits.

B. Govt. cuts building programme = private sector loses jobs output and profits

A= higher tax revenues, lower welfare payments; deficit narrows

B= lower tax returns, increased welfare payments; deficit widens

Antoin O Lachtnain said...

So then we can have higher tax revenues, higher public spending and keep tax rates low? And we can do this into the long term?

I think you are oversimplifying things.

Rory O'Farrell said...

@ Antoin O Lachtnain

I do think tax rates have to increase (especially inheritance tax).

You said something about multipliers from investment. True, but still the first round effect is higher for spending. Also saving does not automatically equal investment. Its very hard for private firms to get finance due to the state of the banking sector, so the public sector can take up the slack for two or three years. They can take the money from the pension reserve fund.

You raise some points about intellectual capital. The original post was just about the budget, and getting the structural deficit on track, so I don't really want to stray too far from that topic. The intellectual capital thing is a longer term solution. I wonder what effect Transition Year in schools has on entrepreneurship. We can't really 'plan' for innovation, but we can set a framework by having a financial system that works properly, have a simple bureaucracy (which compared to Belgium we have), have an educated workforce. The biggest problem I think is that management ability in Ireland is mediocre, but this problem is largely ignored. But I don't think these are issues for the budget, but they can be dealt with by other government bills.

Antoin said...

Investing is an active pursuit, saving is passive. We are turning from a nation of downward into a nation of savers. We need to turn into a nation of investors.

What is wrong with spending the money through tax incentives for people who invest in national infrastructure? This would have at least as much of a multiplier effect as the TASC-proposed scheme to use taxpayer money ito prop up SMEs that politicians and civil servants liked, without any prospect of a meaningful return.

You say I am going beyond budget issues. For sure, I am. But it is being dragged off into giving the government a bigger role in allocating ever scarcer capital even though it has no capability, claimed, proven, attributed or otherwise to allocate the capital meaningfully for the types of project that are required.