Monday, 13 December 2010

Beware economists bearing models

The following is abridged from a post that appears on Notes on the Front. See also Nat O'Connor's post here.
Michael Taft: So the 2011 budget is reasonably progressive. Indeed, budgets over the last two years have been reasonably progressive. And to prove all this, the ESRI researchers ran the numbers through their Switch tax/benefit model. It tells some useful things.

But does it tell us how the 2011 budget impacted on people’s living standards? No.

A major omission in the ESRI model is that it assumes disposable income is, by implication, equivalent to ‘living standards’. For instance, they claim that the top quintile experienced a -2.7 percent fall in their disposable income, while the bottom quintile experienced a -2.8 percent. Okay, not progressive; just neutral. But is it?

Out of our disposable incomes we must pay for necessities that we may have little cost-control over. For instance, we need housing, food, electricity, gas, telephone, etc. Therefore, our disposable (after-tax) income can be broken into two elements:

• Non-discretionary disposable income – which is spent on necessities which we have little cost-control over.

• Discretionary disposable income – the amount after both tax and necessities.

The CSO’s Household Budget Survey 2005 puts some numbers on this distinction (the following is indicative - a new Survey will be out soon). And I take only three necessities: housing, food and utilities (fuel, light and fixed-line telephone). We find:

• The bottom quintile spends approximately 58 percent on these necessities (or non-discretionary disposable income).

• The top quintile spends approximately 22.2 percent

So what happens when we apply the ESRI’s fall in disposable incomes to ‘discretionary disposable income’ (that is, after payments for necessities are made)?

The bottom quintile experiences a fall of approximately -6.5 percent while the top quintile is only hit for -3.5 percent.

Even this doesn’t fully measure living standards. A household with surplus income will more easily absorb a fall in disposable income than those who have a deficit (i.e. spends more than they take in).

Again, the Household Budget Survey shows that the poorest households experience the worst deficit at -37 percent; the highest income households had a surplus of 26 percent. High income households can easily absorb substantially higher falls in disposable income than the rest of the population without denting their life-styles.

These are other data must be integrated into any model if we are to get a more accurate measurement of budgetary impacts on living standards. In addition, we must take care to integrate ‘real-life’ wage and income increases. For instance, the CSO shows the decline in average weekly earnings over the last six quarters, 18 months:

• Management / Professionals: -1.1 percent
• Clerical / Secretarial: -6.2 percent
• Production workers: -6.6 percent

Add in the estimate increase in non-wage income next year (29 percent according to the ESRI) and we can see that those on high incomes have been able to protect their living standards (and in some cases, even enhance them) to a much greater extent than the vast majority of workers.

It is incumbent upon the ESRI to produce its full findings, rather than just a newspaper article. It cannot expect the public to accept its findings on faith. We have learned the harsh truth about models.

We know, for instance, that the Government’s model was flawed – fatally so. We also know the considerable limitations of the ESRI’s Hermes model, upon which researchers were actually suggesting only a few months ago, that the Irish economy could return to near full-employment by 2015. We know these were badly mistaken.

At the end of the day, the ESRI’s Switch model cannot tell us about impacts on living standards for it doesn’t seek to do so. It only gives us model-driven data to contribute one piece of a very large, more complex puzzle.

The ESRI started its article by asking the question: ‘Was Budget 2011 fair?’ After reading the article, we are no wiser.

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