Wednesday, 8 December 2010

Budget 2011: biggest fiscal consolidation ever

Paul Sweeney: The 2011 Budget is the biggest fiscal consolidation imposed by any government in the developed world since the Second World War. It dwarfs the consolidation under McSharry back in the late Eighties and far exceeds the biggest adjustment in another country - that of Denmark in the mid Eighties. We have heard of the Finnish adjustment after its exports collapsed with the fall of the Soviet Union in the early 1990s, but that was a fraction of this adjustment.

Based on a recent paper by Alesina, Carloni and Lecce, the following emerges. In terms of Ireland’s fiscal adjustment under McSharry, undoing the tax cuts and heavy public spending policies after the 1977 Election, the 4-year adjustment 1986-89 cumulatively was -4.82% of GDP and averaged -1.21%. Finland’s was a four year period of pain and was 6.23%. This averaged just over -1% a year over the six years, 1993-98.

The largest fiscal consolidation was in Denmark and it lasted 4 years between 1983 and 1986, averaging a savage -2.43% consolidation of cuts and tax rises a year.

So with the savage adjustment of €6bn in cuts with some tax rises, which is 4.7% of GNP (4% of GDP) Ireland’s Fianna Fail/Green Government wins the shocking economic prize as the world’s leading (lagging?) deflating government. The total adjustment is to be €29.6bn over the 6.5 years from mid 2008 to 2014 inclusive, (p 6 of Lenihan’s speech) or 23.3% of GNP in 2010 or 2011. The average will be somewhat less at a still massive 4.55% year from mid 2008 to end 2014. This is some pain to be inflicted upon the Irish people.

From a quick read of the EU’s 1st Review of the Greek Economic Adjustment Programme, it appears that the total consolidation will be 8% of GDP over 4 years and the IMF/EU MOU states that the will be 3.2% in 2011 (4.3% if carryovers from 2010 are added in).

As this is a blog post and written quickly, I suggest further study is undertaken by academic economists to see if this is correct and to develop it. It does seem that this Government is making economic history – for all the very wrong reasons!

“We all partied” say some in the commentariat and so we all must pay. Of course, that is untrue and many did not rise in the rising tide of the Domestically-Induced Boom of 2002-08.

But why should the poorest pay most, as per this incredibly regressive Budget? Of course, we may later have the ESRI or some body cited on this Budget to “prove” how progressive it is. But such a study will only examine some aspects of the total package, like income tax and welfare, and it will omit (by necessity of complexity), for example, various charges, indirect taxes, or the failure of Government to insist that the corporate sector step up to the plate in this deep crisis and contribute even 2% of profits (only profits made) which would contribute €630m a year to running this debt-ridden country, the one in which they are happy to operate in.

It was corporate Ireland – specifically the banks, which all but destroyed this economy. And these banks were “governed” by the heads of Ireland leading corporations, heads of public bodies, top advisors and lawyers from the big firms etc., as TASC’s “Mapping the Golden Circle” demonstrates. Thus when you hear calls for public sector reform, modify them to institutional or corporate reform for both public and private sectors.

Alesina et al’s paper is ironically called “The Electoral Consequences of Large Fiscal Adjustments. It is available on Alesina’s website at Harvard.
In this paper they also suggest that “tax-based adjustments” (over cuts) make it more difficult for incumbent governments to be reappointed when they implement large fiscal adjustments. Alesina is criticised on this important point of the supposed superiority of cuts over tax rises by others, including even the IMF in its recent Outlook paper.

Aleseni is often cited by proponents of cuts vs taxes. Lenihan’s Budget statement cites “economic theory” as supporting cuts over taxes. It is of course the liberal economic view, that is the view from a certain side of the house!

In my opinion, this Budget is perhaps the first Irish Budget to be so overtly informed, if that is not too flattering a word, in the language of liberal economic theory. Of course, all Irish Budgets since 1998 have been strong models of this perspective, moderated with some social democratic values. But it was largely the pro-cyclical, direct tax-cutting and de-regulation which led to Ireland’s economic Crash of 2008 and our downfall continues with this Budget.

Last year in his Budget, Mr Lenihan promised “we are on the road to recovery.” Yeah? He concluded by asserting that “our plan is working.” He then asserted that “We have turned the corner”. Green shoots? Where?

With the biggest deflationary Budget in the western world, with this saturation bombing, it will be many years before there are any “green shoots”.

1 comment:

SlĂ­ Eile said...

@Paul, I agree that the scale of this current deflationary adjustment is very large - and counter-productive. Factually, the 1976 cut by the then FG-LP Government in capital spending equal to 4 percentage points was possibly just as deflationary as the present single-year adjustment. However, given the global context as well as the cumulative effect of cuts since 2008 we are on a roller coaster of little recent historical parallel. The Winter 2009 ESRI QEC contains some analysis of the extent of deflationary shock up to that point. It would be instructive, indeed, to estimate the net deflationary impact of say €4.5bn, €6bn (or even larger if deemed necessary by the next Government-EU-IMF).
A further point worth considering is the multiplier impact of a given fiscal contraction. Over time, we would would expect GDP to decline by more than a one-off cut in spending or increase in taxes. Hence, a €30bn adjustment equal to€14.6 to date plus a planned €15bn could, other things equal, give rise to a cut of more than 20% in GDP. However, many other dynamics are involved including trade, private investment and consumption. The latter are particulary impacted by fiscal stance.