Monday, 28 November 2011

Budget 2012 - Choices

Tom McDonnell: According to Eurostat, Ireland will have the lowest rate of gross fixed capital formation in the EU next year (see pages 68-69 of the pdf).

Fitch partially justified their downgrading of Portugal to junk status on the basis of Portugal's stygian and austerity related growth prospects. As austerity bites harder throughout Europe, the OECD is now forecasting the Eurozone and UK economies will enter recession again next year. In this context Tony Dolphin, the chief economist of the UK think-tank "the Institute for Public Policy Research" (IPPR), has released a short piece suggesting 10 ways to promote growth in the UK economy.

No one denies the Irish Government is heavily constrained in terms of its fiscal stance. However within those constraints the Government still has the ability to make choices. As Olli Rehn wrote today in the Irish Examiner:

“the programme leaves considerable policy discretion to the Government in terms of how to meet its key objectives. It is the Government, and not the so-called "troika", that is responsible for taking the key decisions that matter to the lives of Irish people.”

Ajai Chopra has expressed similar sentiments in the past.

Those who say we have no choices are not being honest. But has the Government chosen well?

The UK's Office of Budgetary Responsibility OBR has looked at the 'impact multipliers' of changes in different taxes and types of spending on growth.

OBR Estimates of fiscal multipliers - tax decreases/spending increases
- Changes in personal tax allowance and national insurance contributions 0.3
- Change in VAT 0.35
- Welfare measures 0.6
- Current spending 0.6
- Capital spending 1.0

What is crucial for policy is the relative efficacy of the measures. Changes in personal tax/social insurance are the least effective measures at stimulating growth while capital spending measures are the most effective. Of course capital spending has the additional advantage of adding to the economy's productive capacity over the longer term. See this discussion last year in the UK parliament on fiscal multipliers. Thus it was a curious decision by the Irish Government to choose to double the level of cuts to capital expenditure. Presumably this was to avoid the politically more difficult choices of increasing taxes and cutting current spending.

Best international evidence suggests the Irish Government's policy choice was the worst decision they could have made in terms of future economic growth and employment. For example see this IMF Position Paper on fiscal multipliers. The effects of the different policy measures can be seen in the Appendices of the document starting on page 22 of the pdf. The IMF paper shows capital spending to be the most effective measure for increasing growth.

Of course cuts to capital spending are politically easier than other choices. One wonders if political concerns are overriding sound economic policy. A lamentable start by the new Government.

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