Thursday, 28 June 2012

Splashing the water

Michael Taft: First there was Claiming our Future with its bold but common-sensical proposals to promote growth and equity in the economy. Now we have the Nevin Economic Research Institute (NERI) laying down a new fiscal framework to pursue such an alternative economic strategy. And it poses a real challenge to all progressives.

Some of us have just been working at the edges of the pond. For instance, some of us have argued for a freezing of current public expenditure at current levels up to 2015, substituting tax increases in place of spending cuts, and relying on an investment programme (mostly paid out of own resources) to increase our productive capacity in the medium-term. Of course, this approach accepts real cuts in the overall spending package (after inflation) but the argument is that savings on unemployment costs can be redirected into other areas of current spending. It still represents an expansionary fiscal platform, but a tight one.

NERI, however, runs past us all, jumps into the pond with both feet and starts splashing the water all around – including all over us. They, too, propose an expansionary programme but instead of freezing public spending, they want to increase it – increasing it to EU averages in the long-term. This would be combined with increasing government revenue to similar EU levels.

Let’s look at the differences – comparing Government projections, a ‘freeze-spending’ scenario, and NERI’s proposals. The following looks at overall spending minus interest payments – that is, primary expenditure.

As seen, while freezing spending would provide an additional €4.3 billion for current and capital spending above the Government’s projections, NERI’s proposals would provide an additional €9.8 billion. That’s a mighty sum.

The objections will be loud and voluminous – you’re adding to debt, you’re avoiding tough decisions (no one ever mentions avoiding bad decisions), you’re padding an already wasteful and inefficient public sector, etc. etc. and more etc.

But let’s briefly looks at some of the issues NERI’s proposals raise.

The first is whether you use GDP or GNP (or more properly GNI – which is GNP plus net EU payments) to measure spending. This is one of those bottom-less pit debates where consensus is almost impossible. I don’t intend to re-run the arguments here. However, it is worth noting that while Irish GDP per capita exceeds the EU-15 average, owing to the froth of multi-national accounting, Irish GNI per capita is about average. Average income, average spend – that’s NERI’s approach.

This suggests another approach to looking at expenditure. The following looks at Government spending on public services per capita. This is useful category given that overall spending can be skewered by pension expenditure in EU countries with a much older demographic.

Ireland would have to increase its spending on public services by €7.5 billion just to reach the average EU-levels. There’s doing more with less as the mantra goes; then there’s doing less with a lot less.

Second, NERI’s proposes to increase Government revenue to EU-15 averages. This would be a substantial sum. By 2017 it would mean €13 billion extra. I can hear a big gulp. But the important point here is that this doesn’t mean that this amount must be met by increasing current tax levels. Increasing growth and employment will make up a large part of this gap.

For instance, the Government intends to increase tax by €3 billion over the next three years. However, they project government revenue will increase by €7.5 billion. Growth will increase government revenue by nearly two-thirds; the fiscal adjustments will only account for a third. And that’s in a scenario where the Government is cutting investment and domestic demand. Imagine the increase in government revenue in a scenario where investment and domestic demand is increasing.

Third, the idea that public spending is a drain on public finances has been firmly established in the public debate by the austerity orthodoxy. NERI’s programme challenges this view.

For instance, the ESRI shows that increasing spending on public services by €1 billion (a combination of increased employment and wages) would mean an increase in the borrowing requirement of €580 million in the first year. Increasing income tax by €1 billion would reduce the borrowing requirement by €744 million. In other words, a straight one-for-one increase in income tax and spending on public services would result in a net reduction in the borrowing requirement.

This is not an argument that we can spend our way out of a recession. We can’t, we must invest. But it is an argument for a more sophisticated fiscal approach which uses a number of instruments in a carefully calibrated way. Increasing taxation beyond the economy’s capacity to absorb it (such as happened in the last few years) while increasing public spending without regard to productivity (which happened under Fianna Fail’s failed programme in the late 1970s) is a recipe for a real mess.
However, increased spending combined with similar increases in taxation can be a net boost to the economy and public finances. Imagine if we introduce a wealth tax and took the proceeds to roll-out an early childhood education network – that would be a boost in the short and long-term.

None of the above constitutes a ‘model’. There is still considerable work to be carried out. But there is considerable evidence to show that NERI’s programme would work, that Claiming our Future’s vision is achievable.

NERI has jumped into the pond and is splashing the water all around. I suggest we all follow suit. I have dipped my toe in. And the waters of an expansionary economic strategy are just fine.


Paul Hunt said...

I have commented elsehwere on this:

Damian said...

@ paul hunt

That’s all well and good, Paul - but the current financing structure in utilities as in health and other areas of the economy, is a legacy of a severe running down in investment by successive governments since the 1970s. They are also a legacy of a regressive taxation system that has focused on consumption taxes and levies rather than taxing income. OECD comparative tax data show that Ireland is a clear anomaly in this regard.
I know you are not keen on higher income taxes – but it seems a far more equitable way of removing the financing taxes you regard as so unjust and help finance and deliver a public infrastructure and service that is comparable to other European countries.

It seems odd to argue instead for a privatisation/financialisation of state assets when the main beneficiaries will be the usual bunch of investment banks and consultants...a model that has hardly proved its worth in other countries.

Paul Hunt said...


It's not that I am not keen on higher income taxes. It's simply the fact that changes in taxation require democratic consent and it proves very difficult to secure this consent - and to implement effective procedures to minimise tax avoidance and tax evasion - when taxes have been lowered for a considerable period and there is now a requirement to increase them. Paying tax is the most basic act of solidarity and increases in taxation require the strengthening of the national common bond that has been seriously frayed over the last 15 years. It will have to be done, but purusing the required reform of the tax system will prove economically and politically challenging.

And it's not that I regard these 'financing taxes' as unjust. They are - and are perhaps the most regressive form of taxation.

It is a little ironic, but rarely understood, that, despite the apparent, if waning, dominance of the US in many economic policy areas, the approach to the governance, ownership and regulation of infrastructure and utility businesses in most advanced and many emerging economies is largely determined by the initial approach established by UK governments in the 1980s.

Particularly for gas and electricity the UK policy, regulatory and market model has been, and is being, applied, with relatively limited modification, throughout the EU. As a result, its fundamental failings have been widely diffused and often amplified.

There are a number of these, but, in this context, a key failure was the prohibition on regulators having any effective control of the financial structure of the businesses they regulated. This, of course, perfectly suited the right-wing proponents of privatisation. They could extract equity and load the balance sheets up with debt. Which is precisely what they did - so that now most EU energy businesses do not have the balance sheet capability to finance the huge increase in investment the continent requires. So citizens, as both consumers and taxpayers, are on the hook. How long they'll take this pummelling, is anyone's guess.

In Ireland, this failure has been magnified in an almost surreal fashion. For the ESB and BGE, consumers have contributed, via the excessively high network revenues awarded by the CER, in final prices and in capital contributions, more than 75% of investment financing. The state hasn't contributed a red cent - either directly or via dividends forgone. This has allowed the ESB and BGE to have limited reliance on borrowings and to subsidise all sorts of green whizzo schemes and external acquisitions.

The latest effort by the CER to load any possible stranding of the gas interconnectors from Scotland on to suppliers and consumers:

is a perfect exampple of this anti-consumer and anti-economy lunacy.

But we wouldn't want to look too closely at this lest it lead to any damage to the style to which the managements, staff and unions of the ESB and BGE are accustomed. It's perfectly fine for citizens as consumers to continue contributing to this largesse. It may prove impossible to sustain this indefinitely. And when consumers wake and the dam breaks, a lot of nonsense will be washed away.

Damian said...

@ Paul Hunt,

I always thought the most ironic part of the UK privatisation model was that its biggest beneficiaries were the subsidiaries of French and German state-owned companies - who used the state guaranteed proceeds to finance investment in their own countries and offer rubbish customer services - a point the UK labour party appears to have belatedly realised.
Few would doubt the way the Irish state has run down investment - but my point is that this is widespread and not just confined to utilities networks - so financialisation/privatisation does not offer a solution.
I also don't buy your point on postponing tax reform - it reads nice but it is no excuse for policy inactivity. Public sector workers have already experienced significant reductions in take home pay - with limited democratic consent required - while there remains ample scope to increase effective corporate taxation rates. The latter could easily be used to shift the burden away from consumption taxes.

Paul Hunt said...

The German companies operating in the UK energy sector are privately owned - even if they are treated as 'national champions' by the German government. The French companies have some degree of state ownership and, yes, they are part of the incestuous business, policy, political tier at the top of the French system - and operate, in France, to keep their managements, staff and unions in the style to which they have become accustomed.

But their behaviour in the UK, if not exemplary, is far better than that of others - and they, like many others, suffer from profound dysfunction in UK energy policy and regulation. But they are far better than the carpet-bagging private equity ghouls - and other 'financila engineers' - who have hollowed out balance sheets.

I just can't see how the Irish state has 'run down investment'. Over=spent in some areas, misallocated it, financed it inefficiently, yes, but the NDP was spraying money during the bubble era with gay abandon. Telecoms investment was inadeqaute but most of the remaining semi-states subject to 'economic regulation' were able to spend without limit. And considerable physical evidence exists in the built environement.

There may be some requirement for additonal investment in schools and hospitals - but some rationalisation of existing facilities may be more in order - but the key areas that are identified are broadband, insulating houses and costly and unjustified green whizzo schemes that provide a paradise for subsidy junkies and rent-seekers.

And I'm not proposing that tax refrom be postponed. It's a quation of sequencing. Ireland can no longer afford to have a cost of living 15% higher than the EZ average. It is in the Government's power to close this gap rapidly. Then lots of things will be possible.

Damian said...

Paul, the problem with your argument is that many French state companies such do fine under what you describe as the "incestuous" French system; but it is wrong to say that their behaviour in the UK market is in any way exemplary - √Člectricit√© de France (EDF) has one of the worst customer service records of all UK utility companies. Whether this is a consequence of a dysfunctional UK regulatory model or a simple case of profit maximisation at the expense of customers I'm not sure. Others such as MTR (HK) appear to do well both in home and overseas markets.

On investment it would be wrong to assume that the so called bubble years are in any way representative of the Irish state's investment record since the 1970s. Data on health expenditure show that the state's direct contribution has declined even though expenditure itself has remained stable over the period. You have pointed out that the state has not invested directly in utilities - I’m not sure how this does not constitute a running down of state investment....

Regarding prices I wonder how much of the difference could be removed by reforming taxation since much of the difference is accounted by energy (Ireland is cheaper in other areas) and much of the base price is in any event determined externally?

Paul Hunt said...


I'm not sure if you're trying to be deliberately obtuse. I wrote that GdF's behvaiour is not exemplary, indeed far from it. They're all pretty obnoxious, but there are more obnoxious players.

And I just can't get how you can equate a failure of the state to finance directly investment in some semi-states with a running down of state investment. What has actually happened is that, particualrly for the the biggest spenders (both at home and abroad), the ESB and BGE, the state has used the CER to force final consumers to finance the lion's share of this investment.

But it appears that anyone in Ireland who would align them with the 'progressive' camp simply refuses to recognise this. This, quite simply is disngenuousness, dishonesty and hypocrisy of the first order.