The Irish Economy

This is very worrying.

Jim O’Leary had a piece yesterday in the Irish Times which was worth reading for a couple of reasons. First, he has a nice account of the incentives facing economic forecasters. Second, he draws attention to a truly astonishing forecast, or assumption, in the Central Bank’s recent Quarterly Bulletin: that, while domestic demand will collapse in 2009 (which makes sense: the Central Bank assumes that gross domestic expenditure will fall by 7.6%), our exports will only decline in volume by 0.7%. If true, this would obviously mute the overall fall in Irish GDP, and the Central Bank is forecasting a decline of just 4%.

Jim convincingly shows why the assumption regarding exports is implausible. Here are a few more facts. According to the CPB Netherlands Bureau for Economic Policy Analysis, the volume of world trade fell by 6% last November. That’s right: by 6%, in one month. US imports fell by 7.8%; Japanese exports fell by 10.8%.

The CPB cautions that monthly world trade figures are volatile, and that one should focus on moving averages. Of course, that becomes a less useful strategy when one has just passed the peak! More evidence of the extraordinarily rapid collapse in world trade comes from IATA, which reports that the volume of international cargo shipped by air was 22.6% lower in December 2008 than in December 2007 (HT Calculated Risk).

By way of comparison, the volume of world trade fell by a little more than a quarter over the 3 years 1929-1932.

As Jim says, it seems safe to assume that exports will contract by a lot more than the Central Bank is currently forecasting, and that the same will therefore be true of GDP and employment as well.

Paul Sweeney is today’s contributor to the Irish Times series: you can read his article here.

There is much in his article that would be commonly accepted across the economics profession. However, I discuss below a few points of potential disagreement.

His article seems to suggest that those who advocate cuts in public sector pay are necessarily against the elimination of tax breaks for businesses, farmers, property development etc .   Rather, I would think most of those who have written on public sector pay  would also agree with the elimination of most of these subsidies (see, for example, my own paper.)

He also argues that our low-ish international ranking in earnings means that labour costs are not a major problem. However, it is important to make a distinction between ‘movements along the labour demand curve’  and ’shifts in the labour demand curve’.    If we can boost productivity, we can raise wages and employment at the same time through an outward shift in labour demand.   Everyone is in favour of this, of course.  However, boosting productivity growth is complex and is really a medium-term process (few instantly effective policies).

However, at the current level of productivity, we can still raise employment by accepting a wage cut (a movement along the labour demand curve).  At a time of sharply rising unemployment, this seems like a sensible approach.

The article suggests that the economic model must “shift rapidly from Boston to Berlin: from the Anglo “shareholder value” system, to the European “stakeholder” model“.  It is certainly true that the crisis should lead to a deep and critical re-assessment of how we should regulate the banking sector and, more generally, the appropriate extent of government regulation across the economy. However, the recession is now getting to be as deep in Europe as in the United States, even if  the origin was American-made. The appropriate analytical framework also needs to be wider than ‘US v Europe’ in view of the rising share of world output that is generated by the emerging markets.

Finally, the article refers to ‘conservative economists’.  I am not sure exactly what he means by that term, but I doubt that the political preferences of academic economists can be easily inferred from their views on topics such as public sector pay.   It is possible to analytically conclude that public sector pay cuts would be a good idea for the overall economy, while holding a very diverse range of views concerning the appropriate level of redistribution in society and other dimensions that differentiate ‘conservatives’ from others.

In similar vein, the article suggests that a neoclassical approach to economics requires a belief in ‘efficient markets’.  This is at odds with the evolution of the profession, with much of the last two decades devoted to using neoclassical economics to analyse market failures (very long list of contributors).

I am interested in the readership’s opinions on how to increase the tax take in ways that respect the advice of Jean Baptiste Colbert (1619-83), finance minister to Louis XIV: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

Ireland can learn much from the new Mirrlees Report in the UK that commissioned studies from the world’s leading tax experts. See the material here.

It is also interesting / entertaining to read about some novel taxation strategies: taxes that vary with age, gender and height at least do not suffer from moral hazard, since it is quite difficult to change these personal attributes!

Alberto Alesina’s propsal to condition tax rates on gender is explained here.

The logic of conditioning tax rates on age is explained in this post by Greg Mankiw.

His proposal to condition tax rates on height is explained here.

In this article in today’s Irish Times, I explain why EMU is neither a primary source of our current woes nor an obstacle to recovery.

Danny McCoy of IBEC is today’s contributor to the Irish Times series: you can read his contribution here.

My thanks to my Bruegel colleague Zsolt Darvas for an interesting set of charts showing GDP per capita in Purchasing Power Standards. If the European Commission’s projections pan out, living standards here will take a hit for sure, but it could be worse: We could live in Austria, Finland or Spain. Of course, GNP per capita is lower.

The Draft Partnership Pact referred to in today’s Irish Times states, in the section on “Stabilising the Financial and Banking Sector”, that government action will seek to  ”assist those who get into difficulties with their mortgages.  In early 2009 a new statutory Code of Practice in relation to mortgage arrears and home repossessions will be brought forward and the mortgage interest scheme will be reviewed”.  I’d be interested to hear people’s opinions on this.

Rossa White is today’s contributor to the Irish Times series: “The Time to Take Hard Decisions on Public Pay is Now“.

He concludes by advocating a new system that will avoid fiscal procyclicality in the future, through a ‘golden rule’ policy, plus the establishment of a rainy-day fund.

Institutional reform along these lines is highly important. Indeed, I post a link below to a 1998 article  I presented at Kenmare and published in the now-defunct Irish Banking Review, in which I advocate a similar approach.  However, I wonder about the political incentives to establish such institutional restraints on the conduct of fiscal policy. Again, the current crisis may provide the right environment for undertaking such reforms.

Philip R. Lane, “Irish Fiscal Policy under EMU,”  Irish Banking Review,  1998.

VOX has launched a new initiative that is intended to act as a central forum for an open-format discussion of the global crisis.  This promises to be quite interesting  (I am acting as moderator for the macroeconomics theme; Luigi Zingales on regulation;  Francesco Giavazzi on institutional reform; Dani Rodrik on development; and Richard Baldwin on open markets).  You can read more about it here.