Table 2.1 of the OECD’s recent survey of the Irish economy provides a sobering statistic: when the anticipated adjustment in the December budget is included, the total discretionary fiscal adjustment for 2010 implemented this year will add up to 6.4 percent of GDP. This is an extremely pro-cyclical fiscal policy by any standard. It is also occurring while other industrialised economies are applying discretionary fiscal stimulus. Unnerved as we all are by the escalation in debt and the rise in the risk premium, there seems to be broad agreement among academic and financial-sector economists that Ireland is different and has really no choice but to pursue this fiscal course. Maybe it is my unhealthy suspicion of too much consensus, but I think it is worth asking if the Irish case is really that different.
Borrowing loosely from Albert Hirschman, the arguments against a smaller discretionary contraction than being targeted in the budget might be divided into three: futility, perversity, and jeopardy.
Futility: Potential output has fallen
Few doubt that the property bubble led to a distorted picture on sustainable real incomes. The bubble drew in foreign capital, led to an over-appreciated real exchange rate, and ultimately real consumption wages that were divorced from productivity. Real consumption wages must now fall, with higher equilibrium unemployment the primary mechanism for inducing the necessary wage cuts and improvements in competitiveness.
Associated with the higher unemployment is a lower potential real GDP level (and with it lower real incomes). In its recent survey, the OECD has lowered its estimate of potential real GDP by 7 percent. If the slump was solely due to the fall in potential real GDP then it would indeed be ultimately futile to try to sustain demand. However, the OECD estimates a cumulative reduction in real GDP from it 2007 level of 13 percent by the end of 2010. (The the fall in real GNP is already more than 13 percent.) Earlier this year, the IMF estimated the output gap (the gap between real GDP and potential real GDP expressed as a percentage of potential) would be -5.7 percent for 2010. It seems likely the economy is now undershooting its much lowered potential.
Perversity: Expansionary fiscal contractions
I think most economists would agree the Irish economy is now operating below potential. But few support the “textbook prescription” of demand stimulus. The almost consensus view is that the Irish economy will make a faster recovery with a more front-loaded fiscal adjustment. The most natural line of support for this position is to invoke the possibility of an expansionary fiscal contraction, whereby fiscal contractions lead to an expansion in demand through a combination of small multipliers, expectations effects, and changes in the risk premium. I have found some of the commentary on this a bit confusing, however. There seems to be a pattern to argue that the expansionary fiscal contraction is not supported by the data – including the Irish experience of the 1980s – and then to argue on the basis of a vaguely defined confidence effect that it is better to front load the fiscal adjustment.
I actually find evidence for a weak version of the expansionary fiscal contraction argument reasonably compelling. This is the evidence that adjustments based on current expenditure cuts are less contractionary and their sustainability more credible than adjustments based on tax increases and capital expenditure cuts. This suggests a richer menu of fiscal policy options and in particular the possibility of designing a less contractionary fiscal package combining front-loaded current expenditure cuts with a measure of tax and capital expenditure stimulus.
Jeopardy: The risks of debt exposure
The third argument emphasises risks associated with a high and rapidly rising debt. Putting aside crude scare stories based on rising debt service costs, I take these arguments very seriously. Ireland is already paying 1.5 percentage points over German bonds, and a larger and faster rising debt will push up this premium. [See here (p.64)for a summary of findings on the links between deficits, debts and interest rates.]
But it is also important not to exaggerate the international bond market constraint. For one thing, the timing of the post-crisis jump in the risk premium is better explained by news on the size of the banking related contingent liabilities. While I’m open to being convinced, I do not share the presumption that a small open economy borrowing predominantly in its own currency (which happens to be the second most important currency in the world) faces a significantly tighter borrowing constraint than larger countries. Is the Irish situation so different from, say, the United Kingdom (estimated 2009 deficit = 14.5 percent of GDP) to warrant such a radically different fiscal prescription? (Philip Lane has made the argument that a difference between Ireland and the U.S. or the U.K. is that they control their own currencies. But countries that control their own currency have to convince markets that they won’t try to inflate away their debts. Being in the eurozone seems to me an advantage not a disadvantage here.)
Whatever the short-term deficit target, the government could be doing more to ease the long-term fiscal constraint. It was a mistake to effectively set aside the Report of the Commission on Taxation. A credible commitment to implement the proposed tax-broadening measures over a two- to five-year horizon would have improved perceptions of long-run solvency. Other possible measures to help build longer-term credibility include indexing future state pension retirement ages to life expectancy, putting in place a proper resolution regime for the banks, and a move to multi-annual budgets.
An additional argument for caution in running up the debt is the risk of negative shocks in the future. It is the combination of uncertainty and the irreversibility of debt that argues for a “wait and see” approach. On the other hand, the evidence suggests that today’s actual rise in unemployment could have long-lasting effects on equilibrium unemployment (e.g. see here). Irreversibility cuts both ways.
To sum up, while I very much share the concern about Ireland’s fiscal precariousness, I just can’t see how the case for such a severe pro-cyclical tightening as is being planned is so overwhelming as to justify the degree of consensus among academic and financial sector economists on the issue. Elsewhere, there is a very active debate among economists about the appropriate fiscal response to the crisis. Moreover, advocacy for fiscal stimulus does not seem to break down along a left-right divide in other countries the way it does here. On the merits of the policy issue, I remain to be convinced Ireland is that different.
22 replies on “Is Ireland That Different?”
Thank heavens! A debate at last maybe!
@ John Mchale
You are comparing Ireland to the wrong places. Irish economists should rely on comparisons to medium-large US states rather than to large nations with autonomous fiscal and monetary policy tools and less mobile populations. Ireland could be compared to New Jersey, for example. New Jersey also has pro-cyclical macroeconomic policies. New Jersey cannot devalue its currency, and if it raises income taxes unduly, its most productive citizens and the jobs that they create for New Jerseyans will flee to alternative jurisdictions. New Jersey is in much better shape than Ireland, but like Ireland it runs the risk of default if it borrows excessively in its “domestic” currency.
There has been a substantial improvement (as you know) in the data on Ireland. Most notably, since the April 2009 measures kicked in in May/June, unemployment has risen by an average of 0.1% per month, down from a rate of 0.5% p.m. in the previous months. This raises two obvious questions:
1. Why have such radical measures not deflated the economy more? In particular, the volume of retail sales is higher today than it was on Budget day! Given the scale of the withdrawal from the economy, why has domestic demand moved in line with the mass of other countries engaged in active fiscal policy? The difference between Irish contractionary policy vs Euro expansionism is around 5% of GDP!
2. Regardless of the last 4/5 months, if unemployment is after all close to a peak, given execution lags, has the time for fiscal expansion passed?
Interesting point. I do see the relevance of the comparison to states given Ireland’s relatively high degree of international mobility. Although I should have a rough sense of the relative degree of labour mobility into and out of Ireland relative to a typical US state, I must admit I don’t. Do you some figures at hand? My guess is the the flow rates will be considerably higher for a state like New Jersey. Even if the rates were comparable, I’m not sure that proves it is optimal not to use stabilising fiscal policy where you can. For the US, it is a second order issue where people end up living (you may disagree). I think the Irish public think its matters a great deal whether young people have to emigrate in order to earn a living.
I would distinguish between the signs of stabilisation and the fact that the economy seems to be operating well below potential. You are better placed to make forecasts, but I would think growth will continue to be weak, leaving the waste of a negative output gap (and associated excess unemployment) for some time. In any case, what is at issue here is really not fiscal stimulus as normally conceived, but the extent of additional fiscal contraction that will be imposed next year. Are you arguing that the underlying growth turnaround will be so strong that a discretionary fiscal contraction is the right policy from a countercyclical point of view?
You also raise an interesting question as to why the economy hasn’t deflated even more given the scale of the procyclical adjustment so far. I assume we seeing the effects of natural stablisation forces that come into play when as the economy falls well below potential (eventual limits to delays on spending, inventory rebuilding, automatic fiscal stabilisers, ???). At the moment, I would be very happy with something even approaching a neutral budget. As I argued in the post, I think this could only be pulled off without an adverse bond market reaction with a package that is tilted towards cuts in current expenditure and a serious attempt to put in place measures to increase the tax take and cut expenditure over the medium run.
Like the New Jersey analogy but would add the wrinkle that in general US states have strict budget balancing laws, so the risk of default applies not to outstanding bonded debt but to obligations to suppliers (California recently resorted to paying with IOUs, and others may follow suit). These state laws significantly undermine the Federal Govt’s efforts at countercyclical policy (for which there’s no counterpart in the euro area) but that’s another story ….
@John: jeopardy is what I would focus on. If our bonds were guaranteed by the European taxpayer I would be advocating different policies, but they are guaranteed by what was laughably referred to as ‘the financial might of the Irish state’ at the time of the bank guarantee.
So, I would not compare us with countries like the US or UK, with centuries of borrowing and paying back large sums of money behind them, with the capacity to borrow in their own currencies, and with the possibility of inflating those currencies if it came to that. In the context of those countries, I am 100% behind Blanchflower. I would compare us with other small countries without such advantages (borrowing in your own currency is in my view less useful if you don’t control the currency). The Reinhart Rogoff book suggests that sovereign debt crises are something you do have to worry about.
It is really important and valuable that you raise these issues and that we debate them properly. IMO the functioning of the sovereign debt markets is the key issue.
By the way, my own opinion for what it is worth is that this crisis has shown up a serious design flaw in EMU that we have all been aware of for a long time, namely the absence of a strong fiscal centre.
John – thank you for this thoughtful piece. Hopefully, we can start re-assessing the impact of fiscal measures on economic performance in a way that has been difficult at times given that the debate over the two has, at times, been detached. It is interesting to note that the latest ESRI Quarterly Review stated that if the €4 billion fiscal contraction didn’t proceed in the upcoming budget, the recession would end earlier and the economy would register overall growth next year. This is not to suggest we abandon consolidation measures next year, but it does suggest that more creative, considered strategies might be in order.
In terms of consolidation strategies – the ESRI’s fiscal multipliers published earlier this year suggest that a tax-based approach would be less deflationary, do far less damage to employment, and have more fiscal ‘kick’ in terms of net savings and reductions in the borrowing requirement than would current expenditure cuts. No doubt, fiscal consolidation will involve a little from all the columns but, again, we should take note of which is more productive and which is less.
Ronnie – I’m not so sure I would be as upbeat as you (though, for the sake of us all, I hope you’re right). The increase in the Live Register has slowed but as to exactly what is happening is less clear. Much of this could be due to rising emigration; unfortunately the data lags on this. Another factor could be those dropping out of the labour force or otherwise not showing up on the Live Register – such as those exhausting their period of benefit but not able to draw down allowance due to means-testing. In contrast, though the number of monthly redundancies has fallen from a peak level in June, they are still as high as in the first two months this year and much higher than the last three months of last year.
As to the deflationary impact, the EU estimates that Irish domestic demand will fall over the three years 2008-2010 by 20%; the Eurozone average fall will be 3%. Regarding private consumption, Irish rates will by over 10%; the Eurozone will fall by less than 1%. Those are big hits compared to European norms.
The Retail Sales Index shows that since the budget (and this includes the April numbers since the budget was launched in the first week) volume is down up to end-August. Value is down further with discounting attempting to sustain volume. While during the summer months there was some indication that retail sales were stabilising, it took another sharp drop in August – the latest month we have data for, and this was with the IKEA bump. The August monthly fall was the worst for this year, April being the only exception. I’m not sure we’re out of the woods on this one, yet – and Ministers talking up massive cuts and the spectre of the IMF, it is difficult to know how this will play on consumer psychology.
“As to the deflationary impact, the EU estimates that Irish domestic demand will fall over the three years 2008-2010 by 20%; the Eurozone average fall will be 3%. Regarding private consumption, Irish rates will by over 10%; the Eurozone will fall by less than 1%. Those are big hits compared to European norms.”
How much of that lost demand had been fuelled by consumer debt, do you think?
Such a debt-driven splurge is hardly sustainable, or something we should seek to maintain. It was pure bubble-froth and is never coming back, at least not for a generation.
@ John McHale
I thought this was a very useful contribution to the debate.
There is a case being made for Irish exceptionalism with regard to what is now an extreme pro-cyclical fiscal policy. Other have done so in some detail elsewhere on this blog. That policy is itself a mirror-image of an extreme pro-cyclical fiscal policy during the boom. This is to repeat a grievous error, not correct it. We should all know what two wrongs don’t make.
Yet this policy, not just the debate, is out of step with nearly all the other economies of the Euro Area. I have highlighted the fiscal relationary measures being take across the Euro Area elsewhere http://www.progressive-economy.ie/2009/11/guest-post-by-michael-burke-why-is-rest.html . And the context is one in which, in many respects, Ireland’s debt crisis is not qualitatively greater than those of other economies. I have used the example of Belgium (very open economy, debt over 100% of GDP, next biggest bank bailout ofter Ireland, which has raised taxes on banks, insurers and energy producers to curb the deficit, not cut wages and spending).
Some key points following on from your analysis:
* A rising output gap cries out for increased investment (where the private sector won’t the public sector should). This raises trend productivty and lowers real wages
* The multipliers are a given, but can work positively as well as negatively. Cuts do the latter, and continue to push the deficit target over the horizon. Investment, particularly in (much-needed) infrastrcture does the opposite.
* There is one area where Ireland IS and exception. The bailout is 232% of GDP, more than 4 times the next worstn4 Euro Area countries put together. The risk premium on Ireland’s debt is clearly a default risk premium and is associated with the huge size of the bank bailout. A removal of the bank guarantees in 2010 would see the risk premium (and Ireland’s large credit default swap spread) compress dramatically
* As elsehwere, the EU does not have a common fiscal policy. In the US there are automatic stabilisers via the Federal budget (especially unemployment benefits and the tax take) which kick in, which do not apply in the EU. Therefore an Irish pro-cyclical in a dowtnurn also contains the risk of a flight of the brightest and best (or at least the most mobile), all of them lost taxpayers. This only exacerbates the situation, making Ireland less attractive for FDI. That potential vicious circle is being avoided by virtually everyone else.
The balanced budget laws in US states enshrine pro-cyclical policies in boh phases of the cycle, which is why California is bust. Why would Ireland voluntarily go down that route?
Yeah, Ireland is different, or at least it is different to the UK.
1. Small economy
2. Open economy
3. In the euro – we can’t improve competitiveness by devaluing 25% the way sterling has or use inflation to reduce debt burdens. Still, at least our debt is in our own currency… oh, well apart from the stuff the NTMA is issuing in dollars.
4. History of net migration – when the going gets tough, the employable get going.
Compare us with Hungary or Iceland maybe, but the currency issue remains. Portugal? But they didn’t have a bubble like ours.
Besides which, just because the British are jumping under a bus, you think we should do too?
Well it strikes me that the terms like “severe pro-cyclical tightening” of fiscal policy embodies some notion of the cycle and potential output.
Most economists will start from the standpoints of the OECD or the IMF… with the judgement “Ireland’s potential output is likely to be permanently lower and recent developments call into question how much of the good performance over the most recent years was structural rather than cyclical.” (to quote the OECD country study)
Thus as the OECD says,
“Living standards are likely to be permanently lower”
That requires a sharp narrowing in the public deficit. I’d be looking for a far sharper, up-front adjustment that even e.g. John Fitzgerald argued for in Kenmare. It strikes me that many (including of course the government) are in denial about the hit to wealth and potential income. In this context, I find differences between between “structural” and “cyclical” deficits rather dubious.
Clearly Ireland is the different to the larger economies in that it is an SOE. That is a surprise for no one, but there is just a fleeting reference to it in the argument.
As pointed out above, Ireland also has a fixed exchange rate, and far worse, a large neighbour on its doorstep with beggar my neighbour currency depreciation (which NJ does not have). Moreover Ireland strong trade linkages to the UK and the US, and a large share of trade denominated in non EUR currencies.
Running a double digit public deficit in double figures strikes in this context as throwing good money after bad.
But the differences don’t just stop there. Ireland has taken a far bigger hit to its stock of wealth than most countries (far bigger than Belgium as cited above). It still has a highly protected domestic banking sector (unlike Belgium, and I see a call above for “a proper resolution regime for the banks”). It also has wage levels in some sectors and social welfare payments that are far in excess of European norms in real terms (as well as a number of other competitive disadvantages, but let me stop here).
This is all reflected in elevated debt rollover ratios for 2010, particularly elevated relative to the rest of Europe if guaranteed banking debt is included.
Yes right, the government could be doing more to ease the long-term fiscal constraint. It was a mistake to effectively set aside the Report of the Commission on Taxation.
For your information, California 5y CDS is trading 180bp, off from a year high of 350bp, while NJ is at 80bp (off from 225bp). I wouldn’t say there is no default risk here, and the IOUs (among other signs) that governments have been running up should be a salutary warning. Ireland 5y is at 140bp.
Kevin O’Rourke wrote “By the way, my own opinion for what it is worth is that this crisis has shown up a serious design flaw in EMU that we have all been aware of for a long time, namely the absence of a strong fiscal centre.”
EMU is much worse than that in its effects. The effect of EMU interest rates will be to drive Ireland from binge eating (1997 – 2007) to crash dieting (2008 – ???). Consider the impact over recent years of changes in inflation and unemployment rates in terms of the Taylor Rule.
Until 2008, Ireland had an unemployment rate below the Eurozone average and an inflation above the Eurozone average. The Taylor Rule implication of that was that EMU interest rates were too low for Ireland. That is – to my mind – the key explanation for Ireland’s credit boom from 1997 – 2007.
Consider the changed sitation today. Our unemployment rate is well above the Eurozone average while our inflation is well below it. The Taylor Rule implication of this is that interest rates that may be right for the Eurozone will be too high for Ireland. This situation is likely to last as long as Irish unemployment remains above the Eurozone average and our inflation remains below the Eurozone average: these conditions could last a decade.
EMU interest rates will therefore impart a deflationary impact to Ireland for several years. Pretty much the same scenario is unfolding in Spain.
To my mind John McHale’s arguments against pro-cyclical fiscal tightening at the current time, need to be seen in this light. A significant element of the growth in economic growth we experienced over the last decade was based on a credit bubble and is illusory. Notions that we can defend the fruits of such growth with fiscal measures are therefore misplaced.
Thanks to you all for the thoughtful repsonses. With a two-year old beside me demanding attention, please forgive some very partial responses where you have not managed to convince me.
Jeopardy is also the one that gives me most pause. But I’m not with you that Ireland would be more creditworthy if it was in control of its own currency and could inflate away the debt if need be. Putting myself in the shoes of an international investor, I would think that having the currency I am lending in effectively controlled by Germany a distinct plus. Now I do see that in the context of nominal rigidities not being able to devalue may lead to a larger output loss, which itself may reduce creditworthiness. But on balance I think that our current currency arrangements are a plus from borrowing point of view. I would also add that the alternative to the euro is likely to be some sort of pegged arrangement. We know how susceptible such arrangements are to currency crises. And the experience of recent decades has shown us that currency crises tend to go hand in hand with broader economic, financial and sovereign debt crises.
Thanks for the kind encouragement. I do recall from before that you are singularly unimpressed with my proposed composition of the adjustment. It is a pity that we don’t have better information on the key parameters in the calculation, including the relative size of the relevant multipliers so as to narrow our disagreement. I have seen the ESRI multiplier numbers and they do support your alternative composition. Maybe John FitzGearld or someone else from the ESRI can enlighten us as to how they are estimated. However, the recent work by Benetrix and Lane points to the relatively a relatively low multiplier for government wage consumption and a relatively high multiplier for government investment, with non-wage government consumption in the middle. As they authors note, however, these estimates are based on long time series and could be misleading in a recession. That is why I mainly turn to the literature on the effects of actual fiscal adjustment programmes (notably the work of Alesina and Perotti). While as ever the econometrics are not beyond reproach, their work does consistently show that adjustments based on current expenditure cuts are less contractionary and tend to be better sustained that adjustments based on tax rises and capital expenditure cuts. I hope you will believe when I say that I am not recommending an expenditure-based adjustment on ideological grounds, but rather I believe it is superior in terms of the macroeconomics. I recall hearing a quote from James Tobin that went something like: “It takes a lot of Harberger Triangles to fill and output gap.”
It is extremely useful to have the take an actual participant in the sovereign debt markets. But a couple of quibbles. First, I really tried to emphasise that I believe Ireland’s potential output is substantially lower than was previously believed. The OECD’s figure of 7 percent strikes me as plausible. But from everything we know about the dynamics of demand in recession there is good reason to think that output will overshoot on the downside leading to an output gap. Second, if I interpret you correctly, your main point about being an SOE is that the leakages associated with any domestic demand expansion are likely to be very high. One of the frustrations about about thinking about the Irish economy is that there seems to be huge uncertainty about even basic parameters. A key parameter here is the marginal propensity to import. My sense is that people tend to exaggerate how high it is given that imports are close to 90 percent of Irish GDP. But much of this reflects Ireland’s integration into global production chains — i.e a large amout of those imports are intermediate inputs. In a post some time back, I reported a simple first differences regression of imports on domestic demand where I also control of the level of exports (to crudely take account of the processing of intermediate imports). This suggests a MPI of about one quarter, which is high but hardly suggests the impotence of domestic demand. I don’t think we should be surprised at this given the importance of non-traded goods in the baskets of consumers in all countries.
You had me until the end. Your argument that ECB interest rates are too high based on a Taylor rule for Ireland suggests an economy operating below potential. While fiscal policy is an inferior stabilisation tool for dealing with an output gap, it is the only one we have. Yes, a significant part of the bubble growth is unsustainable — Colm McCarthy had it right with his warnings on 2007 nostalgia — but that does not mean we have not fallen below even a much lowered potential.
John – thanks for the follow up. I certainly don’t want to suggest that your preference for one type of consolidation strategy or another is premised on an ideological prejudice. Indeed, I note your statement ‘Moreover, advocacy for fiscal stimulus does not seem to break down along a left-right divide in other countries the way it does here’ and fully concur. In other countries there is a consensus between business and trade unions for the need of stimulus, though they may disagree on the composition. The same for fiscal consolidation – any arguments should be evidence-based, not only the composition but on the timing as well. I’m familiar with the Lane-Benetrix multipliers and they should be given more prominence in the debate (except that we don’t have a debate about stimulus). My understanding is that, during a recession, the multipliers could potentially be more positive. More work in this area would certainly be extremely useful. All this to say, your contribution has the potential to carve out a space where an evidence-based debate can be had on all options, a debate where partisanship and past differences are left outside the door and discussion revolves around what works. That surely is the best way to proceed.
School Marm – I’m not fully farmiliar with the composition of household debt. However, clearly such debt is high and is by and large made up of housing-related debt. As to non-housing debt, I’m not sure the level or international comparisons. I certainly would welcome any information that you or anyone else might have, or be able to direct me to. I would just point out, though, that private consumption is pretty average by international standards. The OECD records household consumption to be 56.2% of GDP, while in Ireland its 58.9%. I suspect the volume levels for Ireland would be lower given our high prices (one could run them through a PPP). You may be right – that our consumption was too bubble-froth. However, I’d like to see more of a breakdown and analysis before agreeing with you.
@John: I do think having their own currency to borrow in is a plus for the US or UK. I don’t think it would be a plus for us necessarily, size matters here, but also reputation, which depends on history.
This is a very good thread. Seeing as €4 Bn comes nowhere near closing the actual deficit it is probably partly
(A) Cutting the structural deficit while praying for recovery,
(B) Symbolic act to give confidence to markets,
while not actually drastically deflating.
Given their record of utter failure it would be very difficult for the government to change course without losing all credibility – even if they should.
We should have a once-off statutory cut in private sector wage levels as well as competition measures.
Instead we will have to hope that low interest rates and a strong international recovery will see us through before the debt goes too high.
In the mean time a whole world of misery caused by FF, the Department of Finance and the regulators.
@ Kevin O’Rourke
It is not the case that either the US or the UK have an unvarnished reptutaton regarding management of their debt. The history of both is littered with episodes, both minor and major of debt, crises (collapse of Bretton Woods, 1994 bond crisis, UK IMF bailout in 1970s, etc.).
In fact, the whole issue is posed incorrectly. Neither US nor UK are benchmark yields in the sense of being the lowest. That honour belongs to Japan, despite a govt. debt level over 200% of GDP (more than double the worst forecasts for Ireland). The reason is a high domestic savings level to underpin it.
How to increase domestic savings? Not by reducing the private sector financial surplus via austerity measures, but by increasing its surplus through a revival of growth, ie reflation.
@ Ciaran O’Hagan
The arguments about the (undoubted) begger-my-neighbour policies of the UK and US would have greater force if it weren’t for the fact that there is clearly an inelasiticity of demand for Irish exports, as they have held up well compared to the slump in exports elsewhere, notably Germany and Japan.
And substituting that for a beggar-my-neighbour policy of competitive deflation in Ireland will only compound matters; if followed elsewhere a general disaster. If shunned elsewhere potentially leaving Ireland isolated in the EU (as well as exacerbating emigration).
Well, of course, all comparisons are lame and the crisis in Ireland needs to be analysed concretely. And, no, there is no example directly comparable to Ireland’s bank bailout-induced debt burden (232% of GDP). But Belgium (92% of GDP) comes closest of the Euro Area economes, and is a SOE. But, again, no wage cuts there.
@ John McHale & Michael Taft
Re: multipliers. In my view this is the most valuable part of the debate. The European Commission also places both a high and relatively high multiplier value on government investment (in the QUEST model), compared to all other fiscal stimuli. Now of course, it can (and probably will) be argued that this is an undifferentiated mass of EU economies over time, and not specifically the Irish patient, which would be true. But it might have as much bearing as a time series of one economy (Ireland) which has undergone a series of structural changes over the longer run.
In any event, for all their faults, most econometric models tend to be in agreement on the following:
* Govt. investment is the most efective form of fiscal stimulus
* All stumuli are more effective when interest rates are low
* All stimuli are more effective when access to private credit is hampered
Therefore, the best means of stimulating activity is govt. investment and there could hardly be a more propitious time to set the multipliers working positively than now.
There has been malinvestment. Banking, when unrestrained, degenerates into a Ponzi scheme. Bubbles occur in the investments made by borrowers.
Land price is way out of line with EU. Debt burden is being maintained and financed by public sector. As these competitive factors are higher than necessary, due to vested interests, the other factors, wages, prices etc must deflate more than otherwise normal.
Procyclical is the result! Ireland is being turned into a Switzerland? We are doubling our stake in banking at the wrong time in the Kondratieff cycle.
Your (slightly) contrarian stance is refreshing and useful. In the thread (http://www.irisheconomy.ie/index.php/2009/11/04/the-benefits-of-increased-investment-and-efficiency-in-public-infrastructure-and-utilities/) which Richard Tol kindly provided me with the opportunity to kick off, my focus is on stripping out the rents and inefficiencies in the sheltered sectors which have increased in scale during the false boom.
In my view the primary benefit of stripping out these rents and inefficiencies is to reduce the impact on domestic consumer expenditure of the contractionary fiscal consolidation that is inevitable and to enhance the competitiveness of the tradable sectors. A balanced and sustainable recovery requires growth in both consumer expenditure and exports.
But there are additional benefits of stripping out inefficiencies, particularly in the state-owned sectors. Stripping out these inefficiencies requires major restructuring of the finances of these businesses. Up to €15 billion of equity is locked into these semi-states – much of it contributed by consumers via excessively high point-of-use charges – and it generates a rate of return well below the Government’s current cost of funds.
Unlocking this equity would provide a clear and welcome signal to the international capital market about the seriousness of the Government’s intent to achieve fiscal stabilisation. It would greatly enhance the Government’s room for fiscal manoeuvre and it would provide investment opportunities for domestic (e.g., pension and insurance funds) and external providers of capital.
I’m not suggesting that the proceeds of this very necessary restructuring should be invested willy-nilly in “famine follies”, but it should provide scope for targetted investment in infrastructure and utility services that will enhance economic performance and for the support of ALMPs.
Timely IMF monitor on fiscal developments:
We should follow the example of that country that managed a 20% turnaround in 13 years by lowering spending in real terms year on year…