Unpleasant Stimulus Arithmetic

One by-product of Paul Krugman’s latest intervention on Ireland is that it will provide further ammunition for the many people who believe the government should abandon fiscal austerity and provide a stimulus package of new spending to boost the economy. Stimulus advocates believe that budget cuts are self-defeating and that, by contrast, a stimulus package will pay for itself and actually improve our budgetary situation.

I know that the majority of Irish economists don’t agree with this idea but perhaps we’re not doing a very good job at communicating why, so here’s a brief explanation.

Like Krugman, I was in favour of the US stimulus package last year and believe he was correct that the stimulus should have been bigger. Here’s a document worth looking at: It’s the Obama administration’s own calculations of the effects of its stimulus package, written by White House economists Christina Romer and Jared Bernstein. Keep in mind that this is written by people who advocate stimulus.

Page 12 of the Romer-Bernstein paper sets out their assumed multipliers for spending and tax cuts.  They assume that a government purchases of 1% of GDP raise output by a peak amount of 1.57% after 8 quarters. Tax cuts have a lower multiplier of about one.

Now suppose for a second that these multipliers could be applied to the Irish case. The Irish government takes in about one-third of GDP in tax, so an increase of GDP of 1.57% would produce higher taxes equal to 0.33*1.57= 0.52% of GDP. In other words, the stimulus package would increase spending by 1% of GDP and increase tax revenues by 0.52% of GDP, so it would raise the deficit by 0.48% of GDP.

But, of course, Ireland is not the US and fiscal multipliers here will be smaller because much of the stimulus will be spent on stuff that is made in other countries. If you’re reading this, there’s a pretty good chance you’re familiar with the elementary multiplier formula 1 / 1-c, where c is the marginal propensity to consume. In the open economy case, this is 1/(1-c+m) where m is the marginal propensity to import. Stick in reasonable figures for Ireland and the US and you’ll see why our fiscal multipliers are likely to be far smaller.

These considerations mean that any attempt at fiscal stimulus will see the Irish budget deficit increase, not decrease. So what, I hear some of you say? We can pay back the debt over time. Well, you need to find someone to lend the money to you. Right now the bond market is very jittery about Ireland’s ability to pay back: For this reason, we’re paying three percent more on our debt than the Germans.  

And like it or not, bond market participants go along with the boring mainstream analysis I described above: They believe stimulus packages would raise the deficit. If they see the Irish government acting in a way that, rather than reducing the deficit, would raise it for a number of years, they will just pack it in. Borrowing rates would either rise enough to offset any positive effect of stimulus or the bond market would just give up on lending to Ireland altogether.

Note that this isn’t a neoconservative conspiracy—the average market participant will always adopt the mainstream analysis, which in this case just means believing that stimulus packages tend to raise budget deficits.

To sum up, stimulus packages tend to raise budget deficits. This is particularly true in small open economies like Ireland. With our current budgetary path looking barely sustainable to the international lenders, there is no room for a discretionary policy involving higher budget deficits.

By the way, it gives me no joy whatsoever to write this. I would love to be in a position to recommend fiscal stimulus. The vast majority of us dismal mainstream economists believe that fiscal policy should be counter-cyclical, so that deficits are run up during recessions and run down during expansions. We would love to be recommending stimulus programs. However, the extent of the fiscal mis-management of the country means that there’s no room to do this.

59 thoughts on “Unpleasant Stimulus Arithmetic”

  1. So in simple terms, if we had no constraints, we would not cut. Cuts will not help the economy grow, will not increase jobs or prevent job losses. But since we have a huge deficit and worse outgoings exceeding income, we are completely constrained, and must cut. Right?

    Just making sure I understand the full horror.

  2. Mr Krugmans obviously aware that he provides ideological fodder.
    I have been reading his nyt columns for over 10 years and he has become more political.
    He should stand for election rather than swing from the sidelines….

  3. “Trinity College Dublin finance lecturer Constantin Gurdgiev said that point of view (Krugman’s) ignored a key difference between Ireland and the United States.”

    “Tiny Ireland is one of the most open economies in the world, but it has no power to dictate to bond markets or print money. We simply do not wield anything like the kind of power to run up deficits and debts that America has,” he said. “America can spend its way out of problems. We cannot … So we must cut, and we must reassure our lenders.”

    http://www.nzherald.co.nz/government/news/article.cfm?c_id=49&objectid=10660077&ref=rss

  4. “Not since Ken Rogoff’s famous attack on Joe Stiglitz has the dismal science of economics provoked such pompous, self-important, personalised squabbling. Professors Paul Krugman and Niall Ferguson, of course, have form; they’ve been at it on and off for nearly a year now over the efficacy of deficit spending in fighting the downturn, and today they return to the fray.”

    http://blogs.telegraph.co.uk/finance/jeremywarner/100006939/krugman-versus-ferguson-round-two/

  5. Karl, Is there anything the government *can* do to promote growth and reduce unemployment? (Aside from cutting the deficit, which doesn’t really count)

  6. @Karl – well put, but I doubt the message is getting through to some people!

    Wolfgang Franz (of Uni Mannheim) writing in the Handelsblatt pulled Krugman up on the multipliers some weeks ago but Krugman preferred to ignore that (even though he responded to that article). He argued that the multiplier in Germany was about 1. While it might not be very neighbourly, in the context of full order books in core industries in Germany it is understandable why they are starting to reign in public spending.

  7. Karl,

    I’m delighted that there is some engagement with the idea of stimulus (I’d prefer to use the term investment, which is not a semantic difference alone).

    I should say at the outset, that I think that bringing down the deficit should be a key objective of policy. It’s just the current policy of cuts isn’t working. Investment will.

    Now, there are I think a number of flaws in your use of the US data(leaving aside that there are perfectly good data on the returns to Irish investment).

    1. But for now, let’s agree to using the 1.57% return. You assume that the tax return will be 33% of that, presumably on the grounds that taxes are approx. 33% of GDP.

    But that is a false premise. Taxes are elastic, rising and falling disproportionately with activity. In 2008-09 recession nominal GDP fell by €29.7bn (GNP the same), whereas tax revenues fell by €14.3bn, despite a series of tax increases in 2008/09 amounting to €5.9bn. (This doesn’t include the December 09 Budget). If, very conservatively, we estimate that only €2.7bn ‘worked’, that is brought in higher revenues, then the actual fall in taxation revenues would have been €17bn (14.3 + 2.7). Therefore the actual elasticity of taxation to a change in output was 57.2% (17/ 29.7)

    2. But you have omitted entirely another category government finances, namely expenditures. Government spending automatically rises as output falls, no matter how many are forced into emigration by welfare cuts. Over the same period of the recession, government spending rose, by €3.2bn. But there were also cuts to spending, especially welfare which totalled to €4.6bn. Let’s say, very conservatively, that these cuts amounted to actual savings of €2.8bn (of course advocates of the cuts say that they all work, but then these multipliers would get very big). As a result the negative impact on government expenditures from the recession is €6bn (3.2 + 2.8). So the sensitivity of outlays was 20.2% (6 / 29.7).

    Therefore the overall impact on both sides of government finances was 77.4%.

    3. Taking your earlier equation, and substituting an assumed 0.33 for a realised 0.774, the outcome would be 0.774 * 1.57 = 1.215% of GDP.

    But, without delving into the inadequacies of the Obama stimulus, which was better than inaction, it is clear that much of it was an inducement or stimulus to spend by others, either by households or by companies. The latter has not occured with business investment continung to decline. The more effective measure is government spending on its own account, through investment.

    Yet there is no need to use the US estmate. There is a large number of assessments of the multipliers attached to government in investment in this economy, especially but not exclusively in assessments of the NDP. Your colleagues, Philip Lane, John Fitzgerald, Edgar Morgenroth and others have produced some very detailed research in this area.

    They vary between 2 and 2.8. I will provide a link to them in a following post on this thread. But 0.774* 2 = 1.548.

    There is therefore no logic in the refusal to increase government investment (even worse to cut it). Current policy is forcing those multipliers to work in reverse, and so the deficit rises. Investment can close the deficit.

  8. Your stimulus argument is remarkably similar to Colm McCarthy’s about the car scrappage scheme – you’re suggesting it just results in a rise in imports – that all it does is send money out of the country.

    But surely it’s possible to focus the stimulus? If we can have a national agency to manage ‘assets’ couldn’t we have a national agency to manage infrastructure and put the multitudes of young unemployed men back to work fixing the country’s infrastructure?

    Isn’t it possible to spend stimulus money in a way that promotes employment here and buys goods and services produced here?

  9. @ dealga

    It would be hard to prevent the money leaving Ireland pretty quickly without breaking EU competition laws and tendering rules.

  10. @MarcusOC

    Well it occurred to me that given the current situation it should be easy enough to ensure Irish companies would win the majority of any such contracts fair and square.

    On the flipside a lot of EU rules are being ignored continent-wide at the moment.

  11. @ Conor Sullivan

    It could be argued that the Government is supporting employment by not reforming the public sector.

    It is also providing lots of money for research which also maybe seen in time as a welfare service for the better off.

    There are a great deal of so-called job incentives, and this week when Máire Geoghegan-Quinn announced nearly €6.4bn of European Commission investment in research and innovation for about 16,000 participants from research organisations, universities and industry, including about 3,000 SMEs, it occurred to me that it’s surely a great opportunity for fraud unless a lot of bureaucrats will be tasked to policewhat is not a simple area to keep track of.

    @ dealga

    The Dublin-Naas dualcarriageway was completed in 1968 and it took more than 40 years to complete a motorway to Cork.

    Our project management record has been a joke.

    People come up with a 1,001 ideas but shouldn’t we first have fundamental governance and administrative reform?

    The National Competitiveness Council again today referred to the ‘sheltered’ zones in the private sector. Why is so much rent-seeking still tolerated?

    In the recent ESRI QEC, the economists recommended that improving skills of some of the unemployed would be better than more spending on infrastructure.

    But what does that conjure up but the Black Hole of Calcutta known as FÁS.

    @ All

    What is striking about Krugman and local advocates of stimulus spending is that they do not try and enhance their case by proposing reforms that would reduce wasteful spending and insider privileges.

    For examples the unions defended bubble era costs including sham benchmarking while tens of thousands in the private sector were losing their jobs.

  12. Karl,
    thank you for your contribution in this area. As a reasonably well-educated, but not-an-economist, reader of this site I sometimes find the contribuitions on NAMA overwrought. In my limited understanding I would probably agree with your assessment on NAMA, but it is my understanding that our budget deficit is at least as important, if not more important.

    So, the issue of cuts versus stimulus is extremely important and discussions such as these contribute enormously to my understanding.

  13. @Michael

    I suppose in my naiveté I was making a presumption that beggars can’t be choosers and that the carrot of centrally managed stimulus spending would be accompanied by a stick to smack some vested interests around a bit.

  14. @ Michael Burke

    Agreed that it’s good to engage on this via discussing people’s positions in relation to key parameters.

    A couple of points I’d disagree with:

    1. Revenue elasticity: The huge decline in tax revenues relative to the decline in GDP represents the extraordinary fall off in asset-based revenues from stamp duty, capital gains etc. due to the property boom. These revenues will not reappear if the government engages in a stimulus program. I’d still be happier with one-third as a working approximation but it would be nice to see some detailed work on this.

    2. The collapse in the employment-intensive housing sector likely also means that your “automatic stabiliser expenditure” elasticity is too high — but it’s a good point that this needs to be factored in.

    3. On multipliers, forgive me for perhaps a US-centric approach on this but there has been far more reliable work done on the US than on Ireland. I think we can probably agree that Irish multipliers should be a good deal smaller than US multipliers (again, stick in figures for 1/(1-c+m) for a really basic starting point on that). Given that, your preferred figures of multipliers over 2 would put you on the extreme upper end in relation to US fiscal multipliers.

    All told, I don’t agree with the idea that stimulus programs will pay for themselves but I’m happy to debate the evidence about the key parameters involved.

  15. Karl – thanks for that post. It is critical to identify the distinct strategies that too often become confused when using the shorthand ‘stimulus’. If the term is used in the conventional sense – temporary interventionist strategies to substitute for declining private sector activity (consumption, employment, investment, etc.) until such time as markets return to normal – then there is considerable grounds for pessimism in the Irish context. It is difficult to identify what ‘normal’ we can return to? Asset bubble-led activity? Reliance on foreign capital that is far less job-dense than it was in the 1990s? Traditional domestic investment patterns? Davy’s analysis of investment over the last decade should give us pause on the latter (along with O’Riain and Honohan) .

    That is why Michael Burke is correct to point to an investment strategy as distinct from a conventional stimulus – a strategy highlighted by the TASC open letter in the Irish Times. We need to identify the infrastructural weaknesses in the economy of which there are many (physical, social, income / wealth distribution, indigenous enterprise, sustainability, etc.) and develop appropriate strategies. This will require a complex set of policy interventions – but at the heart of all these is investment.

    An investment strategy to modernise our economic base would be necessary regardless of the recession. So all that is being asked for is to do what we need to do in any event. The advantage of doing it now is that it would have an extremely high demand-side impact (employment, consumption, GNP growth, etc.) while maintaining supply-side benefits over the years. In this respect, the multipliers developed by the ESRI and Lane-Benetrix are helpful tools. But we do need more data and research.

    The issue of accumulating resources for investment is, of course, bound by our fiscal situation (a situation not helped by deflationary fiscal strategies). But that shouldn’t lead to defeatism. It would be helpful to distinguish between fiscal austerity (which would appear deflationary in principle, though I’m open to alternative takes) and fiscal consolidation. The latter merely suggests aligning spending and taxation; it is silent on the level at which that consolidation should take place. If we want to consolidate at the Government’s proposed level – to maintain a low-tax, low-spend (ex interest) economy – we will not find the investment resources. However, Prof. Fitzgerald gave a personal preference in an ESRI paper that in the long-term consolidation should converge at the EU average (i.e 45% of GDP). That would give us some space.

    If we are agreed on the need to repair our economic deficits, and that investment can help (knowing that this can make an important contribution to employment and growth), then the difficult issues of where to identify the resources for that investment should be a pragmatic discourse.

    It would be unfortunate if the debate divided into ‘pro-austerity’ vs. ‘pro-stimulus’ camps – when the issues are much broader than that.

  16. My understanding of the US situation is that if the dollar weren’t the world’s reserve currency they wouldn’t get away with the non austerity approach The Monthly Review has some excellent articles on the relentless growth in US debt, both public and private, since the 70s. Anyone on here interested in Marxist economics ?

    http://www.monthlyreview.org/1106fmagdoff.htm

    The US still needs to deleverage and the process has barely started. Ireland has no choice other than to deleverage. It doesn’t taste nice but is there any other medicine?

  17. I am glad Karl Whelan has spelled this out.

    I wish Mr. Krugman, as one of the more influential economists in the world, would stop using us as a speaking aid.

    It is crystal clear that Mr. Krugman does not worry about the impact of his pronouncements on us, and I guess there is no reason why he should. However, his comments can have a negative effect of themselves. Perhaps he could pay us less attention for a while?

    Is Brian Lucey in coreespondence with him by any chance? His views on the prevalence of cronyism in Ireland during the bubble seem very Luceyesque. Perhaps BL could suggest to PK that he use other countries for his amusement.

  18. “Is Brian Lucey in coreespondence with him by any chance? His views on the prevalence of cronyism in Ireland during the bubble seem very Luceyesque. Perhaps BL could suggest to PK that he use other countries for his amusement.”
    My Nobel laureate contacts are more in the finance side of things Zhou. For what it’s worth, sitting in the evening sun in montebudello dreading

  19. From a peak of c €38BN fixed capital formation this year may come in around €7 – 8BN. Using comparatives v GDP and given the infrastructutral deficit the steady state should lie around €16 – 18BN. Given this collapse in demand 1) there is large capacity in the construction industry to deliver – prices are 30% off peak and there is value in the market. & 2) We are far off the level of activity that should be expected for a market of this size

    We have a road building programme that is going to be stretched out. We have a school building programme that takes an age to get kids in seats. We have a PPP programme that cannot get a deal to financial close (or can but very slowly). We have waste to energy projects that cannot start. How can this be quickened up?

    From a position where we had a construction industry with capacity to deliver and capability to match we have now the situation where as the solution to lack of Ireland demand Enterprise Ireland is promoting undercapitalised Irish Construction and Design companies to target international growth against better capitalised and in place competitiors as a survival strategy. The nature of the sector requires a presence in the international countries to deliver with much of the salaries staying in the local economies and tax paid locally – how does this hugely assist the stimulation of Irish jobs. In may cases the Irish company may just breakeven on the business development costs of chasing the international work.

    What is being done not to create jobs in this sector in Ireland but sustain jobs in the sector so that some capacity is retained. There is a senario where in 12 months time a further 50% of capacity disappears from the sector given the current lack of new projects on site or at concept stage.

    I have an interest being employed in the sector but before the masses criticise the mess that builders go us in to consider how we are all doing in the absence of the tax receipts that the construction activity generated and the fact that we (the construction industry) generated alot of tax revenue for the Government.

    There needs to be some kind of investment strategy and acceleration of spend – starting on filling the potholes might be a good place to start.

  20. “Is Brian Lucey in coreespondence with him by any chance? His views on the prevalence of cronyism in Ireland during the bubble seem very Luceyesque. Perhaps BL could suggest to PK that he use other countries for his amusement.”
    My Nobel laureate contacts are more in the finance side of things Zhou. For what it’s worth, sitting in the evening sun in
    dreading Sunday I’m more with Karl who’s a damned good macroeconomist.

  21. Karl

    thanks for the reply.

    On Multipliers first:

    Philip Lane’s multiplier estimates for a one-off increase in govt. invesment = 1% of GDP for this economy are as follows:

    Yr 1: 1.24, Yr 2: 1.61 Yr 3: 0.51 Yr 4: 0.43 Yr 5: 0.16 Yr 0.06 for a total of 4.01 (for a permanent increase in investment the total falls to 2.19 as in years 5 and 6 the returns are modelled as negative. But before that, the multiplier is a cumulative 4.44).

    The other researchers mentioned above provide comparable results.

    I think there is an important terminological difference underlying the 1.57 vs 4. The former relates to stimulus, the latter government investment. The latter ensures the money is spent, the former rests on a hope that it will be, often and currently disappointed. Hence the difference.

    The IMF, relying on their own model and 6 others (OECD, ECB, Fed x2, etc.) http://www.imf.org/external/pubs/ft/wp/2010/wp1073.pdf
    concluded,

    “the multipliers from government investment and government consumption [general government spending]…are clearly larger than…” all types of tax cuts and only “….targeted transfers [to the poor] come close to having the same multipliers as government spending” (p.16).

    In their models, better results were achieved when the fiscal stimulus was over two years rather than one and when interest rates are low. Under those conditions, the US multiplier for government investment was 1.5 after one year and accumulated to approximately three over five years.

  22. @ MB

    Econometrics is fine — I do it myself sometimes. But it can often give a very wide range of answers. Often, it isn’t a good substitute for a simple model calibrated with sensible figures.

    Take US multipliers for instance. I’m going to use high theory to declare that 1 / (1 – c + m) is likely to be an upper bound on the multiplier.

    Now go to http://www.bea.gov/national/nipaweb/SelectTable.asp and click on Table 1.1.5.

    We get:
    C/Y is approx 5/7
    M/Y is approx 1/7

    Use averages to approximate marginals and we get
    1 / ( 1 – 5/7 + 1/7) = 7/3 = 2.33.

    So, without econometrics, I’m comfortable with 2.33 as an upper bound for US multipliers.

    Now factor in that imports equalled three quarters of Irish GDP last year and it’s clear that we’re going to have much, much lower multipliers.

  23. @ Seafoid: “The US still needs to deleverage and the process has barely started. Ireland has no choice other than to deleverage. It doesn’t taste nice but is there any other medicine?” No. Problem is its toxic – like chemotherapy! Bits fall off.

    Gov (courtesy of taxpayers) mails each citizen a cheque for EU 1000 (thats a stimulus – yes?) So what happens? Some gets spent, some gets saved and some is used to pay down debt. Only the spent bit generates some tax revenue. Savings may get spent sometime, but debt payment is the destruction of money.

    But where does the money come from? – and do we have to pay it back, plus the interest of course? Do those multipliers actually create additional money? Whole thing sounds a tad like a Ponzi scheme! Ah! You HAVE to keep injecting increasing increments of money – else the scheme stops! Definitely Ponzi!

    B Peter

  24. I would argue a scrappage scheme is mostly counterproductive – better to let people hang onto bangers and create incentives for garages to repair (much of which will be labour) rather than sell. There’s a huge backlog of repairs in schools – send unemployed and underemployed trades in to paint and plaster and rewire. A euro of stimulus might yield 30 cents in tax on average, but it’s not hard to think of ways to game it, rather than the American way to fund every shaggin’ congressional pet project that crossed their path.

  25. Karl,

    I couldn’t agree more about the relative merits of econometrics. But so far as I am aware, Philip Lane’s and the others (which I promise to get around to linking) have used your method, ie calibrating multiplier returns based on actual changes in the economy. However, they have used long-run averages.

    It’s OK, so far as it goes, to use a national accounts snapshot of 1 year to do that. But this overlooks entirely both the multi-year effects of a boost to aggregate demand as well as the long-tail supply-side effects of investment. Taking both of those into account easily gets a much higher upper band for the multiplier attached to government investment.

    As I said previously, the IMF et al research centred on a multiplier of 3 for govt. investment (with usual caveats about low interest rates, etc.)

    ==============================================

    Re the declines in revenues:

    You are correct, stamps, CAT and CGT have plunged as the unbalanced and under-taxed bubble burst. These account for €4.97bn of the decline in revenues from end 2007 to end 2009. But the total decline in revenues has been €14.3bn. Not all the shortfall is housing.

    There is a surfeit of housing in the economy (although there may not be a surfeit of decent, well-located housing). But there is a deficit of infrastructure. This economy fell from 22nd to 25th in the WEF’s global competitivenes index in 2009, 52nd for infrastructure, worse access to ports than Switzerland and worse rail infrastructure than Azerbaijan.

    There is therefore both a pressing requirement and large capacity to increase non-residential (& non-hotel) labour-intensive construction, with the all the anticipated uplift in government revenues/reduction in welfare outlays that would bring.

  26. Karl – it would be helpful if you examined the impact of Government investment; in particular, temporary investment. Your post is certainly useful in examining the impact of all Government expenditure categories (wage and non-wage consumption, investment) on a permanent basis but, as far as I know, no one in Ireland is making that argument. All those arguing for an expansionary fiscal policy – TASC open letter, Progressive-Economy contributors, UNITE – have focused on investment.

  27. @ Michael

    The multipliers cited in Romer-Bernstein are for expenditures on goods and services. Over the long run, capital investment projects may bring greater supply-side benefits benefits than non-investment expenditures. However, these take time to come on track (in Ireland they seem to take a very long time). Meanwhile, the logic of the Keynesian models that view fiscal stimulus as having a positive effect applies to both investment and non-investment expenditures.

    In other words, while there are long-term benefits to capital investments (and all such projects should be subject to cost-benefit analysis) in the short run the stimulus effect of paying people to dig ditches and re-fill them is the same as the effect of paying them to install broadband.

    Now, I imagine that perhaps rather than investment spending per se, you have in mind the idea of spending on particularly employment intensive areas. However, big infrastructure projects don’t necessarily fit the bill. They take a long time to plan and rely on importing lots of equipment and raw materials. In its recent QEC, the ESRI argued that the cost per job created through infrastructure spending is quite high.

  28. Karl

    “With our current budgetary path looking barely sustainable to the international lenders,”

    Karl,

    What is your view on the sustainability of our budgetary path?

    Assuming global growth assumptions which you beleive to be the most likely, and the continuation of NAMA in it’s current form, will we have to restructure our soverign debt?

  29. Karl,

    the type of investments I have in mind are actually an expansion of the NDP beyond originally envisaged, not its contraction as per current policy. The NDP was (rightly) curtailed during the boom so as not to exacerbate the construction boom. The approriate policy now would be to expand it to counteract the slump.

    Investment of that type has both short-run as well as long run effects, as all the evaluations show. The short run efects are of the investment multipliers already mentioned, but the long run are additional, very long-run supply-side effects.

    The evaluations also, of course, include any supposed ‘leakage’ effects. To you earlier point, I cannot agree to the reductive assumption that high import levels automatially lead to excessive leakage.

    On the contrary, the bulk of Irish imports are for re-export. In the input-out analysis of 2005 the 2nd to 5th biggest categories of imports amounted to €27.1bn – in food and drink manuf., chemicals, office machinery and insurance and their total trade surplus was €39.4bn (ie total exports were €66.bn from these sectors). The biggest category of imports were ‘other business services’ which were €28.6bn in imports and a net deficit of €23.8bn.

    CSO explains that this category is the purchase of inter-affiliate management services by large MNCs. This is impermeable to govt. investment here. While the other big import categories actually yield huge net exports.

    The high degree of Irish participation in the international division of labour would tend to increase efficiency and therefore the returns on all investment, including govt. investment.

  30. If we and other small economies including the UK do not follow the USA. Then the USA has written a cheque -expecting us to cash it- with nothing to back it up. It is that simple. There is no great economic mystery about this the conditions are exactly the same as in 2007. The odd thing is though, once the US put their package together that was the time to allow the Banks to hit the wall.
    Oh, in case anyone missed it, there is NO value to be had in any English speaking economy, none what so ever. And while that pertains nothing will happen. There just isn’t a base.
    And quite simply who cares what the Bond markets say about us or Greece when all they are doing is kiteing US wishes.

  31. The effectiveness of a genuine stimulus package is doubtful.

    What isn’t so doubtful is that many Irish proponents of stimulus are less interested in stimulating the economy that protecting public sector pay and conditions. This’d be the view that protecting pay via increasing taxes is a stimulus.

  32. Our establishment created the massive construction labour force. To utterly abandon them by slashing capital expenditure would be deeply dishonourable.

  33. @Oliver Vandt

    It’s interesting to note how the government has been quietly backsliding on capital expenditure over the past couple of years, from the initial talk about ring-fencing the NDP to today. At the same time, even a campaign of building roads, bridges and tunnels wouldn’t provide much relief for, say, carpenters and plasterers (though it’s true that we could do with a few schools as well).

    @Michael Burke

    If you were given a choice between exactly one of the following two alternatives: a 5% cut in public-sector pay and benefits, with 100% of the deductions going into the NDP, or the status quo – no cuts and no extra capital expenditure – which one of these two options would you consider preferable to the other?

  34. It’s refreshing to see both sides of this argument being advanced in some detail.

    Kudos to Karl and both Michaels.

  35. @ Oliver Vandt,

    “Massive construction workforce”….

    I would not be too sure that the Govt created this.

    Lots and lots of young immature boys left school after the junior cert to go earn the big bucks on the building sites.

    They gave up the opportunity to educate themselves to Leving certificate and or 3rd level. A grave error.

    They made this decision of their own free will, perhaps their parents / teachers advised them, or perhaps they did not. We might never know.

    But its a lesson to other immature students, never pass by the chance for a good education.

    If you have a transferrable skill, like engineering the world can be your oyster.

  36. Government debt is an explicit liability, but we also have implicit liabilities. Everyone knows we will have to pay for things like pensions, school buildings and other infrastructure. Why not move forward these infrastructural projects and complete them while there are plenty of construction workers available?

    Investing 1% of GDP in infrastructure would cost the government less than 1% of GDP due to savings to social welfare (which in Ireland are more generous than in the US).

    RE: Multipliers
    The multiplier should be closely related to the output gap. As our output gap is fairly massive, historical estimates of the multiplier can only serve as a minimum estimate. Also any notion of a expansionary fiscal contraction can be safely ignored given that it would require easy access to credit, which simply does not exist at the moment.

  37. @Mr Vain

    ????
    Seriously
    A great education like law, architecture, engineering, all flush with employment oppurtunities at the moment.
    There are people who have dedicated years of their lives to a career that wont see a return.

  38. Economics not my strong point but great to be able to agree with our leader for a change.

    The gubbermint is providing a 20bn stimulus so this is a question of degree. We have just about convinced the markets/ECB that the current budget strategy is sustainable, no scope for a reversal now.

    That great disciple Gene Kerrigan will be disappointed, he is an avid fiscal stimulator.

  39. Karl – thanks for that. The issues you raise are certainly valid – time-lag, job-density, cost per job. However, the existence of these does not invalidate the exercise of assessing the impact of temporary increases in government investment and/or non-wage consumption – particularly the former where the supply-side benefits persist long after the demand-side benefit has been exhausted. My concern, as I mentioned previously, is that you may be framing the issue in a way that is, while useful, does not address the current debate in Ireland nor shed light on the options available to us.

    Were you to subject such investment proposals (of the type being advanced here under the generalised and not wholly satisfactory term ‘stimulus”) to the same calculations as you applied to a permanent increase in Government expenditure, it would be interesting to see if the result is similar (GDP growth, resulting tax revenue, budgetary sustainability, etc.). Were such results to show a more beneficial impact then obviously one should, then, assess how viable such a programme is – taking into account the issues you raise. We would have the benefit of a new fiscal base-line and tackling those issues would, then, have a pragmatic character, one that may or may not wholly or partially negate the benefit in principle. However, in the absence of such a recalculation the question remains unanswered – would a ‘stimulus’ work in Ireland.

  40. @ Michael

    I’m happy to agree that, ultimately, we have to subject all public investment programs to detailed cost-benefit analysis to try to figure out their effects. I can’t rule out that there may be projects that tick all the right boxes — short time delays, employment intensive, positive supply-side effects — so that they pay for themselves and suggestions for these kinds of projects should be welcomed.

    However, I still don’t think that this deals with the last problem I raised in the post — finding people to lend you that money.

    Suppose the government announced tomorrow that it was changing course and instead of cutting public investment, it was going to start raising it over the next few years. Even if the government assured everyone that it was only going to focus on high quality projects that paid for themselves, my guess is that the reaction would be “well they would say that wouldn’t they?” One also must remember that the pretty poor track record of our government in its costing and completion of infrastructure projects would undermine the credibility of this kind of statement.

    I strongly suspect that an announcement of this type would not be welcomed by the international bond market who (rather than this being some sort of consipiracy) would just apply standard analysis to project that this program would raise the deficit.

    So even if these projects existed, I doubt if we could raise the funding for them.

  41. The Irish private pensions industry manages a sizeable volume of assets (around €70bn I think), much of which is invested overseas. Would it not be possible to put together a “green jersey” programme to invest some of the new annual flows into carefully selected stimulus programmes along the lines of what TASC have been suggesting, especially if the government can’t ?

  42. Investing in equities , the pensions alternative, isn’t going to bring much return over the next few years what with all the deleveraging that has to happen and given the ongoing bear market which began back in 2001 or so. The traditional institutional investment approach of investing in “blue chips” such as AIB and previously GPA has been a failure.
    Ultimately a long drawn out recession isn’t in the interest of any pension fund or its still working beneficiaries.
    Pension investment has the capacity to bring people back into work and re-engineer aspects of the economy to make them more future ready.
    There is also an argument that the chasing by pension funds of unreal financial returns divorced from the real economy was one of the drivers of the great bubble and subsequent crash. Stimulus packages could bring some much needed diversification to the pension investment pot. US pension funds are getting into commodities for a bit of diversification, for example. Surely this crisis represents a chance to think differently and creatively, not just about the semi states.

  43. @ Seafoid

    EU rules about free movement of prevent governments from introducing rules that force financial institutions to invest their money in home country assets. So this just can’t be done.

  44. @Karl Whelan

    I was thinking more along the lines of opening a discussion with the Irish Association of Pension Funds. There wouldn’t be any coercion. Many Pension Fund Trustees have no idea where to invest today. The idea could be presented in terms of likely returns. The money has to be invested somewhere anyway so why not in Ireland ?

  45. I agree with Karl Whelan’s analysis. It is spot on.

    The (almost unique) openness of the Irish economy means that a stimulus package would have much less effect in Ireland than in other countries.

    However, the other side of the coin is that, due to this openness, Ireland’s economy benefits disproportionately from other countries’ stimulus packages, indeed from whatever growth occurs in those countries regardless of whether or not it was stimulus-induced. So, very good news that the UK GDP growth figures for Q2, which came out this morning, were much better than expected.

    Also noteworthy are the CSO figures just out this morning, which show merchandise exports from Ireland roaring ahead in May, exceeding their pre-recession peak, and the surplus at an all-time high. While I can’t be certain, not having checked for all countries, Ireland is probably the first EU country to achieve this. As services exports are also growing strongly, it is clear almost beyond doubt now that Ireland’s exports will grow much more in 2010 than the 4.8pc the Dept of Finance predicted a few weeks ago (as indeed I posted here at the time that they would). It is virtually certain now that the next Dept of Finance quarterly report in the autumn will contain yet another upward revision to their forecast for GDP growth in 2010 (having allready been revised upwards from -3pc last summer to +1pc this summer).

    Of course, exports themselves generate relatively few jobs. Only when they trickle down into increased consumer spending, via the wages of those producing the increased volume of exports, do jobs get generated in large numbers. This is a slow process, much slower than a government stimulus package, but much more sustainable. There are now signs that this is beginning to happen, as evidenced by today’s statement by Britvic and the survey on Irish retailing reported earlier this week.

  46. The analysis by Krugman and even above by Whelan fail to take into account the effect of crowding out.

    The long-term return of capital projects financed by borrowed money has to take into account the future income stream generated by the project. This, in turn, is a function of the wealth of the project’s future consumers, who are the taxpayers paying to reimburse the project.

    For example, Ireland Inc. borrows 5 bn to build a metro. The metro’s projected profits are a function of future consumer discretionary spending (a rich future Ireland has lots of metro punters willing to buy expensive monthly passes, etc.). This future consumer discretionary spending is a function of how much the future taxpayers have to pay to service the future debt. An extra 5bn in debt reduces their stream of future spending by 5bn.

    If you want people to dig holes at least have the decency to allow them to bury themselves before filling the holes in again.

  47. Karl – I appreciate the engagement on this issue. One last point – and I raise this to identify issues of divergence that might eventually be narrowed: am I right in thinking that if the fiscal benefits of temporary investment could be established, and that the programmatic obstacles could be overcome (admittedly, substantial obstacles with plenty of scope for stumbling), then your major areas of concern revolve around (a) finding the resources for such investment in the current climate, and (b) the reactions of international markets to such a change in direction?

  48. Michael, yes that sounds about right.

    I wonder however whether imagining

    (a) just the right programs

    combined with

    (b) solving the funding problems

    doesn’t have a touch of “imagine a tin opener” about it.

  49. @ Seafroid

    Remember the pension funds aren’t running a charity. The government did have some engagement with them last year and the offered to provide very expensive long-term funding. Perhaps others can fill in the details but it was something like 20 year funding at 2 percent over then prevailing 10 year rates.

    I’m happy to be corrected on the specifics of this by those who remember it better.

  50. Karl

    I agree, the pricing of Irish bonds, and others, ultimately reflects a view of the likelihood of repayment, and the risk premium sought to compensate for that risk. The focus is all on cashflows, and Irish taxes (govt. cashflows) have collapsed.

    It should be very sobering for those arguing for further austerity measures that Ireland’s risk premium has risen by 235bps since this policy was adopted.

    To break a rule, I’ll answer your quaestion with one of my own, if I may. What if tomorrow govt. announced that an independent body, let’s call it the Office for Fiscal Recovery, composed of EU, US and Irish experts was being allocated €2bn from govt. finances (financed by borrowing at 5.5%) in order to invest in NDP-style projects? The OFR would only invest in those areas where there was a return significantly above 5.5%.

    In the Mid-Term Evaluation of the NDP 2003, Fitzgerald and Morgenroth estimate that the return is between 14% and 18% annually, depending on the composition of the investment. (They could be two nominees to the OFR, along with other EU experts on monitoring CSF allocations).

    The government could announce that the members of this independent body had previously identified such high-return investments, and would oversee their implementation, not the politicians (although the OFR cold take submissions from all intersted parties). The government would also ensure that the evaluation of the investment returns was independent. And that they would only release further funds to the OFR if that were proven to be the case, ie that the investment returns were high and actually helped to reduce the deficit.

    Given that the markets didn’t blink when the Ango bailout was announced, I don’t think €2bn woud phase them.

    In this way we might be able to dis/prove the proposition that investment returns to reduce the deficit. (In Britain, for example, the 2009 Budget was mildly stmulative and brought forward govt. investment, altogther about £50bn in fiscal expansion. The official forecasts for the deficit for this year have fallen from £178bn to £145bn. Given that this economy is both more open and more highly educated, the effectivenes of all investment, govt. included, should be greater).

    My only stipulation would be that, if the returns to govt. were greater than the initial €2bn, the OFR can shout it from the rooftops, and that the govt. would then be obliged to investment large sums to revive the ecoomy and close the deficit.

    All investors, including bond investors, will have no problem lending at 5.5% if the anticipated return is c. 16%. They do have a problem lending at 4.3% (when austerity was adopted) when the returns are negative.

  51. @ Karl

    Does the result of a CBA change when the employment sustaining element of a programme/project is taken into account due to a change in market conditions? i.e. when the incremental savings from not having to pay job seekers allowance etc. v the PAYE tax take etc. Does this bias progressing investment projects (improve the overall CBA) in times of involuntary unemployment?

  52. But guys we have a stimulus package – it’s called NAMA.
    It pumps money onto the economy with the long term goal of freeing up more money. That’s a stimulus.
    To be honest this argument between stimulus and austerity is nonsense. The two are not mutually exclusive at all – don’t waste money (austerity) and spend money where it will have a beneficial effect (stimulus). We need both.

  53. If the main argument against investment is that it will not produce the desired effect in a small open economy and simultaneously raise the national budget deficit, then, logically, this is not necessarily an argument against investment. Right? It is an argument that Ireland, on its own, cannot engage in a stimulus programme.

    In this regard (and for the sake of consistency) is it not logical to argue in favour of a coordinated Eurozone stimulus strategy? If we have no intention of leaving the Euro to adjust our exchange rate then it seems that the only logical strategy for Europe (not just Ireland) is a collective coordinated response driven by Brussels. That is, the choice is national strategies based on deflation or federal strategies based on coordinated investment.

    At present, and from my reading of Paul Krugman, he is critical of Ireland not because of its deflationary policies per se, but because it has started a series of competitive internal devaluations as the primary strategy to exit the recession. This ‘beggar thy neighbour’ approach, exemplified by Ireland, has put pressure on other economies to behave in a similar manner.

    To put it another way, which two scenarios would work better for economic recovery:

    1. Every economy adopts a strategy akin to Ireland

    2. Every economy adopts a strategy akin to Krugmans proposal

    It is pretty obvious that if every economy behaved like Ireland the world, and in particular, Europe, would be in a pretty bad place. Thus, Krugman is right to be critical of economic policy proposals that resemble the Irish response to the crisis. He knows that it is setting a dangerous and uncertain precedent.

    It is a classic collective action problem – adopt a self interested zero sum strategy or adopt a collective positive sum strategy. To be logically consistent with the former we may as well exit the Euro. To be logically consistent with the latter we have to wake up to the policy constraint/opportunity of European integration.

  54. @ Al,

    Just noticed your comment, now, sorry I was travelling over the last number of days.

    Your comment is valid for the current time about educated people who are unemployed in Ireland.

    However when the upturn comes, these people should find employment prior to uneducated workers etc.

    Secondly a person with a good third level education also has the choice to emigrate to another juristiction, i.e. Canada, Australia etc.

    It is much easier to gain access to these countries if one is qualified to a high level, rather than just Junior Cert level etc.

    I am sure you would agree with the above points.

    When I wrote “the world can be your oyster” I ment the world outside the island of Ireland.

    However I note Mr Gilmore is starting to flex his muscles, he is now promising to tax people with a Irish passport.

    So there may be no point in emigrating as you will be subjected to double taxation, pay tax to the juristiction you live and work in (Australia for example) and pay income tax to the Irish authorities for having a Irish passport.

    So if one emigrates, one will have to change your citizenship to avoid double taxation.

  55. @ Michael and Karl

    We don’t face just one crisis, we face several interlinked ones. The fiscal and economic crises must be solved, but we must also make a rapid transition away from our over-reliance on imported fossil fuels. Expert groups like the IEA and industry groups including the likes of Richard Branson have warned of a severe (and possibly permanent) energy crunch within 5 or 10 years, and many experts say it could be closer. If Ireland were to somehow emerge from this crisis with a growing economy, only to be hit by the post-peak decline in world oil supplies, the economic damage would be so great that it would undo all our efforts so far.

    The only way to deal with all of these crisis is to take an investment-led approach to solving the deficit and growing the economy. Because to do otherwise would fail to achieve energy security.

    Austerity makes transitioning to energy security impossible. So even if Karl’s calculations are correct, they are so only because they do not factor in all the other problems that arise from not investing (to which we could also include failing to improve our water infrastructure, communications infrastructure and our education system, all of are liabilities which will either cause economic damage or reduce growth in the future…). We could also add that without investing in conservation and wildlife protection we leave our country more at risk to the destabilizing effects of climate change. And failing to invest in a top-quality public transport system will leave us in big trouble if oil prices rise making road transport hugely expensive.

    It is as if Ireland were threatened by two foreign armies at once, and our defence forces were stretched thin. The military leaders then decide that the problem looks more solvable if they just pretend that one of the foes doesn’t exist, and concentrate all their resources on the other. They score a victory against that foe, and just close their ears to the sound of the other army bearing down on them, because if they don’t recognize it as a threat then they can tell themselves that they have won the war.

    We face many overall problems, all interlinked: The fiscal crisis, the unemployment crisis, vulnerability to a possible energy shock, neglected communications transport and educational infrastructure. All of which threaten our economy. You can’t just focus on the fiscal crisis and neglect all the others, because the others will all undermine your attempts to balance the budget.

    One more problem we need to solve: inequality, which as the Spirit Level and other research shows, is very socially damaging. By redistributing resources from the wealthy towards job creation we could tackle this problem as well.

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