A Jobs and Creditworthiness Special Budget

The new government’s difficult navigation through the crisis took significant steps forward last week with the stress tests and strengthened lender of last resort commitment.   While we can hope for some easing of the bailout terms, the next milestone is likely to be the upcoming “jobs budget”.   For a new centre-right/centre-left coalition government, this will be an opportunity to demonstrate political capacity on the fiscal side.  Unfortunately, market assessments of Ireland’s chances of avoiding default are less favourable than we might have hoped when the EU-IMF programme was agreed (see Colm McCarthy’s post and article below).   With this inescapable reality in mind, it is worthwhile considering case for sending a strong signal on adjustment capacity by accelerating some of the planned deficit reduction. 

I do not make this suggestion lightly.   As Karl Whelan has emphasised, Ireland has already engaged is a truly massive discretionary adjustment (roughly €20 billion euro, or about 13 percent of GDP), involving huge sacrifice.   I have also no doubt that the austerity measures have deepened the recession.  Additional austerity is thus doubly unwelcome.  However, a demonstration of adjustment capacity by a new government that is still being assessed by markets and official funders could be a well-timed “investment” at this stage.   This could be combined with the planned improvement in the mix of policies designed to spur growth and employment, though realistically these measures would probably only the edge off any accelerated austerity.    A “jobs and creditworthiness special budget” (it clearly needs a better name) would allow the new government to show it is taking control of the situation, rather than passively following a course laid down by its predecessor, and build the sense that the adjustment-with-assistance strategy provides a clear path to exiting the crisis. 

Behaving Like Teenagers?

A development that I have noticed lately in the comments section of this blog is the tendency to argue that the Irish people deserve little sympathy from our European partners because we are somehow unwilling to implement obvious solutions to our problems.

Every story about public sector inflexibilities (such as the silly business about the privilege days) is taken as evidence of mendacious insiders and nasty trade unionists defending their ill-deserved high salaries while the nation heads towards sovereign default. Similarly, stories about cuts in pay for politicians or academics are merely greeted with outrage that the cuts are not big enough.

Discussions of welfare rates provoke the question of how dare we ask for improved bailout while we pay higher benefit rates than elsewhere. Similar moral outrage is applied to the corporate tax rate discussion and, less often but occasionally, to the fact that (even after recent increases) Irish rates of income taxation for low and middle-earners are still low by international standards. A call for immediately cutting the deficit to zero so that we would not need a bailout was greeted very positively by many of our commenters, who clearly take the view that this can be done easily if only we had the will.

The conclusion often reached from these discussions is that the Irish people are a feckless and inflexible lot who are “behaving like teenagers” in looking for help from Europe.

I understand the moralistic instinct that underlies these comments as well as its implicit faith in simple solutions. With the country effectively in administration, this belief—that solutions are clearly sitting out there, but cannot be implemented because “other people” are feckless, inflexible and pampered—provides a lovely warm blanket of indignation in which to wrap oneself.

In my opinion, however, this kind of commentary is based on a gross misunderstanding of the challenges posed by the scale of the Irish fiscal adjustment. It is also extremely unfair to the Irish people and acts to undermine valid arguments for looking for additional help from the EU.

Let’s start with a hugely important fact that tends to receive little attention. The Irish adjustments thus far have been enormous by international standards. Prior to the December 2010 budget, the government implemented a combined €14.6 billion in adjustments from summer 2008 to December 2009. With Irish GDP estimated at €157 last year, these adjustments added up to over 9 percent of GDP, with the vast majority of the underlying impact distributed about equally between 2009 and 2010.

To get a sense of how big these adjustments are, consider the chart below. The numbers on the x-axis are the IMF’s estimates of actions taken to reduce fiscal deficits in 15 advanced economies during 1980–2009, while the y-axis shows the change in the cyclically adjusted budget deficit. The paper in the IMF’s World Economic Outlook argues strongly that its fiscal action measures are superior to simply measuring the change in the cyclically adjusted deficit when considering the stance of fiscal policy.

The IMF chart shows the Irish 2009 fiscal adjustment as the largest across the sample of advanced economies over the thirty-year period studied  (measured against GNP it would not have been a close race with Italy 1993). The paper was prepared before they could enter in the 2010 adjustment but by my calculations, it was about the same size. Then the government implemented an additional €6 billion in adjustments in the December 2010 budget.

Consider this for a second. In 2009 and 2010, the Irish public experienced the two biggest years of fiscal adjustment anywhere in the advanced economic world over the past thirty years. And this left Ireland with a budget deficit of nearly 12% of GDP. After another budget implementing adjustments similar in size to the previous two years, the public then elected a government consisting of parties who proposed a further €9 billion in cuts over the next three years in the case of Fine Gael or €7 billion in the case of Labour.

By the time the stabilisation programme is supposed to be finished, the cumulative fiscal adjustment will have been close to 20 percent of GDP. Previous academic studies of large adjustments reported cumalative adjustments of 10 percent of GDP as the outer limits of what had been achieved (see here and page 17 of this paper).

I’m my opinion, those who wish to characterise the Irish public as feckless teenagers have it exactly wrong. Fiscal adjustments are extremely difficult to implement. Every society in the world has powerful institutions and organisations designed to protect vested interests and various types of status quos. Many of these societies would respond to one year of fiscal adjustment on an Irish scale with mass public protests and strikes.

In Ireland, however, we have largely accepted three years of these adjustments without serious disruption and then voted in a government charged with implementing further large adjustments.

So pick on Irish public servants and trade unionists if you want but if you think that their equivalents elsewhere would have been open to larger pay cuts, you’re kidding yourself. Irish public sector workers have seen enormous reductions in take-home pay via cuts in gross pay, a pension levy and tax hikes and many are now struggling to meet their mortgage commitments. Yet there hasn’t been a single strike of notice because these workers and their union leaders understand the gravity of the fiscal situation.

And of course there are inefficiencies and waste in the public sector and people who are paid wage rates that are out of line with common sense. But show me the large organisation, public or private, that doesn’t have such inefficiencies. To be fair to our political processes, the current crisis has brutally exposed a wide range of public sector inefficiencies and the people elected two parties that have both committed to public sector reform.

And rail against welfare benefits being too high if you want. But these are the least well off in our society and they have put up with consecutive cuts in their modest incomes without serious protests.

And you can compare Irish income tax rates for low and middle-earners with other EU countries and reckon there’s room to raise more income there. However, the vast majority of these people have entered into commitments (mortgages, car loans, childcare payments) that cannot simply be reversed at the drop of a hat and many are already under enormous pressure. This is why fiscal adjustments are so small and gradual elsewhere.

No doubt many of our commenters will continue with their negative characterisations of the Irish people. However, I think the past few years have showed that we are a strong people who have displayed great courage in coping with immense adversity. Requesting a small amount of assistance from our European partners (particularly in relation to the repayment of loans made to insolvent banks by the ECB and European bondholders) to help Ireland avoid a sovereign default—this shouldn’t be too much to ask for if European solidarity is to be more than just a cheap slogan.

Limiting the Fall Out from Fiscal Adjustment

Ben Broadbent and Kevin Daly at Goldman Sachs have released a new study examining how the composition of fiscal adjustment packages affects the overall economic impact of fiscal tightening: you can read it here.

Large Changes in Fiscal Policy: Taxes versus Spending

Alberto Alesina and Silvia Ardagna have a new research paper on this topic: you can download it here.