‘All the wrong options have been pursued’

Today’s Irish Times publishes an open letter by 28 social scientists [co-ordinated by Tasc] that criticises the current set of economic policies and proposes an alternative vision: you can read the letter here.

It is hard for anyone to disagree with many of the policy recommendations in the letter. An important point is  that many of these policies could be pursued simultaneously with the current strategy of stabilising the fiscal situation and  contributing to the process of real devaluation as a mechanism to improve competitiveness. As has been repeatedly pointed out on this blog, labour demand can be boosted both through outward shifts in the labour demand curve (through productivity improvements) and through reductions in wage costs (movement along the labour demand curve) and there is no direct conflict between these two strategies.

The letter assigns at least part of the responsibility for the depth and severity of the recession to current government policies.  Policy failures during the pre-crisis period (inadequate financial regulation and pro-cyclical fiscal policies) have certainly contributed to the severe contraction and it would have been much better if Ireland had accumulated sufficiently large surpluses during the boom years to provide the fiscal space required to engage in counter-cyclical fiscal interventions.  In addition, it is possible to debate the appropriate mix between current and capital spending within the current aggregate envelope and the optimal sequence for the required increases in the overall tax burden.

However, given the massive shock to the economy and the public finances, the over-riding imperative in setting fiscal policy has been to demonstrate a commitment to fiscal sustainability. If the government had not undertaken a sizeable fiscal adjustment, the spread on sovereign debt would surely be much higher than the current elevated level and the upward movement in interest rates (influencing the funding costs for the banking system as well as for the government) would have had an even more contractionary impact on the economy.

Conditional on the environment facing the country, the path of fiscal adjustment is more certain of returning growth to the economy than an aspirational alternative that seems to rely on investment-led growth to jointly solve the fiscal crisis and the economic crisis without having to resort to cuts in the level of public expenditure (beyond any savings from efficiency gains).  The international economic consensus highlights that  the optimal fiscal response to the crisis varies substantially across countries, with fiscal adjustment required for those countries that face a difficult funding situation. As such, it is perfectly consistent to advocate more expansionary fiscal policies for some countries while also supporting fiscal adjustment in Ireland.

Finally, the letter makes a number of recommendations for re-shaping longer-term economic policies. The debate about post-crisis policies is important and the coherent vision provided by this letter is a valuable contribution – but the first order of business is to safely emerge from the current crisis.

A Critique of Irish Economic Policy

Eoin O’Leary provides a critique of the government’s overall economic policy strategy here.

Papers and Slides from TCD-DEW Economic Policy Conference

You can find the papers (where available) and slides from today’s TCD-DEW Economic Policy conference here.