January 28th Afternoon: The Recession Diaries

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I had intended to treat each of the offerings in the Irish Times ‘What is to be Done’ series individually, hoping that they would provide us with new, innovative ideas. Boy, did I call that wrong. Jobs are being lost, enterprises are closing, our GDP is contracting, confidence is being lost – and all we get are folk so fixated on the budget deficit that they can’t see the house around them falling down. John McHale starts off:

‘It should never have come to this. Fiscal austerity in the face of recession means breaking what Nobel Laureate Paul Krugman calls the “Keynesian compact” – the expectation that governments can and will aggressively manage demand to counter severe downturns.’

However, just as John Fitzgerald dismissed economic stimulus out of hand, McHale concurs. Because the downturn resulted in a fiscal crisis. This is a strange logic – the reason why you should engage in economic stimulus is the very reason why you can’t. We are, it seems, condemned to repeat the mistakes of past Fianna Fail Governments: just as they pursued pro-cyclical policies in the boom (fuelling demand through tax cuts at a time of rising demand) so now we must pursue pro-cyclical policies in the bust (deflationary fiscal measures while the economy is deflating).

This ‘trap’ is best seen in the call by all three economists – McHale, Alan Ahearne and Richard Tol to cut public sector wage cuts – in some cases, quite draconian. McHale calls this ‘the least the wage bill gives the least-deflationary bang for the euro cut.‘ Yes, it may be the least-deflationary but to what degree is it deflationary? Will it still be a substantially so? To what degree will such cuts be met by a reduction of savings and a reduction of spending? And is this deflationary move justified or helpful during an economic contraction? At least, Ahearne provides a cautionary warning: it won’t really save that much. And:

‘I suspect that much of the rhetoric in the media about public sector pay and reform is an attempt by some of the least well-informed commentators to distract attention from the main source of our economic woes. The mess in which the Irish economy finds itself largely stems from the house price bubble, not from problems in the public sector. It is probably not a coincidence that some of the most vocal critics of the public sector today were among the most conspicuous cheerleaders for the housing boom.’

Yes, it was the property boom that what done it. But this was layered on top of pre-existing and already glaring deficiencies in our economic base – a poor indigenous enterprise sector, a poorer physical infrastructure and a social infrastructure which only European only in name. Still, his point is taken. Which is why it is disappointing to hear him come out with a cliché – one that is hardly reflects social reality.

‘Put simply, we are living beyond our means.’

Whoa, wait a minute – it is not so simple. Over 1.4 million earn below the average industrial wage – or about two-thirds of all taxpayers. Add in all those on social welfare and we could find that up to three-fourths have incomes of less than the average wage. Even at the household level – yes, expenditure exceeded income in the lowest 70 percent of households. This ‘living-beyond-our-means’ is best understood against a backdrop of relatively low wages compared to European norms, social welfare rates below the relative poverty line, high levels of relative poverty and low-pay, and low universal provision of services that other European citizens take for granted (primary health care, childcare, primary education, etc.). To blame people with relatively low incomes for our fiscal crisis is missing the point.

But pain is the name of the game these days. All three economists claim ‘pain’ is unavoidable, is necessary, even purgative. But in McHale’s case, he seems to fall into a contradiction:

‘As the Asian economies found out over a decade ago, immediate pain is the price to restore confidence.’

Yet, a few paragraphs later he states:

The IMF appears to have learned a lesson from the Asian crisis, where excessive upfront austerity worked to undermine confidence rather than enhance it.’

So, immediate pain restores confidence, but upfront austerity (and that’s where the pain comes from) undermines confidence. I’m sure there is a logic here – it’s just that I can’t figure it out.

Ultimately, the problem with the analysis of the three economists is that they have put the cart before the horse. If the fiscal crisis is the result of economic decline (the property bubble bursting, the structural deficit arising from previous tax cuts, the loss of ‘competitiveness’), then how can we assume

(1) That ‘fixing’ the fiscal problems will result in economic growth, or

(2) Assume it is even possible to ‘fix’ the fiscal crisis during a period of rapid economic decline?

To work the symptoms and overlook the disease is a sure way to ensure the disease festers. That is the trap the three economists fall into, a trap laid by the way the Irish Times framed the debate. At least Ahearne tries to broaden it a bit – listing new taxes and tax increases to close the fiscal deficit. These deserve a longer treatment than I can afford it here. Suffice it to say that general tax increases during a severe contraction may only exacerbate the contraction and, so, the deficit. That is not to dismiss the idea of taxation – clearly, when growth resumes we will have to abandon the low-tax model that prevailed in the past, if only to overcome the structural deficit caused by over-reliance on property-related and spending taxes. But to impose it now on working income?

But, so far, the Irish Times has been worth it – mainly due to Richard Tol’s contribution. It is a masterpiece. I am cutting it out and hanging it on my wall. It is almost mystical in its perverse way – like the medieval flagellants who divined the face of God while flogging themselves to death. For Tol, pain is an end it itself:

Cut spending now, next year and the year after that • Cut public sector wages, even the lower-paid • Cut supports to exporting industries • Privatise the ESB and CIE and An Post • Sell-off shares in Aer Lingus • Cut capital investment • Cut social welfare • Cut fuel allowances • and on and on and on • and on some more

I didn’t know economists could be so funny and scary at the same time.

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