March 27th Lunchtime: The Recession Diaries

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A good friend made a bet with me in January. He wagered the economy would contract by 10 percent or more by the end of the year. I gladly took the bet. But he rang me yesterday wanting to know if I wanted to pay up now. For the news that the economy contracted by 7.5 percent in the last quarter of 2008 suggests, if anything, that my friend was being too optimistic.

We’ve exhausted the thesaurus. We now have to turn to song to describe this appalling situation, and together sing Elvis Costello’s line:

‘I would rather be anywhere else but here today.’

But, not, let’s light some candles rather than curse the darkness. Brian L seems to be reading the interesting discussion over at Irish.economy on distinguishing between the two parts of the deficit:

  • The structural element: that part of the deficit that would exist even if the economy were functioning at full potential. We would still have a deficit because we over-relied on temporary property/construction activity for our tax revenue while at the same time cutting more reliable streams such as income tax, PRSI etc.
  • The cyclical element: that part of the deficit which will disappear once the economy returns to normal (higher employment, less social welfare costs, normal patterns of consumption resulting in higher spending tax revenue, etc.).

Disentangling these two elements is not easy. But in the early part of the recession, the structural element made up a significant part of the deficit. Now, the cyclical element is growing in proportion as unemployment rises with all its knock-on effects on tax revenue and social welfare costs.

Some at the Irish.economy believe we should focus on the structural element, rather than chase the moving target that is the cyclical element. I don’t agree. A stimulus approach prioritises the cyclical element. We can deal with the structural element later for the simple reason that even in good times, closing the structural element would be difficult (increasing income taxes, etc.). Trying to do this during a recession will only exacerbate the cyclical element. So my advice: forget the structural, it’s not going anywhere, it’s not growing, it’s not the immediate problem.

However, that’s not the point of this post. We should welcome the more sophisticated approach of deconstructing and analysing the individual components of the deficit. So let’s get even more sophisticated, more creative. Let’s take a look at what Franklin Roosevelt and the New Deal did when it came to budget deficits.

FDR was, initially, a fiscal conservative. No surprise there; that was the fundamental discourse of the time. Don’t forget, the lasting achievement of the New Deal was to transform the very nature of the Federal Government’s role in society. Only a few years previously there was implacable opposition to Federal relief for flood victims in Louisiana on the grounds that this was a ‘state’ matter, not a Federal one. The New Deal started in a very conservative period.

So FDR didn’t come into office as a raging Keynesian. In fact, after he met Keynes in 1934, he was none too impressed (he complained that all Keynes did was leave a ‘whole rigmarole of figures’). But FDR was not just the supreme pragmatist; he was also an enlightened activist. He launched a series of programmes – putting people back to work, strengthening the financial sector, introducing pensions and benefits. All this cost money, money that could not be raised by conventional means such as taxation or public expenditure cuts. So how could he balance his initial instinct (and the overwhelming consensus) for a balanced budget with the obvious need to borrow and spend?

His administration came up with a novel solution. They introduced a ‘regular’, or a non-emergency budget alongside an ‘emergency’ budget. The former they tried to balance. The latter, however, funded the Works Progress Administration (a public works scheme to employ 2 million unemployed), the Public Works Administration (which contracted out large public works), the Civilian Conservation Corps (which employed young men to perform unskilled work in rural areas) along with other stimulus and job creation measures. This emergency budget was allowed to run a deficit for the simple reason that that was the whole point – place the deficit outside the regular budget.

Was this a bit of fancy footwork? You bet. But that was FDR’s great skill. He danced, he tangoed, he waltzed, he even boogied – all to get the economy going. For him, all that mattered was what worked; and anything you had to do to make it work was fair game. Eventually he lost his concern for a balanced budget, becoming almost an accidental Keynesian, when he realised that the sky didn’t fall in just because the Government spent more than it took in.

So how can we do some fox-trotting here, now? We could divide the budget in a similar manner – a regular one, and an emergency or ‘stimulus’one. The stimulus budget would obviously be in debt. It’s only concern would be to borrow or draw down the NTMA’s cash balance, to spend on clearly identified and costed stimulus measures (Fine Gael’s infrastructural investment programme would be one, Sinn Fein’s policy proposals would be another, when Labour produces their stimulus programme, that would be included).

The increased stimulus expenditure would be recorded in the ‘stimulus’ budget. The success of the stimulus measures, however, would be recorded on the regular budget – with rising tax revenues and reduced social welfare expenditure. This would complement fiscal consolidation measures that would use the least deflationary measures (tax on high income groups, unproductive capital and unearned income; along with cutting regressive tax expenditures). This would reduce the fiscal deficit in the ‘regular’ budget.

Would that mean we will still have a high overall deficit when you combine the ‘regular’ and ‘stimulus’ budgets? Wouldn’t we still have to overcome both? Yes. But by separating out the two elements you would be better able to measure the impact of the stimulus on the regular fiscal deficit rather than lumping them all together in an obfuscatory manner. You would first target the regular deficit over a five-year period while making clear that would address the stimulus deficit at the very end of the process.  When the economy is back on its feet, when we have brought the regular deficit under control, we can start raising general taxation and social insurance in tandem with economic, employment and consumption growth.

Is there a precedent for this type of accounting? Yes. The current Government is doing it – by inserting into the budgetary tables the line item, ‘Cumulative Fiscal Consolidation Objective’. This is pure invention and makes a mockery of the headline expenditure and taxation projections. We should abandon this fiscal subterfuge, make the headline figures credible and insert a new line item ‘Emergency Stimulus Expenditure’. This would be more accountable and more honest, providing us with realistic targets that can be achieved.

For let’s not be under any illusions. An economy that is sliding by 7.5 percent in a quarter cannot sustain traditional fiscal consolidation measures; indeed those measures will only make it worse. And if the Government tries to walk a high-wire circus line between preventing ‘over-deflating’ the economy and balancing the budget, they will fall off. And it’s a big government. It will crush all of us.

There is only one alternative: stimulus. Smart stimulus, targeted stimulus, forensically constructed and implemented – but stimulus all the same (in a later post, I will put some numerical flesh on these strategic bones).

If we embark on this road – that ‘ribbon of highway’ – we won’t have to return to the thesaurus. We can still stay with song to describe our new situation. But this time, hopeful song. So that when the fog finally lifts we will see, brothers and sisters, that this land, this economy, this world belongs to all of us equally, without prejudice or privilege.

I’m getting ready.  I’m going to learn to play the guitar.

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