Dates with the Devil: The Recession Diaries June 28th

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What would be your reaction if it could be shown that a set of policies would result in deepening the recession, increasing unemployment, reducing domestic demand (meaning more business closures) while having only a minimal effect on the fiscal deficit? What would you say to the political party or the Minister who offered you such a programme? You’d probably say:

‘Get thee away from me, fiscal Satan!’

And you’d be right. But hey, this is Fianna Fail country, where economic demons rule and the orthodoxy hail them as angels, even saviours.

The ESRI has done us a considerable service by showing what the impact of certain budgetary policies will have on economic activity. This is all the more urgent with the IMF report calling for a gigantic smashing ball to be hurled at society – repeatedly. And today’s Sunday Tribune suggesting that An Bord Snip will come out with a swinging programme of cuts, cuts, and more cuts.

The ESRI takes a number of policy proposals and shows how they will affect a range of economic categories – GNP growth, unemployment, private consumption, the borrowing requirement, etc. Here’s one example. The Minister comes into the Dail and in solemn tones announces the Government will have to fire 10 percent of all health and education staff (okay, provocative; he will reduce the payroll through redundancies, wastage and vacancies left unfilled). Oh, he will be sorry, he will wish he didn’t have to do it, but times are hard and we have to reduce that ol’ fiscal deficit, so there’s no alternative; yes, he’s possessed by the demons. So, what will be the effect of reducing the health/education payroll on the economy? The ESRI provides hard numbers for the first year:

  • GNP will decline by 0.9 percent
  • Unemployment will rise by 0.9 percent
  • Consumption will fall by ½ percent in the first year, falling by over 1 percent in the third year
  • While the public sector wage bill will fall – by €1 billion, the effect on the borrowing requirement (and, so, the deficit) will be negligible. This will fall by less €500 million, or 0.2 percent of GDP.

Wow. Getting rid of all those lazy, unproductive workers – which we are told is an absolute virtue – sends all the indicators in the wrong way. And we only end up cutting the borrowing requirement by a 0.2 percent (remember, the IMF and their deflationary cheerleaders here want the borrowing requirement cut by nearly 10 percent in four-five years).

ESRI Multiplier

Let’s say the Government (a) cut public sector wages by 5%, (b) cut health and education employment by 10%, and (c) cut capital investment by €1 billion. What would be the reaction? It would be called a victory, proof to the ‘international markets’ (those grand bazaars lodged in the boardrooms of hedge funds and pension funds and banks) that we are ready to take ‘courageous action’. After all, this would cut €3 billion off Government expenditure – nearly two-thirds of the amount An Bord Snip is looking for.

Now, in the real world, what would be the economic effect of this ‘victory’? According to the ESRI, in the first year (2009) the economy declines by 1.5 percent, consumption falls by slightly less, while unemployment increases by 1.3%. Just what we need – more recession, more unemployment and falling domestic demand (why isn’t the Small Firms Association jumping up and down in protest against these policies, rather than supporting them). And with the deficit expected to be between -12 and -13 percent, how much do these measure reduce that figure? By 0.9 percent. More pain, more misery and minimal effect on the budget.

We would still have an unacceptably high deficit but, now, by reducing growth and domestic demand, while increasing unemployment, we would find it an even greater burden to generate the growth needed to overcome our mounting debt problems.

A second finding of note from the ESRI calculations is that tax increases have a less deflationary effect on the economy. This is important since we are constantly being lectured that public spending cuts are more ‘beneficial’ than tax increases. Let’s take the following three taxes:

  • A rise in income of tax approximately equivalent to a 1% rise in the standard and higher tax rate)
  • A carbon tax of €34 per tonne, and
  • A lump-sum house property tax, averaging roughly €600 per house

The combined effect would be to lower GNP but only by 0.3 percent (five times less than public spending cuts), increase unemployment by only 0.3 percent (four times less) and reduce the fiscal deficit by 1.4 percent – ½ percent more than spending cuts. But, unsurprisingly, these tax increases would reduce consumption – by 2%, substantially more than spending cuts in the first year.

Now, I wouldn’t push this distinction too far. These tax increases are still deflationary and their impact on the fiscal deficit is still insignificant. And, like, spending cuts, we may end up years hence struggling with a stubbornly high deficit and a reduced capacity to bring it down. But it shows that more carefully crafted taxes – focusing on high income and wealth sectors – can have even less deflationary effect. True, they wouldn’t immediately raise the same level of revenue. But now we know.

That continuing with the Government’s policies, the policies of the Right, the policies advocated by orthodox commentators will only sink the economy further with marginal effect on the deficit. The ESRI’s conclusions confirm a truism, which somehow gets lost in translation here: that you can’t cut or tax your way out of a recession. You can only grow.

Anyway up for an exorcism?

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