‘What Does an “Open Economy” Mean?’ & Other Important FAQs
On Monday Michael Burke put up an excellent post on the news that the 10-year government debt climbed to 5.7% by close of trading on Friday. Since then of course, we know that yesterday it climbed to over 6%, reaching levels unseen since just before the 750 bn EU bank bailout was put in place to avoid contagion of the sovereign debt crisis in Greece.
But what he has to say in that post remains the same a few short days later:
“Supporters of the austerity policy have persistently claimed that there is no alternative; to do otherwise would cause yields to rise intolerably higher and increase the risk of being shut out of financial markets altogether. But it is the austerity policy, combined with repeated bank bailouts, that have created just such a situation. The policy has clearly failed, not least because tax revenues have not revived.”
And without any indication that a change of policy is to be put in place to acknowledge this failure it seems that it will remain true until it is no longer possible to ignore - although there is every possibility that it will continue long beyond that.
However, what is handy is that the post has some comments from the usual suspects asking the usual questions and posing the usual challenges to Michael’s oft repeated points. But Michael’s responses to these comments work well as a kind of FAQ on the economy as each is a succinct and clear answer to the questions that are frequently raised when challenging the idea that we can stimulate the economy rather than slash and burn our way to a reduced deficit.
So, in the interests of putting to rest many of the myths that are frequently recycled as the ‘plain truth’ in media commentary on the economy I’m putting them up here.
Note: I’ve rewritten the questions for clarity. To see the original discussion go here.
But stimulus won’t work here (unlike France, Germany and Belgium) because Ireland has an ‘open’ economy.
‘Open’ is a frequently misused term, with connotations of an open wallet, open vault or open chicken coop.
‘Openness’ is measured as the proportion of the economy devoted to external trade, both imports and exports. In that sense, this economy is very open, with a very high proportion of both.
This last point is frequently overlooked by opponents of government spending, who argue that any increase will just ‘leak’ out of the economy via increased imports, ignoring entirely that this economy exports much more than it imports and that the overwhelming bulk of those imports are inputs for re-export.
The overwhelming bulk of goods and services consumed in Ireland are produced here. One key exception is vehicles, where bizarrely the government did provide a stimulus (cutting VRT).
But isn’t the increase in the bond yield only due to the size of the bank bailouts, particularly with the uncertainty about the amount needed for Anglo?
The banks are dragging the country down, and Irish bond prices show it. The yield on the Irish 10yr bonds climbed to over 6% yesterday.
This is a specifically Irish question, as Italy was lower at 3.8%, Spain unchanged at just over 4%, Germany a little lower at 2.25%.
This is all about the government’s imminent decision on Anglo- bond investors may not be the smartest in the world but they’re not dummies either, if you keep handing over sums that represent big chunks of GNP to bailout your mates, they’ll stop lending to you.
However, I don’t think the fiscal crisis can be attributed to the bank bailout, as many here wish to believe (thereby absolving fiscal policy).
In fact, in Europe as a whole the bank bailouts seem to have no correlation at all to the crisis. Italy spent nothing on bailing out banks, Spain 5% of GDP, Portugal 3%(compared to Ireland’s 232%- and counting).
See a good article and the details here.
The next biggest bailout after Ireland’s was our old bugbear Belgium (my note: PE comments frequently cry: “But Ireland is not Belgium, we have a small open economy”. See FAQ on ‘open’ economy above), followed by the Netherlands, both of which retain the ‘approval’ of the bond markets.
Right now, there is an increased risk attached to Irish government debt because the markets fear Anglo will be bailed out again.
But aren’t tax breaks themselves a stimulus?
I think there is a misunderstanding. Tax breaks do not provide the requisite boost because they have lower multipliers, as private agents fearful of their incomes save rather than spend. This is confirmed in the most authoritative research from the IMF et al, IMF, The Effects of Fiscal Stimulus in Structural Models, IMF WP/10/73, which argues for government investment, and against tax breaks.
As for the claim that Germany can grow without trade, that will come as news to both German exporters and statisticians. German imports are equivalent to 40% of GDP and exports 50% of GDP. The entirety of record Q2 growth was due to the external sector.
And no sensible person in Germany argued against stimulus measures because imports are 40% of GDP.
Discussion
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Comment by: Robert Sweeney
Sep 8th 2010 at 13:09
“the overwhelming bulk of those imports are inputs for re-export”.
I’m not sure it’s entirely accurate to say this. If goods are inputs, then, by definition, they are not included in the figure for imports which is supposed to include finished goods only. GDP and its components, imports, exports, consumer spending etc. measures the value of finished good. Any intermediary good should not be included.
The general point is taken though that a lot of Ireland’s imports are just re-exported. Otherwise, it would be impossible to account for how a country imports or exports more than its GDP. Does anyone have a breakdown on exactly how much of Ireland’s imports are just re-exported?
Comment by: Donagh
Sep 8th 2010 at 14:09
I think its fairly well known that MNCs import ‘compenents’ which are assembled here and exported as finished products. Certainly in the case of pharmacuticals, the chemicals used in the products are considered to be imports.
Conor McCabe has a little on this already:
http://dublinopinion.com/2010/08/10/value-of-imports-by-broad-commoditty-group-2009/
and
http://dublinopinion.com/2010/08/12/the-dynamism-of-irish-exports-2005-april-2010/
And details of other discussions here:
http://dublinopinion.com/2010/09/03/the-timidity-of-the-irish-leftliberalprogressive/
But this isn’t a precise answer to your question, but I’ll try to find out.
Comment by: Michael Burke
Sep 10th 2010 at 15:09
Robert,
There is a misunderstanding. All imported goods, finished or otherwise are included in the national accounts. Finished or not, they must be paid for, incurring n outflow of capital.
If, say, oil is imported that is indeed counted as a debit in the national accounts even if it is only an input into the generation of electricity or production of glassware, production of transport services, etc. In the latest data the total use of imports was €112.8bn, but their final consumption here was just €23.4bn. The remainder were inputs for production and re-export.
The spreadsheet can be found here.
http://www.statcentral.ie/viewStat.asp?id=182
Yet no sensible person thinks that this should be halted. On the contrary, it needs to developed as this adding of value is the basis of any country’s prosperity.
What opponents of measures to boost the economy seem to have in mind is the personal consumption of imports. But in the same year, this was just €10.6bn, just 9.4% of the total import bill. It was also just 10.7% of total personal consumption of €98.7bn.
These ratios are lower than in many countries which did adopt measures to boost growth. They in no way undermine the case for government action to boost growth.