The latest growth data confirm that Ireland went back into recession at the end of 2012. Despite all the talk about corners being turned, we find that economy is going backwards. GDP is lower than it was in 2009. GNP, which does not include the effects of movements in profits by multinational corporations, is back to where it was in the middle of 2010.
The ability of the Irish government to return to bond markets is being promoted as the main or even the sole criteria for the success of government policy. Strange that it is simultaneously said that this is a government debt crisis, and yet its resolution is measured by the ability to add to government debt.
The purpose of all economic policy should be the optimal sustainable increase in the well-being of the population. Instead, a return to the bond markets has become the overriding objective of economic policy. But this is itself unsustainable if the economy is contracting as the debt burden rises and the deficit widens once more.
On growth it is clear that the fall in investment remains the overwhelming source of the Irish Depression. GDP and GNP have contracted by €13.3bn and €11.9bn since the end of 2007 respectively. Investment (Gross Fixed Capital Formation) has fallen by €21bn. It is an investment strike which is responsible for the slump.
The national accounts are shown in the chart below from the end of the boom in 2007 to the end of 2012.
While investment has collapsed by €21bn, the fall in personal consumption has been about one third of that, at €7.1bn and the fall in government spending slightly lower at €5.6bn. It is repeatedly asserted that the performance of exports proves the validity of current economic policy. But while the increase in net exports has been very significant, this owes more to falling imports (which are treated as a negative in the national accounts) rather than rising exports. Recorded exports have risen by €11.7bn over the period while imports have fallen by €15.8bn – and there are question marks about how real these exports are.
The issue of resolving the economic crisis is therefore essentially about reversing the investment slump. From that, all other questions can be resolved, such as government spending and falling real incomes.
The source of the investment strike is a broad based refusal by the private sector to invest, which embraces all sectors of the economy. It has been exacerbated by the government’s cuts in its own investment.
The purpose of capital is its own preservation and expansion, not the general public well-being, or even growth of the economy. Without profits, or the expectation of profits, capital will not be invested by the private sector and will instead be hoarded. This is true whether it is an airline considering leasing aircraft, or a developer building houses or a haulage company buying new vehicles.
Output only really has two destinations, either consumption or investment. If the proportion devoted to investment falls, so will the growth rate of the economy. Ultimately, the whole of output can be consumed, but this can only lead to zero growth. The country with consistently the highest proportion of output devoted to consumption is Greece. The fact that the US is also close to the top of this league table is merely because the rest of the world is willing to lend it money to finance that consumption, which is not an option currently available to Greece. The country with the highest proportion of investment is China.
An advanced economy already has a large proportion of fixed capital, so there is a rate of capital consumption (capital used in production, plus wear and tear or dilapidation) which requires investment simply for replacement. Currently, the proportion of investment in the Irish economy devoted to investment is just over 10% of GDP. This is approximately the same as the rate of capital consumption in the economy and means it will be impossible to sustain growth. These are both shown in the chart below.
Who can pay for investment?
Some of the supporters of austerity express a militant enthusiasm for reducing wages and reducing social expenditure. Others sometimes express more sorrow than anger. In Colm McCarthy’s famous dictum, ‘we haven’t run out of compassion, we’ve run out of cash’. If this were true then it would be impossible to refute and there really would be no alternative. But it isn’t.
Data for 2012 are not yet available for wages and profits. In cash terms the compensation of employees fell by €10.5bn over that period 2007 to 2011 while the Gross Operating Surplus of firms (effectively profits before interest, taxes and other charges) fell by €11.4bn.
The fall in profits is a natural consequence of lower sales, as business revenues fall as costs are unchanged or even increase. The purpose of austerity is to transfer this reduction in incomes from capital to labour; from profits to wages. That fall in sales is not mainly falling personal consumption. Most goods produced are as inputs for the production of other goods. It is the fall in the production of these inputs (a form of investment) which produced the slump.
In the Irish economy, as elsewhere in the earliest phases of the recession, wages and salaries continued to rise because this was a crisis of profitability. But since 2008, when austerity measures were introduced, to 2011 the Compensation of Employees has fallen €13.2bn in nominal terms. Over the same period the Gross Operating Surplus is barely lower, down €400mn, as shown in the chart below.
As austerity really began to bite, with compensation continuing to fall, the Gross Operating Surplus has actually begun to rise. From 2009 GOS has risen by €5.9bn even though the economy contracted on the same nominal basis. This was achieved by driving down wages, with CoE falling by €5.6bn over the same period. It seems probable that the nominal increase in output in 2012 will have gone entirely to increased profits.
This explains why the representatives of Irish business are not up in arms over the effects of current policy. Of course, some firms go bankrupt. But IBEC’s surviving members will not complain while profits are being restored. This is austerity’s main purpose – to restore profits- and to this extent, it is working.
The incomes of workers and households have acontinued to fall. It is impossible for them to increase investment. But the incomes (profits) of companies are recovering. Yet their investment level has fallen, or at least it did until 2011.
There was a very slight increase in investment in 2012. It was a paltry increase, of just under €200mn in the year as a whole compared to a €20.8bn decline in investment in the previous 4 years. At this rate, it would take 100 years for investment to recovery its pre-crisis levels. But it does highlight one way of resolving the crisis.
If wages and the social wage can be reduced sufficiently, and sufficient capital can be scrapped, then the profit rate can recover. This will then encourage capital to be invested once more, which is what happened in 2012. But the very small increase in the level of investment to date shows that the process of reducing wages and scrapping capital would have much further to run before this type of recovery can be secured. The burden of resolving the crisis is being shifted on to the shoulder of workers and the poor. It has much further and deeper to run.
The alternative is to use the levers of the state to direct idle capital towards investment; not reducing either investment or wages. These levers include the state’s own financial assets, not handing them over the creditors. They also include using the tax system to capture retained earnings, dividends and to prevent or discourage the repatriation of profits. The Government could also direct the real assets of the banks licensed in this jurisdiction, their deposits, towards productive investment with a return on those savings. Waiting for the private sector to lead a recovery isn’t working.
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- Investment Remains the Key to a Real Recovery - September 24, 2014
- Hoarding Cash While Refusing to Invest - July 9, 2014