Stop the Presses! Cutting Public Sector Employment Actually Increases the Debt

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Well, well, well.  You know that policy of reducing the number of public sector employees?   Nurses, Gardai, civil servants, local authority workers?   The Government trumpets the success of this downsizing:  since late 2008, public sector numbers have fallen by nearly 30,000.  This has saved, according to Ministers, a lot of money:  the Exchequer pay bill (excluding pensions) has fallen by €5 billion; though some of this is due to pay cuts.  Leave aside the impact on public services – fewer people offering services with less resources; just focus on the fiscal side of things.  It would appear that public sector downsizing is successful.

There’s just one catch:  it is actually driving up the debt.

Readers of this blog will be familiar with the multipliers that the ESRI has produced in the past – estimating the impact of different fiscal measures (tax increases, spending cuts) on the economy, employment and public finances.  Now the ESRI has produced their third impact study:  ‘The HERMES-13 macroeconomic model of the Irish economy’.  In many respects, they confirm their previous results.  But they add a few new wrinkles.  One of them is the impact on the general government debt.  And when it comes to reducing the number of public sector employees, they found that doing such a thing actually increases the debt.

First, let’s go through their numbers.    They assess the reduction of public sector numbers in order to ‘save’ €1 billion in 2013 (in previous studies, they assumed this would mean a reduction of 18,000 employees).  Then they looked at the impact of this measure on a range of indicators – GDP / GNP growth, consumer spending, employment, deficit, etc.  This is what they found for the impact on the government debt.

Impact_Cutting_Public_Sector_Numbers_Gov_Debt

As seen, the debt rises in the first year – by 0.6 percent of GDP.  By the fourth year, the debt is still higher.  Only in the sixth year after reducing public sector numbers does the debt start to fall.

The austerity brigade might point to this debt reduction in the long-term and, say, ‘well, yes, it does increase the debt in the short-term but in the long-term everything comes right.’  However, there is a real sting in the tail; actually, two stings.

The long-term reduction in the debt only happens because of emigration.  Indeed, of all the fiscal measures (income tax increase and cuts in public sector wages, employment, social transfers and investment), the cut in employment has the highest negative impact on emigration.

‘If the external environment were to continue to be very difficult such a level of emigration might not materialise resulting in higher unemployment in the medium term.’

The second sting is that when public sector numbers fall, wages fall.  This is because lower employment in the economy creates downward pressures on wages. In the ESRI model falling wages is a good thing – it makes us more competitive and, therefore, marginally drives up exports in the long-term.  Personally, I don’t buy this (competitiveness cannot be reduced to wages and, in any event, wages make up a tiny proportion of total costs in the export sector).

So this is what we have.  Cutting public sector number drives up the debt.  Over the long-term, the debt falls only if more people are driven off this island looking for a job and if the decline in wages increases exports.  Emigration and wage cuts:  that’s a pretty dismal calculus.

Why does cutting public sector employment result in a higher debt?  It seems counter-intuitive; after all, spending on the public sector pay-bill falls.  S why doesn’t the debt fall?  Let’s focus on two areas.   First, is the combined impact on the economy and the deficit.

Between 2013 and 2018, according to ESRI estimates, the deficit only falls by 0.2 percent of GDP (a pretty fractional amount given that last year the underlying deficit was 8.6 percent).  However, GDP falls on average by over 0.7 percent – in other words, by over three times the amount of the deficit fall.  So, the deficit falls (marginally) but the economy falls much further – the classic ‘spinning the wheels in the deficit ditch’.

Second is the impact on employment – a major driver in the deficit. The ESRI estimates that in the first year of the cut, employment falls by 1.2 percent.  In 2013, this would have equated to 22,000 jobs.   If the €1 billion cut in public sector employment equates to 18,000 employees, this means that approximately 4,000 private sector jobs are lost.  Again, this is not a surprise – removing 18,000 jobs from the economy reduces consumer spending which, in turn, hits private sector employment.  In short, for every 100 jobs removed from the public sector, employment falls by over 20.

So, there you have it:  the economy falls faster than the deficit while losses in public sector employment leads to substantial private sector job losses.  That’s why the debt burden rises.  And the only way this can come right in the long-term is if emigration rises higher than what the ESRI is already projecting and private sector wages fall.

Next time a Minister is trumpeting the success in cutting public sector employment as proof that the Government is taking the hard decisions to correct our public finances, hopefully the interviewer will ask:

‘But Minister, estimates show that you’re only increasing the debt.  How does increasing the debt count as a success?   How does making the wrong decision count as a hard decision?’

I really would love to hear the reply.

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One Response

  1. dingle berry

    August 27, 2013 10:47 pm

    Don’t know why this is surprising. Reducing public servants puts people on the dole and reduces income tax. Right away savings are reduced. Add to that the impact on the economy of reduced spending–most of the people sacked spend all that they are paid–and the impact on public services and you have to wonder is there any saving at all. This is not about solving the problem, it is about ideology.