Who Was Right? The Magic Trick of Austerity

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mag_tri_rabThe Irish economy has finally recovered 8 years after the slump began. This is the longest depression in the history of the State.  Since its inception the economy has grown at around 3% a year. So the lost output over 8 years means that the economy is now about 25% below its trend growth rate.

Supporters of austerity will claim that growth is a result of austerity. But this is a conjurer’s trick, asking us to suspend disbelief. The reality is very different. The Irish economy experienced a change of policy and a change of circumstances. It was these that produced recovery. Everything else is sleight of hand.

When Fine Gael/Labour came to office they implemented their own version of austerity. The response of the economy predictably was to re-enter recession from mid-2012 onwards for 4 quarters, creating the rare phenomenon of a double-dip recession. This is shown in Fig. 1 below. Recovery only happened later.


Fig.1 Real GDP

The policy response was marked, if little publicised. From the end of 2012 onwards there were no new net austerity measures. Instead government spending was actually increased. This was a turn towards stimulus spending, not austerity and is shown in Fig.2 below.

It is not possible to claim that austerity led to recovery. Government spending was increased after the end of 2012 and recovery began 6 months later.


Fig.2 Real Government Spending

The change of circumstances was even more dramatic and had a bigger overall effect on growth.  Since early 2014 the Euro has fallen by 25% against the US Dollar, providing a boost to exporters across the Eurozone and especially to very open economies like Ireland. Many other currencies are linked to the US Dollar in one form or another, notably the Chinese Renminbi. Together, these two economies alone account for 30% of all EU trade.

This has provided an enormous boost to Irish exports. Fig 3 below shows the level of exports and GDP since the crisis began.  GDP is now €7.3 billion above its pre-recession peak. But exports are now €53.5 billion higher. Therefore export growth more than accounts for the entirety of the Irish recovery. The bulk of this increase, €32.9 billion is since the end of 2013. That is, the growth of exports is largely a reflection of the fall in the exchange rate value of the currency.


Fig. 3 Real GDP and Real Exports

Therefore supporters of austerity cannot possibly sustain the claim that austerity led to recovery. Policy changed towards stimulus spending and there has been a boost to exports from a falling currency. But what of the critics of austerity who argued that investment was the alternative to austerity (including the present author)? Are they not wrong too, as export growth has been more effective?

Fig. 4 below shows the trend in investment (Gross Fixed Capital Formation, GFCF) since the recession. Investment is no longer at its low-point, but it is very far from recovery. As all output is either used as consumption or investment this means that the economy has been tilted towards consumption including government and exports. A smaller proportion of GDP is now devoted to investment. As only investment can create increased productive capacity and therefore prosperity this regression towards consumption will undermine future growth.


Fig. 4 Real GFCF

Internationally, it is only possible to sustain an export boom through investment. Investment is required either to make existing goods more cheaply, or to create higher quality goods. At some point the Euro will stop falling. Without investment or a new surge in the global economy the export boom will rapidly fade.

Domestically, the lack of investment means a glut of housing has turned to a dearth. There is a housing crisis. There is too an incipient crisis in the schools, with dilapidation of structures and rising school rolls. There is a largely hidden crisis of affordable childcare, and a visible one in healthcare. There is too a very evident crisis of water services. All of these occur through lack of investment.

The advocates of investment said that this was the alternative to austerity. They further argued that cuts to government investment, exacerbating the investment slump in the private sector, would mean things literally fall apart. Unfortunately, Irish Water shows that this argument is correct.

The current government wants to lay claim for a boom yet simultaneously argue there is no money left for investment. Its policy is boosting consumption and undermining investment. In effect, it is replaying the Fianna Fáil years in reverse; austerity recession and unsustainable consumption boom.

The population is tired of sleight of hand. They want a fair, sustainable recovery grounded in reality.



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