A real crisis this time?
THE PUBLICATION of the next quarterly report on the economy by the Economic and Social Research Institute --expected within the next few weeksis awaited with more than the usual amount of interest. Psychologically, the report will mark the end of the Summer doldrums in economic affairs caused, as in most other aspects of political life, by the anti-climax of the June election and the disappearance of Ministers, Civil Servants, and economic commentators to their various holiday hideaways. More importantly however, the ESRI's forecast is awaited for indications as to whether the economy really is heading towards a crisis and whether as a consequence some of the promises and predictions freely traded before and during the election are going to hold true or not.
What constitutes an economic " crisis" is, of course, a debatable matter. Opposition parties apply rather liberal criteria and tend to classify as critical circumstances which merit only minor adjustments of budgets, credit ceilings and the other instruments of economic policy. Governments, understandably, attempt the reverse; to dismiss as minor and temporary mammoth failures in their judgement and understanding of economic conditions. What makes the present situation so confusing is that this usually predictable pattern of reactions has not occurred-at least not exactly. For while the Opposition parties have indeed issued the customary jeremiads the government has, in the recent past, agreed that there could be a crisis brewing, then denied it and wound up in the end apparently with two definitions of what a " crisis" is.
The confusion began last November. With serious but hardly critical inflation making itself felt in rising prices and a deficit in the balance of payments, Mr. Lynch, deputising for the injured Mr. Haughey, introduced an Autumn " mini" budget. Instead of the moderately restraining measures widely thought to be sufficient to deal with the situation, Mr. Lynch unleashed massive increases in taxes and charges sufficient to raise £18t million in a full year. Since this was larger by £15t million than the amounts exacted in the regular budget of the preceding April, the general public could have been excused if they associated the then prevailing conditions of price increases of 6% per annum and a deficit of £20 million in the balance of payments, with an economic crisis.
The conviction that the economy was heading for serious economic difficulty, could not have been reinforced by the result of the maintenance strike in February which resulted in a large increase in wages paid to the striking unions. Actually, this situation was serious by any calculation and in a series of meetings with the leaders of both sides of industry, Mr. Haughey, now recovered from his car accident, warned of the harshness of the measures that were required in any case, but which would be made more brutal still if the maintenance men's award was to spread generally through the economy. "To frame a budget to meet this situation (before the strike) was clearly going to be a formidable task anyway. There would have to be increases in taxation with small, if any, increases in benefits for those who would normally be expecting them. .. Now (after the strike) this situation must be looked at again. The maintenance dispute made the situation worse."
Surprise, surprise, when Mr Haughey finally introduced his budget in May there was no sign of the grim measures promised two months before. Where previously he had held out little hope for increasing welfare benefits he was now able to announce that the prospect of a crisis had receded and that the government had" decided, therefore, to make substantial improvements in the main benefits payable under the Social Welfare code. . ." Mr. Lynch's definition of what constituted a serious situation had also been altered. Whereas in November the Taoiseach had warned against a balance of payments deficit" considerably in excess of £30 _ million. . . ,. by May his Minister for Finance was able to dismiss airily the prospect of a deficit of £55 million as no very great threat."This (£55 million deficit) is still large but must be viewed against our strong reserves position, the voluntary capital inflow and the prospect of substantial increases in output, savings and investment."
Obviously the attitudes which prevailed between November and March on the one hand, and those which emerged suddenly in May cannot both be correct. Either a deficit in the balance of payments of £55 million is 'or is not serious and thus either Mr. Lynch or Mr. Haughey are misjudging the economy. Of course it is possible to find an explanation for the two different positions on political rather than economic grounds. As a Special Correspondent of the Irish Times darkly noted of the Autumn budget" this budget may not alone be unduly severe from an ecnomic viewpoint but this severity may have been influenced not so much by an economic viewpoint, however misguided, as by a political judgement." In short, it can be argued that Mr. Lynch inflicted a severe budget in November in order to build up reserves from which to dispense goodies in the following year when the general election would not be far off.
What is a Crisis Anyway?
But while this may reconcile the differing positions taken by the government between November and May it does nothing to indicate what the government genuinely regards as an economic crisis. Put otherwise, and in slightly more scientific terms, we still don't know, from what the govern.;. ment's recent words and deeds, in what circumstances it would be prepared to impose severe economic measures such as a wages freeze, import surcharges, or heavy tax increases. As a matter of fact, Mr. Haughey probably was nearer the truth than Mr. Lynch. A balance of payments deficit of £55 million in 1969 might not be too disastrous given reserves of close on £300 million. The £55 million figure might suggest a serious situation, however, if the deficit promised to become much larger in the following year. In other words the size of the deficit is not the only important consideration; its direction (up or down) and the rate of change, are also important factors.
Charles Haughey T.D., Minister for Finance-Another Autumn Budget The situation with respect to prices, the other measure of inflation, is less relaxed. The rate of inflation associated with present government policies implies not only a payment deficit of £55 million but also, according to Terence Baker who writes the ESRI's reports, an increase in prices of 6'5%. Unfortunately prices, unlike deficits, do not have" reserves." So far as can be seen prices are about as high in Ireland as they are in England, our main competitor. Moreover, an increase in one year of 6'5% is far higher than that expected this year in England and indeed in almost all other European countries. In fact the projected increase in prices this year is the largest annual increase recorded by the Consumer Price Index since it was introduced in 1953 ! And unlike this year's deficit, it must be remembered, the 6'5% price increase cannot be reversed.
These considerations alone-all of them fairly obvious since before the May budget-may be sufficient to prompt the government to introduce an Autumn budget although government ministers have denied, in response to opposition charges of cynicism, that any post-election budgets would be necessary. But even if Mr. Haughey and his colleagues were sincere at the time in believing that the pre-election budget was suited to the economic situation and would not have to be cancelled by budgets later in the year when the election was over, several developments since then seem likely to prove this judgement inaccurate.
To begin with the balance of payments seems destined to rack up a greater deficit than either the Department of Finance or the ESRI projected last May. In the first quarter of the year thedeficit in merchandise trade widened to £53'3 million-an increase of about 30% on the deficit in the corresponding period last year. Unpublished preliminary figures for the second quarter show that the trade deficit in the second quarter is up to £60 million which is an increase of 50% on the second quarter of 1968. The trade deficit seems, therefore, not only to be much wider than last year's but to be widening as the year goes on although the maintenance strike may account for some of the increase in the deficit in the second quarter. Still, making allowances for this it would seem that the visible trade deficit may be somewhere around 40% larger than it was last year. That is to say, the 1969 trade deficit could be about £220 million!
"Invisible" receipts from tourism, emigrants remittances and so on, have to be deducted from this to get the overall deficit on the balance of payments. On this score too post-budget data is not encouraging. Net receipts from tourism, the largest single item in the " invisible" accounts, is unlikely to show very much increase. Although the number of tourists appears to be larger than last year their spending will not be much above £100 million compared with £93 million last year. Given a normal increase in Irish tourists going abroad this extra £7 million could be wiped out giving us no increase in the net receipts from tourism. It's anybody's guess what sort of returns might be derived from the other invisible items but it's hard to see how they could record an increase of more than £10 million. This would mean total net invisible receipts of £147 million for this year. Set against the deficit on merchandise trade this rough approximation suggests an overall deficit on current account of roughly £73 million.
This nasty outcome could be softened a bit by government action. For one thing the government could intervene in all forthcoming wage negotiations (a number of important agreements come up for negotiation late this year and early next year) and push hard for minimal income increases. Of course the government is involved in this already. Last March, Mr. Haughey got the union leaders to agree not to follow the example of the maintenance men and initiate a wage round. Unfortunately, while union leaders are unlikely to be able or willing to ask for what the maintenance unions got they will hardly confine themselves to anything less than a 10% increase in wages. Already, 50,000 building workers have been awarded increases of more than that.
The second area in which the government can act to stem the inflationary tide is monetary policy. Since Mr. Haughey's budget last March the Central Bank has adopted a severely restrictive stance in requiring the Associated Banks to limit their credit increases this year to a total of £75 million to £80 million. Since tlle government is to get £50 million of this only £25 million to £30 million is available for the private sector. This is about half of last year's increase in credit to businesses and individuals and if the banks can stick to it they could deflate the economy enough to lop a few millions of the prospective deficit.
But how likely is the Central Bank to succeed in keeping credit growth to the prescribed £75-80 million? As the Bank itself candidly concedes in its annual report the last two guide-lines it issued for the years ending March 1968 and April 1969, were substantially exceeded by the Associated Banks. The Bank's report also shows that in May, the first month of the April to April year over which the guidelines are to apply, credit has grown by £9'9 million which is a good deal more than one-twelfth of £80 million.Moreover the Report shows that this was a net increase in total credit. In May government credit declined by £5'6 million so that private credit must have expanded by £14'5 million In other words, in one month half of the targeted increase in credit for the year to the private sector has been taken up!
Although the liquidity of the banks (the relationship between their liabilities to customers and their external reserves plus deposits with the Central Bank) is now very low and declining, these figures show that the credit demands of the private sector is very intense. In an inflationary economy credit demands rise rapidly as businesses and individuals try to accelerate purchases in anticipation of price increases and try to build up stocks of goods and cash to accommodate surging demand and to anticipate further credit stringencies. With the government current budget in deficit at a high level and with large incomes increases in prospect for this year, it seems unlikely in the extreme that the Central Bank will be able to hold the Associated Banks to anything near an increase in private credit of £25 million to £30 million.
The third and last group of actions by which the government can influence the economy is, of course, through its own budget. And with incomes policies and monetary policies incapable of themselves of dealing with the current inflation, the burden on the govern-, ment's spending and taxing policy this year is unusually heavy. Unfortunately the scope for cutting government spending is practically zero. Every year brings its crop of government projects for which no provision was made in the regular budget. Because the last budget did reduce the increase in non-social welfare spending to the bare minimum this year's lot could be a good deal heavier than usual. Rapidly rising prices and incomes will give an added impetus to the growth of government spending in the near future.
Another Autumn Budget is thus going to be required to reduce the present rate of inflation. Conceivably it may incorporate temporary increases in import duties which will delay some imports for a few months and yield some revenue to the government. Certainly however, the government will be raising taxes-presumably on the old stand-bys, petrol, spirits, beer and tobacco. It is not beyond the bounds of possibility, however, that the government will reach for increases in other taxes and charges.
But an Autumn Budget would by no means get the economy out of the wood. Next year's budget will also have to be restrictive and throughout the next calendar year incomes and credit will have to be carefully controlled. Even then the balance of payments will hardly be in surplus until sometime in 1971 although it may be close to balancing by the end of 1970. Providing firm action is taken in the near future, and adhered to throughout a large part, if not all, of 1970, then it should be possible to reduce the rate of increases in prices and balance our external payments without drastically reducing economic growth or seriously disrupting Irish industry. In the longer run, however, the government will have to learn to resist the temptation to steer their economic policy by the light of political necessities.