How Fianna Fail's economic policies cannot get this country moving again
An analysis of the Government's economic strategy by Paddy Geary
Fianna Fail's analysis of the economy has been seriously incomplete.
IN ITs PRE-ELECTION manifesto, the Fianna Fail party outlined the economic policy it proposed to adopt should it be returned to office. In January of this year, seven months after the general election, the Fianna Fail Government issued the White Paper "National Development 1977-1980" which confirmed that the economic policies of the manifesto would be implemented. The Budget which followed a few weeks later displayed a reemarkable fidelity not only to the spirit, but to the letter of the manifesto.
This consistency attaches considerable importance both to the problems of the Irish economy which underlines
the Government's policies and to the question of whether or not the policy instrumen ts employed are appropriate to the desired objectives.
The manifesto described the state of the economy in May 1977 as follows. There was a record number of people out of work; the Irish inflation rate was the highest'. ! ne EEC; the Coalition government was borrowing "at a phennono mal rate." To confront this sittvation, a " crash campaign" to boost ind ustrial and agricultural expansion was proposed; once the economy was growing again measures would be adopptee1 to sustain growth. In brief, the economy was viewed as being in recesssion; a pump-priming exercise was warrranted to renew economic confidence and hence the growth of investment, employment and output.
This view was seriously incomplete.
In the third quarter of 1975, there was evidence that the recession was coming to' an end- in the industrial sector. In that quarter, the volume of output of transportable goods industries showed a small rise after five successive quarters of decline.
The recovery continued in the final quarter of 1975 and gathered momenttum during 1976, when the volume of production grew by 9.0%- the corressponding figure for the manufacturing sector was 10.6%. The growth of output continued during 1977 so that by May, there had been seven successive quarters of expansion. Exports of manuufactured goods also grew rapidly during 1976, an inncrease of 20% in volume terms being achieved after a fall of about 4.5% in 1975. Other indicators, such as the volume of imports of prooducer capital goods, provided further evidence that recoovery from the recession was well under way.
However one significant aspect of the recovery during 197 6 and early 1977 was the failure of the unemployment rate to record a significant decline. The level of employyment in transportable goods industries did not begin to increase until the second quarter of 1976 but it rose by about 6,500 in the period June 1976 - June 1977. Despite this, there was little change in the number of people on the Live Register. The level of unemployment failed to show much response to more than eignteen months of sustained growth in industrial output. It was this failure that the manifesto concentrated on and made the redduction in the level of unemployment the central target of Fianna Fail's economic policy.
The manifesto's discussion of the rate of inflation was brief and extremely misleading in its suggestion that domestic policies alone could cut the inflation rate from 15% to 7%, regardless of devvelopments in Britain, while the link with sterling was maintained. There was no suggestion in the manifesto that a change in the Irish exchange rate pollicy was contempletd.
The White Paper was essentially a more detailed presentation of the secctions of the manifesto dealing with economic policy. The need for a pumpppriming exercise was again asserted- this was described as the first phase of the Government's development programme and consisted of various measures adoppted in 1977 and the Budget. A number of longer term objectives were defined, most of them closely related to the main objective of increasing employyment.
In this regard, the quantitative tarrgets which appeared in the manifesto were reasserted. They were an average annual reduction in the numbers out of work (25,000 in the years 1978-1980) and a growth rate cf real GNP of 7% per annum over the same period. There was a much greater acknowledgement of the existence of constraints which might affect the achievement of the targets than was evident in the manifesto; whether or not it was adequate can be judged by the policy instruments which have so far been adopted.
The policy instruments used by the Government to date have, with a few exceptions, been macro-economic in the sense they have been directed by broad economic aggregates such as personal consumption investment and so on. Policies to deal in detail with individdual sectors are to form a major part of the Green Paper, to be published early this summer. Since they are, by now, well known, a brief summary will suffice here; it consists of the main provisions of the Budget and of the public capital' programme, together with measures announced earlier.
First, there were a number of policy decisions directly relating to personal incomes. These included the abolition of rates on private dwellings, the reeplacement of motor tax on smaller cars by a flat-rate tax of £5, and increases in personal income tax allowances. Second, there was a set of policies dirrectly aimed at stimulating investment, which included the introduction of free depreciation on new industrial buildings and making permanent the free deprecciation on plant and machinery.
Third, there were policies directly related to job creation. Among them were provisions for more than 11,000 new jobs in the public service; more than 6,000 new jobs in building and construction and a further 5,000 jobs in youth employment projects. In adddition, employment incentives were provvided for private industry in the form of reduced corporation tax rates, connditional on achieving 3% employment growth, and in the form of payroll subbsidies to some labour intensive industries.
The emphasis on job creation is reeflected in the changes which occurred in the structure of the capital programme. A comparison of the estimates for 1978 with the out turn in 1977 reveals that the share of those items, which in the main involve building and construction, has increased from 33.4% to 39.4%. Since the real value of the public capital programme changed very little, this reppresents a significant switch back to the building sector.
The overall effect of these and other budget policies was to produce a current budget deficit of £405m. When borrrowing for capital purposes is added, the total government borrowing requirement for 1978 amounts to £821m or 13% of GNP on the assumption of a 7% growth rate this year. The corresponding figures for 1977 were £545m- 10.2% of GNP.
These policies may be assessed from a number of standpoints. The first conncerns their implications for the role of macro-economic policy. As was noted above, the economy had begun to reecover from the recession in late 1975. Growth in industrial output and exports contributed to an increase in real GNP of 3% in 1976. During 1977, growth continued in all sectors and real GNP rose by 5%. This is higher than the average growth rate achieved during the 1960's or in the period 1968-1973. In the absence of any budget stimulus, a growth rg.tk of 4.5% to 5% was forecast, still above the trend rate of growth of the economy since 1960.
Although the size of government borrowing requirement is a flawed measure of fiscal impact, the 1978 Budget was unambiguously expansionary and intentionally so. This suggests that, for the moment at least, the Government has abandoned what the economists would regard as one of the basic goals of macro-economic policy, that of econnomic stabilisation, i.e. of using budgetary policy to stimulate the economy when its growth rate is relatively low, and of contracting it when its growth rate is relatively high. It is true, of course, that the extreme openness of the Irish economy, especially its trade dependence limits the effectiveness of such policies but this does not make the case for abandoning them.
It is fair to point out that this is not the first time that what economists call " pro-cyclical" policies have been adoppted by Irish governments; the Coalittion's budgets of 1973 and 1976 were of the same character and the Inter-party government of 1956-57 provided a celebrated example.
The case for having an expansionary budget in 1978 appears to rest on two grounds, One is that the level of unemmployment justifies such a stimulus; the other is that a legitimate goal of macrooeconomic policy is to increase the rate of economic growth. The first of these points presumes that the unemployment level may significantly be reduced by means of budgetary stimulus. There is no doubt that the direct job creation policies will reduce unemployment in 1978; there are, however, strong doubts that such policies can be used repeatedly. The Government is committed to a reduction in its borrowing requirrment to 10.5% of GNP in 1979 and to 8% in 1980; continued resort to a policy of expanding public sector employment under such circumstances would have interesting implications for taxation.
The goverment therefore expects employment in the private sector to grow sufficiently rapidly to meet its unemployment targets. .
There is no precedent in the postwar Irish economy for such sustained economic growth. For example, in the period 1968 to 1973, the average annuai growth rate of employment in the manufacturing industry was about 2%, compared to the 5.9% envisaged for 1978-1980 in the White Paper. World trade in manufacturing grew by almost 10% per annum in that period, a faster growth rate than is expected in the next three years.
Thus, even under favourable external circumstances the achieved growth rate of employment in manufacturing was one-third of the Government's present target. The same type of arguments may be made in connection with the target of 7% GNP growth for a three year period; this, too, lacks a historical precedent in the post-war economy.
There are also reasons for doubting whether the policies of the Government will achieve the 1978 targets, much less the objective of sustained growth. There are two points to be made here. First, the Government's budgetary measures were biased towards personal consumption, a bias due almost entirely to the various tax concessions. Increased personal incomes will lead to increased demand for goods and services' the exxtent to which it will be for Irish goods depends on the proportion of income increases spent on imports and on the extent of unused capacity in Irish inndustrv to meet the increased demand.
Neither of these factors provides a basis for optimism that domestic employment will expand rapidly. The Irish propensity to import is high and the " Guaranteed Irish" campaign is unlikely to reduce it very much; after ten successive quarters of expansion, it is questionable whether there is a sizeable amount of unused capacity in industry. The second, related point is that if the incentives to firms to expand their capacity prove successful; the lag before output expands could mean that the increased demand generated by the budget would already be satisfied by imports. Thus, the short term effects of some of the Government's measures may be reflected more in imports than in sustainable employment.
The implications for Irish industry of the budget measures are of some interest. It is suggested in ministerial statements that, in return for the various incentives which have been offered, the private sector has a dutyto expand employment in accordance with government targets. The vast majority of Irish firms are, due to our membership of the EEC, in competition with producers from the UK and continental Europe. To survive in export markets or in the domestic market, they must be able to produce goods of comparable quality, of commparable prices to those of their commpetitors;
There is no presumption that this goal and the Government's employment targets are complementary- they could easily be in conflict. If firms choose to adopt criteria for increasing employment other than those which relate to their ability to compete successfully, they place at risk their own growth prospects and possibly even their survival. The long run consequences of such behaviour could weil be to reduce the level of industrial employment; some of the lessons of recent British industrial exxperience should be studied before overrmanning is made an objective of policy.
Considerable attention has been focussed on the size of th~overnment's borrowing requirment in 1978 and on the implications of the budget for the balance of payments. There is really no possibility of the Government being unable to borrow what it reequires in 1978; such a situation has not yet arisen for an Irish government.
There is, however, a distinct possibility that further foreign borrowing will be undertaken. The external debt of the Irish government has risen dramatically in the past four years; during 1977, the combined external debt of the Governnnment and State sponsored bodies exceeded the value of the official currrency reserves. What is even more immportant is the structure of the debt. More than 70% of the existing debt has less than five years to maturity - i.e. has to be repaid in foreign currency.
Under existing circumstances, there is little doubt that this debt could be rolled over; new debt would replace the old. However, the greater the volume of foreign borrowing undertaken by Irish governments, the closer the scrutiny their policies will receive. If it is found that a significant part of its borrowing is to finance current budget deficits while the economy is already growing, the cost of borrowing could rise. If this coincided with a series of large balance of payment deficits, a serious borrowing constraint might be encountered.
There are recent precedents for such a scenario; Italy found itself having to fulfill stringent restraints on its policy conduct laid down by Germany and while closer to home, the UK had to accept IMF restrictions on its domestic credit expansion as a condition for the credit facility it received at the end of 1976.
It would be wrong to suggest that Ireland is on the verge of such a sittuation but it is not difficult to envisage how it might arise. A failure to come closer to the unemployment target of the White Paper could present the choice of either modifying that target or some other one. If it was felt that too much political capital had been sunk in the target of unemployment reduction, the planned reduction of the borrowing requirement might be posttponed, thereby establishing circummstances which would threaten either the ability of Ireland to borrow abroad or to maintain the link with sterling.
The foregoing discussion contains strorig reservations about the efficacy of the policies chosen by the Governnment to achieve the highly ambitious targets of the White Paper. It noted that employment and output have hever displayed sustained growth at anywhere close to the target levels and that the type of policies so far deployed appear to offer a prospect of, at most, limited success. The question that then arises is whether anything can be done about the unemployment problem in Ireeland. Are there any policies available to the Government which will make a significant impact?
A prerequisite for answering this question is a detailed examination of the nature of Irish unemployment. Unemployment increased in the early 1970's despite a substantial growth in output and some growth in employment. The failure of unemployment to respond more than slightly to more than two years of economic growth since late in 1975, has been noted.
Both of these facts indicate that interrpreting the unemployment problem in terms of demand efficiency and applying a conventional, closed economy remedy, as the Government has done, will be inadequate.' The slow rate of growth of the world economy, and especially that of the' United Kingdom, means that the potential for export growth is afffected, the prospects for only a modesttly expansionary budget in Britain in April are now strong, which offers some but not much scope for increased demand.
This points up the urgency of an assessment of the factors which govern the supply of labour in Ireland. The latter is affected by not only demographhic factors, but also migration and labour participation. In addition, policies which, for a given level of demand foroutput , influence the demand for labour need to be examined. In this connection, attention should be paid to the affects of the employers' social welfare conntribution, minimum wage laws and the capital bias of the taxation of firms, among others a forthcoming study of Irish unemployment by Professor Brenndan Walsh discusses many of these questions.
The size of the wage settlements neggotiated in the new national wage agreeement are highly relevant to the foregoing discussion. The Government's target of 5% was undoubtedly preferable to the negotiated 8% from the viewpoint of its effect on unemployment. The reejection of this agreement by the Congress of Trade Unions in favour of a higher wage settlement would result in a reduction in the growth of emmployment rather than any enduring inncrease in the inflation rate. It is immportant to recognise that those who are out of work would bear the real costs of such an outcome.
Little attention has been paid in this article to the inflation rate for the simple reason that as long as the link with sterling is maintained at parity, there is little that domestic policy can do about the inflation rate- apart from the once-for-all effects on prices of indirect taxes
Ireland is a small, open economy; itsinflation rate is, in the long term, deterrmined by British policies. The evidence in support of this proposition is overrwhelming. The inclusion of target rates of inflation for 197 8-1980 in the White Paper serves little purpose, since there is no indication that the Governnment has any intention of changing its exchange rate policy in the event of the British government allowing inflation to increase. If British policy maintains its existing stance, the Irish government's inflation targets may well be met, provided the economy avoids the circumstances described above in which a devaluation , or continuous depreciation of the Irish pound become unavoidable because of a combination of balance of payments disequilibrium and large scale foreign indebtedness.
This review of the economic policies of the Fianna Fail government has conncentrated on those most asociated with its major objectives. In doing so, a nummber of issues have been ignored. These include the implications of the abolition of the wealth. tax in the area of income and wealth redistribution; the abolition rather than the reform of rates, a tax with many advantages; and others.
It is concluded about the policies so far adopted that they are unlikely to ensure the achievement of the government's objectives. It is much to be hoped that the Green Paper directs most of its intentions for the forrmulation of alternative policies related to the reduction of unemployment and that it signals a retreat from the reckless policy of budgetary stimulus adopted in February.