Answering the sceptics
Investment-based expansion that increases growth, combined with tax-based fiscal consolidation, is more likely to result in fiscal stability than cutting investment and demand while pursuing ineffective spending cuts. By Michael Taft.
On Saturday, the Irish Times devoted a full page to the question of whether austerity is working, on foot of the letter from 60 prominent public figures published by the paper last week. International commentators such as Joseph Stiglitz and Nouriel Roubini, and domestic commentators Terence McDonagh from UCG, Bríd O’Brien from the Irish National Organisation of the Unemployed and businessperson Brian Donovan were all critical of austerity, calling for an alternative growth and fiscal stability strategy.
Let’s examine, however, the comments of those sceptical of alternative approaches. If we are to build a political momentum for an expansionary policy, we need convincing responses to criticisms, both legitimate and ill-founded.
In all this we need to remember, it’s not that austerity policies will fail. If one believes that "in order to save the village, we must destroy the village", then destroying the village works, regardless of the long-term economic and fiscal impact. Nor can we automatically assume that expansionary policies will work. The crisis in the Eurozone and the persistent determination to avoid the real problems (the financial sector, the flawed design of the Eurozone itself) could overwhelm economies regardless of the appropriateness of national policy.
All that needs to be done is to show that expansionist policies based on investment are more likely than austerity to work.
The primacy of export growth
Sceptics refer to the need to expand our export sector. I don’t know anyone who disagrees with this truism – though it is rightly acknowledged this will depend in large part on external demand. But would an expansionary investment programme have more success in stimulating greater export growth? Yes – in two ways.
First, the business sector, including multinationals, benefit from a stronger infrastructure. How much easier would it be for the IDA to win foreign investment if we had a national next-generation broadband network or a labour force with higher work and language skills? Economies with strong infrastructures are likely to have a strong business base. Therefore, an investment programme aimed at raising the productive capacity of the economy is likely to result in a stronger export platform.
Second, raising domestic demand will also contribute to a stronger export profile; namely, among indigenous companies. Many indigenous companies start-up in the domestic market and then enter export markets once they build scale and expertise. However, with domestic demand continuing to fall, indigenous companies won’t be concerned with expanding – they will be desperately trying to survive; and they will be forced to do so by downsizing (cutting employment, training, R&D, marketing, etc.). Downsizing firms do not expand.
Conclusion: An investment-based expansionary programme is more likely to build a stronger export platform for both multinationals and domestic firms.
We need to reduce the deficit
The sceptics claim we need to reduce the deficit. Again, there is no dispute about this. What is in dispute is whether austerity policies are the most effective means to that end (or, indeed, whether it makes the fiscal situation worse). Merely stating that we need to reduce the deficit does not answer the question: how do we reduce the deficit?
The problem for those arguing the austerity route is that after fiscal adjustments of over 15% of GDP, the deficit is projected to fall by approximately 3% of GDP in the years 2009-2012. That is a lot of destroying for very little of saving. Another problem is that debt is still rising even though austerity is being intensified. In Fianna Fáil’s last budget overall government debt was estimated to come in at 105% of GDP in 2014. The Fine Gael/Labour government came in, increased austerity measures by 20% and extended the Maastricht target deadline. But they had to accept that overall debt would now rise to 118%. This should not be surprising – you don’t reduce your debt/GDP ratio by cutting the GDP denominator.
Even more problematic for the “cuts equal savings” argument is that leading forecasters (NCB, Goodbody) are now projecting that current policy will fail to reduce the deficit to sustainable levels by 2015, with debt projected to exceed 120% - bringing us dangerously close to the default abyss.
An expansionary programme starts from the premise that economic growth and deficit reduction are inextricably intertwined. The letter refers to a two-fold strategy: increase growth through investment while engaging in growth-friendly fiscal consolidation – namely, increasing taxes on higher income groups in the short-term. In the first, the Department of Finance shows that for every extra €2 of growth, the deficit is cut by €1. That’s a pretty good return. Regarding growth-friendly fiscal consolidation, the ESRI has shown twice that tax measures do less damage to the economy and are, therefore, more effective at reducing the deficit. Targeting tax measures at high-income groups is likely to be even less deflationary and more successful at reducing the deficit.
Conclusion: Investment-based expansion that increases growth, combined with tax-based fiscal consolidation, is more likely to result in fiscal stability than cutting investment and demand while pursuing ineffective spending cuts.
Where will we get the money?
This would appear to be the most damning criticism of an alternative strategy. Even if it were conceded that investment was desirable, the response is likely to be that “we’re broke”. And the Troika is unlikely to provide us the resources. QED, as they say.
This is not the case. Ever since the crisis began, Ireland has had the resources to launch investment-based expansion. Back in 2009, we had between €40 and €50 billion in cash and assets to draw upon. A significant amount of this was blown on bank bailouts, Anglo and the impact of austerity measures.
We still have resources, though. The Minister for Finance has told the Dáil there will be between €15 and €20 billion in cash and assets up to 2015. This could be a start.
But we shouldn’t think that all public sector-led investment must be drawn from the Exchequer. The European Investment Bank, the European Investment Fund, ICTU’s proposal to incentivise private pension funds, public enterprise development potential, etc, are other sources which could contribute. There is also scope, once we have returned to the market, to sell specific investment or enterprise bonds for commercial-return activities (and to use tax incentives for domestic investors).
Conclusion: We have the resources for an investment programme.
More work needs to be done to nail down the superiority of investment-based expansion; namely, to model its effect on GDP and the deficit. But advocates of expansion will have to address the institutional deficits that exist in the Government’s capital programme (its opaqueness, its hit-and-miss cost-benefit analyses, etc). Advocates will also have to construct an alternative programme for public sector reform; or rather, to launch proposals for reform (we don’t actually have a reform programme; we just have a policy of cutting public sector employment – the worst fiscal measure you can take in a recession).
But in terms of export growth, fiscal consolidation, and resources, the arguments favour the authors of the Plan B letter.
That is a good start. {jathumbnailoff}
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