Fiscal Advisory Council's report is a poor start

The Fiscal Advisory Council's basing as far-reaching a claim as ‘austerity is working’ on a mix-up of terms is a serious matter. By Michael Taft.

The Irish Fiscal Advisory Council’s first report is out. It is a poor start. There is much to chew over but here I want to take up one contention – the one that says austerity is working. For if this argument is the best it can come up with, then it will have its work cut out to establish credibility.

The report urges the Government to substantially increase its fiscal adjustment targets to ensure that it reduces the deficit to 1% of GDP by 2015 – going further than the 3% required by the Maastricht guidelines. This would entail an additional €4 billion in spending cuts and/or tax increases (and the report indicates sympathy with the spending cut route).  Let’s leave aside the issue of whether this increased adjustment will actually achieve its target.  What caught my eye was this statement:

‘Austerity measures are working to reduce the deficit.’

What argument does it employ to substantiate this claim?

‘Even though domestic demand has fallen significantly (at least in part due to the austerity measures undertaken) and domestic demand has remained weak, the General Government deficit is improving. The underlying deficit has declined from 14.3% of GDP in 2009, to 12% in 2010 and to a projected 10% this year.’

It’s an interesting argument. It’s also untrue.

The report confuses the ‘underlying deficit’ with the ‘headline deficit’ in a way that significantly weakens its claim. The difference between the two is simple:  the ‘underlying deficit’ excludes special payments to the banks (in this case, our old friend Anglo-Irish). The ‘headline’ deficit includes the special payment.

The report is right to highlight the underlying deficit. Special payments – sometimes called exceptional payment – are supposed to be once-off affairs (though with our banks it seems to be an annual affair). The underlying deficit removes these special payments and is more reflective of the basic relationship between income and expenditure.

The problem is the report mixes up the ‘underlying’ with the ‘headline’. As the Department of Finance’s letter to Eurostat shows, in 2009:

  • The headline deficit was 14.3%
  • The underlying deficit was 11.8%

The report claims that the fall in the underlying deficit from 14.3% to 10% (the estimate for this year) – a fall of 4.3% – shows that austerity is working. The problem is that the underlying deficit didn’t fall by 4.3%. It fell by only 1.8%.

So, spending cuts and tax increases of €20 billion (equivalent to 12.8% of GDP) reduce the deficit by 1.8%: is this proof that austerity is working? Hardly. It is a highly wasteful, inefficient and wholly ineffective policy resulting in spiralling unemployment, destruction of our productive capacity, rising arrears and falling confidence.

This begs a follow-up question. If €20 billion cuts and tax increases only resulted in a deficit-reduction of 1.8% – then how credible is the report’s prediction that a further €16 billion in cuts and taxes will result in a deficit reduction of 9% by 2015? It’s a big ask.

That the report mixed up the underlying and the headline deficit in 2009 would normally be no big deal. We all make such mistakes. However, basing such a far-reaching claim as ‘austerity is working’ on that mix-up – that’s a different matter.

And to make matters worse – the report claims in the footnote to this statement that there were promissory note and other payments to Anglo-Irish in 2010. Actually, there were none.

It would be helpful if the Irish Fiscal Advisory Council clarified this matter. And if it finds that the above criticism is correct – then hopefully it will find a better argument to substantiate the claim that austerity is working.

If they can’t, then they should admit that whatever about future predictions, the past provides no basis that austerity will work.

Image top: Kiril Strax.