And in other news…..the IMF also discovers we need air to breathe

Earlier this week Ashoka Mody, one of the original troika representatives when they took hold of the Irish economy last year, has admitted that austerity alone was a mistake.

Then the Taoiseach comes up with “well, hindsight is a wonderful thing.”. Yes, Enda, it is, but there was no need for hindsight when many economists, including Nobel prize winner Paul Krugman, economics popularist David McWilliams and your’s truly told you so back then. It’s information that can be found in standard textbooks for third-level economics studies.

But I suppose you need to be a VSP (Very Serious Person) to be taken seriously.

So that’s a yes then.

The yes vote has carried – not a huge surprise to most I’m sure. The one thing the yes side always had going for them was that a no vote would have been a “jump into the unknown.” So it’s the devil we know then; the Taoiseach has already said he will be pushing for a better deal on the bank debt we’ve been saddled with – let’s hope he can get it.

Right, so what now? I’m going to be keeping a close eye on tax rates of all stripes, as well as social welfare, health and education spending. That will tell us who is really going to pay for the promised investment, stability and recovery. Next is the banks – our banking system is broken. Can the government secure a deal that will ensure cash flow for the banks that will find its way into the economy? Banks are supposed to be the vehicle through which money is created (yes, I probably need to do a separate post on this magical power of the banking system). At present the Irish economy is like a pumping system with a broken motor. The stuff is there but it’s not moving anywhere other than out of Ireland.

I’ve made no secret of my distrust of both the euro and this treaty, however I don’t want to be a doomsayer, that gives me no pleasure. I hope we can achieve the growth we need without breaking what will now be our own law. If we can do that, I’ll be the first to hold up a paw and say I was wrong. I don’t think we can do it though. In terms of established economic theory, what we have signed up for points towards economic contraction and prolonged recession. The treaty also has inadequate mechanisms to deal with future crises. I think we will, and sincerely hope we don’t, continue to lurch from one funding crisis to the next.

I get an email from Fine Gael

Those of you who use Facebook in Ireland may have noticed an advert on the side asking “Why vote Yes?” I sent in the following question, not really expecting an answer: “The treaty is asking us to balance our “full employment budget” each year, to avoid going into structural deficit. How do you reconcile this with the need to grow the economy out of a severe recession?” I must say I wasn’t really expecting an answer, but lo and behold this was waiting for me in my inbox on Monday: Continue reading

Austerity is here to stay, regardless.

In the first series of Blackadder, the king sends a messenger away telling him: “I don’t like that news, bring me some other news!” The messenger leaves the room and immediately returns, saying exactly the opposite of what he had just said. At the moment we’re all like Brian Blessed’s wonderful King Richard IV – we don’t want to hear the bad news, and both sides of the current referendum campaign are telling us it could be different.

I’ve been musing over the scenario facing us regarding a possible Eurozone exit, assuming we follow the route that now seems inevitable for Greece. Our crisis was different to that of Greece – there they had a government debt problem that became a banking problem. Here it was the other way around. Either way, we’ve ended up at the same place and we need to keep a close eye on Greece now as they are the canary in the coal mine. I think in a few ways we’re in better shape, the most important of which is that many Irish people do still have money, they just aren’t spending it at present. If we can get them to stop hoarding it in European banks, but rather to invest it directly into the Irish economy, we can fund ourselves, we won’t need bailouts from Europe. This recent pronouncement that we’ll be unable to return to the bond markets is such so much fear-mongering nonsense. The markets have no memory, they will move on.

But what will happen if we leave the Eurozone? There is no question that a new currency will be significantly devalued compared to the Euro. This is because of confidence factors that are inevitable in such a situation. People will want to hold euros during any change, and the initial differential in demand between the two currencies means that the new currency will cost less. This means that anything we import – in particular fuel and medicines, will increase in price, and we all know the knock-on effect of fuel prices. The ubiquitous “sun holiday” will become a luxury few can afford. Our standard of living will drop significantly; in fact we’ll achieve overnight what the Fiscal Treaty aims to achieve in 5 years. So austerity is here to stay, for a while, no matter which choice we make next Thursday.

That’s the bad news, is there any good news? A weaker currency than our major trading partners means a boost in exports. We can also expect to see more local shopping – buying from and selling to each other. A current account surplus (resulting from export trade) along with private savings means we can fund ourselves. We will be able to borrow on the bond markets if we need to, because the markets like a country with low debt. At present, the EU wants to increase our debt burden. We need debt forgiveness; we need relief for our mortgage holders in negative equity, and an organised, clearly communicated default on our sovereign debt to European banks, debt which should never have been made sovereign to begin with.

Why the Treaty is bad for Ireland right now

I mentioned in my previous post that I’m not sure if the referendum at the end of this month is really going to matter in the end. But I feel compelled to lay out the economic reasons why this treaty will not work. It has a fatal flaw which will lead to the break-up of the Eurozone anyway. Humans, this is not heterodoxy that I’m about to preach to you; you will find this in any university Economics textbook.

First, let’s revisit the Treaty (summarised):

The budgetary position of each government must be balanced or in surplus. Budgetary discipline requires an annual government deficit of no more than 3% of GDP, together with a debt-to-GDP ratio of 60%. The annual deficit target implies a ‘structural deficit’ which should not exceed 0.5% of GDP annually, unless it has a debt-to-GDP ratio “significantly below” 60% and the long-term sustainability risks to the public finances are low.

Ok, what is a structural deficit?:

A structural deficit seeks to measure the underlying state of the public finances, independent of the ups and downs of the business cycle. Such a deficit results from a fundamental imbalance in government receipts and expenditures, in other words when the fiscal regime in a country persistently yields revenue below expenditure.

On the face of it, this is quite good. Let me explain: An actual budget position is not necessarily a good indication of fiscal policy. For this reason economists distinguish between a “full-employment budget” – what we would be spending and taking in with taxes if the economy was at full employment, and the “actual budget” – the real position at any given time with respect to tax revenues vs expenditure. If the economy goes into recession, we expect tax revenues to fall and the deficit to grow. To try to balance the actual budget under these conditions would be suicidal; indeed this is a “policy trap” that the US government fell into in the early 1930s that plunged them into the deepest part of the Great Depression. An actual budget deficit is not in itself an indication that there is a problem with your economic fundamentals. Yet the temptation is there to misdiagnose the problem, ignore external factors and conclude that the government must be spending too much. It’s like if your child does badly in a school test; is your first conclusion that the child is lazy and didn’t study hard enough, or do you also look at how the teacher is presenting the material? I think that would depend a lot on the child’s record in this regard, and that’s really what the above italicised paragraph is saying.

So the Treaty is not saying we should balance our actual budget every year, which would be calamitous. Europe wants us to balance our full-employment budget (this is what is meant by reducing the “structural deficit”). Since this budget doesn’t automatically swing into deficit during recessions, it does not give a false signal that a tax increase or spending cut is needed.

What then, is the problem?

It’s the Recession, baby. This one in particular, which is why it has a capital “R”. In a severe recession, balancing the full employment budget is inadequate. All it does is to allow the automatic stabilisers (economic features that mitigate recessions without changes in policy, such as the existing tax regime) to combat the recession. It does not allow the government to go one step further and actively fight the recession by introducing fiscal stimulus. Such stimulus, for example, a cut in the tax rate, would violate the rule, since it would pull us into structural deficit. So this rule is an unambitious strategy that aims to avoid destabilising actions, not to actively stabilise the economy. It reminds me of the doctor’s motto: Primo non nocere, (First, do no harm).

There are two other ways to ensure a measure of government restraint while allowing the government to take initiative in managing the economy. You could aim to balance your full-employment budget only during times of full employment, allowing a deficit in times of recession, but returning to balance when full employment is achieved. Or you could aim to balance the actual budget over the business cycle (instead of every year), using surpluses in good times to cover deficits during recessions. But neither of these approaches is allowed by the Treaty. Also, remember that we have been asked to write this balanced budget rule into our Constitution (hence the referendum). This effectively removes the power of our government to deal with unforeseen emergencies in the future. It also raises some technical complications. How exactly is the budget to be defined? And who, if not us, is going to interpret what “the underlying state of the public finances” really is?

Let’s look at a real world implication of what I’ve been talking about. Ireland has a very low corporation tax rate, something I agree with in principle. But let’s say the government wants to attract business to a specific part of the country. They would need to introduce a specific policy for that region, perhaps to exempt corporations from local taxes for a period of time, or perhaps payroll taxes. This is a change in policy, which, if it moves us into structural deficit, would not be allowed. Europe already doesn’t like our low corp tax, I can foresee a very close scrutiny of such measures not passing muster in Brussels. I can also see our government (this is Ireland, remember, the land of the “little lie”) being tempted to change accounting methods to remove such deficit items from the structural budget. Europe won’t be fooled. Also, although we’ve been assured that our corp tax rate won’t be changed, what if Europe decides tomorrow that our low corp tax is a fundamental policy error that is causing us to remain in deficit too long? They couldn’t directly force us to raise the tax rate, but they could penalise us in so many other ways that could outweigh the benefits of having it.

I was going to talk about the Euro as well, but this post is too long already. I’m off to tell the human that I’m hungry – maybe he’ll do a special trip to the shops for me. If not, I’ll ignore him for the rest of the day.

Is the treaty vote really going to matter?

It’s not a rhetorical question. I really am wondering, after listening to the live debate earlier this afternoon on Today FM, why anyone should bother voting. I suspect that indeed, the turn-out will be quite low, and the yes vote will probably carry. I also suspect it’s not going to make the slightest bit of difference in the long run. I can’t help feeling that both sides of this debate have missed the point and maybe there is no point. What we’re hearing is just everyone’s favourite talking points, most of which have nothing to do with the actual treaty.

So I want to list some facts, and what I consider to be the most likely outcomes of them:

  • There are financial crises in several Eurozone countries. These crises have different causes, but have ultimately brought those countries to the same point – the governments are spending more than they are taking in.
  • The EU has stepped in to ensure funding for those countries at lower interest rates than they would get in the financial markets. However, this access to cheap, easy money provides little incentive to channel spending into the right, effective areas. All this bailout money is going towards funding current consumption and paying existing debts, not to grow the economy.
  • The treaty is an attempt to put the brakes on government spending, but it does not differentiate between different types of spending. So governments keep pouring cash into what is effectively a bottomless hole; there’s nothing coming back up or out the other side. And the debts keep mounting.
  • So governments are spending, but not investing. Individuals are saving and not spending. Small business has no access to credit.
  • In an effort to bridge the gap between spending and income, required by the EU, governments raise taxes and cut spending on things such as health, education and infrastructure. But they don’t look to reduce the bloated public sector – money continues to flow into non-productive areas, where it effectively disappears. Unemployment remains high, people emigrate, further reducing the prospects for economic recovery.
  • People get tired of bearing the brunt of other people’s bad economic decision making; unrest breaks out in the more volatile EU nations (don’t think that it can’t happen here).
  • Germany gets tired of writing out cheques to the rest of the Eurozone, even though there’s nothing else they can really do with their enormous surplus. If they were to store it, the euro would appreciate, rendering their exports too expensive for China, their biggest customer.
  • One by one, the fringe Eurozone members default on their debts, not necessarily because they want to, but because they have no choice. Confidence in the Euro drops because no-one knows what it can do any more. Speculators are betting on it failing, and Germany, the only country with the power to ensure it does not fail, is no longer committed to its survival.
  • The Eurozone breaks up. Europe retains it’s common market and political union, but abandons the fantasy of a single currency.
Ireland is the least of Europe’s worries right now. The outcome of this vote is not really going to matter in terms of the bigger picture, which is impending meltdown. If I were over 18 and not a cat, I’d be voting no, because it would at least send the message that the Euro is bad for Ireland right now (and I’ll be laying out an economic case for that in my next post). If the No vote carries, there will be temporary instability, yes. There will be uncertainty, for a while. There will be difficulties; do we float our own currency, stamping our existing Euro notes? Will credit cards still work? (I don’t see why not). Do we peg it to the British pound, at least temporarily? If so, how popular will that be, politically? And is it a Hobson’s choice?
This post was meant to be a review of the live debate on Today FM, but there was nothing said that hasn’t been said already. Oh, there were some amusing bits; Richard Bruton, minister of something or other, said that delaying ratification of the treaty would put us into “Greek territory”. Matt Cooper (hosting the debate) asked him if that meant Germany and France were also in “Greek territory” (whatever that means), as both countries have delayed ratification of the treaty. Yes, Germany could walk away from this too. That’s something nobody has considered. Nigel Farage, leader of the UK Independence Party, had quite a lot to say but I still don’t know why he was there; he put across the point (very eloquently, I might add) that we’ll be voting on a treaty that won’t exist later this year. Um, ok, so why are you here spending British  money on telling Irish people to vote No for something that won’t be there anyway? He was asked that and his answer, as Ceiling Cat is my witness, was that he doesn’t like Herman van Rompuy. Seriously, you humans must try to pull yourselves together.
Except for Mary Lou McDonald. I want to be Mary Lou’s cat, this human of mine just aint cutttin’ the catnip. She remained calm under the barrage of nonsense from Micheal Martin; I loved it when she was asked to name an economist who agreed that a Yes vote would cost €6 billion just in implementation. She did; but Michael Taft wasn’t good enough for Micheal Martin. Apparently to be recognised as an economist in Micheal’s bizarro world, you can’t also be a trade unionist.
I’m tired now, and maybe I’ll be less cynical tomorrow. Maybe.