'Government Must Extend Period of Adjustment to 2017'
19 Oct 2010
Congress General Secretary David Begg will say tonight that the Government must extend the timeframe for the budgetary adjustment or risk "doing permanent damage to our economy and to the fabric of our society."
In a speech at the Irish Taxation Institute David Begg Begg said the target of achieving a budget deficit of three percent by 2014 is entirely arbitrary. Mr Begg said that extending the period of adjustment until 2017 was far more realistic and that the key to cutting the deficit was not austerity measures, but growth and job creation. The full text of his speech follows:
'Period of Adjustment Must Be Extended'
"Ladies and Gentlemen, thank you for the invitation to make some remarks about the forthcoming budget. I do not think this forthcoming budget is primarily about questions of tax. I do not think it is even about economics. What it should be about is political economy and the deeper question of whether the economy is embedded in society or the other way around.
"So, like the Kerry man asked for directions I too have to say that I wouldn't start from here in the first place. By this I mean that I do not subscribe to the accepted orthodoxy that the budget deficit must be reduced to 3 per cent of GDP by 2014. I do accept that we cannot sustain the high level of borrowing and the cost associated with it indefinitely. But the target date of 2014 and the figure of 3 per cent are quite arbitrary. More importantly they cannot be attained without doing permanent damage to our economy and to the fabric of our society. I shall try to explain why this is so.
"Growth is the key. Fiscal retrenchment cannot be achieved through austerity alone. Some months ago it was being confidently asserted that the 'Green Shoots of Recovery' would shortly be in evidence. It was not to be. The CSO data for the second quarter of the year revealed that GDP had in fact declined further by 1.2 percent.
"The truth is that Government is delusional about the effects of the fiscal crisis on growth. But markets can assess the reality. That is why after three brutal budgets the cost of borrowing has risen rather than fallen. The Financial Times put it succinctly when it said:
"'The problem for Ireland is no longer a question of profligacy, but whether the country has been too austere in its efforts to reduce debt at the expense of growth'"[1].
"Similarly, Adam Posen, a member of the Monetary Policy Committee of the Bank of England, has pointed out that low growth, if it persists, can cause people to drift into long term unemployment and machinery and plant that is temporarily mothballed to be taken out of commission entirely. The combined effect of these two factors is to permanently reduce the productive capacity of the economy.[2]
"But why you might ask would any Government persist with policies which are so obviously failing. The answer lies in the difference between a political economy approach and one guided by classical economics. The latter is based on models and precepts which assume certain things which do not occur in the real world.
"In the last couple of weeks I have discerned a more empathetic emphasis on the need for a four year austerity programme. Mr Peter Sutherland of Goldman Sachs has lent his considerable influence to this objective. Speaking at a dinner of the Dublin Chamber of Commerce he addressed some of the arguments I have outlined. In particular he made the case that in the late 1980s fiscal contraction had in fact brought economic expansion. This is, I believe, known to economists as the 'expansionary-fiscal-contraction' hypothesis.[3]
"The problem is that conditions are not anything like they were in the late Eighties. At that time Ireland had the benefit of two currency devaluations and the implementation in 1986 of the Single European Act which provided us with a magnet for American foreign direct investment. Moreover, we were not then experiencing a synchronised global downturn. I do not think we can again expect growth from fiscal contraction.
"In any event this hypothesis has been undermined in the last week by no less a source than the International Monetary Fund (IMF).[4] [5] They argue that a fiscal consolidation equivalent to 1 per cent of GDP leads on average to a 0.5 per cent decline in GDP after two years, and to a 0.3 per cent increase in unemployment. Moreover, simulations carried out by the Fund show that slashing spending in an environment where interest rates have no more room to fall doubles the contractionary effect of such cuts compared with a situation where the Central Bank still has scope to cut rates. In such a situation, GDP can be expected to decline by 1 per cent rather than the historic average of 0.5 per cent. If, in addition, everyone else is cutting, the effect of a fiscal contraction is further magnified.
"A second argument sometimes deployed, although not by Mr Sutherland, is that the certainty generated by austerity will give people the confidence to spend money and reduce savings - which are now at a very high level. This is known as 'Ricardian Equivalence' but it is all neo-classical guff as far as I can see. I certainly don't know anybody who thinks like this but I do know a lot of people who are saving all they can in case they lose their jobs in six months time.
"It seems to be generally believed too that we can compensate for the effect of a deflationary strategy on the domestic demand side of the economy by growing exports. Now, domestic demand accounts for 60 percent of all economic activity so it is very important. Exports are important too of course and they have held up very well during the course of the recession. At a time when every country is trying to pull itself out of recession by increasing exports it seems improbable that we can greatly increase our market share. It is worth reflecting that this singular emphasis on exports is why we are having currency wars. So unless we can find a way to run a balance of payments surplus with Mars I doubt that exports will be our salvation. If this is indeed the case then it makes no sense to sacrifice the domestic side of the economy. That is the only possible source of significant new employment.
"So if you combine all these factors with an observed slowdown in the global economy, it is unreasonable to assume that Ireland will return to normal growth rates - as predicted by the ESRI and others - once the acute phase of he crisis is over. Even a decade of stagnation in this context is hardly an extreme prediction.
"But, I hear you say, what choice have we. If we do not show firm intent to get our borrowing below 3 percent of GDP by 2014 the bond vigilantes will get us. We have to ask what is the evidence for this? We assume a disposition on the part of the bond markets that they have never stated.
"On the contrary Mr Hans Bloomstein, Head of Bond Markets and Public Debt Management at the OECD, is quoted in The Financial Times of October 11 as saying that there was a danger that some Governments might go too far with austerity measurers as they sought to reassure investors that they were tackling their deficit problems. That in turn could jeopardise their economic recovery.[6]
"It would be irresponsible for anyone in my position to mislead people into thinking that we can continue indefinitely to live with a large gap between income and expenditure. But is is equally irresponsible to call for a level of sacrifice that the population cannot endure.
"To my mind there is a better, fairer way of doing this and growth is the key to it. Growth can both do the heavy lifting of adjustment and diminish the scale of the problem by increasing the size of the economy. Growth needs time to get a foothold and it needs investment. That is why we believe the adjustment cannot be accomplished in four years and should be stretched to seven years. There is nothing scientific about four years. It is purely arbitrary.
"Some say we have no right to bequeath debt to future generations. But it is hardly wise to bequeath them a smaller economy either. In other words sustained low growth can become a self fulfilling prophecy. If so we risk a deflationary spiral in which austerity kills growth and jobs leading to higher welfare costs and less tax revenue necessitating even more severe austerity. Is that not the experience of fiscal retrenchment to date? It is certainly the experience of Japan in the 1990s and we too are threatened with a lost decade if we do not change course.
"To stay on course is not only economically dangerous it is politically unwise too. The distributional unfairness inherent in this policy may induce a societal reaction which could undermine our long-run stability and prosperity.[7] [8]
"For the reasons stated at the outset I have not emphasised taxation in this paper. Another reason is that the Executive Council of Congress has not yet signed off on our Pre Budget Submission to the Minister for Finance. I can, however, say that there are certain principles we will ask the Minister to consider viz:
"That the burden of fiscal adjustment be more balanced this time as between tax and expenditure cuts than it was in Budget 2010;
- That income from all sources be taxed in the same way;
- That higher earners bear the greatest burden of adjustment;
- That those with wealth and assets make a fair contribution to widening the tax base;
- That tax expenditures and tax avoidance be seriously tackled with a view to eliminating them.
"In conclusion I would make this point. Just as in 1987 the crisis that faces the Irish state has two major components - a very high rate of unemployment and a very large national debt. The difference is that external conditions were much more benign then. But even with an export-led growth rate in GNP of four percent, both the volume of personal consumer expenditure and the numbers at work declined. Then, as now, decision making was centralised in the hands of the Department of Finance. Then, as now, the instrument of choice for dealing with the deficit was large scale expenditure cuts.[9] We are still living with the consequences of those cuts in our health service.
"My point is that adopting the same approach in the much more challenging international environment of today is doomed to failure. We need to allow for thinking about the problem in a different way and foreclosing on all options other than a four year austerity plan is not a good start.
Thank you again for inviting me.
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[1] Oakley, David and Hughes Jennifer (2010) 'Is Ireland Restaging Greek Tragedy?' The Financial Times. September 29, 2010: P. 36.
[2] Posen, Adam S. (2010). The Case for Doing More'. Speech to Hull and Humber Chamber of Commerce, 28 September, 2010.
[3] As reported in The Irish Times of October, 8, 2010.
[4] IMF (2010) 'Will It Hurt: Macroeconomic Effects of Fiscal Consolidation' World Economic Outlook. Chapter 3. October, 2010.
[5] 'Does Fiscal Austerity Boost Short-Term Growth? A New IMF Paper Thinks Not' The Economist. October 2nd, 2010. P. 76.
[6] Oakley, David (2010) 'Eurozone Bond Investors Accused of Overreacting to Sovereign Risk' The Financial Times. October 10th, 2010. P. 1.
[7] Munchau, Wolfgang (2010) 'Ireland's Taxpayers Have Shouldered Too Much'. The Financial Times. October 4, 2010: P. 17.
[8] Posen, Adam S (2010) The Case For Doing More. Speech to Hull and Humber Chamber of Commerce. September 28, 2010. P. 3.
[9] Breen, Richard et al (1990) Understanding Contemporary Ireland: State, Class and Developments in the Republic of Ireland. London. The MacMillian Press Ltd.
ends
