Time to change tack?

Albert Einstein once said that insanity was doing the same thing over and over again and expecting different results, Michael Taft at Notes On The Front points out that government efforts to bridge the fiscal deficit by raising taxes and cutting spending are sucking money out of the economy, causing the economy to shrink and the deficit to grow! As previously discussed on Slugger, he is not alone as an economist in taking this view. Having tried this approach three times so far in less than 8 months, is it time for the Irish government to call a halt to tax rises & spending cuts?

Adds : Karl Whelan at irisheconomy.ie covers related ground when explaining why funding construction stimulus projects off-balance sheet is a bad idea.The argument in favour attempting to balance the budget is that it reduces (at least in absolute, but not apparently proportional terms) the amount of money the government must borrow via the bond market. By appearing fiscally responsible the government hopes that investors will be inclined to purchase Irish government debt and thus help fund the remainder of the deficit. Irish Liberty highlight a recent article in the Sindo reporting that Irish banks are making use of ECB facilities to purchase Irish government bonds. Rather indirectly, it appears that the ECB is underwriting Irish government debt. This fact, coupled with evidence that budget balancing measures are having the opposite effect suggests to me that Michael may be correct. Is it time to stop raising taxes and cutting public spending and take full advantage of our Eurozone membership to fund the fiscal deficit throughout this crisis? Once the crisis is over we will still need to take austerity measures to deal with the structural deficit caused by the collapse in transaction based tax revenues, but my feeling is we could pick a more opportune moment to do this than when unemployment is approaching 12% perhaps on it’s way to 20!

  • Dave

    “…is it time for the Irish government to call a halt to tax rises & spending cuts? ”

    Here’s a free lesson about Keynesians: they expand the state, not shrink it. Even those Keynesians who argue that state expansion should be a temporary expediency do so because they fail to grasp that the expediency makes itself permanent. The state never has the courage any of its public sector or cut their entitlements, nor does it have any inclination to do so. The state will always expand itself if it is allowed to.

    Another free lesson for Taft (and yourself) is that public spending cuts do not “take money out of the economy.” The opposite is the case: public spending cuts keep money in the economy. It is the taxes that are needed to pay for the uncut public spending that take money out of the economy. There is no short cut by public sector borrowing, since public sector is simply deferred taxation.

    Public sector spending is money taken from the wealth-creators economy and ‘reinvested’ in the economy by idiots who know nothing about creating wealth. Forgive me, but I’d prefer to invest my money with business people and not with low rent political hacks from Offaly.

  • Dave

    Typo: “The state never has the courage [i]to fire[/i] any of its public sector [i]workers[/i] or cut their entitlements…”

  • Mack

    Dave – Even with a moratorium on public spending cuts, I’d want to see continued reform, for now any ‘savings’ could and probably will go to other areas (e.g. welfare in particular). The question is whether now is the right time to try and tackle the structural deficit?


    Another free lesson for Taft (and yourself) is that public spending cuts do not “take money out of the economy.”

    Ok that is pedantically true. But public spending is being funded in large part by borrowings at the moment, cutting public spending will mean less borrowed money entering the economy. Yes, I know, we’re spending future tax Euros today. Pragmatically though, if by doing nothing in terms of net spending and taxation the deficit remains lower than by tax rises & spending cuts – then it’s probably a more sensible route to take. Not only will government borrowing as percentage of GNP be smaller in the end, less people will lose their jobs or emigrate. With 12% unemployment and rising we probably have a dynamic for improving wage competitiveness in place already.

  • Itwas SammyMcNally whatdoneit

    Mack,

    mmmm. you may be right BUT including the words of a Scientist in such a debate may perhaps suggest some sort of linkage, however tenuous, in the mind of the reader between Economics and Science – surely it would be more appropriate to quoute the words of a palm-reader, soothsayer or astrologist.

  • Glencoppagagh

    A lot depends on what might be done with the money that is not ‘taken out of the economy’. To what extent would it spent rather than saved? And to what extent would any additional spending actually benefit the Irish economy? In an economy as open as Ireland’s would it be patriotically spend on goods and services of Irish origin rather than cars, consumer durables etc which are entirely imported?

  • Greenflag

    Mack,

    Over on bloomberg Jean Claude Juncker -EU Finance spokesman has been praising the Irish Government and people for the policy steps that have been taken. That said Dave has a point about the public sector generally. They do NOT create wealth per se but in a small country like Ireland they do raise our state ‘overhead ‘ costs . When it gets to the point as it has /did in NI that the public sector squeezes out the private sector then you are on the slippery slope to the africanisation of an economy where it only pays either to be in government or in the public sector . NI has avoided the worst aspects of that possibility because HMG provides the 6 billion shortfall in local taxation via subvention .

    Given the scale of the present crisis there will have to be both ‘reform ‘ and cutbacks . It’s for the politicians to choose between one poisoned chalice and another

    Not to worry -George Lee the RTE economics spokesman and selected FG candidate in a south Dublin constituency will have all the answers no ?

  • Greenflag

    Dave ,

    ‘but I’d prefer to invest my money with business people and not with low rent political hacks from Offaly. ‘

    Good man I have just the kind of ‘wealth creator ‘ you need . He guarantees or used to anyway a consistent 12% return and is/was a much respected individual on Wall St .

    He answers to the name of Bernard Madoff and can now be contacted at the State penitentiary in New York along with several others of his ilk 😉

  • Dave – thanks for the free lesson. Free lessons are getting hard to come by what with the Government bringing in university fees, the ‘voluntary’ fees at primary level and the almost total reliance on fee-paying provision at early education level. However, if the Government cuts social welfare – as they have signalled – this will produce considerable negative multipliers in the economy (e.g. reduce consumer spending), drive down growth even further, leading to wider deficits and, thus, increase borrowing, mostly from foreign institutions. Cutting Government consumption (example: public procurement contracts for the private sector) means less private sector activity – this will produce another set of negative multipliers, etc. etc. This is the deflationary trap we find ourselves in.

    We are now cutting investment in our wealth-creators – we are cutting educational spending (after years of under-investment) on our young wealth creators, cutting healthcare to look after our wealth-creators, cutting capital investment so our wealth creators get stuck in traffic jams or have to boil their water before drinking. We are forcing nearly one-fifth of our wealth creators on to the dole queues. This makes no economic sense.

    There is, Dave, one area of cutting public spending I wholly agree with you. Many of those ‘business’ people you’d prefer to invest your money with – they received considerable public subsidies through tax breaks down the years and took that money and invested it into Bulgarian apartment blocks and shopping malls in Basingstoke. The irony is that the wealth creators, first, were forced by the low rent political hacks from Offaly to subsidise these ‘business’ people and now they’re having to pay again – purchasing those ‘business’ assets through NAMA. We should have slashed those property-based tax expenditures a long time ago.

    Glencoppagagh – you’re right about the spending vs. saving issue. That is why focusing on job creation and concentrating support for low and average income groups is vital. For these groups have a higher propensity to spend (unlike higher income groups who have a propensity to save). Regarding the issue of ‘leakage’ – most imports are consumed by businesses – especially multi-nationals – who source their inputs from outside the state. The latest stats (and we are bad at getting up to date data) produced by the NESC shows that only 1/3 of consumer spending has an import content – cars, durables, yachts, etc. Again, low and average income groups’ spending has a lower import content. So in framing an investment stimulus we have to ensure that the business activity has a high-job content (e.g. construction, insulation, public services, etc.) in areas which have a higher domestic sourcing content for material and benefits low-average income groups with a higher propensity to spend with a lower-import content.

  • Mack

    Greenflag –

    Given the scale of the present crisis there will have to be both ‘reform ’ and cutbacks

    I don’t doubt it. Much of the economy in Ireland seems to have been built with borrowed money. Borrowed on the European wholesale markets by the banks, lent to the big developers, spent on wages, materials, land and taxes. Put back on deposit and lent out again to be spent on wages, consumer goods, taxes etc. The government, with their coffers boosted by a tsunami of borrowed money, cut taxes and increased spending.

    When the tide went out we were left with public spending too high for the size of our economy, taxes too low and Brian Cowen starkers – beached in the shallows (with Bertie laughing his head off further up the shore)..

    I get the point that at this stage we are completely dependent on outsiders – we need someone to lend us money just to survive. We’ve also got to clean up the imbalances caused by bubble era policies.

    If current policies and their timing are making things worse rather than better, shouldn’t we be examining alternative approaches?

    Constantin Gurdgiev touches on this topic again today too (from the right, in contrast to Michael’s left wing perspective). He’s speculating on another mini-budget after the local elections with yet more tax hikes.

    http://trueeconomics.blogspot.com/2009/05/economics-06052009-nama-bananas-for.html