23 September 2014

COLUMN: austerity debate gets ever more confused

06:09, Jim Power

The debate about the rights and wrongs of past and future austerity continues to proceed apace. Not surprisingly it is continuing to break down along traditional left/right ideological grounds, with Paul Krugman leading the charge on the left.

Here in Ireland the Fiscal Advisory Council is staunchly sticking to its guns and is firmly advising Government to continue to press ahead with the €5.1 billion of further fiscal tightening that is pencilled in for Budget 2014 and 2015. At least it has rowed back from its call last September for even greater fiscal consolidation to be sure to be sure.

That pragmatic move obviously reflects the easing of the debt burden implied by the Promissory Note deal and the impending deal on the €40 billion of EU funding received as part of the Troika intervention. Thank god for small mercies!

The very sensible argument in favour of further austerity, as in delivering the €5.1 billion planned, is that Ireland is forecast to have to borrow a further €12.5 billion this year, which will be equivalent to about 7.4 per cent of our national income, and €7.5 billion in 2014, equivalent to 4.3 per cent of GDP.

**Whatever way one looks at it, this is way too much money to be borrowing as a country. No sane sensible person could disagree with the notion that such a level of borrowing is simply too high.**

The unfortunate problem with borrowing is that it has to be serviced and eventually paid back, and of course it adds to the stock of accumulated debt, which is already way too high.

The accumulation of debt at the rate that Ireland has experienced since 2008 and which it continues to experience is simply not good for growth. This is an incontrovertible fact despite the recent rubbishing of the 90 per cent debt threshold that was highlighted by Rogoff and Reinhart.

Unfortunately interest has to be paid on debt, and despite the reductions in borrowing costs and the re-structuring of the Promissory Notes, the interest bill on Ireland’s national debt is expected to be just over €8 billion this year. Over 70 per cent of Irish long-term bonds are held by overseas investors so much of this interest payment will flow out of the country and consequently represent a direct loss of resources to the economy.

It imposes a massive opportunity cost on the economy and on society. Failure to curb the accumulation of debt could in theory also result in higher interest rates, thereby exacerbating the debt servicing bill.

The manner in which the debate has evolved over the past couple of weeks has been quite polarised, and some of those who have argued for some relaxation of austerity are effectively been accused of tolerating current high levels of borrowing and debt. Nothing could be further from the truth. Any sensible person would have to recognise that the current level of borrowing is just not acceptable, but the big question at this stage really is how we should proceed from here.

A country’s debt to GDP ratio is made up of two components – the level of debt and the level of GDP. The approach to reducing the ratio since 2008 has been on controlling the debt part of the ratio and ignoring the GDP bit. Perhaps the time has come when more attention should be paid to the GDP bit.

There comes a point where austerity starts to become self-defeating in the sense that it undermines growth to such an extent that the damage to tax revenues and the upward pressure on social expenditure begins to offset the savings made from the policies of fiscal austerity.

Ireland is not there yet, but the evidence so far in 2013 is not particularly re-assuring. The retail sales data for March were pretty horrendous. During the month of March the value of retail sales declined by 1.9 per cent and was 4.1 per cent lower than March last year. The volume of sales was 3.6 per cent down on a year ago. In the first three months of the year the volume of sales was down by 1.5 per cent and the value was down by 1.7 per cent.

Car sales are taking a particular hammering. In fact, excluding car sales, the volume of sales increased by 0.4 per cent in the first quarter and the value of sales increased by 0.2 per cent.

These dismal retail sales data are symptomatic of a personal sector that is in the aggregate under significant financial pressure and feeling very uncertain about the future. The impending property tax is having an impact, but the prospect of two more heavy budgets is not helping.

The problem of course is that such weakness in consumer spending will undermine tax revenues and cost further jobs in the broad retail sector, thereby putting further pressure on social expenditure. Just maybe, the nature of our fiscal austerity has gone far enough.

It is worth reminding ourselves of what the scheduled fiscal future has in store for us. Of the €5.1 billion in further fiscal consolidation pencilled in for the next 2 budgets, €1.8 billion is set to come from revenue increases, with €300 million carried over from past measures, and new revenue raising measures of €1.5 billion planned. Expenditure cuts are pencilled in for €3.3 billion.

If delivered, this would represent a further significant withdrawal of money from an economy that is still clearly struggling along the bottom. It is a classic case of a pro-cyclical fiscal policy, which is generally not what one would recommend.

At a European level, the story in many countries is not much different. This week, we have seen the unemployment rate in the euro zone increase to 12.1 per cent, with rates of 26.7 per cent and 27.2 per cent in Spain and Greece respectively. Spanish GDP fell by 0.5 per cent in the first quarter and EU business and consumer confidence fell further, suggesting that euro zone GDP could contract again in the second quarter.

At the same time the inflation rate in the euro zone has fallen to 1.2 per cent, which is the lowest level in over three years. It is clear that a lack of growth is the problem, not inflation. European policy makers – both political and central bank – need to wake up to this reality.

This is all pretty dire stuff and while the budget deficit of the euro zone is gradually falling, it is exacting an incredibly high price on the real economy.

Interestingly, the new Italian Prime Minister is setting his face against fiscal austerity, but in Dublin the European Investment Bank (EIB) President has described arguments that austerity kills growth as rubbish. Recent evidence is not exactly vindicating his world view.

For policy makers and observers, it is all very confusing.

Here in Ireland 10-year bond yields are now trading at 3.5 per cent, which is not a bond yield that is suggesting that the markets are nervous about the Irish authorities easing off on the austerity.

In fact bond yields here and elsewhere are suggesting that the markets would welcome a relaxation of austerity and a bit of focus on growth, in the knowledge that Europe is at a tipping point and that economic growth would now be more effective at reducing debt than further fiscal austerity.

Perhaps the Irish government should get the NTMA to issue more bonds at current very low interest rates and start to look at serious ways of stimulating growth, while all the time seeking to implement reform of the manner in which public services are delivered. A step back from austerity should not mean a step back from vital reform.

However, all of this discussion is academic at best because in this week’s updated Irish Stability Programme, the Minister for Finance re-affirmed the commitment to proceed with the fiscal consolidation as planned and has forecast a deficit equivalent to 2.2 per cent of GDP by the end of 2015.

I dread to think where the €5.1 billion is going to come from, but one can safely assume it will do further damage to vital public services such as education, and take more money from the already squeezed and suffering middle classes.

*Jim Power is an independent economist*

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