November 18, 2001

Let's talk the tiger back to life

Posted in Celtic Tiger ·

Economic fundamentalism is alive and well in Ireland.

Every day, as evidence of the hard landing mounts, a soothing spin is being manufactured which dismisses worries about the economy. The spin contends that a slump is unlikely here because the economic fundamentals are very strong. Let’s call the subscribers to this creed the ‘fundamentalists’.

The fundamentalists say Ireland will not have a recession because the fundamentals are good. What are these so-called fundamentals? Here the problems start. There seems to be a schism in economic fundamentalism. For concepts supposedly so solid, unyielding and permanent, the fundamentals themselves seem to vary depending on which fundamentalist sect you speak to.

According to the high priestess of fundamentalism, the Tanaiste, the most venerable of the fundamentals are Irish demographics, our low corporation tax rate and solid rates of inward investment. Her followers can be described as the ‘official fundamentalists’. Another lesser group of fundamentalists, let’s call them the ‘provisional fundamentalists’, believe that low inflation, a low debt to GDP ratio and low government spending as a percentage of GDP define fundamentalism.

Yet another subset, we’ll call them the ‘continuity fundamentalists’, argue that social partnership, membership of European Monetary Union (EMU) and the fact that we speak English constitute the pure, unadulterated creed.

Taken together, the various different strands of fundamentalism conclude that Ireland cannot have a recession because there is an underlying solidity and robustness to the economy. (Incidentally, all the disparate strands of Irish economic fundamentalism belonged to the unified, soft-landing school until very recently.) The fundamentalists contend that the financial foundations are so strong that the house is well protected whatever the weather.

Fundamentalism sounds almost plausible until you realise that it is answering the wrong question. The pertinent question is not whether Ireland’s long-term potential growth rate is likely to be higher than that of the rest of Europe. The pressing question is about whether this hard landing will lead to a recession. And if so, how long will it last? Although the fundamentalist view may be right over a ten-year period, they are not looking at the next two years.

By focusing on the next 24 months, we see the fundamentalists betray the weakness of their case. They dismiss questioning of the economy at this juncture with the caution, “We should not talk ourselves into a recession”. But hold on, I thought you guys were saying that the economy is so robust and so sound that something as frivolous as talk can have no impact at all?

Yet as quickly as they can say “V-shaped”, the fundamentalists are telling us to tighten our lips. If they are saying now that talk alone can engineer a recession, there must be something shaky with their precious fundamentals. In short, you can either be a fundamentalist and disregard talk, or a talker and disregard fundamentalism, but you can’t be both.

Given its internal inconsistencies, why are so many smart people lining up behind the fundamentalist flag? Well some are trying to sell something: a political party, a bond, a house or a stock. For others it is a bit harder to explain. My suggestion is that people are confusing structural medium term economic trends with the short-term business cycle.

The easiest way to look at this distinction is to compare it to the weather. We now know that the world is getting gradually hotter. We can forecast with some degree of accuracy, the average temperature in 20 years’ time. We also know what is driving this process of global warming and although I’m no expert on this, it seems that the warming of the planet is almost a done deal. Therefore, we can say that due to fundamental factors the trend in Ireland’s temperature over the coming 50 years will be upwards.

However, this upward trend does not mean that the weather will be constantly improving. It does not follow that we will have hot summers followed by cold winters or that we will not have floods, storms and heavy snows. It tells us nothing about rainfall on a season to season basis. In fact, knowing that the trend in temperature is upwards is useless to those, such as farmers, for whom the weather is important.

In economics, the fundamentalist arguments about the workforce, the tax rate, our English-speaking status and so on explain why our sustainable growth rates may be 3 per cent to 4 per cent in the future. Similarly, an environmentalist can tell us that the temperature will be two degrees higher on average in 2060.

However, the environmentalist cannot inform us about the chances of a dry summer in Japan for the next World Cup, nor can the economic fundamentalist shed light on the imminent recession and the nature of the recovery. To make a stab at near-term forecasting, you have to forget fundamentalism and go back to talk.

A country can talk itself into a recession in the same way as this country talked itself into a bubble in 1999 and 2000. If the fundamentalists were happy talking up the economy even though their own analysis indicated that any growth rate above 5 per cent was not sustainable, they know it can be talked down as well.

However, in a strange perversion of standards, the fundamentalists believe that it is totally acceptable to have cajoled and frightened people into paying way over the odds for starter-homes this time last year, but to advise others to hold onto their cash today is heresy.

Today’s cautious talk is about people voicing legitimate concerns about their jobs, houses and income. To chastise people for getting worried about the future is a very fundamentalist way of viewing the world.

The most important factor for the business cycle in any country is confidence, not some ambiguous economic ratio.

Talk is confidence, confidence is talk. When confidence is high, people borrow and spend and everything is hunky dory. High levels of demand soak up excess labour and unemployment falls. This rise in jobs reinforces the initial confidence and the process becomes self-reinforcing.

Such dynamism leads to stronger growth and many of the ratios that the fundamentalists hold dear become respectable on their own, such as the debt/GDP ratio and the net budgetary surplus.

When confidence evaporates, the opposite happens. By talking up the story and hyping the economy in 1999 and 2000, we have created the conditions where the evaporation of confidence has a significant negative effect of the economy. In short, talk is more important than fundamentals whether that is “highly educated English speaking” talk or its Urdu equivalent.

Economic fundamentalism as practised by Irish fundamentalist commentators is a form of denial. It confuses long-term structural analysis for short-term business cycles. That is not to say it does not have its place and any economist that fails to acknowledge that fact should not be in the business. But the business cycle is a very different beast.

One is miles away, the other in your face. Would you believe a scientist who couldn’t tell the difference between a telescope and a microscope? I doubt it.

Likewise, if an economist replaces hard thinking with fundamentalism, you know you are in trouble.

David McWilliams will be talking to US economist Paul Krugman about the prospects for Ireland on Agenda on TV3 at noon today

Granted, there will be someone who will now buy land in Waterford on the basis that in the long-run, Tramore will have the same summers as Torremolinos. But most of us take the same view as the great John Maynard Keynes who said, “In the long-run we are all dead.”

The Taliban are dead, long live the Taliban. You don’t have to be wearing a burka or to be a female resident in Kabul to suffer at the hands of fundamentalism.

The Taliban are dead, long live the Taliban. You don’t have to be wearing a burka or to be a female resident in Kabul to suffer at the hands of fundamentalism.