December 10, 2009
Minister and his mandarins forecast neither boom nor bust...so why trust them now?Posted in Irish Economy · 144 comments ·
THIS Budget is unfortunately without any real merit, apart from the national recovery bond idea which is interesting and shows an ability to think logically about where we are at this stage.
But the net result of this Budget will be to make the economy contract more, to make people spend less and gradually to drive this Government further up the economic cul de sac which they have chosen.
Let’s begin with the panglossian world view of the Department of Finance, where the minister said the worst was over. He predicates this view on the ability of the great forecasters of the Department of Finance who have got everything wrong in terms of forecasting the economy since 2000. Why should anyone believe these guys now when they neither foresaw the boom nor the bust?
Yet we are supposed to believe them today when they say that the economy will recover next year and the year after. Can we do a little bit of basic economic forecasting to unravel this nonsense and then see whether the Government’s efforts yesterday will make things better or worse for growth and employment.
At its most basic, the way we calculate economic growth is by adding together four variables: consumption, investment, government spending and exports and then subtracting imports. According to the Government’s figures (www.budget.gov.ie/Budgets/2010/Documents/Final%20SPU.pdf) the economy will turn in the second half of next year.
This means that consumption, investment, exports or government expenditure will rise next summer. But where is the logic of this? We know that far from rising, government spending in the economy will fall by billions. So growth won’t come from there.
We also know that investment in the economy will not rise because investment is driven by the return on equity which is the return that an investment in Ireland will give an investor over and above what they can get elsewhere. For Ireland to achieve this state, the productivity of Irish workers has to rise dramatically (which won’t happen) or the price of Irish workers (our wages) has to fall dramatically, which again isn’t going to happen, to bring us in line with our competitors. So why would there be a surge in investment here next summer?
So, the other bit of the equation that could rise is consumption. The mandarins seem to think that when faced with pay cuts and the insecurity of unemployment, we the punters will go out and spend. But the opposite is more likely. We will continue to save and wait until the worst has passed before we spend.
The final piece of this particular spending jigsaw is credit. It takes credit in an economy to get people to spend to generate the growth rates which generate the tax revenue which allows the Government to get the budget deficit under control. But our banks are actively taking credit out of the economy because they are having to increase deposits and reduce lending to make sure that their capital ratios are sufficient. If they are not, the Government will have to come in and buy more of their stock, inject state capital and, in short, nationalise them.
The State doesn’t want to do that, so barring some dramatic change in international market sentiment towards the Irish banks the Government will either have to nationalise them or, if it doesn’t, the marginally private banks will retract credit from the system. In so doing, they will dampen spending, making rubbish of the minister’s claims that the economy will turn next summer.
Finally, exports from Ireland may rise. But as exports didn’t fall in the bust, this can hardly be the turnabout factor. Yes imports into Ireland will fall, but just to show the myopia and inconsistency of the Budget, the car scrappage scheme will increase imports of cars which will cause the import part of the growth figures to rise, reducing the overall growth figure!
So, where does this whole thing make sense? Will it cause a reduction in the central government balance? Will it, in other words, bring us closer to solvency?
The charitable interpretation is that it will bring us a bit closer but the â‚¬3bn in savings have already been cancelled out by the â‚¬4bn we injected into Anglo Irish Bank. And, obviously, some â‚¬6bn more will have to be injected to keep that basket case from folding. So, as long as the banks are still insolvent the prospect of NAMA 2, 3 and 4 is out there because of widespread defaults on mortgages, car loans, credit cards and the like.
Put simply, we are in a debt trap. This means that because prices are falling here by 5pc to 6pc; and interest rates, if you want a loan, are 5pc, the real rate of interest is more than 10pc. When the economy is contracting, this means that the debt dynamics are moving against us.
We need to reflate, either by inflation or growth, but neither is likely. So there is a real danger that the tax take falls further, expenditure rises even after the cuts and the so-called stabilisation of the finances fails badly.
The most important thing about economics is to join the dots. You need to know how everything is related in order to make a definitive statement about how the place runs and is likely to function in the future.
There is little point talking about one bit of the economy without making the links to the other bits.
Yesterday’s Budget was an exercise in this one-sided approach. The minister avoided talking about the elephant in the room, which is the broken banking system. Without making the connection between credit and the rest of the system, we only get a one eyed-view of what is going on.
Plato said that in “the land of the blind, the one eyed-man is king”. Maybe this is precisely what our ambitious minister is hoping for.