July 18, 2011
Wynne Godley, the brilliant Anglo-Irish economist who sadly died last year, once declared that, because he wasn’t much good at mathematics, he was one of those economists who was ”obliged to learn how to think”.
Godley’s people come from Carrigallen in Co Leitrim, where he spent his childhood summers. Gladstone granted a title to Wynne’s grandfather, Lord Kilbracken, because of his support for the Liberal cause of Home Rule in Ireland.
Godley was one of those (far too few) renaissance men in the economics game. Not only was he a professor at Cambridge, but he was also a professional musician, the principal oboist at the BBC’s Welsh Orchestra.
Like the great Keynes, he hung around with interesting people. His wife had been married to the painter Lucian Freud, and his father-in law, Jacob Epstein, was a renowned sculptor who led a bohemian lifestyle.
What made Godley so interesting was his ability to predict things using basic economic rules and principles, rather than mathematical models — what might be termed ”common sense economics”.
Maybe this was because, unlike other academic economists, he worked for many years in the normal world before setting foot in Cambridge.
Godley’s perceptiveness and ability to think laterally made him one of Britain’s most brilliant economic minds. I thought about him last Friday when I heard the report on Dublin from the so-called troika.
I couldn’t quite figure out how they could report that everything in Ireland was moving along just fine and yet the markets were pricing Irish debt as junk, almost guaranteed to default.
The two views could not both be right. So let’s see what’s happening in Ireland.
We know that punters who have money are saving. But didn’t Mr Noonan exhort the nation to spend? So if we are saving, who is spending? And if we are not spending and the government is set to cut its spending, what happens to the level of demand in the economy?
This is where our economist friend from Leitrim comes in.
He was, a bit like myself, interested in the hydraulics of economics or the ”if this goes up, what goes down” end of things.
One of Godley’s insights was a straightforward economic truism, which was that the balance of trade of an economy is nothing more than a reflection of the balance of savings in the economy.
If the punters are saving or hoarding and not spending, then the government will have to spend to offset this saving, otherwise the economy will contract.
The only way to prevent this is if we can persuade foreigners to buy stuff from Ireland in huge quantities. But why would they buy stuff in Ireland that they can get at home?
Bear this basic idea in mind when we look at why the markets are scarpering from Ireland, and why Irish money is still leaving the Irish banks looking for a safe deposit abroad.
Who is right? Are people right to be taking their money out? Are the financial markets right to be selling Irish bonds and also taking their money out?
Or is the troika right in saying everything is more or less hunky-dory?
If we follow the troika’s austerity programme and bring the government deficit down from14 per cent of GDP to 3 per cent in (say) three years, where will that missing 11 per cent of GDP come from? If government spending isn’t replaced, the economy will shrink by the same amount.
We are talking about 11 per cent of total income. If the economy shrinks by the same amount, so does the tax base.
If the tax base shrinks, what happens? Well, if we are to achieve the austerity targets and the tax take falls, the cuts will have to be much bigger.
But this won’t make the economy grow — it will have the opposite effect. The cuts will make the economy shrink.
Unless, of course, the trade surplus can increase dramatically, which would mean that our savings and the government savings were offset by demand from foreigners.
But the simple back-of-the-envelope calculations would mean that, for the economy to stay stable, the trade surplus would have to increase by at least 11 per cent of GDP from here.
The trade surplus today is ’2.8 billion. But, given that our GDP is about ’170 billion, our trade surplus would have to move sharply from ’2.8 billion to ’21.5 billion in the next three years to keep the economy stable.
Our main export markets are the US, which accounted for ’13.3 billion last year, Belgium and Britain. What Belgium is doing there is beyond me, though it appears to be due to the shipping of some multinational products through that country to other final destinations.
But these three territories comprise 52 per cent of the total value of our exports.
How likely is it that we can increase exports to these countries when we know that the US economy is struggling and we also know that Britain is pursuing its own austerity programme? In addition, how likely is it that we can increase exports to these countries with our high cost base, when they are allowing their currencies to drop?
How can Irish exports to the US and Britain be competitive, particularly when a small change in their currencies, which can happen overnight, will more than compensate for any fall in our cost base which, because we can’t devalue, has to come gradually and with political consensus?
Obviously, to achieve this type of trade turnabout quickly, we would need our own, highly competitive exchange rate to give our exports a chance, and to make us think twice about buying imports, particularly non-essential consumer ones.
Taken together, it seems highly implausible that we can increase our trade surplus eightfold from’2.8 billion to ’21.5 billion, without a change in our currency. Countries such as Finland, Sweden, all The Asian tigers and, more recently, Iceland have responded to banking crises with massive devaluations — all of which have been successful in terms of trade enhancement.
This has to be an option for us, particularly As we can’t go on borrowing, otherwise we are caught in what could be termed ‘Godley’s paradox’. The domestic economy — as we have already seen with the latest GNP figures — will contract with austerity because we won’t be able to export enough, quickly enough.
Wynne Godley, like that other great Cambridge economist, Keynes, was never scared to change tack. Keynes once famously said: ”When events change, I change my opinion.
What do you do, sir?” We should not be afraid to change our policy.
This is particularly the case when basic, straightforward economics tells us that the present course of action simply cannot succeed.