Stimulus for Development

Sean Ó Riain30/03/2009

Sean O Riain: Commentators across the spectrum have worried that the April budget will tax and cut so much money out of the economy that we will face serious deflation. There has been a shift in emphasis from the over-riding importance of minimizing the budget deficit to recognizing the need to minimize the deflationary effects of fiscal measures. We are seeing an increasing number of proposals in that regard.

This is not unrelated to a second major political shift – the re-opening of partnership discussions and the potential for working through more complex and multi-layered ways out of this crisis. I can’t see any other institutions that can put together a combination of measures to promote a growth strategy that would accompany fiscal measures.

Without that growth strategy, the fiscal measures will not achieve their desired goal. We will simply end up chasing our tails, raising tax rates on a declining tax base and promoting deflation by combining tax increases, employment reductions, spending and wages cuts in a single year. Immediate measures to restore a degree of fiscal stability and reduce the budget deficit are necessary – but require a strong countervailing growth policy to restore the economy, and even to maintain those narrow fiscal goals.

I am skeptical that a growth plan that is simply based on cutting wages (although it is clear that wages are declining already in some sectors) and waiting for international demand to pick up will work. There are, for example, significant wage and non-wage elements to increasing costs (e.g. energy costs, communications costs and professional fees) and other areas where labour costs are not the critical components of competitiveness. Improvements in energy and professional fees would benefit consumers as well as firms and would make a recovery plan much fairer than an exclusive focus on wages.

But more importantly, our industrial development is very much an unfinished project. We haven’t built the firms and industries that can be the basis of sustainable prosperity and have been struggling in that department since the momentum of the late 1990s was lost. Even with the boom of the past decade, our banking, enterprise and social investment sectors have major structural defects that will weaken the effects of any efforts to increase cost competitiveness. Any growth plan must also be a development plan – even where particularly important to competitiveness, cutting costs will be an element in a growth strategy but will not deliver the development in organizational capabilities that is required.

Is there a way to square the circle? If there is, it needs to be rooted in three crucial features of the current situation

  • The efforts to deal with the public finances must be combined with a strategy for growth in a creative multi-year approach.
  • These efforts must be located within an integrated solution, as NESC point out. This should encompass solutions to deal with the financial crisis, the fiscal crisis, the economic crisis, the social crisis and the reputational crisis. An exclusive focus on re-capitalising the banking system, cost competitiveness or public sector costs will not generate the economic or political dynamic to get us out of this mess.
  • Solutions must not only be adaptive, but also developmental – this crisis has only emphasized the weaknesses of our existing systems. If we simply restore business as usual, then we go back to banks that don’t lend to productive businesses, to a weak industrial base that is stuttering towards the ‘knowledge economy’, to weak systems of social support for workers, and so on. Institutional reforms need to be developed not only for the public sector but for the banking and private sectors.

Each of these aspects of the crisis poses enormous challenges. But each also provides opportunities. There is a chance to make reforms that can set us on a more sustainable path of development. While the current focus is on cost containment, our over-riding medium term goal should be to become a high investment economy. We have in fact signally failed to become an investment economy, just a high growth and high spending economy. This applies equally across the private and public sectors. Non-housing investment is weak and public spending, even with comparatively high public sector wages, has been well below any of the high performing small European economies.

We need a ‘stimulus for development’ plan. This would incorporate a short-term plan for fiscal restoration, linked to a serious growth strategy that will establish bank lending to growing enterprises and support those firms with an enterprise strategy that goes far beyond our excessively narrow industrial base. This should be tied together through a plan for recovery of living standards, particularly among those on lower incomes.

The plan should contain certain key elements.

The first is significant banking reforms. Simply recapitalizing banks that go back to their existing business models will do little for growth – Patrick Honohan has shown that banks contributed little to the Celtic Tiger boom of the 1990s and it is clear that their lending since the late 1990s has been speculative rather than promoting development. The property assets that are now being underwritten by the state should be carefully reviewed to assess the social purposes to which they could be put (a back of the envelope list would include social housing, enterprise centres, libraries and public internet facilities, community facilities). Bank lending should be focused – either through nationalization or regulation - upon much more significant elements of investment in enterprise development. In an era when public funds are under severe pressure, we cannot afford to get as little return from the funds in the recapitalized banks as we have in the past. Simply quarantining toxic assets in ‘bad banks’ won’t deliver this kind of reform – and will still cost us a fortune. We can have our own ‘stress test’ of banking reforms. If the banking system we design won’t invest heavily in the innovation funds proposed in the Smart Economy plan, then our reforms have not done their job.

The second element should address the economic crisis through taking the opportunity to deepen and extend the elements of enterprise strategy that we have in place that have worked in pockets of the economy. Obsessed by the search for the new Nokia to emerge from Ireland, government has neglected the overall infrastructure of learning and innovation. While spending has increased it has not caught up with the historic infrastructure deficits, nor has it kept up with the increasing population or the complexity of the demands of ‘knowledge economies’. We do have institutions that have been successful in this regard. Research council and other funding has boosted research in Ireland to new levels. State agencies have a track record not only in attracting foreign investment but in supporting the growth of indigenous firms. But we have not generalized this model and we have not built the overall system of lifelong learning and high rates of investment that support such enterprises in the more successful European economies. The obsession with big science has led us to stop asking the firms and state officials working to promote innovation across the economy what they need and what supports they can develop for this process. Re-invigorating a general enterprise strategy is something that we have the expertise to do, where we have some track record of success and which is an essential element of the competitiveness of firms and industries. We need this generalized enterprise strategy to address the structural weaknesses of Irish business, that include but go well beyond cost competitiveness issues. There are many suggestions in the Government’s Smart Economy strategy, ICTU’s Ten Point Plan and the various party documents that can contribute to this area.

The third element should be the maintenance of social investment. While we often focus on the positive stimulus effects of capital investment, in an economy when services and human capital are increasingly significant elements of the economy, social investment is increasingly important. This means placing new emphasis on services that support labour market participation – education, training and childcare come to mind and the work of NESC on the ‘developmental welfare state’ maps out a clear path that shouldn’t simply be abandoned at this point. I suspect that, if we could figure out how to estimate the effects of these ‘development services’ embedded within the broader system of public services we would find important multipliers – we know that the investments we did make in education and in industrial policy paid off handsomely.

Enhancing social investment among the lowest and middle income groups reduces inequality, tackles the inefficiencies in the waste of skills and talents in the current system, and improves the prospects of any deal being politically workable. Right now, our institutions work in highly unequal ways. Attacking that inequality will both give us greater fairness and increase efficiency. If we allow communities to become racked by high levels of unemployment now, we - and more importantly those communities - will face the consequences for years to come. The rumoured forthcoming cuts in services to the weakest will increase inequality and also cause significant long-term costs.

This involves an integration of the efforts to tackle the social and economic crises. As NESC argue, we need an economy that is embedded in society. Education and training should be a critical element of the development plan – and at the same time work to re-train those who lose their jobs and reduce unemployment benefit costs as workers end up in education rather than on the dole. The greening of public infrastructure is urgently needed, and offers the chance to re-train construction workers and build ‘green enterprises’ while tackling some of the social costs of collapsing construction employment. There are many ideas in circulation at present but the debate around making them into a cohesive strategy hasn’t really been engaged.

The reputational crisis that NESC refers to is also central to the problems we face. However, that reputational crisis is both domestic and international. A plan that addresses the need for reforms across the public, financial and enterprise sectors; that addresses the weaknesses that got us into this position; and that provides a pathway for future development that is credible and allows economic actors to plan and work out new strategies within some kind of stable expectations about the future.

Pushing funds into these areas also has the advantage that the funds are delivered through services that are provided within the economy, avoiding the tendency for stimulus funds to flow straight out of the economy through imports. It combines immediate stimulus with long-term development.

Nor does it require us to develop new skills overnight. Existing evidence suggests that government investment and non-wage consumption has worked to stimulate the economy over the past three decades. Such a strategy draws on expertise that already exists within public institutions - on enterprise development, financing of enterprises and social investment. It does not require the invention of new capabilities on the part of public agencies but on recognizing their value and mainstreaming and extending them.

Can such a plan be funded through external borrowing? Recent discussions on the importance of distinguishing the structural and cyclical budget deficits are helpful here. If we are taking action to restore the balance of the structural deficit (the underlying balance between revenues and expenditure) then cyclical borrowing to support a specific ‘stimulus for development’ will be easier to justify. We certainly need to get the structural deficit in order. However, identifying the cyclical component of the deficit also allows us to identify a space for temporary stimulus spending. It also gives us the chance to develop new institutional capabilities to promote long term development. It is costly but without it, it is difficult to see the austerity measures working.

There is also the opportunity for forming a political coalition to push this through. The fact that the challenges are across multiple areas and years and that the reforms required are institutional as well as budgetary opens up the possibility of trade-offs across these various dimensions of the crisis. The kinds of financial losses being distributed across the economy are going to be difficult to justify without clear indications that we are not returning to business as usual. But this cannot be achieved effectively through pluralist policy-making dispersed across these different policy areas nor through government fiat. If social partnership institutions fail to figure out this integrated strategy, then it seems unlikely that any other set of institutions can deliver a strategy that will work economically and politically.

Posted in: InvestmentEconomicsEconomicsFiscal policy

Tagged with: stimulusIrish economypublic financesinvestment



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