Home truths from abroad

Michael Burke11/11/2009

Michael Burke: It’s in the nature of a globalised economy that all economies tend to exhibit a specific combination of global trends. For a small extremely open economy such as Ireland, this is an inescapable truth. It is especially true in a period of crisis. So, despite widespread claims to the contrary, there is little that is unique in the current Irish crisis. And there is nothing which justifies the uniquely pro-cyclical fiscal policy that is currently being implemented. Instead, to treat the Irish patient, what must be diagnosed is the specific combination and strength of the widespread virus that it has acquired in the current pandemic.

The European Commission’s latest biannual economic forecast for the European Union is useful in this respect. It shows, amongst other things, what is and what is not unique about the current situation in Ireland. In doing so, it helps to undermine some the myths that have grown up regarding the features of the current crisis. Below are some of the key issues for Ireland that are worth highlighting:-

* Ireland’s bloated public sector: Before the current recession Ireland’s government spending as a proportion of GDP was the lowest of any economy in the Euro Area, 33.6% in the years 2002-2006, compared to a Euro Area average of 47.4% (Table 35, p.205). A number of countries, France, Belgium and Austria, have a public sector which is proportionately 1½ times greater than Ireland, at over 50% of GDP.

* There is no scope to raise taxes: In the same 2002-2006 period Ireland’s tax take was also the lowest of any Euro Area economy, at 34.9% of GDP compared to Euro Area average of 44.9% of GDP (Table 36).

* Ireland has a uniquely high level of public debt: Even with the disastrous and counter-productive policies currently being pursued, the Commission forecasts that Ireland’s public debt level will rise to 96.2% of GDP in 2011, compared to 135.4% for Greece, 117.8% for Italy, 104% for Belgium and a Euro Area average of 88.2% (Table 42). Shifting the goalposts a bit, it is also often claimed that Ireland’s export successes should be ignored in calculating debt ratios (even though exports can provide part of the taxes to fund deficits). But even if GNP is used, Ireland’s debt ratio is still the second lowest in the Euro Area at 38.4% of GDP, and still way below the average.

* There’s no scope for fiscal stimulus: Ireland’s output gap relative to potential GDP is expected to be up to 8.5% of GDP in 2009 and will still be as high as 5.4% of GDP in 2011, the largest in the Euro Area and compared to averages for the Euro Area as a whole of 3.6% this year and 2.5% in 2011 (Table 13).

* Ireland has become uncompetitive internationally: In the years 2002-2006, the price deflator for Ireland’s exports fell at an annual average rate of 2.7% and the price deflator for imports fell at an annual average rate of 2.3%, compared to Euro Area average rises of 0.5% and 0.7% respectively (Tables 18 & 19). In addition, Ireland’s growth of per capita labour productivity was an annual average 2.2% compared to just 1.2% for the Euro Area, and 1.6% for Britain and 2.1% for the US (Table 26).

Absolute, historical and relative comparisons are all useful to establish context. It is certainly the case that the pace of the rise in Ireland’s public deficits is the most dramatic of all the OECD economies. According to the EU, there has been a deterioration in public debt equivalent to 12.3% of GDP in just two years, compared to a Euro Area average of just 4.7% (Table 37).

But, as shown above, this had nothing to do with the entirely false assertion that Ireland has a bloated public sector. Instead, it relates to two genuinely unique factors in Ireland, in addition to the very small and narrow tax base which has exacerbated the rising public deficits.

The first unique factor is the depth of the recession itself, a forecast decline of 13% in GDP over the recession and more than double the average decline in the Euro Area (Table 1). This has driven down taxation revenues as well as forcing welfare spending higher. The second is the bank bailout, which at 232% of GDP is greater in Ireland than the next worst 4 Euro Area economies put together.

In relative terms, compared to the Euro Area economies, Ireland is unique in these two particulars; a uniquely severe downturn, as well as a uniquely dysfunctional banking sector which is sucking the lifeblood from the economy. The scope of the economic decline would require uniquely dramatic stimulus measures to revive it, while a rapid exit strategy from the policy of bailouts for bank bond and shareholders is also urgently needed.

Posted in: Fiscal policyEconomics

Tagged with: fiscal stimuluspublic finances


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