The ESRI Quarterly and 'The Small Open Economy'

Michael Burke20/06/2012

Michael Burke: The latest ESRI Quarterly deals very briefly with the issue of economic stimulus.

‘We would be very cautious about a domestic stimulus in Ireland, however funded, as history and experience shows that such a stimulus would have little effect on the domestic economy, but would lead to a worsening of the balance of payments’ (ESRI Summer, QEC, p.41).

Of course, if it were really the case that an Irish stimulus would lead to a worsening of the balance of payments than it would be counter-productive by increasing the overseas indebtedness of the economy, to add to all its other debts.

It should be noted that the ESRI makes no distinction between types of stimulus. Promoting the purchase of goods not at all made in Ireland would be counter-productive, as that could only be met by increased imports. This is what happened with the cut in VRT. But promotion of investment in or purchase of goods wholly or mainly provided in Ireland would not have that effect.

The ESRI also engages in hyperbole when it argues that the experience of the 1950, 1970s and 1980s is that any stimulus measures means a large proportion of stimulus would go to imports. The series of National Development Plans have precisely been a domestic investment stimulus which lifted both the growth rate and the long-term productivity of the economy.

Where Would Stimulus Go?

The assertion that any stimulus would lead to a worsening of the balance of payments is not supported by an analysis of the Input-Output Tables for the Irish economy.

In effect there are distinct categories of sectors in the economy where that would not be the case. The first is comprised of those sectors where the import content of inputs is negligible. This means that any increase in the output of these sectors would require no increase in imports. The second category of sectors includes those where the export output is much higher than the import content. This means that firms based in Ireland are importing lower value goods or services and re-exporting them having added significant value to them. The third category is comprised of those sectors where, even though the import content of inputs are high, the domestic multiplier effect is so large as to produce a significant boost to the domestic economy.

The first category is where import content of inputs is low. As the CSO says (p.10), of 53 sector groups there are 7 which have an import multiplier of less than 0.15, that is for every €1 extra of domestically produced output in these sectors, less than 15 cents is required indirectly in imports. These include wholesale trade, real estate services and education, motor repair, retail trade and repair of household goods. Health services have in import multiplier of just 0.16. Investment in these areas would overwhelmingly boost the domestic economy.

The second category is comprised of those sectors where the export component of output is much greater than import inputs. They are naturally dominated by the sectors in which the overseas multinationals predominate, printed materials, chemical products, office machinery and financial intermediation. But that is not exclusively the case, as the manufacture of food and beverages and the wholesale sectors both export more than they import. Providing services or ancillary inputs to those MNC-dominated sectors, or investment in the two large indigenous exporting sectors would be a positive for the balance of payments, as well as boosting output and employment. Altogether there are 27, of 53, product categories where higher value added means they export more than they import.

In the third category are those sectors where the boost to the economy from increased investment (the ‘multiplier effects’) are so great as to override concerns regarding import content. There are also 7 out of 53 sector groups where the output multiplier is 1.66 or greater (pp. 38-40), implying that the State would have a direct positive return on investment in these areas. These include agriculture, food and beverage manufacturing, water collection and distribution, construction, hotels and restaurants and water transport. The state could either directly invest in these (eg, water distribution and collection, construction/refurbishment of schools) or facilitate investment (eg, through promotion of tourism to benefit hotels and restaurants) and provide a positive return to the Exchequer. Indeed, in the case of tourism promotion, it would make sense for the overwhelming bulk of the investment to be made overseas.

The truisms regarding Ireland’s status as a small, open economy should not obscure the potential for State-led investment in a wide range of product sectors which have little import content, or whose domestic impact is so great as to render the objection that there will e increased import demand meaningless.

In fact, we could go further and argue that the ESRI’s entire framework is wrong. If the aim of policy were to prevent imports then there are numerous examples internationally and in Ireland’s own history where everything from import-substitution to autarky where that has been tried and failed.

27 of the 53 product sectors in the Irish economy export more than they import. Investing in those sectors, either directly or indirectly would boost imports, but exports would grow by a greater amount. Even those sectors which currently export nothing according to the CSO, like education, could become significant exporters by attracting overseas students. There is a vast and growing demand for high value-added education primarily in English and, as coverage of Euro2012 shows, everyone likes the Irish. But that too would require state-led investment and the input of high-value imports, both material and human.

Posted in: Fiscal policyFiscal policy

Tagged with: stimulusesri


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