Here’s a piece I wrote in the Irish Left Review responding to Michael Taft’s article in the ILR a few weeks ago. Full text is below, but check out the discussion on the site itself also.
The late, great monetary economist Hyman Minsky (1986:110), quoting Nobellist James Tobin, once wrote of economics theory that:
“the terms in which a problem is stated and in which the relevant information is organised can have a great influence on the solution”.
Minsky goes on to write:
“But the way the problem is stated and the identification of the ‘relevant’ information reflect the economic theory of the policy advisor. That is, the game of policy making is rigged; the theory determines the questions that are asked and the options that are presented. The prince is constrained by the theory of his intellectuals!”
Minsky echoes Keynes’s over-used turn of phrase, which reminds us that men and women in power who believe themselves above every influence are, in fact, the maidservants of long dead obscure scribblers.
Michael Taft has written a call to progressive thinkers and those on the left to change the manner in which the economic problems the Irish economy currently face are phrased, and in so doing, change the articulation of policies which constitute an attempt at solving the current fiscal crisis. Taft obviously hopes the effort of articulating leftist policies will unconstrain the prince, that is, policy makers, who once exposed to a wider range of options than their advisors offer, will be able to help make decisions to stimulate the economy in the manner Taft suggests.
I thoroughly enjoyed thinking about the issues Taft raises in his piece, and I’ve some brief comments and criticisms of his approach. Hopefully the debate will prove constructive.
Writing in the Irish Left Review, Michael Taft sets out a detailed invitation to progressives to draft proposals for economic reform, and he gives the type of proposal he has in mind. My plan is to go through some of these proposals, and offer comment, constructive criticism, and perhaps even guarded support.
The word Taft uses most often in describing his mix of policy prescriptions is `expand’. Expand fiscally, expand demand, and expand indigenous enterprise. He wisely suggests that one size fits all policies will not work, not even in tiny Ireland. Instead, a government blueprint for several policies, fleshed out by regional authorities would be more in tune with the type of approach Taft encourages Irish policy makers to adopt. My only criticisms with Taft’s approach comes from the exact details of and timing for these expansions, given the deteriorating state of the Irish economy as I write.
Let’s take Taft’s recommendations in sequence.
Borrowing
The first support of Taft’s plan is borrowing. Taft wants the Irish government to plug gaping fiscal hole left by the drop in government revenue from collapses in private consumption and spending in construction. The main reason borrowing should be the first resort for the government is the adverse effects cutting spending on public services like the public wage bill would have on consumption and investment. This approach can be attacked and defended upon the same lines: those in public services now make more, on average, than their private sector counterparts (where those exist), and they cannot be fired. The public sector is not the mainstay of private investment—the private sector is. Civil servants just don’t start businesses, by and large. So Taft can be attacked for keeping an overpaid unfirable minority in the manner to which they have become accustomed, while the private sector, which created and realised all the gains from Irish economic growth in the boom, suffers all the losses in the bust. Taft can be defended because theorists like Minsky and Keynes would adopt similar policies, once all gains from monetary policy is gone. Given that we are now in a currency union with monetary policy set by the ECB, only fiscal options remain. Borrowing to retain current levels of spending is prudent in the short term, especially as Ireland has a relatively low govermental debt—at the moment.
Right now, Ireland’s fiscal stance is looking poor. In 2009 the government reckons it will spend 79 billion euros, of which it will spend 20 billion on pay, 28 billion on transfers, and 31 billion on ‘other stuff’, loosely conceived. The Govrnment assumes right now it will get 60 billion in taxation revenue, generating the current expected budget shortfall of 19 billion. The policy mix the government chooses to plug this 20 billion euro hole must be made up of a combination of taxation changes, borrowing, and restructuring, which is code for firing people.
Figure 1: Components of Tax Revenue of the Central Government. Source: CSO. Chart created by Dr Aidan Kane, NUI, Galway.
Tax
Taft argues that taxes must rise, and no one is going to argue with him. The plot above (from Dr. Aidan Kane, NUI, Galway) shows Irish government tax revenues over the period 1970—2008. We can see from the plot that the government has, historically, derived around 70% of its income from taxes on income, and 30% or so from taxes on deaths, DIRT, capital gains, and Stamp Duty. Over the last 5 years, we can see that tax cuts to individuals and businesses created a hole the government’s finances which were plugged immediately by the increase in capital gains revenues and stamp duty. As long as the boom continued, Irish private income taxes could by supplanted and supplemented by revenues from consumption and construction.
That is no longer the case.
Taxes must rise again to redact the changes in the composition of government revenue brought about by successive budgets in recent years. The question is: who gets taxed? First, I would be in favour of returning to a three schedule taxation structure: 20% for incomes below 30,000, 43% for incomes above 30,0000 to 100,000, and 45% for incomes above 100,000. This is in contrast to Taft’s proposal to tax unused capital assets over 1 million euros over a seven year period. The proposal has merit only in the dynamics— wearing a populist hat, one would like to see highly net worth individuals baring the brunt of the increase in taxes, as they stood to gain the most from the boom. Wearing the pragmatist’s hat, one understands the history of Irish private capital flight in the late 70’s and early 80’s was a function of the shape of the taxation schedule. High net worth individuals, by and large, have accountants and stock brokers on speed dial. In our modern era of globalised commerce, the assets Taft wants to tax would be sold, and their proceeds moved abroad, to avoid the tax consequences. The only detail which might make Taft’s tax-the-rich plan a success is the illiquidity in many markets at the moment. A rich man who wants to sell some of his property to avoid Taft’s tax just won’t be able to, at least for the next year or two, until the property market recovers. Then their money will be gone from the Irish economy, though the government will collect a once off Stamp duty or capital gains dividend from these actions.
Who’s spending the money?
Taft wants local committees to oversee the spending of the government’s largesse, and, somehow, test each line of expenditure for economic efficiency and social equity. Where the line of expenditure doesn’t cut the mustard according to these criteria, the expenditure must be cut. Taft essentially wants a `bottom up’ approach to public spending cuts, ignoring the details and dramas of local politics, corruption, and the inevitable infighting it would cause. The role of time here is important—decisions need to be made in a matter of weeks. Large scale public consultation would take months, if not longer. Yet if we begin now, then by the time of the next budget (in December, hopefully), these consultations would be complete. Taft’s proposal for public scrutiny of the government’s accounts is a welcome one, and open-source approaches to the management of these resources should be encouraged in the short term. But these measures don’t get us out of the hole today. These recommendations are medium term (3-5 years) incremental benefits which, it has to be said, accrue to the middle and upper classes disproportionately.
Unions
The unions, of course, need to be involved in this action, with collective local bargaining returned as a force for the worker at the local level. As an example of the type of spending Taft wants to cut, Taft wants public subsidies to private schools to drop to zero, while further provision should be made for those who become unemployed.
Prices
Taft, like everyone in Ireland, wants lower prices, especially for relatively demand inelastic `utility’ consumption purchases like electricity, water, and so on. In the case of electricity, less regulation and more international competition is the answer, and I agree completely. If retailers of particularly necessary products (petrol stations, say) are compelled to advertise their prices in real time to the National Consumer Agency, the thinking is that increased consumer information will result in price drops and less price gouging, as people shop around online for cheaper petrol.
Again, the devil is in the details. Take petrol prices. There already exist price comparison websites for this sector (at www.pumps.ie). The theory of price determination says that geography and psychology matter far more than simple price comparisons, especially when the price differences are small. People simply don’t maximise their utilities in real life. That’s why you can see two petrol stations with wildly different prices side by side, experiencing the same level of demand for their products, website or no website. Consumer price sensitivity does change over the business cycle—we look at the details of the restaurant bill now, we didn’t last year—but it doesn’t change enough to make a huge difference, which is why Dunnes Stores is still in business alongside Lidl and Aldi.
The other issue one might encounter once downward pressure on prices becomes a more regular affair in Irish economic life is firms squeezing their workers for more productivity for the same level of wages (which will agitate unions), or letting people go (which cuts costs in the short run), and will lead to a reduction in prices as well, while not exactly helping the situation. The irony is that a recession this bad will actually be good for those who have a job, because prices will fall, and previously unreachable consumption choices (that second car, that house extension) are now realisable. Whether these consumption choices will benefit the economy enough to see us out of the recession in a short space of time is debatable.
Infrastructure & the Green agenda
Every time since the foundation of the State an Irish government has faced fiscal problems, they have cut back on infrastructure spending first, because it is politically easier not to build a new hospital, because the alternative—firing people or reducing service levels—will have the public up in arms, as we have seen. The cumulative effect of such a stop-go attitude to public infrastructure is poor quality roads, rail, and ports. Apparently we’re 64th in the world in terms of our infrastructure’s quality. Which should surprise no-one reading this.
Taft wants to reverse the now decades-old policy of slashing infrastructure spending during a downturn, and pay for green-infrastructural products which can buoy both the domestic Eco-construction, ICT and waste water treatment sectors, and achieve the socially beneficial goal of improving the environment through large scale government policies which increase local employment and hence consumption and investment. I agree with Taft on every word of this part of his proposal. President-Elect Obama and Primeminister Brown are both considering `green job’ promoting fiscal stimulus packages, to achieve the crucial twin societal objectives to getting people back to work and achieving a greener economy in the medium term.
Banks
Why isn’t there a small, local bank which says to its customers `look, we’re not into fancy stuff, no high mathematical finance. You give us your money, we’ll pay you interest for it. You need more money, if we think you can pay it back, we’ll lend to you at another interest rate. We’ll make our money on the difference between the two, and we’ll stay local.’ Irish banks are in poor shape, with some of them having lost 95/6% of their share value over the past 18 months. Only one executive has fallen on his sword, and, sadly, not because of his incompetent management of the bank. The sad fact about the public’s perception of banking and finance is that when money is being made for them, the bankers are Newton-level geniuses. When it all goes wrong, the same Newtons quickly start looking like crooks. The public, through the media, cry out “How could they not see it coming? What about their bonuses and salaries and lending practices? Heads should roll!”.
To some extent the drama currently playing out in public discourse in Ireland reminds me of a Greek play, with zero moral absolutes and an unseen God determined to despoil the happiness of whomever happens to be prancing around the stage at the end of the second act. We have our tragic twist of fate, a foreseen prophecy, a fair amount of inbreeding between the polictical elite and the banking and legal classes, and, of course, the fall.
What we don’t have is a small and medium sized enterprise sector willing to secure the low hanging fruit people’s uncertainty about their personal finances represent. By continuing to invest in Irish banks, we condone their activities with our inaction.
Why isn’t there a business development fund, paid for in the good times and the bad by the banks, by essentially increasing their reserve ratio, from which small business development can be properly funded?
Time
The issue which really grabs me when going through Taft’s discussion is the timing and implementation of each of these policies. Right now, this minute, it makes sense out of simple survival to increase the level of government borrowing to meet national expenditures. It does not make sense to continue this policy of borrowing into the medium term, because as we borrow, so our cost of acquiring capital increases. Already our borrowing stands at 34% of GDP. To increase that amount significantly would require the costs of borrowing on international bond markets to exceed its benefits. Cuts in government spending on infrastructure and public sector employment are now politically unavoidable, as politicians struggle to contain the public’s perception of dithering by commiting to potentially injudicious action to change expectations about their future behaviour.
Concluding Remarks
Timing matters. The lagged (positive) effects of educational policy changes and SME development programmes have to be estimated and implemented for years before clear benefits become obvious. The green infrastructure and ICT developments are economically useful again in the medium to long term, while providing jobs now at a much increased cost to the public purse today. If politics is the art of the possible, then these two policies are surely impossible for this government to pursue.
The reform of banks through nationalisation and reputational sterilisation by firing the heads of the major banks will have to take place in the next 12 months if the banking sector in Ireland is to maintain any competitive edge in raising funds internationally.
Our export markets have been uncompetitive for several years now. Only an decrease in the cost of doing business in Ireland (read: wage moderation for those who aren’t fired, emigration/retraining for those who are) will allow Ireland back into export markets in a sustainable manner.
Policies to keep people in work are always preferable to keeping banks in business, at least politically if not economically.
The questions need to change: we need to stop advising the princes that a return to stability is possible in our small open economy, regulate and deregulate judiciously to allow the increase of certainty and price competition into our economy, and provide policies to get our workers back to work, rather than priming them for the boat.
I’m looking forward to the debate on Michael Tafts work, and thank the editor, Donagh, for the invitation to comment at length in this forum.
Stephen Kinsella, PhD, is a Junior Lecturer in the Department of Economics, Kemmy Business School, of the University of Limerick.