When will we know if Irish pre-emptive fiscal austerity is a failure?

Brad DeLong asks:

When would it be time to judge the Irish experiment in preemptive fiscal austerity to be a failure, Tyler?

The immediate question is whether Ireland had a choice in the first place.  When it comes to total external debt, private plus public, Ireland is in one of the most desperate situations.  (Be careful, though, some published figures include financial institutions to which the Irish government has no real liability and thus overstate Irish external debt by quite a bit).  Ireland doesn't have the same flexibility as do Germany and the United States, nothing close to that.  Read this article for an estimate of the change in primary fiscal balance required for Ireland; it's scary and doesn't indicate a lot of flexibility, which supports the conventional wisdom on Ireland, from the OECD, the European Commissionfrom Ireland itself, and arguably you add the IMF to that list as well. 

Furthermore, Ireland as a small, open economy experiences a relatively high degree of fiscal leakage.

By the way, you shouldn't simply assume that the initial fifteen plunge in gdp was due to fiscal caution; Ireland was after Iceland perhaps the most overextended country in the crisis.

Here's a Morgan Stanley analysis of Ireland, which basically suggests "it's complicated."  It also suggests a reasonable chance the current strategy will work out OK.  It is complicated, and the mere fact that spending is a component of national income accounts doesn't mean that more spending is always a good thing. 

Ireland in fact has done a negative fiscal stimulus.  Earlier, Ireland made the mistake of joining the Eurozone.  See also this study of Ireland, 1987-89, an earlier decisive and successful fiscal adjustment, in the days of the Irish Punt.  The Euro today makes matters harder for Ireland, yet that doesn't imply they have greater license to spend today, in fact it can imply the contrary.

Paul Krugman pointed out that the fiscally tighter Ireland did not have a better CDS price than the more wishy-washy Spain.  Yet Ireland has a bigger external debt problem, may be less protected by "too big to fail," is a smaller nation, and has less control over its destiny; the (roughly) equal price may reflect what is a superior Irish effort.  In any case, Spain is hardly a walking advertisement for not going the Irish route.

The Irish also hope that whatever output they "leave on the table" today, they can make up with Solow catch-up growth.

If you would like to read a brief on behalf of Irish stimulus, try this.  The author admits that Ireland would have to significantly raise corporate taxes, a former linchpin of its growth (whether you think that efficiency-enhancing or international rent-seeking, it is still true).  Is it worth it?  How much would such a policy damage Irish growth and credibility?

Kevin O'Rourke also has good but scattered writings on the topic of Irish stimulus.  His first preference is greater fiscal federalism within the EU.  Last month he also wrote that, lacking such a reform, Ireland had no choice.

This June, Irish consumer confidence hit a three-year high.  Here's one estimate that wages have been falling four to five percent a year, and will continue to fall, plus the Euro has been falling.  You could argue there has already been an adjustment in the twenty-five percent range.  None of that is proof of recovery, but there are some green shoots.  Here is the very latest report, indicating that economic growth may be resuming; admittedly it's just a forecast from the government.  Exports are showing growth and retail sales are rising slightly.

The Irish Times reports today: "For the first time in three years, there are now more reasons for hope than for despair.  This week a raft of indicators, when taken together, give grounds to believe that the foundations of a jobs-generating recovery are falling into place."

Do interpret that with extreme caution.  For various debates, follow The Irish Economy blog, including in the comments.

On these critical questions, in the pro-stimulus for Ireland posts, I don't see a level of detail which would rebut these quite mainstream, not-emanating-from-the-gamma-quadrant opinions — that the Irish did more or less the right thing in a very unpleasant situation. 

The Irish experiment remains an open book.  In the meantime, it's simply not true that the pre-emptive austerity advocates are committing some kind of economic malpractice.  Three years out from now, let's compare Ireland to the other PIIGS.

Comments

I would recommend this blog for a thoughtful analysis of Ireland.

http://trueeconomics.blogspot.com/

Another piece on Ireland that ignores that the country only lifes from tax evasion and financial non regulation. The politics of tax evasion and financial regulation are what matters for Ireland. Other countries have even lower tax rates and even less regulation - but those other countries usually are no EU members, no Euro members, dont have tax threaties with all the major nations.

The level of tolerance towards Irish dirt should be much lower now on the financial regulation side, possibly also on the tax side since the crisis also delegitimiced market fundamentalism in general.

Tyler, please tell us when you will consider the current economic policies of both the Obama Administration and the State Administrations of California, New York and Illionis (among others) a failure. For your assessment, you can rely on several articles and opinions in today's edition of the NYT as well as in many other publications. Given what is going on in your country, I think it's stupid that U.S. economists debate about the policies of China, Ireland, and other countries about which they know little or nothing. I hope that at least U.S. economists can explain and assess U.S. policies --although most are too partisan or dogmatic to be taken seriously.

Now that I've read through the DeLong thread, I wonder if advocates of Irish stimulus actually think that austerity caused the entirety of our problems, and this makes me doubt that they understand the situation, lending credence to my 2. above.

Millan:

Maybe the US and Ireland are not so different. Our construction industries have been/are major generators of unemployment.

And as for being protectionist, it certainly isn't working very well, what with our world leading trade deficits and position as the 'buyer of last resort.'

After joining the Euro easy money flooded Ireland which lead to an over expansion. After the collapse they have limited options to fix the problems.

Taxes from construction was too big a part of the budget.

Many Americans have roots in Ireland that makes it interesting for many, plus Krugman is wrong on the issue.

The Irish are concerned with growing the economy in contrast to the Obama administration which is about redistribution.

Th Irish are using a crisis ti fix things.

Obama is using a crisis to push a social agenda

So the Irish made a mistake in joining the Eurozone, and Iceland was ravaged because they hadn't joined the Eurozone.

OK, got it.

I don't see how you can even begin to talk about Ireland without a serious look at their national accounts. That must be some weird economy. The difference between GDP and GNP most recently is 19% of GDP.

If foreigners owned all the private housing and business assets in the US, and thereby received all the interest and corporate profits on these assets, and if there were no countervailing US ownership of foreign assets, the corresponding number would only be 16%. And if, as I suppose, the Irish GDP is more inflated than ours by indirect taxes (sales, property, VAT), that comparison is even weirder -- that is imagine you strip those indirect taxes out of GDP and compute asset income as a % of what's left, which would be basically asset and work income.

What's the net foreign debt (owed by Ireland to foreigners less the reverse)? Can't find a number for that. Even that must be huge, given the GDP / GNP disparity. Like several times the Irish GDP. How can that be? What could be the use of all those funds? Don't think it could be to fund domestic demand overall, PCE and business and housing investment -- I don't think the Irish have run trade deficits. So what is it then -- some huge financial enterprise?

When you go through all of the lists of facts and studies listed in your post as a reply to DeLong,

YOU STILL DID NOT ANSWER DELONG'S QUESTION.

If you believe in the self correcting nature of an economy--the premise of the Austrian and Mellon School--then say so and show how austerity will work or when you would judge it a failure.

Think of it as an exam question. When I grade, and ask a question such as this, I do not accept an answer that sounds like it was taken from the Encyclopia Brittanica.

I would also add that you cannot create an economy--or a fiscal system--based on serving as the place where MNCs can hide their profits through various transfer pricing schemes. If anyone is ever called to aid Ireland--including the countries that have lost taxes from transfer pricing schemes--I would not blame them for demanding that Ireland's corporate tax laws change as a condition of assistance.
To say that the US is different than Ireland, then are you saying Ireland made a mistake in using austerity as a way to get out of their problem, and that we are different, and for that reason it will work here?

Bill,

Go read the Brad DeLong link, and you will see that Tyler answered it there: "2-3 years is a good window for judging".

Two to three years. What do you get for that?

I think the market has it right: From Bloomberg:

"Concern governments around the world are curtailing stimulus measures too soon spurred Barton Biggs to sell about half of his stock investments this week.

Biggs, whose Traxis Partners LLC gained 38 percent in 2009 when he bought equities after the Standard & Poor’s 500 Index fell to a 12-year low, sold most of his U.S. technology holdings, he told Bloomberg Television yesterday.

Signs the U.S. economy is weakening convinced Traxis to reverse course as the S&P 500 posted a weekly slump of 5 percent, bringing its loss since April 23 to 16 percent. Biggs, 77, said yesterday he cut bullish bets by about half since June 29, when they made up 70 percent of his fund.

“I can change my mind very quickly,† Biggs, who manages $1.4 billion, said in a telephone interview following the Bloomberg Television appearance. “I’m not wildly bearish, but I don’t want to have a lot of risk at this point. I just want to have less exposure at a time like this.†

The withdrawal of government stimulus, including the U.S. Senate’s vote against extending unemployment benefits on June 30, may turn a “soft patch† into a recession, he said. The second recession in three years isn’t inevitable should “rational politicians† take action to avert it, he said."

@dieter:

If you want Paul Krugman, you know where to find him.

"Big adjustment needed." Yep, Ireland needs a big adjustment. It has the biggest cyclically adjusted primary deficit in the OECD. Just don't forget who is second in that sweepstakes--the good ol' US of A.

"hat must be some weird economy. The difference between GDP and GNP most recently is 19% of GDP."

Already said it above: Its tax evasion. Multinationals set up a small link in their production chain in Ireland, or sometimes just a mailbox at some lawyer, then they pretend that small production in Ireland would be the most expensive part, so that all profits get taxed at the low Irish corporate tax rate. The de facto value of that production is usually rather limited. The important part for the Irish subsididy is a good accountant.
Thats why Ireland has so much pharma, software etc, because its harder to pinpoint where the profits come from in that field. For a while, Microsoft had just a small office in Ireland that added over a billion to Irelandas gdp (and a couple of hundred million in taxes).

See for example this:

http://www.finfacts.ie/irelandbusinessnews/publish/article_10005150.shtml

"Ha'penny Bridge, Dublin - Microsoft's Round Island One is Ireland's biggest company. It operates from the offices of corporate lawyers and reported €3.23 billion ($3.88 billion) in fiscal 2004 pretax profit and paid $308 million in Irish corporate tax."

@dieter:
If you want Paul Krugman, you know where to find him.

I read Tyler for his links. Without Paul Krugman and the others, Tyler wouldn't have anything to add his minor quibblings and diversions to.

Let's leave PIGS and PIIGS to the pigs. GIPS and GIIPS is more decent.

"The immediate question is whether Ireland had a choice in the first place."

A still under-evaluated point. It's all well and good for the Krugman Klan to tell Ireland how deep into hock they should go, but no quantity of argument by the pro-debt crowd can change the amount of credit available to Ireland. "The market is always right" is not an ethos, it's a truism; in this case, the truth is how much money buyers are willing to lend the PIIGS cheaply, and the answer is "not a lot."

The grow-your-way-out-later fantasists are not the bond market or a rating agency. Paul Krugman can tell me it will be fine if I buy an expensive car; it doesn't matter if I believe him or not if the bank doesn't.

PQuincy asked:

After the last decade, can anyone argue that "markets [always] efficiently allocate savings," as Roberts' statement does?

What does the last decade have to do with anything a free market would do?

What the last decade DOES prove is that in highly regulated "mixed" markets containing a few nominal elements of freedom dominated by massive fascist government controls, rules and regulations, government can, indeed, stimulate economic activity and employment.

Using the full fiscal, monetary and regulatory powers of the Federal government, a massive "stimulus" was applied, with great success, to the housing construction market. By all appearances, the government stimulus was highly successful, creating a huge increase in the demand for homes, and increasing employment in construction and related industries. This, no doubt, "primed the pump" and "kicked in the multipliers" across many segments of the economy.

Of course, the stimulus had to come to an end, as they always must, and when it did the boom turned into a bust, decreasing the demand for housing and decreasing employment in construction and related industries. This, no doubt, “unprimed the pump† and “kicked in the now-negative multipliers† across many segments of our economy.

Hence, a severe recession.

This recession is very bad, but by all means, let’s see if we can’t repeat the scenario -- let’s try again with government “stimulus† and maybe, somehow, for some reason, this time the bubble will never pop.

I don't understand why anyone still believes aggregate demand from gov't is the answer. Growth is a result of economic efficiencies, and gov't does not produce these. If they did, the Cold War would have seen people fleeing into East Germany, we'd all have elected Communist governments by now (and have been merrily flying the hammer and sickle this past weekend), and North Korea would be the richest country in the world.

Keynesian stimulus, understood as a temporary buffer to demand, might have made some amount of sense in the far less efficient and government-dominated economy of the 1930s, but with today's productivity, debt levels, and gov't proportion of the economy one should expect it to be more of an anchor than a flotation device. Only the non-government portions of the economy produce real growth, and anything that worsens the ratio beyond the optimum (which was calculated to be roughly the proportion of government spending last seen circa 1965) isn't helping us keep our heads above water.

How odd.

DeLong and Krugman haven't (to my knowledge) said Ireland could or should do something other than what it's done. Why are most of the commenters responding as though Profs Krugman and DeLong were giving Ireland advice???

What they have said, very clearly, is that the austerity measures in Ireland have not solved Ireland's economic problems. Their point, repeatedly made, is that the Austerians can't point to a single instance of austerity working. Nonetheless, the Austerians demand that the US try austerity.

It may well be that Ireland had no choice. That doesn't mean that the US has no choice.

So pretty much all of Tyler's post, and almost all of the comments on it, are non-sequitors, having nothing to do with the points of Krugman and DeLong...

TA

Yes. In other words, Ireland is the site of a huge number of tax driven investments.

The very low rate of corporate tax plus other protections essentially encourages very large transfer pricing schemes (read: corporate tax evasion/ avoidance) from multinationals especially US multinationals in Europe and British multinationals.

Similarly the large financial services sector is constructed around a similar proposition. Money flows out of the UK and wealthy investors in other parts of the world, offshore, and back into Ireland where many hedge funds are listed.

There are some pretty hairy (and impressively clever) tax schemes utilized by multinationals, financial institutions (the Guardian had a long series of exposes of Barclays Bank in this arena) and wealthy individuals.

So a significant chunk of Ireland's GDP is not 'there' from the perspective of the domestic resident or consumer.

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