Friday, March 27, 2009

ESRI's latest outlook: more waffle, less real news

The ESRI - a largely Government-sponsored quasi-official 'research' institute has issued another of its macroeconomic updates. This one is available here.

In case some people have not noticed it yet (presumably, someone employed in a state-sponsored organization might be detached from everyday reality of our economic collapse), ESRI opens its latest missive with the following statement:
"The combination of the domestic housing bubble unwinding and a world financial crisis has particularly unpleasant consequences for the Irish economy. However, while the bursting of the property bubble makes things much worse ... up to a half of Ireland’s current problems with the public finances and in the labour market arise from the global financial and economic crisis – they would have happened anyway no matter how appropriate fiscal policy had been over the last decade."

So let us get things right here: according to ESRI, at least half of our problems are attributable directly to the Government fiscal policies. Out of the other (at the most) half, domestic housing bubble is not attributable to the Government fiscal policies. So, dear ESRI 'researchers', narrowly targeted tax breaks for developers and property purchases, over-stimulation of construction in the areas with no demand (National Spatial Strategy, hotels, various tax-sections apartments etc), linkages between tax revenue being raised out of property transactions and fiscal spending - these are not related to our fiscal policies and 'would have happened anyway'? How? By spontaneous self-combustion?

ESRI goes on: "The structural [fiscal] deficit is relatively invariant to short term fluctuations in the outside world and is, thus, a more certain and appropriate target for fiscal policy. Our research suggests that the structural deficit this year is of the order of 6-8% of GDP... If Ireland did not currently face a structural deficit, then the appropriate public policy response would have been to let the “automatic stabilisers” work. ... However, we do have a serious structural deficit, which became apparent early last year. This problem, together with the severity of the recession and uncertainty about when a recovery can be expected, means that there is no option but to take severe action to substantially reduce that structural deficit."

Several things here:
  1. The structural deficit in fiscal policies has become apparent to the ESRI only at the beginning of last year. They could not see the structural problems emerging since 2004 when the Irish Exchequer chose to pump vast amounts of stamp-duty and other property tax revenues surpluses into current expenditure, permanently raising the latter despite a temporary nature of revenue collected. Indeed, the ESRI has for years egged the Government to raise spending. They issued dozens of papers on 'relative' poverty, the need for more 'investment' in public services, denied for years that there was a significant surplus in public sector remuneration and so on. Now they tell us that the structural deficits are a recent thing?
  2. The ESRI, despite stating that only 'up to a half' of fiscal problems is due to fiscal policies misfires, still manages to attribute jobs losses and unemployment to world recession. Yet, most of our unemployment increases in 2008 were driven not by the IFSC layoffs (which are attributable to global crisis in financial services) but by contraction in domestic construction. Surely this was not due to something that was happening in Bear Sterns or Lehmans?
  3. Note that the ESRI implicitly assumes that global economic recovery will lead to a recovery in Ireland - an assumption that is simply undefended in their analysis.
"Before taking account of measures to be announced in the budget on the 7th of April, the general government deficit in 2009 is likely to substantially exceed 10 per cent of GDP." Well, at last, this blog's forecasts are being followed by ESRI (see here), albeit with almost two months delay!

Back to the structural deficits: "It would probably be appropriate for fiscal policy this year and next year to work to roughly halve the structural deficit by the end of 2010. As the economy recovers in 2011 and in subsequent years, further action of a less draconian nature would be needed to reduce the structural deficit to below 3 per cent of GDP by 2013 and to eliminate it by around 2015."

Note my emphasis - up until yesterday, the Government was targeting the total deficit reduction to 2.5% in 2013. Now, ESRI is telling us that we should reduce the structural deficit (which is by their estimate accounting for roughly 7% out of ca 12% total deficit) to below 3%. So do the math - the overall deficit for 2013, according to the ESRI should be somewhere around 4-5% - well above the 3% EU limit.

So how can we do this? According to the ESRI: "In making cuts in expenditure, priority should be given to areas where services are inefficient or of low value. If the public wishes to preserve the current level of public services, then revenues will have be to be raised to between 35 per cent and 40 per cent of GNP. Under these circumstances it seems likely that a substantial increase in tax revenue, combined perhaps with more user charges, will be required to restore the public finances to a sustainable growth path. In choosing the mix of sources of additional revenue it will be important to take account of the likely effects of higher taxes on the labour market. This would argue for developing new sources of revenue such as taxes on carbon and on property."

Ok, I agree with property tax - although it should be structured not as a function of property value (as this will discourage property upgrades and will do nothing to improve land-use efficiency), but as a value of the land on which the property is located, as this will encourage more efficient use of land and will remove distortionary subsidy to developers.

But what about 35-40% of GNP as a tax base? If you consider my budgetary update from this morning (here), you can see that assuming GNP falls 8% this year, this target implies tax revenue of €56.6bn in 2009 - or ca 77% more than the Government is likely to collect under Budget 2009 provisions. How on earth will the Government be able to raise such taxes? In December 2008 report, total tax revenue for 2008 was shown at €40.8bn, total 2007 revenue was €47.9bn. So in effect, the ESRI gang is suggesting we raise tax revenue in excess of pre-crisis levels by some18.2%?

This is mad, irresponsible and dangerous. And this is what informs Government decisions in this country!

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