While lightning may not strike twice in the same location, this is not necessarily true for economic crises. However, countries that have paid a very high price for economic mismanagement tend not to repeat the same mistakes, at least not for 15 or 20 years. Hopefully Ireland won’t.
Finland suffered a financial crisis in the early 1990s and recovery proved very painful, lasting until the end of that decade. Fifteen years later, in the mid-2000s, the Finnish government still remembered the painful lessons of the past.
As a result, instead of adding to the boom in the economy by spending burgeoning government revenues, they kept the lid on demand by running a growing government surplus, which peaked in 2007 at over 5 per cent of GDP. This prevented the economy from overheating, and the accumulated surpluses provided major insulation for Finland in the ensuing European recession.
As Finland’s boom had been fed by Nokia’s dominance of the mobile phone market at the time, the decision to save boom-era revenues prepared the economy for a different world where iPhones became dominant.
Ireland has come through a more recent and more serious economic and financial crisis from 2008 to 2012. Hopefully the Government, and the people who elect them, still remember the economic mistakes of 2003 to 2007.
Ireland’s financial crash was rooted in two big policy failures – a massive failure in financial regulation, which brought our banking system to the brink, and a fiscal policy that spent what proved ephemeral tax revenues and stimulated the economy beyond its capacity to deliver.
Is mortgage interest relief a really bad idea?
Today all of the advice from external experts, as well as from the Government’s own economists, is pointing in the same direction: dampen down the current excess demand in the economy.
Earlier this week a perceptive article by Central Bank economists suggested that, despite full coffers, growth in government expenditure needs to be limited to at most 5 per cent a year. If there are to be exceptions these should be funded by raising taxes, not cutting them.
Because the economy is at full employment further government expenditure would add to demand, while domestic supply is unable to deliver increased goods and services.
Some of that expenditure would bid resources away from other sectors in the economy through inflation. In the 2000s that excessive government expenditure squeezed out a lot of private sector firms that had provided good jobs. When the recession hit those jobs did not reappear.
The Central Bank article notes that the Government plans to ramp up public investment in infrastructure, to provide for a growing population and the need to decarbonise our economy. This investment is really desirable. However, unless the increase in expenditure is matched by some increase in taxation to take the heat out of the economy elsewhere the planned spending will push up prices, and will deliver lower than planned investment.
We’ve been here before. Running up to 2007 the then government also planned a major investment programme, including big spending on social housing. At the time the ESRI, in reports in 2003 and 2006, warned that if the government wanted to deliver on its investment commitments it would have needed to substantially increase taxation to free up resources elsewhere in construction.
This message fell on deaf ears in the Department of Finance, though the department then responsible for housing, the Department of Local Government, privately acknowledged the wisdom of this advice.
It will be difficult for the Government to resist the temptation to spend the burgeoning surpluses, particularly as we move closer to an election. But there’s a real risk that giveaway budgets will do significant damage to the economy, as happened in the 2000s, as well as achieving poor value for any excessive spending.
The only way big spending increases can avoid doing economic damage is if they are spent entirely or largely abroad. Development aid is one such example. Another would be imports of equipment that is only produced abroad, like extra tram-sets for the Luas. We would still need robust mechanisms to ensure any such spending was adequately managed and delivered value for money.
We also know how fragile our bonanza corporation tax receipts are, and how vulnerable to the economic success of just a handful of companies. Just as Nokia’s market share plummeted with the advent of the smartphone, changes in technologies or consumer preferences could rapidly shrink our golden geese.
Changes in where profits are booked or earned, could also impact Ireland’s revenues from this small group of firms. Our watchword should be caution.
