Lessons to be learned from Sweden's recovery

Ictu's plan for recovery has been influenced by Sweden's approach to its 1990s economic crisis, writes JIM O'LEARY

LAST WEEK, the Irish Congress of Trade Unions (Ictu) published its plan for economic recovery, There is a Better, Fairer Way. The thinking behind it was influenced by Sweden’s approach to economic crisis in the mid-1990s, in particular by a paper * written in 2007 by Jens Henrikkson, an economics adviser to the Swedish finance minister during that crisis.

There are some interesting ideas in the Ictu document, as well as proposals likely to command widespread support. The suggestion that the social welfare system be overhauled and integrated with education and training programmes is worth exploring, as is the idea that the Government raise funds through a national recovery bond.

The proposal that executive pay be capped, especially in the banking sector, is perfectly understandable, all the more so after President Barack Obama’s move in the US.

Regarding the public finances, Ictu is keen to promote two principles: (i) that the wealthy make a major contribution and (ii) that higher taxes provide a substantial part of the adjustment.

The first of these has never been contentious. In the early stages of the current crisis, the second might have been, but the hole in the public finances has become so big that it is now widely accepted that a sizeable increase in the tax burden is inevitable.

Some of Ictu’s specific tax proposals are unremarkable, including the selective abolition of tax shelters and the introduction of a property tax. Others are open to criticism on the grounds that they run the risk of overly diluting incentives. The proposal that the new income levy be graded upwards significantly on incomes over €100,000 and that a new 48 per cent rate of income tax be introduced, imply marginal tax rates in excess of 52 per cent above this income threshold.

Still, these are not exactly radical ideas and there is reason to suppose that the disincentive effects of high tax rates are lower in current circumstances than in normal times.

However, even if all the Ictu tax proposals were implemented, swingeing expenditure cuts would still be required. The document is entirely silent on this score.

Here, inspiration from the Swedish experience seems to have run dry. The fiscal consolidation there in the 1990s featured big across-the-board reductions in public spending, including cuts in welfare benefits.

Ictu criticises the Government’s policy response to date on the grounds that it has been deflationary and goes on to say: “Surely the most sensible option is to stimulate the economy, rather than dampen spending and growth?”

It is not clear what exactly Ictu is advocating here. If it is suggesting that the Government attempt to stimulate the economy by increasing an already dangerously big budget deficit, then it has not read the Henrikkson paper very closely. One of his articles of faith is that sound public finances are a prerequisite for growth.

With reference to the present Irish situation, it is becoming increasingly clear why this is so.

Much of the fear and uncertainty now stalking the land and depressing economic activity reflects the widespread perception that the public finances have spiralled out of control and that the very solvency of the State is at risk.

The surest way of stimulating the economy in such circumstances is to get the budget back under control and be seen to do so.

The biggest deficiency in the Ictu plan though, relates to wages and competitiveness. Ictu acknowledges there has been a deterioration in competitiveness but observes that this “comes from the weakness of sterling, not wages”. So, that being the case, what is the recommended policy response? To pray for sterling to strengthen again?

Yes, an important proximate cause of the decline in Ireland’s competitiveness has been the steep fall in sterling, but that means that wages and other domestic costs of production are too high at the current exchange rate. The only instrument at our disposal for dealing with this serious problem and averting the resultant loss of employment is to cut wages and other costs.

The Ictu counter-argument is that “the state of the global economy is such that wage devaluation is unlikely to have much impact on exports, whereas it will seriously depress domestic demand”. This simply doesn’t stack up.

First of all, our exports are determined by the state of global demand and our competitiveness: for any given level of global demand, however weak, our exports will be higher the more competitive we are.

Secondly, sustaining domestic demand is of limited value if an increasing proportion of it goes on imports: again, the more competitive Irish producers are, the greater the share of domestic demand they will capture.

Besides, domestic demand is more likely to be sustained by keeping people in employment at lower wages than by forcing them on to the dole queues through uncompetitive wage levels.

There is another lesson from Sweden in all of this. A critical ingredient in its recovery from deep recession in the 1990s was a big currency depreciation – the krona fell by more than 30 per cent in 1992-93. That policy option is not available to us, but we can emulate it by bringing about a big reduction in our cost base.

It is essential that we do so: if we don’t, we’re going to be mired in recession and mass unemployment for a lot longer than would otherwise be the case.

Any document that purports to be a plan for economic recovery must set out how this is going to be achieved.

* Ten Lessons About Budget Consolidation, Bruegel 2007