ECONOMICS:Poor policymaking can make a bad situation much worse. That is the lesson from the 1930s, writes Austin Hughes
IT'S A time of very good news for people who only like bad news. Ireland, together with virtually every other economy in the world, faces into a period of faltering activity and employment. While the downturn is severe, exactly how bad it might be and how long it may last remain unclear.
If extraordinary problems are being visited on the global economy, exceptional policy responses could limit both the extent and length of the current weakness.
Repeated comparisons with the Great Depression tend to understate the major lesson from the 1930s, that poor policymaking can make a bad situation much worse. Early and aggressive action is needed to limit the fallout when severe economic downturns threaten. The major policy shifts of the past month or so give grounds for a little less pessimism. Aggressive rate cuts by the Bank of England and a belated awareness of changed realities by the European Central Bank point in a slightly more encouraging direction.
Lower interest rates alone won't solve the current crisis but they will ease the pain for many households and firms.
Efforts to unblock the global financial system have intensified and there are tentative signs of a gradual improvement in the workings of money markets. However, the most notable development of late is the onset of a massive global fiscal stimulus. This makes sense. It is vital to get government money flowing when financial arteries are clogged.
Understandably, much attention is focused on the prospect that US president-elect Barack Obama will introduce a further economic stimulus package in the US. It can be argued that an earlier package had little impact but that neglects the possibility that conditions could have been far worse. It is also suggested that a ballooning budget deficit casts a shadow on the long-term health of the US public finances. However, a gruesome depression could worsen the long-term outlook even more.
The scale and breadth of the US response to current woes stems in part from the geographic origins of the subprime crisis. It also owes much to America's can-do attitude and, of course, it reflects the pre-eminence of the States in global matters, economic and otherwise.
In this respect, a telling pointer towards a changing international order is seen in this week's major Chinese fiscal stimulus. The amount involved at just under $600 billion bears comparison with the US government's recent $700 billion support package for the financial sector and is some 25 times the scale of the budget stimulus now being mooted in the UK.
Around the world, the economic slowdown and substantial policy responses will play havoc with budgetary positions. Even if we leave out some very costly elements of the bailout, the US budget deficit could hit 7 per cent of GDP in 2009 and seems unlikely to fall below 5 per cent for some significant time. I reckon that as many as six euro area countries, including Ireland, as well as another half-dozen European countries outside the single currency area, will have budget deficits above the 3 per cent of GDP reference point next year.
Ireland's projected deficit at 6.5 per cent of GDP may appear relatively large but it is easy to envisage a similar outcome for the UK. Importantly, signs of a sharp but far more recent deterioration in many European economies hint that other countries' public finances may unravel far more than is generally expected. If that is the case, the exceptional aspect of the Irish budgetary situation might not be the size of the deficit. It could be the nature of the fiscal response.
The Minister for Finance is right to say, as he did this week, that there is no painless way of dealing with our economic difficulties. Equally, there are painful ways of making things worse. That is certainly the lesson of the 1980s.
While most media focus on Budget 2009 has been on some controversial spending changes, the major economic consequences are likely to come from an increase in the tax burden on an already fragile economy.
Although the commitment not to increase corporation tax is extremely important, the barrage of tax-raising measures will contribute to perceptions of an economy where the burden of taxation is increasing markedly. In this context, the argument that higher headline tax rates might threaten jobs looks far less compelling given that the income levy will take about €335 million more out of the economy than a 1 per cent increase in both the main income tax rates.
In some respects, the array of revenue-raising initiatives in the recent Budget harks back to the bad old days of the 80s. That was a time when taxation policy effectively became a residual that reflected a wide gap between the borrowing level deemed possible and the spending level deemed inevitable.
A jump in current government spending of 200 per cent in the past decade must be seen in the context of an Irish economy that increased in money terms by about 130 per cent. Until this year, tax revenues had risen at a broadly similar pace to the economy.
It might also surprise some that new house prices also roughly tracked nominal growth in the economy. So, if there has been a bubble in the Irish economy, it may make sense to examine areas other than the property market.
Tough policy decisions remain to be made in Ireland and elsewhere. The key question is whether the choices made improve or weaken the prospect of recovery and sustained growth thereafter.
