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Celtic Tiger Getting Sicker?

From home of Modern Monetary Theory;-  ‘Billy blog’ , Bill Mitchell writes on Ireland.Centre of Full Employment and Equity (CofFEE), at the University of Newcastle, NSW Australia.

..The interesting feature of the Boone and Johnson article is that they focus on Ireland and explain why the fiscal austerity program will fail. They say:

Ireland was one of the first nations to introduce tough fiscal austerity in this cycle – in spring 2009 the government slashed public-sector spending and raised taxes. Despite the cuts, the European Commission forecasts that Ireland will have one of the highest budget deficits in the world at 11.7 percent of gross domestic product in 2010. The problem is clear: when you cut spending you also lose tax revenues from people who earned incomes from that money. Further, the newly unemployed seek benefits, so Ireland’s spending cuts in one category are partly offset by more spending in another. Without growth, the budget deficit still looms large.

So the point is – fiscal adjustment comes with growth. The raison d’etre of fiscal policy is to support growth when private spending is undermining it and to constrain growth when private spending is supporting it.

The mainstream economists’ case against the use of fiscal policy as a counter-stabilising tool of policy activism was based largely on their claim that it tended to be pro-cyclical due to implementation lags (the time taken to actually get projects rolling and the funds flowing). Now, the mainstream exemplar of fiscal prudence is to enforce pro-cyclical policy positions. Go figure that one out!

Boone and Johnson offer this interesting insight to further their contention. They show how the growth miracle that led to the “Celtic Tiger” reference was in large part a mirage and driven by major US corporations evading US tax liabilities by exploiting massive tax breaks supplied to them by the Irish government. They conclude that”

… 20 percent of Irish gross domestic product is actually “profit transfers” that raise little tax for Ireland and are owned by foreign companies … the Irish miracle was a mirage driven by clever use of tax-haven rules and a huge credit boom that permitted real estate prices and construction to grow quickly before declining ever more rapidly. The biggest banks grew to have assets twice the size of official G.D.P. when they essentially failed in 2008.

…The graph (from the latest Irish National Accounts ) shows the difference between Gross Domestic Product (which counts all output produced) and Gross National Product (which exclude the profits of foreign residents) for Ireland. Once you make that correction, then you can see how much worse the domestic contraction has been in the Irish economy.

So GDP was 7.1 per cent lower than in 2008 while GNP was 11.3 per cent lower than in 2008.

Once you adjust for this (ignore these transfers) by using Gross National Product (GNP) which “excludes the profits of foreign residents” then Boone and Johnson conclude that the “budget deficit was about 17.9 percent of G.N.P. in 2009, and … will be roughly 14.6 percent in 2010 and 15.1 percent in 2011″. They say that “(t)hese numbers make Ireland look similarly troubled to Greece, with a much higher budget deficit but lower levels of public debt”.

And they say:

Ireland’s politicians, rather than facing up to their problems, are making things ever worse.

However, I part company with them when they argue that the Irish government has to persist with the “tough fiscal steps” and take advantage of the IMF and EU bailout funding to “bridge the tough journey of fiscal cuts ahead”.

From an MMT perspective, all this is doing is insulating the government from being 100 per cent exposed to the private bond markets. It doesn’t stop the demand drain arising from the austerity and the already weak private spending.

It will also not allow the government to reduce its deficit very quickly at all – indeed as we have witnessed the budget deficit gets worse and places further strains on the government funding crisis. This vicious circle can only eventually collapse in default (a la Argentina). The same goes for Greece.

The problem is that the Irish government has no real options while they remain constrained by the Maastricht Treaty and their lack of sovereignty. As noted above, while the Prime Minister might define economic sovereignty as the avoidance of default in a fixed exchange rate world this is far removed from what true currency sovereignty constitutes.

Boone and Johnson understand that too. They say:

… the Irish need to consider seriously whether being in the euro zone is worth the cost. The adjustment to this awful situation would be far easier outside the euro zone – even though leaving the zone might have adverse repercussions for other nations.

This is one of my regular themes when discussing the Euro problems. The design of the monetary system is incapable of delivering sustained prosperity and is crisis-prone when there is a major asymmetric aggregate demand shock experienced across the member nations. All the bailout packages and other add-ons will not change that.  (link to full article)

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