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Is Ireland Different? Marshall Auerback says ‘No’.

Tuesday, 06/8/2010 – 12:29 pm by Marshall Auerback |

ireland-200Responding to Barry O’Leary (IDA), Marshall Auerback argues that austerity measures in Ireland will drain demand, weaken private spending, and actually worsen the deficit.

Barry O’Leary argues that in contrast to the other PIIGS, Ireland will be able to make the adjustments that the EMU is demanding and by cutting “fiscal spending sharply … [to] … pull themselves out of this mess through austerity”. He’s wrong.

People calling for fiscal austerity assume that major cuts can be made in public spending at a time when private sector spending has collapsed, confidence is at a low, and foreign direct investment is weak and paralysed by uncertainty. They also think that you can increase taxes (that is, reduce private demand further) and cut wages (and hence private incomes) and not expect major multiplier effects to make things significantly worse.

The Irish also seem to have bought the IMF line that the fiscal multipliers are relatively low and that the automatic stabilisers (working to increase deficits as GDP falls) will not drown out the discretionary cuts in net spending arising from the austerity packages.

The overwhelming evidence shows that the implementation of policies based on this way of thinking causes generational damages in lost output, lost incomes, bankruptcy and lost employment (especially in denying new entrants from the schooling system a robust start to their working life).

The following graph is taken from the latest Irish National Accounts which cover up to the fourth quarter 2009. Flash estimates for the first quarter 2010 are available but not broken down like this.

The graph 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 percent 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 Simon Johnson (amongst others) concludes 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”.

However, I part company with Johnson when he argues 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 a Modern Monetary Theory perspective, all this is doing is insulating the government from being 100 percent 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. The design of the monetary system in which the Irish find themselves 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.

Either they have to enter a fiscal union to support the monetary union or the nations should exit the system.

And also, in the specific case of Ireland, I don’t see how they can make credible their guarantee to back all of the country’s deposits, which are 600% of GDP. And they’ll get little help from the Germans who view the growth of their financial services industry to be a form of regulatory and tax arbitrage, which undermined the German economy.

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