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The Myth of Austerity in Ireland’s Political Economy

Aidan Regan of Irish Public Policy writing in the Irish Left Review has helpfully published an account of the last time ‘austerity’ was the popular policy response in Ireland.  Note the fact that the economy only really took off after we devalued our currency, agreed a massive tax amnesty and crucially, after we got debt-free  structural funds from our EU partners.  None of these factors feature in the current ‘austerity’ plan.

The Myth of Austerity

Published: March 11th, 2011

…In this regard, it is worth comparing the current situation to what occurred in 1987. This was the year when the Programme for National Recovery (PNR) was negotiated between Fianna Fail, ICTU and the FUE (what later became IBEC). It was agreed that significant cuts in public expenditure had to be implemented. They were nothing on the scale of what we have witnessed over the past 24 months or what is being proposed for the next five years. What is important to note from the 1987 ‘fiscal adjustment’ is that it established a consensus amongst Ireland’s political elite that ‘expansionary fiscal contraction’ (EFC) can work. Irelands economy improved rapidly from 1987-1990. The debt-GNP ratio came down, exports picked up, consumer expenditure increased and investment improved – on the back of a currency devaluation. The public finances rapidly improved but unemployment remained persistently high. Employment did not improve until the mid 1990?s. This success was all attributed to harsh but necessary ‘fiscal adjustment’.

The Irish economy, thankfully for the signatories to PNR, did improve and enabled the continued re-negotiation of social partnership agreements. Given this rapid improvement in the economy, the 1987-1990 expansionary fiscal adjustment was gradually introduced into economic textbooks as an example of how to improve economic performance through fiscal austerity. Ireland in 1987 and Denmark in 1982 continue to be the only two cited examples of where and how this can work. Thus, it is important to note that the fiscal austerity promoted by the Irish political establishment (Fine Gael, Fianna Fáil and Labour), ECB and the Department of Finance as a response to the current crisis is premised on the success of this period of fiscal adjustment. In economic terms, and delightfully praised by Trichet in the ECB, it is called ‘Ricardian equivalence’. But, few if any economists take it seriously. To a certain extent the adjustment in 1987 was required. The debt-GNP ratio had to be stabilised (national debt had grown to 130 percent of GNP in 1986) or the economy would have ended up in the dark ages. The question is whether the adjustment was the ‘cause‘ behind economic expansion.  If it as not then all the policies aimed at economic recovery by the FG/Lab government will be in vain. It may improve the exchequer accounts but not the real economy. This is how they will be judged by the electorate.

Expansionary fiscal contraction (EFC) was not the cause of Ireland’s economic recovery. There was a configuration of factors that led to economic recovery and they are as follows. Firstly, Ireland devalued its currency in 1986. This led to a rapid increase in Ireland’s exports. In this period most Irish exports went to the UK. Interestingly, similar to today, the 1980-1986 economic crises was primarily located in the domestic economy. It was strangled with high taxes and decreasing disposable income amongst the workforce. The export economy remained relatively healthy during the 1980-1986 crises, particularly the MNC sector. But, this sector only employed approx 13 percent of the economy. Domestic industry, on the other hand, was in decline. Thus, the 1986 devaluation improved export performance and overall national output (growth) as it increased exports to the UK.

Secondly, it was not the devaluation on its own that improved the Irish exports to the UK. In the same year, the UK government introduced a whole series of tax cuts. These tax cuts increased the disposable income of UK workers. In turn, they consumed more in the domestic UK economy. UK citizens consumed more and more of Irish exports. Thirdly, public expenditure increased under the FG/Lab government during 1980-1986 because of a rapid increase in unemployment. Thus, more money had to be borrowed to pay for social welfare payments. The increase in emigration from 1987-1990 stabilised the numbers on the live register. Those claiming unemployment reduced by 2 percent during 1986-1989, or from 236,000 to 2310,000. This was almost entirely accounted for by the increase in net migration – which reached approximately 50,000 per annum in 1989. In this regard, an increase in emigration eased the public finance problem facing the Fianna Fáil administration during 1987-1990.

Fourthly, there was a huge tax amnesty in 1988 that brought in significant amount of revenue to the Irish exchequer. It is hard to fathom how archaic the Irish tax collection system was in the mid 1980?s. There was a huge black market and a whole variety of tax exemption schemes enabled the wealthiest in Irish society to avoid paying any tax at all. This was the opposite scenario for the average PAYE worker. Those earning 2/3 of the average industrial wage were paying 55.5 percent marginal tax rate. Those on the average industrial wage were paying 65.5 percent. The tax amnesty gave the newly elected political administration the political space to cut income tax and thus enable an increase in consumption in the domestic economy. This coupled with the substantial increase in FDI – represented by INTEL – improved the domestic economy and thus employment.

Furthermore, Ireland was a net beneficiary of EU Structural Adjustment Funds. This investment from Europe, aimed at improving the infrastructure of underdeveloped regions acted as a mini stimulus to the Irish economy. This was particularly useful in a context where private investment was on the increase. Exports increased by 13.7 percent during 1987-1989 and investment by 13.9 percent. Combined these were very favorable circumstances for economic recovery. Finally, the gains made by the 1986 devaluation and export growth were consolidated in the first social partnership agreement (PNR). Trade unions accepted the need for minimal wage increases over three years. Wages increased by 3 percent during this period which was less than inflation. But, given the cuts in income tax – real take home pay increased substantially.  Wage restraint enabled firms to increase profits which in turn enabled more job creation (this did not occur until the mid 1990s).

Thus, a configuration of factors benefited the newly elected Fianna Faíl government. It was not austerity on its own that caused recovery. In fact, in the absence of all these other ‘investment’ variables it probably would have made things worse. So, to recap, it was not fiscal contraction (EFC) that led to economic growth but a configuration of factors that include; 1986 devaluation, tax cuts in the UK, 1988 tax amnesty, increase in emigration, increase in exports, increase in private investment, EU structural adjustment funds and the stability provided by trade union wage restraint.

The 1987 fiscal contraction did not, on its own, lead to economic recovery. It stablilised the national debt and decreased the burden of servicing the debt (from 12 to 10 percent of GNP). It decreased the budget deficit over three years from 9 percent to 7 percent. The current Irish government are attempting to reduce the budget deficit from 13 percent (32 if you include the bank bailout) to 3 percent over four years. Furthermore, they simultaneously expect to create 100,000 jobs. This is pie in the sky nonsense.

The present FG/Lab government is operating on the premise that fiscal contraction will improve growth. There is no empirical evidence to support this. Furthermore, the Irish political economy in 2010 has none if any of the configuration of factors that lifted Ireland out of recession in 1987. In this regard, adopting and continuing with the plan to extract a further €15 billion from the Irish economy through public expenditure cuts will make things worse not better. Labour has entered a Faustian pact that they will certainly live to regret. It won’t work. A seriously rethinking of policy is required. This requires serious and fundamental political economic change. It may be too late in 2016.

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