Guest writersOpinion

Slash and Burn Economics Must End

As the Tories plan a massive onslaught on Britain’s public expenditure the evidence mounts that indiscriminate cut backs only further damage the economy, but Europe’s ideological diehards will not listen, according to Aidan Regan.

The Spanish government introduced a massive austerity package on 27th May 2010 amounting to €15 billion, the deepest budget cuts in the country for 30 years. The following day the credit rating agency, Finch, along with others, downgraded its debt rating from AAA to AA+.

This makes it more expensive for the Spanish to borrow money on international markets. They are deemed to be less credit worthy. The Irish government has introduced two significant ‘austerity programmes’ and a series of public sector pay cuts since 2008. The logic presented to the Irish public for implementing such pain was that it will improve our capacity to borrow money on financial markets. However, the premium we pay on our debt has actually increased.

If governments are cutting spending to reduce budget deficits, why are they being punished by the financial markets which they seek to borrow from, and for whom they are cutting spending? This is an important question that has gone completely unnoticed in the current fetishisation of cutting fiscal deficits. The reason is because cutting government spending will not improve economic performance, growth or recovery.

Brian Coulton, Fitch’s person in charge of ratings for Spain, said these exact words in a press release following the downgrading of Spanish debt: “The process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term.”

He then went on to argue, like the OECD, that the primary problem in Spain’s economy is an over regulated and inflexible labour market. The problem in the Spanish labour market is not in reality its inflexibility, but its lack of collective coordination across sectors.

But, either way, the following fact remains: cutting budget deficits will not reduce the premium governments have to pay for issuing bonds. Financial markets reward growth not fiscal austerity. Cutting deficits, by definition and in fact, reduces economic growth. Therefore cutting deficits in the absence of a clear growth strategy increases the probability of a further downgrading of public debt.

This fact becomes more obvious when one examines why the Greeks had their debt downgraded to junk status in June. Despite a €110bn ‘pain for gain’ guarantee from the EMU/IMF recapitalisation package, Moody’s credit rating agency stated that “Greece’s credit ratings will now depend on its future economic growth“. There it is in black and white. The question therefore is: what will improve economic growth and unemployment?

The strategy of the Irish government is based on three policies: stabilise the public finances through cutbacks; stabilise the banking system through a colossal bailout equivalent to 240.1% of GDP; and improve the ‘competitiveness’ of the Irish economy through a reduction in labour costs, primarily wage cuts. All of this will lead to a spiral of deflation and unemployment. It will not improve our borrowing capacity one bit.

Spain and Ireland will not return to growth because what was previously driving their economies has evaporated: real estate activity. Unless this collapse in private investment is replaced with something else quickly, the probability of a default and being priced out of financial markets increases.

Budget cuts will make no difference to this scenario. The more important question therefore is: what will create growth? Reliance upon the private market is an act of faith. Relying upon state or Europe-wide coordinated investment is a rational choice. If the government can find €25 billion for one failed bank then surely it can find the resources to generate employment for the 400,000 + people out of work.

This is a question of ideology as much as it is policy. The government of the state no longer considers job creation as central to its political mandate. It is proceeding with a failed liberal classical economic assumption that jobs are a by-product of private wealth creation. We need a new coordinated jobs strategy.

If Ireland is going to default and go bust it is the result of two factors: a massive state bailout of the private finance industry (primarily real estate banking), and a total collapse in revenue due to an over-reliance on regressive and unsustainable (indirect forms) of taxation. Austerity and massive cutbacks will not solve these problems.

Irish Public Policy – http://aregan.wordpress.com

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1 Comment

  1. noel
    October 10, 2010 at 4:23 pm

    Yes this is something that I noticed,the markets are actually punishing us for what we are led to believe they require.But I have a question does EU law prevent the state competing with the private sector and if so what remains for the state with a jobs strategy.I remember a number of years ago the old An Post brought out christmas cards etc complete with stamps and were doing very well,until the EEC/EU steped in and claimed unfair competition.My question is are states actually allowed to make a profit.