By Michael Burke
The Impact of Measures To Support Growth
The economic response to any stimulus measures is apparent after a time lag of some months. There is a further time lag as this change in economic activity is reflected in government finances. This is because many taxes (self-assessed income taxes and taxes on profits in particular) are paid some time after the income or profits were made, sometimes long afterwards.
The size and composition of the measures to boost growth varied across Europe. The European Central Bank (ECB) has an analysis of those measures, which were mostly adopted in 2009. (France and Germany also took further measures at the beginning of 2010, which are not part of the ECB’s analysis). Following the ECB, the table below sets out the level of fiscal stimulus measures in some European economies as a proportion of GDP. Alongside we show the impact both on taxation receipts and the overall level of the public sector deficit in the latest data for those countries.
The most striking feature is that in all cases, without exception, taxation revenues are increasing and the deficit is falling in those countries which adopted measures to boost growth. By contrast, in the one country which did nothing to boost activity, Berlusconi’s Italy, taxes continue to wilt and the deficit is higher in the first half of this year than in the same period in 2009.
It should also be noted that the size of the stimulus measures has some relationship with the pay-off in terms of the subsequent growth of taxes. But there is not a direct correlation. This is because the composition of the measures is also significant. In Keynesian terms, it is because differing types of stimuli have different multipliers attached; they have a widely differing ‘bang-for-buck’, with investment the highest multiplier of all. In Marxist terms, an increase in productivity relies on the investment of capital - combined with the energy and intelligence of labour. But investment formed only a fraction of the overall stimulus measures in the EU as a whole. The chart below, reproduced from the ECB shows that just 28% of the entire stimulus measures were public investment. The remaining two-thirds were measures to support household consumption and businesses.
But the different impact of these can be noted from the from the fact that the latest forecasts from Eurostat are that EU household consumption will rise by 2.3% this year, while investment (gross fixed capital formation) will fall again, by 2.6%
Lessons From Madrid
If we take the case of Spanish state, which had the largest package of measures, there has been a vigorous economic response. This seems to have completely by-passed the English-speaking commentators and analysts, who have focused on the meagre recovery in aggregate GDP, up just 0.3% in the first half of his year .
But there has been little analysis of the data, which shows a surge in import demand that masks the much stronger rise in the domestic economy and arithmetically subtracts from it. The final consumption expenditures of households, government and the non-profit sector rose by 1.9% in the first half of this year. Only investment continues to decline, down 2.4% in the first half of the year, hampered by the continuing meltdown in construction. But even here, investment in equipment has risen sharply. In the year since the stimulus measures were announced, investment in equipment has risen by 8.7%. As a result of this rising activity, the public sector deficit has halved in the first 7 months of this year. Rising taxes are overwhelmingly responsible, €18.5bn higher of a total €21.3bn improvement .
Of course the combination of EU, IMF, ratings’ agencies and financial markets have all conspired to strong-arm the Spanish government into adopting massive spending cuts, which were implemented after these data and will impact fully only with their own time lag. A rear-guard action in the form of clinging to cherished investment projects and a modest rise in the minimum wage will not be enough to prevent this capitulation from wrecking both the recovery and the improvement in government finances.
Crucially, over 50% of Spain’s measures took the form of direct investment by the government via public works’ programmes. Of the remainder, the bulk was in tax cuts aimed at the poor, along with the 1.5% increase in the minimum wage. It is this composition of the ‘stimulus’ measures, relying mainly on government investment and boosting the incomes of the poor, that accounted for the Spain’s relative success story. By contrast, initially, the entirety of Germany’s measures were tax cuts, with much more modest results.
Lessons From Dublin
The policy of the Dublin government was precisely the opposite to that of Madrid. Beginning at the end of 2008, a series of Budgets and emergency measures provided a fiscal contraction equivalent to 6.6% of GDP. More spending cuts were made this year more again are threatened for 2011.
The effects have been the reverse of those advertised. Recent editorials in both the Financial Times and the Guardian have highlighted the growing disillusion with the Dublin government’s severe reductions in public spending, arguing that they have not led to any narrowing of the Budget deficit. Only The Economist could find (modest) reasons for optimism, by the simple expedient of accepting the Dublin government’s own forecasts for the deficit rather than analysing the current situation .
The latest economic data show the Irish economy contracting once more in the 2nd quarter of this year. In contrast to Spain, the domestic sector has contracted at a faster rate than GDP, as import demand has plummeted. Crucially, this domestic downturn has led to a continuing contraction in taxation revenues despite a series of tax increases. Overall, investment is 54% below its peak level and is equivalent to the entirety of the slump in GDP.
Equally bad, there is outright deflation in the economy, with prices falling since the end of 2008. These price falls include wages as well as goods, and therefore lower the taxation revenues on all activity. This has the disastrous effect of reducing the government’s income stream to finance the existing level of debt. In real terms, deflation increases the debt burden.
Normally, ‘Depressions’ are spoken of when output falls by 20% or more. In nominal terms Irish GNP, excluding the external sector, has now fallen for 9 consecutive even though the Euro Area recession ended a year ago. And it has fallen by 24% from its peak. This is an Irish Depression.
Of course, Irish tax revenues have plummeted as a result, and now the public sector deficit is projected by the EU to be 14.7% of GDP next year. This is more than double the initial size of the deficit in response to the slowdown and is now the highest in the Euro Area. This is a policy-induced crisis of the economy and of government finances.
The cuts promised by the collation government in Britain are of the same order as their fellow Thatcherites in the Dublin government.