This has been some criticism recently of the revised elements in the Memorandum of Understanding which forms the basis of the EU/IMF deal. The details can be read from this DoF statement. One frequent criticism levelled against the programme is that it offers “supply-side” solutions to what is a “demand-side” problem. This is most visible if we consider the elements included under the heading ‘structural reforms’.
Product and Labour Market Reforms
- We are adopting policies to lower costs in sheltered sectors, thus boosting purchasing power and underpinning further competitiveness gains.
- The Government is due to consider a potential programme of asset disposals based on the Programme for Government and the Review Group on State Assets and Liabilities. The Government will discuss its plans with the European Commission, the IMF and the ECB when it has finalised its response to the Review.
- We are committed to create conditions conducive to job creation through the Jobs Initiative, which will be announced in May.
- The reversal of the cut in the minimum wage will be reversed with the effect on business costs being offset by a reduction in employers' PRSI.
- The review of the EROs/REAs and other measures to increase competition in sheltered sectors of the economy (these measures are not conditional on each other but are part of a comprehensive package designed to make work pay and improve the competitiveness of the economy).
No other structural reforms are listed. Here is a thoughtful post on some of these changes from UL’s Stephen Kinsella - Will cutting GP and lawyer fees help Ireland? I too would have concerns about the effectiveness of this list and would largely agree with the conclusion.
The core issues are not supply-side rigidities such as expensive lawyers and doctors and overpaid low-skilled workers. The core issue is the collapse in domestic demand.
Ireland's problem is demand deficiency caused by a collapse in asset prices, expansion in debt, and a fiscal imbalance caused by improper taxation policies during the boom.
Supply-side measures, while useful, won't solve, or even buttress, the problems of our economy, because they aren't the cause of the problem. We should remember this when listening to prognostications from our well meaning EU colleagues.
Although there is a “demand deficiency” I am not sure that demand-side solutions will necessarily work. If we look at the contribution of the domestic and traded sectors to overall GDP growth we can see the domestic demand story stacks up.
It is pretty obvious that the domestic economy that has been the source of the collapse with falls in ten of the past 12 quarters. On the other hand net exports has made a positive contribution to growth in eight of the 12 quarters.
As we have done before we can break the fall in domestic demand into it’s constituent parts of consumption, investment and government expenditure.
Although a negative pull of consumption is seen up to Q1 2009 for the past two years two factors have dominated the growth rates. Net exports has made a positive contribution to growth and investment has made the dominant negative contribution to growth. Here is the same data presented in a different fashion.
Private consumption has contributed to the fall in GDP but consumption has been unchanged over the past two years. In real terms consumption in 2010 was 1.2% lower in 2010 than in was in 2009 (because of price falls the nominal change was –2.5%). However as a result of the falls that occurred in 2008 and 2009, consumption in 2010 was 9.5% below the level seen in 2007 in real terms (the nominal drop is an eye-watering 12.8%). There is no doubt that a fall in private consumption has been a key component of the downturn but most of this occurred more than two years ago.
On the other hand investment has been falling continually over the entire period. Although investment makes up a much smaller proportion of GDP than consumption, it has made a much larger contribution to the collapse of GDP. Since 2007, consumption in constant prices has fallen from €96 billion to €87 billion. Over the same time investment in constant prices has fallen from €46 billion to €20 billion. Consumption has fallen €9 billion. Investment has fallen €26 billion.
One would expect that the fall in consumption is the result of a fall in income, but as we have seen that is not necessarily the case.
In 2009 net household disposable income fell by about 2%. At the same time, consumption expenditure fell by over four times that rate. Demand as measured by ability to pay still existed, it was demand as measured by willingness to pay that fell. We don’t know what happened to disposable income in 2010 but we know that the decline in consumption eased. The impact of the tax increases in last December’s Budget are likely to further tighten income.
The above gap was money that was saved and more than likely used to pay down debt. The savings rate has shot up to near 12%. It is more probable more accurate to say that we have a “debt problem” rather than a “demand problem”, though the two are obviously related. Consumption has fallen because the demand has shifted from buying goods and services to paying down debt. This pattern is likely to continue.
Finally, as we said above, the biggest source of the decline in domestic demand is investment and it is pretty evident that we do not want to go back to the way things were. Here is what has driven the change in the contribution of investment to GDP growth.
Building houses drove the boom and not building them has driven the recession. It is likely that investment is undershooting, but the fall in investment from building 90,000 houses a year at the peak is a necessary one. The fall of this “excess demand” is an adjustment that has to be made. The task is now to find the replacement.Tweet