Sunday 29 May 2011

Growth, Default and Pay in Ireland

I’ve been following some rather disheartening debates about some fundamental aspects of our economy over the past few weeks. The lack of joined up thinking, and the complete unwillingness of most of the players in this game to honestly explain their long term objectives says a lot about how dishonest those who have any power in this country actually are.

The recent debates have covered both the high level macro problems of balancing growth, total employment and deficit reduction, as well as the (more) micro issues of the individual effects of taxation (in particular the new Universal Service charge), minimum wages and unemployment. There have been some interesting ideas and observations made but I’m astonished at the lack of joined up thinking.

We have, for example, the various business groups calling for things like reductions in minimum wages and the removal of agreements that enforce premium rates of pay for Sunday work. The main thrust of their arguments are that our minimum wage is too high (compared to the rest of Europe) and the premium agreement is an anachronism. This is not that different to the popular German view that Ireland shouldn’t be bailed out because we pay ourselves too much. And there is some merit in these points when taken in isolation.

Say we were to remove the minimum wage and remove the sunday premium. I don’t know how much either actually contribute to overall employment costs but since the existing premium under debate amounts to 30% and a market driven drop in real minimum wages is unlikely to drop total wage costs by more than 50% for those on the margin I think it’s reasonable to assume that the overall effect on employment costs can’t really be more than about 10-15%. Those are not trivial numbers but they aren’t huge either. Still let’s take them at face value. Our total Income tax take is about €8bn (and dropping) at the moment at an average effective tax rate of 10% or so indicating total income (of employees) coming in at around €80bn or so.

So if we were to drop the two rates and delivered the savings that the business groups would hope to see we might be able to remove about €8-12bn of their cost base (bonus!) but also a reduction in net individual income of the same amount from the economy (hmmh).

For the people we are talking about here (virtually all minimum wage, low end jobs) the effect cannot be that the affected employees will compensate for the reduction by saving less: they have no effective savings for the most part. They will either consume less, or consume less expensive replacements. For the non-export part of economy it means that there will have to be a contraction, GDP will be reduced. And there will be a multiplier effect, all sectors that serve the poorer sectors of the economy will contract by at least as much, and possibly some multiple of that. And there will be an effect on Government revenue – the reduction in pay will reduce USC and Income tax revenue directly by 10% or so and again the multiplier effect of the loss of that expenditure will impact VAT, Excise and Corporate tax revenue (from those low end product\service providers). It’s also worth noting that such downward personal income pressures will typically push up import substitution, hurting local businesses, since we are stuck in a fixed currency zone and comparative advantage pretty much dictates that most things can be manufactured and served more cost effectively from other countries.

The other core argument, and it’s a good and valid one, is that reducing business costs will increase employment, in particular in the vulnerable lower end of the market and increase overall competitiveness. These too have significant multiplier effects, assuming they result in lower product\service costs, and they should certainly drive export competitiveness, which by the way includes domestic tourist and entertainment revenue. This is why we are seeing the real push for this change coming from the larger business organisations and the catering\hospitality sector rather than the broader smaller firm groupings.

How big each effect will be is an unanswerable question, and the argument about merit hinges on the final equilibrium state you believe would be reached. Such changes are not a universal win.

However what is certain is that such changes, if implemented, will drive down personal income across the board. This is the desired outcome and we need to be clear what that means. The reality is that larger businesses and certain sectors desperately need us to deflate the local economy severely (by 20-30% at least) in order to regain global competitiveness. If we had a universally fair reduction in income coupled with a reduction in costs of living then this could seem like a “neutral” change in the longer term but one thing this cannot do is reduce our debt. And if we reduce income (either personal, or government) then our debts become more of a burden.

This is the core problem. We might be able to reduce government deficit, and reduce average wage costs and costs of living. These are things that are technically under our control but we cannot reduce the lump sum of our debt in this way. And if we make this extremely hard changes, and are successful, we will effectively inflate our debts by the same amount. That €100bn to €200bn hanging over our heads effectively becomes equivalent to €150 to €300bn. A 10 year repayment and austerity environment becomes a 15 year trial.

Add to this the reality that our current austerity regime has already started to produce contraction – we’ve got 0% growth at the moment and facing into 2-3% over the next 12 months. Add in the above contractions and deflationary pressures and our ability to  service our debts, let alone repay them will disappear completely.

We’re living proof that for countries reducing expenditure when you are in a recession makes the recession worse.

We’re owed some better explanations about that the overall resolution plan actually is. The current platitudes about austerity, deficit reductions and returning to the market do nothing to explain how we can get from here (effectively bankrupt) to a viable end state in 3, 5 or 10 years time. Detailed analysis of how we can successfully reduce employee wage costs and cost of living in a sustainable way while not turning a horrific but arguably manageable national debt into something that will kill the country would be a good start.

And that’s before we start to talk about things like the effect on society of having 40% of the under 25 male population who are available for work being unemployed. That’s a social catastrophe of monumental proportions that would be very hard to deal with even if the economy was healthy. 5 years of those rates and you are breeding a widespread criminal or revolutionary class of the dispossessed – countries have fallen on a lot less.

The last few weeks have generated some positive buzz for Ireland with our high profile visitors and some interesting oratory by our glorious leader but I’m sorry to say that the big picture looks a lot worse today than it did three weeks ago.