ECONOMICS:Our problems are not unique, and others have come up with solutions that may help us too, writes JIM O'LEARY.
A STRIKING feature of the current crisis is the contrast between the parochialism of our perspective and the universality of our problems. Much of the time, we suspect that our policy-makers are peculiarly clueless about the nature of the challenge facing them and uniquely behind the curve in their response.
Well, we can take some grim consolation from the knowledge that such misgivings are widespread.
The Bagehotcolumn in last week's Economisthad this to say: "The tide has gone out and, with a very few exceptions, Britain is swimming naked: almost nobody appears to know what he is talking about."
In similar vein, Wolfgang Munchau, writing this week in the FT, described President Obama's stimulus package as dangerously inadequate and delivered the following more general verdict: "Virtually every policy response to the crisis, on both sides of the Atlantic, seems to be falling short
. . . The tendency to disappoint applies to almost every single policy decision by every government.”
Sometimes indeed, the tenor of public discourse here suggests that the very problems we’ve got are unique to us. They’re not, of course, although their scale may be uncommonly large. Interestingly, the fact that our problems are so big means that they have come to the attention of a wider than usual audience.
That can be a curse when the audience comprises traders in credit default swaps, but a blessing when it includes people who have an interest in helping us find a solution. One such is Barry Eichengreen, professor of economics at Berkeley. Last week, he published a thought-provoking piece on the Eurointelligence website drawing parallels between Ireland and California.
California has recently pulled back from the edge of a fiscal abyss. With a €42 billion budget deficit looming for the coming year, the state government faced the prospect of running out of money and was preparing to lay off 20,000 employees and cancel a range of infrastructure programmes.
The gulf between spending and revenues had arisen because boom-driven tax receipts, which had evaporated in the downturn, had been used to fund recurring expenditure commitments (another familiar-sounding pattern).
As the deficit widened, constructing an agreement on how to address it between tax-hating Republicans and expenditure-loving Democrats became a well-nigh impossible task.
Eichengreen makes the point, echoing one that I have made before in this column, that successful fiscal consolidations are typically accompanied by currency devaluations. The logic behind the combination is clear: the deflationary effects of budget cutbacks are offset by the stimulatory effect of a more competitive exchange rate.
As in the case of Ireland, the option of devaluing its currency does not exist for California. However, California has available to it a vital facility that is not open to Ireland, namely access to US federal budget funds, and it was precisely this facility that ultimately brought its package of budget adjustment measures across the line.
Eventually, fiscal disaster was averted by a three-cornered solution that incorporated $18 billion of spending cuts, $14 billion of tax hikes and an $8 billion infusion from Washington.
There are some differences between our fiscal problem and its Californian counterpart, the most notable of which relates to scale. Despite its enormous size in absolute terms, California’s threatened budget deficit came to less than 2.5 per cent of GDP. (The reason it had to be eliminated without delay is that US states are prohibited from running deficits at all.) Ireland’s budget deficit this year is heading for something like five times that figure.
One might reasonably ask: if a 2.5 per cent deficit could only be averted with external assistance, is it not reasonable to suppose that the elimination of a 12.5 per cent deficit will only be achieved on the same basis? As the fiscal hole here deepens at a rate faster than the Government’s attempts to fill it, the answer to that question seems increasingly obvious.
There are different forms that such external assistance might take. One is making credit available to Ireland (and other troubled euro-zone member states) on much more favourable terms than would otherwise obtain. Potentially, given where market rates are at the moment, this type of initiative could save the Irish Government upwards of two percentage points in interest payments on newly issued debt. This would be a considerable saving and, more importantly, would help to prevent a vicious circle of increased borrowing leading to higher borrowing costs.
Alternatively, assistance could take the form of straightforward fiscal transfers from Brussels, analogous to the transaction between Washington and California.
Of these two broad types of external help, the first seems far and away the more likely, given prevailing attitudes in Germany (not to mention their own local difficulties), although one of the longer-term consequences of the current crisis may well be a move in the latter direction.
Of course, external help in whatever form will not relieve us of the requirement to shoulder a heavy and painful burden of adjustment.
Let’s not kid ourselves: the best we can expect of what neighbourly assistance we receive is that it will make our problems tractable, not that it will solve them.
Moreover, external assistance will come with conditions and those conditions will not only constrain our choices in relation to the fiscal adjustment but will also limit our freedoms in the post-adjustment period.
The current crisis has the potential to significantly accelerate the process of European economic and political integration and the speed with which member states surrender further increments of sovereignty.
Conversely, if handled badly, it has the potential to unravel much of what has already been achieved.
