Wednesday, May 16, 2012

Is there austerity in Ireland?

It might seem like a strange question. But the debate over austerity in the Eurozone has reached the It Didn't Work Because It Hasn't Been Tried phase. Here's National Review's Veronique de Rugy taking on Paul Krugman:

My position about austerity in Europe — and why it hasn’t worked– is that in most cases austerity measures have taken the form of some spending cuts mixed with tax increases. With rare exceptions like the Baltic states and Sweden (countries that are growing today), most countries have adopted the “balanced approach” to austerity ... But we can’t deny that austerity in Ireland took the form of both some spending cuts (modest) and tax increases. And that, we know through some 21 peer-reviewed studies, isn’t conducive to debt reductions. My prescription for Ireland is the following: Implement real austerity in the public sector (cut spending) rather than austerity in the private sector (increase taxes). Better yet, implement austerity in the public sector (cut spending) and prosperity in the private sector (cut taxes).

As it happens, the IMF has looked at the spending-tax mix of Ireland (and Portugal) in some detail:

Plans were front-loaded and expenditure-based (in both cases, two-thirds of the adjustment was initially expected from spending cuts). In Ireland, the history of successful expenditure-based fiscal consolidation in the 1980s and 1990s ensured that plans remained expenditure-led throughout, with revenue raising playing a lesser role.

In essence therefore the argument reflects the view from conservative economists that austerity won't work if it contains any tax increases at all, and indeed should if anything be accompanied by tax cuts. Now the trouble is that Ireland's tax increases may have been painful, but they do appear to have increased revenue. Revenue collapsed because of the property bust and the impact of weak economic activity on the tax take, but when tax rates and charges were increased, the leak of revenue was staunched. By the same token, tax cuts would have led to losses in revenue, meaning even wider deficits or even bigger spending cuts. Our Eurozone "partners" would never have gone for the former, and the general public would never have gone for the latter. And in any event, the idea that tax cuts are just what the doctor ordered in a busted economy is a tough sell on its merits.

Nevertheless, there is another angle to the debate. After two rounds of cuts to public sector take-home pay (through a pension levy and pay cuts), Ireland has sworn off further cuts in pay and benefits in the public sector despite a budget deficit excluding bank bailouts of 10 percent of GDP. As a result, austerity has taken the form of fairly blunt chops to the delivery of public sector programs, but with the biggest single element of those programs off limits. And as the country enters 2013 budget season, this process has been going on for 5 years.

The point is that whether Ireland botched austerity by dragging it out and foreswearing the most sweeping instrument of austerity is an open question.