The Cedar Lounge Revolution

Finally! Someone tells it like it is about the economic crisis and how public opinion is being manipulated. April 17, 2009

An excellent and thought provoking piece in yesterday’s Irish Times really lays it on the line as regards the issue of NAMA and the current financial crisis. Michael Casey, former chief economist of the Central Bank and a board member of the IMF allows at least some peek behind the mask which a number of us have been attempting to pull aside.

This, incidentally, is not to say that his proscriptions make for pleasant reading, or even that his analysis is correct in detail. But in one startling paragraph he lays bare a basic truth of our current predicament, that the stories we are hearing from media commentators and economists are very much tailored to a specific agenda, one which ignores the egregious inconsistencies between these stories.

First, the forecasting (and budgeting) record has been poor. It is hard to remember many occasions in the last 15 years when the Department of Finance came close to an accurate prediction of revenue. Too many statements made by government and other official bodies about the state of the economy and of the banks have been proved wrong. It is not that long ago when we were told that the boom would continue and that the banks had plenty of capital. When these versions of events were not believed by the public and the markets, the stories began to change.

When the Government sought to cajole the unions into a pay freeze they painted a more downbeat picture of the economy. In the event this made no difference to the unions, and social partnership failed its first real test. Then we were told a depressing story about the public finances and the virtual impossibility of borrowing. This was designed to soften up taxpayers for the pain to come. Much of the uncertainty is caused by inconsistent stories designed to manipulate public opinion.

Let’s be honest. What we’ve been told have gone further than half-truths and yet they’ve also been assimilated as part and parcel of public debate. I was told directly by someone close to government that we were unable to borrow despite the fact that we had already done so earlier that month. And this wasn’t intended as a lie, but rather was the product of – let’s face it – a complete ignorance of economic affairs and a near naive willingness to accept whatever the business pages proposed.

Casey goes on to poke a few holes in the current plans…

Second, the Government takes the view that stabilising the public finances will restore confidence in the economy. This is far from certain. The tax hikes could have the opposite effect. Bear in mind that the marginal tax rate has been raised by nine percentage points. If this does not have serious disincentive effects then everything the Progressive Democrats stood for must have been utterly wrong.

Well, yes. I think we can be a little more nuanced on that. It is possible that lower taxation can be used in a tactical way and that at certain points over the past decade low taxes made sense as driving economic growth. But that doesn’t mean that low tax is in and of itself the solution to all economic woes, as important is to ensure that the tax base is broad, and the fetish made of low tax is in no small way a contributory factor to our current travails. I was re-reading over Easter some of Michael Taft’s thoughts on these matters from last year and was very struck by his proposition that:

If I had a 10 pence piece for every time I heard the statement, ‘we relied far too much on the property market for tax revenue’ I could buy out the national debt. We didn’t ‘rely’ on property-rely taxes. We had so slashed and burned every other tax (income, PRSI, capital and corporate) that the property boom helped disguised the fact that we don’ have the revenue base to maintain current expenditure levels, never mind levels appropriate to a modern European economy. ‘Disguised’ temporarily, that is. Now in its in our face.

Anyhow, Casey continues:

The Budget was equitable – few can deny that – but it bears down heavily on the middle-class which is the economic backbone of the country.

It should be remembered that the middle-class has also suffered a major write-down of personal assets – houses and pension funds – which will undoubtedly produce a negative wealth effect.

This, combined with the prospect of other taxes – including a property tax – will hit consumption and investment.

Now, although Casey is coming from a centre centre/right perspective on this I find little to disagree with his analysis, albeit I’d have some caveats about the middle-class being the economic backbone of the country… define middle class… define economic backbone. I could make an equally good case that the public sector is the economic back-bone too, and one that is best suited for disbursing the elements of a fiscal stimulus package, and it’s a case that ironically many in the US would agree with. From the start the current policies have appeared tailor-made to ensuring that consumption is cut. Does this make sense in the face of mass unemployment and business collapse? It doesn’t to me.

But he continues:

Third, no one knows exactly how the economy will be affected by the Budget.

Budgets in Ireland are rarely more than book-keeping exercises which ignore wider economic effects. There should be a structural model of the economy which can be used to run policy simulations. Without this kind of analytical apparatus there is little possibility of predicting the impact of budget measures.

But we can make some educated guesses. We could posit that cutting expenditure and increasing taxes simply to balance those books is insufficient in the context of a global financial crisis.

He is excoriating about NAMA:

Fourth, Nama which is designed to satisfy the European Commission on the treatment of impaired assets, could work well – or it could be disastrous. It is a blank cheque. We do not know how it will work in practice. Much will depend on the quality and integrity of the people appointed to value assets and negotiate discounts with banks.

There are at least three groups of stakeholder: taxpayers, shareholders, property developers. Until the agency is up and running we have no idea how these groups are going to fare. If there is even the slightest taint of cronyism or political interference the entire exercise could end in disaster. There is also the probability of expensive legal challenges, exorbitant fees and every conceivable form of rent-seeking.

Who, though, is most important in that mix? To my mind it is taxpayers. After all it is us who are carrying the can on this exercise. And yet the benefits to the taxpayer remain nebulous – at best. What precisely does the Irish state get for funding the bank sector? It remains an unknown. And he follows that by a truly worrying statement, particularly considering all the effort and energy expended in telling us how crucial the banking sector as it currently stands is to economic activity on this island.

Fifth, even if banks offload their toxic assets and even if they get fresh capital there’s no certainty that they’ll start lending to enterprises again. Banks lend in boom times; they don’t lend much in recession. And they certainly don’t lend to firms in difficulty.

This is a central problem. Again, drawing on anecdotal experience, I am well aware of companies suffering horrendous cash flow problems. I’m told that these problems are now systemic in various areas of business. But what is the carrot that will push banks to extend credit facilities to such businesses? After all part of the problem we currently face is directly attributable to shoddy lending practices over the past decade and more.

Casey notes this:

Nominal GNP is likely to fall this year by about 10 per cent; why would we expect any growth in lending? Having lost all credibility, banks are likely to be more risk-averse than ever before. If the Budget does lead to a further fall in demand then it is not clear why banks would lend at all. Indeed, we cannot rule out a liquidity trap i.e. a situation where despite low interest rates there is no increase in borrowed funds or in the money supply. The deflation of prices could reinforce this trend.

Which begs the question what precisely are we supporting the current banking structure for? Is it a case that the state and citizenry must fund them because they’re there? I have my account with Bank of Ireland. I’ve no appetite to see it go to the wall, but neither do I want the status quo to be extended into the future if the only goal of exercise is to keep Bank of Ireland in business rather than enquiring as to how business for individuals, commercial enterprises and others can best be accommodated. And that may well mean that I’m banking with some other entity in the near future, albeit I won’t be able to tell the difference.

Casey still harbours hopes for public sector ‘reform’ although tellingly he doesn’t precisely detail what this is. I’d be interested to know his views on the OECD report which detailed Ireland as having too small a civil service for our population size and how our public sector is in European terms underfunded. I also think we could fruitfully marry Tom McGurks statement at the weekend about all the huffing and puffing over taxes and such like garnering a mere (mere!) €3.5bn as against the absurd sums being proposed for NAMA. Motes and beams come to mind.

But to return to the central point, Casey tells it like it is when referring to attempts to shape public opinion. If I have a quibble with his analysis it is that it gifts too much to Government as the main driver of these attempts and ignores the role of the general media and political and economic commentariat. And this is language used to shape that opinion that has quite frankly scared people at a time when events are already scary enough. It’s that simple and that irresponsible.

Beyond that? I’ve said it before. The sheer ignorance, of which I’ll readily confess I’m guilty of as well, with reference to economic affairs amongst those of us who should know better. This is not a highly abstruse area, not just a dismal science. It is something that those of us on the left should be centrally engaged in understanding.

Far too often we seem instead to default to stances on policy positions and we can see a prime example of that in the current approach of the Labour Party which while its heart is in the right place appears unable, or uncomprehending, of ways to articulate an alternative to the nostrums of economic activity. If we don’t, or won’t understand, the underlying problems, not least in the terms that are used by the centre and centre/right, we certainly won’t have any grasp of the solutions or be able to present them to others.