Imagine, Country A, where GDP fell by 3% in 2008 and is forecast to fall by 8% in 2009. The government calls an emergency Budget.
: Which urgent policies should the government put into place?
: Impose a large increase in taxes and reduce government expenditure.
Oh, you didn’t get that one right? Well I have to tell you that this is not an imaginary scenario, this actually happened this month, and it happened in Ireland.
With the Irish government having predicted that this year will see GDP fall more than 10% from its peak, and the country on the verge of moving from recession to depression, why have they taken these measures?
Up to two years ago Ireland had appeared to be an amazing success story. Several years of growth at around the 6% mark; the third freest economy in the world, according to the Heritage Foundation, behind only Hong Kong and Singapore; and, a vibrant economy which seemed to have turned Ireland into one large construction site.
In fact, just a year or so ago, Ireland had a balanced budget and a low level of public debt. Then the bubble burst. The banking sector, aiming for a global reach, had fuelled a huge construction and housing boom. When the credit crisis came, the government gave a guarantee over the banks’ liabilities, which was worth twice the country’s GDP. The public finances were particularly hard hit because a lot of government income had come via the property sector. In 2007 government revenues were €47.25bn. These fell to €40.75bn last year and are expected to fall to €34.bn this year.
According to one opposition politician, responding to the emergency budget, “the banks bailed out the developers, the government then bailed out the banks and now the taxpayer is being asked to bail out the government.” This leaves the question of who is going to bail out the taxpayer.
Thus on 7th April, Mr Brian Lenihan, the Irish Finance Minister, announced a total reduction in government spending for 2009 of €1.8bn, and further savings of €4.8bn to be made between 2010 and 2011. At the same time heavier taxes were levied upon the middle classes. Mr Lenihan said: “First and most urgent, we must stabilise our public finances. Until we show that we can put our own house in order, we cannot expect those who have invested here and who might invest here in the future to have confidence in us.”
In fact, the exposure to bank losses coupled with deficits in the public finances were causing questions to be asked about the country’s solvency. And, at the beginning of April, one major credit rating agency downgraded Ireland’s sovereign debt rating. It therefore seems that the country had no alternative to the emergency measures taken, which in themselves will initially make the recession worse. Even given the increases in taxation and cuts in spending, Mr Lenihan predicted that the government would still have to borrow the equivalent of 10.75% of GDP, which in itself is not far off four times the limit set by the EU for countries to enter the eurozone.
Ireland now has to pray for the rest of the world to quickly come out of recession so that they have the opportunity of an export- led recovery.
As Paul Krugman, Economics Nobel prize winner in an article in the New York Times on April 20th put it: “…the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.”
is the best selling book by Principal Examiner, Dr Charles Smith
"The coverage is excellent, looking at both the theory and practice of international trade and providing some very perceptive insights into the current debate about globalisation... useful and thought-provoking."
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In this interview Nigel Tree asks Dr Charles Smith, who is a principal examiner, and Senior Lecturer in Economics and Education, Swansea School of Education, Swansea Metropolitan University some questions about the international economy.
Both the US and the UK have a high marginal propensity to import, meaning that as incomes rise in these countries, so imported goods are sucked in. Conversely when incomes fall, as during the current recession, the demand for imports will fall. Another important factor is the exchange rate. The fall of the dollar against other major currencies has helped its trade position. Like the US, Britain has to a large extent given up on manufacturing, and has been relying on China and other cheap-labour countries to satisfy its demand for goods. Most British exports, however, go to Europe, and here the exchange rate of the pound against the euro has a strong influence. It could be that British consumers have been a little slower than American ones to cut back on their consumption of imported manufactures, while British exporters have been unable to take advantage of any improvement in their terms of trade created by exchange rate movements.
"Globalisation" neither fails nor succeeds, the word describes a process which is either happening or not happening. What has definitely failed is "globalism", a project which like any other "ism" is promoted by its believers as a way of organising the world. Globalism as promoted by multi-national corporations, free market economists and right wing politicians (among whome I include Britain's "New Labour" government) has, in my opinion, been exposed as a project aimed at separating the monetary economy from the real productive economy, and ensuring that the people who benefit are separate and insulated from the people who pay the costs. Please do not believe the propaganda that claims that nobody saw this coming. If you go back to what Maynard Keynes actually said (as opposed to what subsequent economists might claim he said) you will read his analysis of the inherent instability of the macroeconmic system. Privatisation and de-regulation have sown the seeds of their own destruction. More recently, Joseph Stiglitz, John Gray and the late J.K.Galbraith have all predicted the current crisis. These are political economists who look at real world institutions and practice the 'economics of walking about', as opposed to theoretical economists who insist on building up mathematical models and can only talk to each other. They speak a language of their own, which nobody else can understand, and they do not connect with real people, or with the real world. I sincerely believe that good "A" Level students are better placed than many professors of economics to explain the current crisis. They have been answering exam questions focusing on an economy built on dodgy mortgages, house price inflation, massive debt, and weird practices like 'short selling' which is simply unsustainable. It remains to be seen whether the public outrage caused by the taxpayer being forced to subsidise the greed of failed bankers is translated into a permanent solution, where it is recognised that inequality is economically disfunctional, and that societies that perceive themselves to be fair and equal tend to do better than economies where the rich get richer and the poor stay poor.
Leaders of countries attending the "G" meetings do have a record of smiling and nodding in agreement for the benefit of the world's press, then doing exactly what they think will please their own electorate when they get back home. As far as protectionism is concerned, the current crisis might help us to decide that some things are actually worth protecting: for example smaller scale building societies, mutually owned funds, cooperatives, indigenous manufacturing firms and public services perhaps should be better protected from being swallowed up or put out of action by the more aggressive forms of large-scale international business. I see the "G" meetings as a bit of a desperate attempt by politicians to convince themselves and their electorates that they still run the world. They haven't quite figured out that to make this true they must tame the power of the multinationals. In other words they must change the very nature of globalisation. We need to see a rebalancing of regulation against unrestrained market forces, saving against spending, investment against consumption, qualitative development against quantitative growth, and equality against inequality. The problem is that some of these rebalancing acts are long term, and politicians tend to have a very short time horizons.
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