Will €6bn of budget cutbacks equate to taking money out of the economy?

[Chris]

In recent weeks I have heard more and more media commentators, union officials and politicians claim that the Irish economy is so fragile that it could not possibly sustain "taking €6bn out of the economy" without bringing it completely to its knees. Now I don't want to debate whether or not the cutbacks are needed or fair or reasonable or possible or what should be cut. Let's just asume that the cuts will actually be made.

The short answer to the above question: No
A slightly longer answer to the above question: No, the polar opposite is true
The longer answer goes as follows. A government that spends money has to either (a) tax it out of the economy or (b) borrow the funds. Even in the latter situation, the money has to be repaid, plus interest, so this money also has to be taxed out of the economy. So no matter which way government spending is funded, it ultimately has to come through taxation of the economy.
This means that if a government spends €6bn less, then it has to take €6bn less out of the economy. At the very best, the economy would neither gain nor lose, as the €6bn in less spending by government allows for €6bn more spending/investment in the productive economy. This of course would assume that government does not spend the money wastefully, which would be quite an erroneous assumption to make.

Bottom line is that €6bn in spending cuts will result in €6bn more in the productive economy than otherwise would have been available. And the more capital there is in the productive economy the more jobs there will be.

Are these commentators really that economically inept or is the public really that gullible to not notice this obvious fact?

 

[Shawady]

Chris, I don't know the answer to your question but one thing that does worry me is that the government has already taken 14.5 billion out of the economy and it has made virtually no difference to our % deficit to GDP.
My gut feeling is that as the government has bluffed it's way from budget to budget , many people are afraid to spend because the government will not say where exactly the cuts/taxes are going to come from. Just look at how the issue of a property tax or college fees has been floated around for the last 2 years.

 

[suemoo1]

in the Indo today, they are saying 800e in uni fees, so they are softening us up, 800e this year, x next year and y the year after so probably still end up at 3k eventually..

 

[sunrock]

6 billion euro out of the economy is a lot.It is 6,000million e.That is equivalent to 1500efor every man,woman and child in the country or 6000e for an average family of four. This 6 billion e is being used to repay our borrowings or put into the black hole of the banksor NAMA.The money does not go into the productive economy.

 

[Chris]

Chris, I don't know the answer to your question but one thing that does worry me is that the government has already taken 14.5 billion out of the economy and it has made virtually no difference to our % deficit to GDP.
My gut feeling is that as the government has bluffed it's way from budget to budget , many people are afraid to spend because the government will not say where exactly the cuts/taxes are going to come from. Just look at how the issue of a property tax or college fees has been floated around for the last 2 years.

I'm not sure about your numbers there. At the early stage of the crisis current and capital expenditure increased (it beggers belief) from 2008 to 2009: http://www.finance.gov.ie/viewdoc.asp?DocID=5750
Budget 2010 anticipated a reduction €2bn (3%) from 2009 to 2010:
http://www.budget.gov.ie/Budgets/2010/Documents/Estimates Book 2010.pdf
Now there may have been some extra cuts introduced that are not covered by this document, but the official figures will not be out for a while. The big cuts have not yet hit.
And the reason why defit/GDP ration is not getting better is because the government is taking in less revenue while at the same time GDP is plummeting.
Bottom line is that budget cuts are very positive for the economy.

6 billion euro out of the economy is a lot.It is 6,000million e.That is equivalent to 1500efor every man,woman and child in the country or 6000e for an average family of four. This 6 billion e is being used to repay our borrowings or put into the black hole of the banksor NAMA.The money does not go into the productive economy.

I think you may be missing my point. My point is that when government spends €6bn less then that is €6bn less taken out of the productive economy. This does not mean that €6bn is taken out of the economy.
The fact that government is borrowing for current expenditure and banks' bailouts is a whole differnet issue. It is this drain on the money markets that is reducing the amount of capital available for investment in the productive economy as well, further exacerbating the problem.

 

[demoivre]

Bottom line is that budget cuts are very positive for the economy.

They aren't. Contractionary fiscal policy reduces aggregate demand which increases unemployment. If we reduce spending by €6bn in the budget the tax take won't reduce because we are overspending day to day by a lot!

 

[Chris]

They aren't. Contractionary fiscal policy reduces aggregate demand which increases unemployment. If we reduce spending by €6bn in the budget the tax take won't reduce because we are overspending day to day by a lot!

Demand does not drive an economy, that is one of the greatest fallacies of Keynsianism. If fiscal increases would boost employment, then the US would now have plummeting unemployment. It would also mean that recessions/depressions would not be a problem, as all the government would have to do is borrow as much as is possible irrespective of interest rates or just print the money. it would also mean that Germany's growth would not be possible, as the state is reducing spending and simplifying taxes.
Economies, just like people, have to produce somehting before they can consume something.

Yes Ireland is overspending, but if Ireland spends €6bn less then it has to borrow €6bn less, which means it will have to tax €6bn (plus interst) less in the future to repay the debt. And Ireland would have to tax less now to service the debt. Just because the money is borrowed does not mean it does not affect taxation.

 

[Shawady]

I'm not sure about your numbers there. At the early stage of the crisis current and capital expenditure increased (it beggers belief) from 2008 to 2009:

The 14.5 billion has been used by Brian Cowen himself and quoted in several articles by Declan Kirbard in the Sunday Times.
Even in 2009, we had the pension levy budget (2 billion), the emergency budget (2-3 billion I think) and the December budget (4 billion). So in 2009 there were 8-9 billion in cuts/taxes alone yet there has been no progress.
I accept we need cuts/extra taxes but if it is too severe will it hamper growth and therefore recovery?

 

[Chris]

The 14.5 billion has been used by Brian Cowen himself and quoted in several articles by Declan Kirbard in the Sunday Times.
Even in 2009, we had the pension levy budget (2 billion), the emergency budget (2-3 billion I think) and the December budget (4 billion). So in 2009 there were 8-9 billion in cuts/taxes alone yet there has been no progress.
I accept we need cuts/extra taxes but if it is too severe will it hamper growth and therefore recovery?

But the links I posted do not confirm that government actually spent less in 2009 or that €14bn was to be saved in 2010. They did raise taxes and levies to plug some of the hole, but they have used borrowings to finance the outgoings. And I, for one, do not a believe a single word that Cowen has to say about the state of the public finances.
I agree that increasing taxes will hamper growth, but decreasing spending does no such thing.

 

[Shawady]

And I, for one, do not a believe a single word that Cowen has to say about the state of the public finances.

We can both agree on that.

 

[jpd]

This means that if a government spends €6bn less, then it has to take €6bn less out of the economy. At the very best, the economy would neither gain nor lose, as the €6bn in less spending by government allows for €6bn more spending/investment in the productive economy. This of course would assume that government does not spend the money wastefully, which would be quite an erroneous assumption to make.

The government takes income from the economy via taxes and puts it back via spending (public service pay, & pensions, social welfare pensions, capital spending). Today it is spending 18 bn euro more than it is taking in - so it is planning to take in some more and spend less 6 bn in 2011 and another 8.5 bn in 2012-2014

So it is going to take more out of the economy (tax increases) and put less back (pay cuts, etc)

 

[Chris]

The government takes income from the economy via taxes and puts it back via spending (public service pay, & pensions, social welfare pensions, capital spending). Today it is spending 18 bn euro more than it is taking in - so it is planning to take in some more and spend less 6 bn in 2011 and another 8.5 bn in 2012-2014

So it is going to take more out of the economy (tax increases) and put less back (pay cuts, etc)

This is true, but if the cuts were not made then it would have to take an additional €6bn out of the economy. Just to clarify, I am not saying that government will increase taxes to fill the whole, what I am saying is that with the cuts less money will have to be taken out of the economy, which is a good thing and does not equate to taking money out of the economy.

 

[JoeRoberts]

I remmber from my school days economics that Ireland has a high propensity to import.
Thus I don't think reducing expenditure may be as bad as some commentators say.
For the same reason, I don't think a stimulus package, as proposed by some parties would do any good.

 

[Chris]

Thus I don't think reducing expenditure may be as bad as some commentators say.
For the same reason, I don't think a stimulus package, as proposed by some parties would do any good.

I agree with you on both counts. Stimulus is like taking water out of the deep end of the pool, pouring it into the shallow end and claiming to have filled up the pool. Same analogy can be used for budget cuts, i.e. taking water out of one end of the pool, pouring into the other and claiming the level has dropped.