Michael Taft: Sweating The Economy

at | 18 Replies

From top: Grand Canal, Dublin 2 last week; Michael Taft

Is the economy over-heating? Are we reaching full capacity? Are we in danger of slipping into heightened inflation and balance of payments deficits?

The problem is we may not know and may not have the tools to measure this.

There are basic measurements that should be able to help us determine our ‘temperature’. First up is the output gap. This measures the gap between actual output and the potential output of the economy. A negative output gap means the economy is performing below its potential.

During a recession, the output gap is negative. A positive gap means the economy is operating above its potential. The higher the positive, the more the economy is overheating. A 0 percent means the actual and potential of the economy are aligned. This is the goal of sound economic management.

The Finance Department is projecting a very positive gap in 2018, falling to a near alignment in 2021. The EU Commission, however, shows the economy to be over-heating last year but falling well below its potential next year.

On either reading, the economy is not over-heating. Should we be guided by these projections? No. The Finance Department is highly critical of the methodology behind measuring the output gap.

‘It must be acknowledged that the concept of potential growth is more complex to assess for a small, open economy such as Ireland, which inter alia is characterised by significant cross-border mobility of labour and capital. Indeed, the positive output gap . . . currently estimated for this year, which is inconsistent with limited inflationary pressures evident in the economy, highlights the health warnings attached to estimates of the cycle using this framework.’

The Department attempted to create an alternative measurement and what they came up with was a more practical graph showing that as the economy recovers the negative output closes and starts to stray into positive – that is, slightly over-heating – territory. It’s what common sense would dictate.

A second measurement to identify over-heating is through the balance-of-payments. This calculates all transactions between Ireland and the rest of the world, consisting of imports and exports of goods, services and capital, as well as transfer payments such as foreign aid and remittances.

A negative balance can pose trouble as a country is importing more than they are exporting (not a greats space for a small open economy to be in), or borrowing more than they are lending. During the speculative boom years, Ireland’s balance deteriorated into negative territory. Following the crash it has been improving.

If we look at the balance of payments as a percentage of GDP or a percentage of GNI* (which removes all the multi-national noise from the accounts) we have seen a sustained recovery.

While using GDP as a benchmark is just as problematic as using it for the economy’s well-being, we can see that the Government’s projections out to 2021 (in dash) shows a slight falling back. If this holds for GNI*, it is reasonable to assume that our balance of payments will remain in fairly good health for the years ahead – with the all the downside caveats like an exploding Brexit, exploding Trump, etc.

So where does that leave us? It leaves us using common sense. It should also compel us to, without complacency or fear-mongering, focus on the real problems.

Here, Chris Johns has some sensible words:

‘Overheating is one of those things that is often mentioned, but there is no commonly accepted definition of the term . . . It’s talked about with dubious confidence . . . Policy should be about acknowledging all risks and problems, particularly the ones that are real, rather than threatened.

Dealing with the problems of today and building resilience to a wide variety of potential shocks, most of which we cannot foresee, is at the heart of good policymaking.

I suspect the overheating warnings are partly a device for pressuring the Government for tighter fiscal policy. There are good reasons for budgetary caution . . . but overheating is not high on that list. Coded warnings risk being unhelpful, and lack both transparency and the context of an overall analysis of what is really needed.’

There is a clue buried in the output gap. If we can remove the obstacles to a higher potential GDP then we can prevent the economy from sweating. The problem is that potential GDP cannot be directly measured; it is one of those benchmarks that are tied up with a methodology which the Department of Finance is rightly critical of.

Nonetheless, we can agree on some obstacles.

If we’re not building enough houses in a planned sustainable manner to accommodate people at affordable rates then we’re going to be in social and economic danger of limiting our capacity to grow.

Affordable childcare: If you’re trying to entice more people into the labour market then making childcare fees expensive is hardly the ticket.

If people want to work more but are prevented by management practices (precarious working, uncertain hours, bogus self-employment) then full participation in the economy will be, for those caught in this trap, elusive.

And if the fear is that the economy will overheat as we build more houses or provide childcare then the fiscal tool of taxation is still available – property and asset taxation, diesel taxation, reversing the temporary reduction in VAT. Oh, yes, and abandon the tax cuts.

We shouldn’t let the debate about over-heating side-track us from the necessary investments in the productive economy. If we cut back on these then we may satisfy this graph or that. But the economy itself will be unable to withstand the inevitable downward cycle, social problems will mount and we will find ourselves weaker.

That would be pretty poor fiscal politics.

Michael Taft is a researcher for SIPTU and author of the political economy blog, Notes on the Front. His column appears here every Tuesday

Rollingnews

18 thoughts on “Michael Taft: Sweating The Economy

  1. Ina.

    We need far more taxation on wealth. Inheritance tax is far too low. And the loopholes allowing tax evasion need to be permanently closed.

    Reply
    1. TheRichList

      I strongly disagree.
      Inheritance tax is in my opinion the most unfair tax in place. I have paid tax on my savings / assets multiple times before I get a chance to pass anything in to my children.
      Why should they be taxed again when they receive inheritance from their parents?

      Reply
      1. Ina.

        Because it’s unearned income. You didn’t earn it, you inherited it. You’d no part in generating the wealth.

        Reply
        1. terry1

          Unearned income that’s great
          So your parents gift you what they have left its unearned income
          Maybe if the corporation tax was paid on par with every business that strives to create wealth by these multinationals like apple and Google and all these companies instead of screwing what’s left out of a dead persons estate this country might have a decent health service and less homeless
          Spoken like a true public sector employee

          Reply
      2. Cian

        Because most inherited wealth is from the family home. And most of the increase of value isn’t due to home-improvements. So why should your kids benefit from the fact that house prices have risen?

        Reply
        1. Andyourpointiswhatexactly?

          Why not? Why should anyone?
          It’s the only way I’ll make any cash so BOO to inheritance tax. HOORAY for inheritance.

          Reply
          1. Brother Barnabas

            inheritance tax isn’t all that harsh, in fairness – first 300k or so is tax free, then 33% thereafter

          2. Andyourpointiswhatexactly?

            Pfft. Depends what you’re looking at inheriting, innit.
            Hopefully I won’t be inheriting for a long time, though, said she piously if a tad untruthfully.

          3. Brother Barnabas

            i see…. an only child

            (i think we’ve probably all done the when and how much calculation)

          4. milk teeth

            Inheritance tax is the cornerstone of any redistributive society. The person receiving the income never paid tax on it – the person who died did pay tax but that is a different matter.
            If you want to complain about a tax go after VAT. That really is a tax on already taxed money. Applied unevenly and of which the burden falls more upon the poor (where as inheritance tax largely falls upon the rich i.e. those who can afford to pay).

          5. Termagant

            “the person who died did pay tax but that is a different matter.”

            Why? The tax has been paid. You’re defending two taxes on hard-earned money in one breath and condemning it in another.

          6. Cian

            “Why? The tax has been paid. You’re defending two taxes on hard-earned money in one breath and condemning it in another.”

            So should capital gains tax be abolished too? If I buy shares/a BTL apartment with my income (which is already taxed) and after 10 years I sell this asset. at the I have to pay capital gains on it (@33% of the increase in value).

            In fact, if my dad bought some shares at 1c and are now worth €100K (I can dream) and he sold them – he would have to pay 33K capital gains. If he died, the remaining €67K would be mine – tax free as inheritance. hurrah I get €67K!

            But if he died before selling the shares, then I would get the full 100K – tax free. Bigger hurrah!

            Is this fair? Should inheritance tax not be the same as capital gains?

  2. Col

    I don’t fully understand what people mean by overheating. Radio and newspaper commentary is unclear, specifically in relation to house building.
    It seems to be a catch 22:
    1. Build more and we create an over inflation of the economy by over reliance on the construction industry (a la Celtic Tiger) = overheating
    2. Build less and rent and property prices will continue to rise at unsustainable rates, requiring higher wages = overheating.
    What am I not understanding?

    Reply
    1. terry1

      That will happen post brexit
      Maybe this time the result will be the public sector pension time bomb finally defused as there will be no money to pay it and no chance of borrowing more cash to keep the old show on the road

      Reply

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