World in depression spells hardship
Beware of politicians’ promises when they claim more tax won’t be needed to pay for public services, writes Dan O’Brien
‘There is likely to be a bust-up when EU leaders meet’
THE coronavirus shock has been likened to World War II in a number of respects. When it comes to the economic effects of the pandemic, it may turn out to be an apt parallel, particularly for those European countries which were not belligerents in that conflict.
The likes of Ireland, Sweden, Switzerland, and Spain were deeply affected by the conflict, despite suffering little or no direct war damage.
The war years — known as ‘the emergency’ in the then Irish Free State — were grim, even for the neutrals. Supplies of almost everything were disrupted. Rationing was imposed for some items. Demand in export markets declined or disappeared altogether. All this disruption caused living standards to fall.
The ending of the current emergency, whenever it comes, could see a rapid economic rebound. Central to the speed of the recovery will be the duration of the shutdown.
The longer it goes on, the more businesses that will fail; and the more businesses that go under, the more the productive capacity of the economy will shrink. A chunk of the economy won’t restart because it will no longer exist.
The ending of World War II also has lessons which could be relevant for the restart. The cessation of hostilities did not bring immediate recovery and abundance across the continent. For almost all of Europe, hardship continued for most of the decade after 1945. This was true in Ireland, too.
Output from agriculture, which at the time was by far the most important industry, actually contracted in the second half of the 1940s. That was, in part, because of under-investment during the war years — imported fertiliser was in short supply leading to yields falling in subsequent years.
Now, investment in all sectors is likely to be contracting sharply. No hard data is yet available, but in countless conversations corporate executives are talking about putting their foot on the ball when it comes to ploughing money back into their businesses.
Again, the duration of the shutdown will be critical, but the longer it goes on, the more under-investment there will be. That will have knock-on effects further down the line.
Some hard numbers came out last week on consumer spending. The Central Bank has figures from the banking system on how much cash is taken from ATMs on a daily basis and how much money is spent using debit and credit cards. Unsurprisingly, these numbers point to something in the region of a halving of consumer activity.
These developments, among many other things, will cause tax revenues to collapse, just as spending on tackling the health emergency soars and the social welfare bill explodes.
Even in the best-case scenario, tens of billions of euro will be added to the national debt, which stood at more than €41,000 per person at of the beginning of the year, according to CSO figures published last Friday.
It will not be easy to form a Government and agree on a policy programme when a hole in the public finances of unknown size is opening up. Despite this, Fianna Fail and Fine Gael last week agreed a joint document which, they hope, will form the basis of a coalition between them and other parties.
It promises ‘housing for all’. The document also promises a shift towards a British-style health system (a model has been chosen despite the fact that Britain does not have particularly good health outcomes relative to peers).
At the same time the parties said that there would be no increase in personal taxation over the lifetime of their government. Promising a significant expansion in the role of the State without a significant increase in taxation is utterly implausible.
Again, going back to the post-World War II period, the role of government across the developed world expanded in an unprecedented way in the decades following that conflict. Public spending, as a percentage of GDP, doubled or trebled in most countries. That was funded by a commensurate increase in the tax burden.
Ireland followed the same pattern. Public health, welfare and education provision widened and deepened in the second half of the 20th century. To pay for it, the PAYE system was introduced in 1960. Value-added tax came in 1973.
Around the same time, the real burden of personal tax rose markedly because tax bands were not changed in line with (runaway) inflation.
If the ongoing economic collapse is as bad as it could be, last week’s aspirations will remain just that. No government will have the money to do more.
The decisions the next cabinet faces will more likely be about spending cuts and tax increases to preserve the most essential parts of the State, not about expanding on what it already does.
If there is some wishful thinking among the political class about not returning to austerity (as if the last dose of that unpalatable medicine was taken by choice rather than necessity), there have also been excessive hopes that outside forces could ride to the rescue.
Again, the post-World War II era has been invoked of late. The American aid package to Europe — the 1948-51 Marshall Plan — is often mentioned as a model, including by the head of the European Commission, Ursula von der Leyen just last week.
Countries around the world will borrow lots of money, if they can get it, to treat the ill and cushion the economic effects of the pandemic. But what is happening now is not like past crises, when shocks were ‘asymmetric’, allowing those most affected to be bailed out. This time is different in that the entire world is slumping (less negative Chinese indicators should be taken with a shovel of sand — totalitarians don’t do transparency).
As of now, around half the countries in the world have gone to the IMF in Washington looking for some sort of support.
Europe, with its large stocks of wealth, is better off than most other regions. But it has its own troubles.
There is likely to be another bust-up at the end of the week when EU leaders have yet another summit.
Ireland and a group of mostly southern European countries want more collective EU action involving large amounts of money.
Northern countries will make some gesture in order to avoid being portrayed as uncaring, but they won’t tell their citizens that significant amounts of their (dwindling) taxes will go southward at a time when they, too, are suffering all the ill-effects of the pandemic.
The unpalatable reality is that a world in depression will be a world of increased hardship.
If wealth is being generated in considerably smaller amounts, there will be less money to spend. This unhappy reality will inform the formation of the next government.
It is likely to be sooner rather than later.