Never A Dull Day In Euro-Land

Keynesian Ditch-Diggers

By Pater Tenebrarum

Ireland has been a model student of the bailout initiative so far, meeting its targets and implementing the 'Troika' devised austerity program very meticulously. However, since Spain is now getting 'special treatment' regarding the bank bailout, it was decided at the late June euro-group summit that Ireland would get special treatment as well. After all, the Irish bailout was primarily a banking system bailout too. Moreover, as Irish finance minister Noonan not unreasonably remarked, Ireland 'took one for the team' when it refrained from imposing losses on senior bank bondholders. The big fear at the time was that this would trigger 'contagion effects' across Europe (which were later triggered anyway by Greece).

In its summit statement the euro-group said:

„The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.“

Noonan is now hoping to clinch a deal on the €64 billion in bank debt in the course of this year, which would help bring Ireland's public debt back below 100% of GDP.

The FT reports:

“Mr Noonan said he was pressing for a deal with European authorities for relief on Ireland’s €64bn bank debts that would reduce the country’s sovereign debt below 100 per cent of gross domestic product and help the country to re-enter international bonds markets in early 2013.

“Our debt will peak at around 117-120 per cent of GDP next year and if you go above 100 per cent then it acts as a brake on growth,” he said.

“If all the capital we put into the banks was removed from our shoulders it would get our debt down to 80 per cent of GDP. Now it is unlikely someone would be that generous but somewhere between 80 and 100 per cent [is the aim]. I still regard 100 per cent as too high,” he said in an interview. Mr Noonan said he would meet Mario Draghi, ECB chief, within the next two weeks for talks on the issue.

Ireland’s borrowing costs have dropped to pre-bailout levels since EU leaders agreed a deal at last month’s summit that could see the European Stability Mechanism, the eurozone’s €500bn bailout fund, take over a chunk of its bank-related debt on its balance sheet.

Mr Noonan said Dublin deserved a deal on its bank debt because the ECB had blocked the previous government from burning senior bondholders in Irish banks for fear of contagion spreading across Europe during the early stages of the eurozone crisis.

“We are saying we took the hit for the team and if the rules are now changing then we need to negotiate a deal with you,” said Mr Noonan. “Moral hazard should not just apply to those who borrow recklessly but also those who lend recklessly,” he said. (emphasis added)

As the article notes, Ireland's bond yields have already declined sharply in anticipation of the deal. So what does the Irish government plan to do with its newly-won financial flexibility? Why, enact 'economic stimulus' of course (i.e., waste scarce economic resources). This is to be done in a manner that does not impair the deficit targets, by way of 'off balance sheet financing'.

The FT article reports on the matter:

Dublin is to unveil a multibillion euro stimulus package later this month in an effort to kickstart its flagging economy and curb unemployment as it presses the eurozone to take over a large chunk of bank-related debts to aid its recovery.

Michael Noonan, Ireland’s finance minister, said on Wednesday that the troika of international lenders – the European Central bank, European Commission and the International Monetary Fund – had approved the stimulus measures as long as Dublin does not breach its spending limits.

“It will be like a parallel capital budget geared towards projects that enhance the capacity of the economy to be more productive, including road and school projects,” Mr Noonan told the Financial Times in an interview.” (emphasis added)

As we have often pointed out, it is not possible to 'kickstart' an economy. It would be possible if the economy were a stalled car engine, but that is not what the economy is: it is not a car engine.

As reasonable as the projects the government wants to spend funds on sound at first blush – who can be against schools and roads after all! – the fact remains that the economy's pool of real resources and capital is finite. There is no way whatsoever to determine whether the resources to be expended on a new school or a new road would not have been better employed in alternative uses, where they may have satisfied more urgent consumer wants. The government just 'spends', but there is no economic calculation taking place. There is no way to gauge the success or failure of these projects because they are not subject to profit and loss accounting. Their opportunity cost will forever remain a mystery. But hey, 'roads and schools' must be good, right?

Well, in this case, consider the entire train of thought as formulated in the excerpt of the FT article above. No-one is actually saying that schools and roads are really needed. In fact, we strongly suspect that Ireland is well supplied with both and that no particularly urgent need to add to them actually exists. No, very likely the sole aim of the project is the 'kick-start' exercise. It is Keynesian ditch-digging, masquerading as useful investment for propaganda reasons. He might as well have said 'new hospitals and airport improvements', or whatever.

It does not matter to them what they spend it on, they just want to spend it. The erroneous assumption underlying such plans is that they somehow must be economically beneficial. After all, government spending automatically 'adds' to GDP, and a number of ditch-diggers, sorry, road construction crews, will be employed for a while. So why doesn't anyone stop to wonder for a moment how it comes that the same exercise is now in its 23^rd year of continuous failure in Japan, or why president Obama's 'shovel-ready' deficit-financed ditch digging exercises in the US have resulted in what economists far and wide now admit remains the weakest recovery of the entire post WW2 era?

In spite of these and countless other, similar examples, the myth that all government spending is 'good for the economy' regardless of how many scarce resources it wastes on useless projects lives on. What is especially fascinating in this particular case is that the would-be spender is presiding over the treasury of what remains at this point a de facto bankrupt government.