False economies and the elephant in the room

What should guide fiscal policy in the short-to-medium term?  What are our goals?

Elephant

How should governments respond to the economic wreckage of the Coronavirus? We can debate policy specifics but the general policy thrust has to date been broadly appropriate. Governments in Europe have moved swiftly and robustly to support the productive capacity of their economies. Further measures will come in the next few weeks and months. The broad sequencing of 'support then stimulate' is widely supported in the economics community despite the enormous fiscal costs.

So what should guide fiscal policy in the short-to-medium term? What are our goals? Lets assume governments are interested in inclusive and sustainable increases in economic output. What kind of fiscal policy will help us achieve that outcome?

The latest NERI Working Paper sets the scene and describes fiscal policy in the United Kingdom and in the Republic of Ireland on the eve of the crisis. In particular, we offer comparisons to the other high-income countries of Western Europe. We identify a number of clear policy failures and argue that rectifying these policy failures will make for a stronger economy in the long-run. 

Lets give just one example of failure. Both jurisdictions spend well below their Western European 'peers' on per pupil education, on public R&D and on childcare. We estimate the under-spend on education at €3.1 billion (Ireland) and €16.1 billion (UK). The under-spends on public R&D scale to €900 million and €12.8  billion respectively. The under-spends on education and R&D are false economies that diminish our collective human capital and our innovative capacity. Future growth levels will be weaker because of these mistakes. Hopefully the creation of a ministry for higher education and innovation is a sign that this policy failure will finally be addressed in Ireland. Time will tell.

The next few years will be characterised by high levels of unemployments and very large public deficits. Well-crafted policy choices will help us generate higher levels of sustainable employment. A combination of green infrastructure spending and housing, free public childcare provision, grants for business, and spending on education/retraining and R&D should form the basis of fiscal policy. On the other hand, tax cuts would be an enormous mistake - they will crowd out the type of policies that will make our economies stronger in the long-run and will be ineffective as a response to this type of crisis. Ireland and the UK already generate amongst the lowest revenue yields in high-income Western Europe on a per capita basis. The reason for this is straightforward - a lack of meaningful social security contributions from employers. At some point we will need to address this elephant in the room. That point should be now.
 

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Dr Tom McDonnell


Tom McDonnell is co-director of the Nevin Economic Research Institute and is based in the Dublin office. In addition to managing staff in the Dublin office he has co-responsibility for the NERI's research programme and for its strategic direction.  

He is also responsible for, among other things, the NERI's analysis of the Republic of Ireland economy including risks, trends and forecasts. He specialises in economic growth, economics of innovation, Irish and European economies, and fiscal policy. 

He previously worked as an economist at TASC and before that was a lecturer in economics at NUI Galway and at DCU. He has also taught at Maynooth University (MU) and is currently an occasional staff member at MU. 

Tom obtained his PhD in economics from NUI Galway. He is a native of Limerick city and lives in Maynooth.

Contact: [email protected] or 00353 1 889 77 42.