Households and Governments: how they differ

Posted on May 13, 2013 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

The gap between what the Government in Ireland takes in and what it spends is running at a rate of €1 billion every month. Clearly this is not sustainable in the long-run because it adds to the total amount of debt owed by citizens year after year. The total amount of debt owed by the Government on behalf of taxpayers is now well more than the size of the entire amount of goods and services produced in a year. It costs the taxpayer over €8 billion each year to 'service' this debt by way of interest payments. It is estimated that, in 2013, the cost of paying interest on this debt will account for two thirds of entire government deficit of over €12 billion.

This would be the equivalent of a household with a combined income of €40,000 a year with a total mortgage and other debt amounts totalling close to €50,000 and an annual interest bill on all of its debts of around €2,000 without any mention of paying back the total debt of €50,000. The household spends around €43,000 a year leaving a gap between total spending and total income of around €3,000 a year. The household borrows an additional €3,000 a year to cover this gap. A household in such a situation might have a number of options:
- Cut back on its planned spending by €3,000;
- Increase its income by finding additional income;
- Continuing to borrow an additional €3,000 a year.
- Enter an agreement with its bank or credit union to temporarily reduce its interest payments (and possibly also reduce some of its outstanding debt by mutual agreement).
A sensible household will adopt one or other of the above courses of action depending on its circumstances and options. It is sometimes assumed that Governments ought to work in the same way - balancing its books, cutting spending or raising taxes - especially if its official creditors and market lenders are putting pressure on them to do so. What makes sense for households does not always make sense for Governments especially if the economy as a whole is in recession along with other countries. Unlike households, every time a Government cuts spending or raises taxes there is a significant impact on what people spend on current goods or services or invest in capital. When all or most Governments in a trading area do the same thing matters get worse for many countries because demand for the goods and services of another country is reduced. So, Governments that seek to 'balance their books' need to act prudently in a way that does not make the situation worse by adding to economic decline. There is rising evidence that 'austerity' measures coordinated and practiced across much of the European Union is making matters worse especially for countries in severe difficulties such as Greece, Portugal and Spain (but also France and Italy).
When recessions are deeply embedded, as they are now, Governments need to spend more and not less because (a) private demand is too low as consumers and companies either cut back or increase their savings and (b) the demand for public services and income supports increase. Governments along with private investors also need to invest more in infrastructure such as public transport, new energy and new technology that will equip economies to grow out of recession and sustain growth in the long-run. Governments that practice 'fiscal austerity' too much and too quickly risk choking off recovery. The maxim that 'your income is my spending and my income is your spending' holds true not only among nations but within a country - even a small open economy such as Ireland where, for example, the public servant pays for groceries in the local shop and those working in the retail sector pay taxes. Spending, income and output are strongly inter-connected and Government decisions on spending and taxation have a strong impact on the economy as a whole.
Most of the above is widely accepted and uncontroversial even among a growing number of conservative economists and politicians internationally. The story, however, changes in the case of Ireland where, it is strongly asserted, the Government has no alternative because:
- The public deficit/debt levels are far too high and need to be brought down reasonably quickly and as a matter of priority;
- The impact of any 'stimulus' (Governments spending more or taxing less) is extremely limited in the case of a 'small open economy' such as Ireland where most of what is spent 'leaks out' through purchase of imported goods and services;
- The Government, here, has no alternative anyway because of the market, institutional and political constraints imposed on the country directly as a result of the 'bailout' programme involving the Troika as well as the on-going monitoring and enhanced supervision of Irish public finances by the institutions of the European Union of which Ireland is a full part already and which will continue after Ireland (hopefully) exits the bailout programme soon.
Space does not permit a full analysis of these assertions. However, the Nevin Economic Research Institute has produced a number of reports, working papers and the Quarterly Economic Observer since March 2012, which illustrate that there is scope for alternative budgetary and economic strategies that:
- Reduce the level of public deficits and debt;
- Impact favourably on employment and growth in GDP and public finances; and
- Are likely to achieve budgetary deficit outcomes that are at least as good as, if not better, than those agreed between the Irish Government and the Troika.

Posted in: Macroeconomics

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