The paradox of national thriftiness

I recently attended a talk given by economist David McWilliams and one of the main points he made was that we need to define where exactly we are at, before we can start think about arriving at a solution.

Spurred on by David’s advice, I think it’s worthwhile examining the Irish Central Bank’s quarterly bulletin.

There’s no excitement in these reports, it’s business as usual, or should that be “lack of business as usual”.

If you are interested in statistics, the report has a useful insight into where we are at — the amount of loans given out in quarter two of 2012 is 16% below what was given out in quarter one of 2010.

In other words, credit has dried up. Even in the sector marked by some as Ireland’s saviour, agriculture, the lending to SMEs in 2012 was more than 13% lower than in 2010.

The report also shows that a net €10 billion has been paid off in loans over the period. Paying off a loan is a good thing, surely?

But from an economic point of view, if we are collectively focused on paying off loans, (and those of us who can, start saving), this results in a perfect storm for retail business.

Retail, and manufacturing, as a follow through, depend on spending and credit. Credit has evaporated, and consumers have stopped spending, and started saving.

One might still think, if we all save a bit and if we all clear down our debts, surely this is a good thing?

The problem of lack of credit and too much debt has been described by one of the world’s most famous economists, Keynes, as “the paradox of thrift”. The more you save, the more likely someone around you is to become unemployed.

If everyone saves, no one purchases, and if no one purchases, there is no manufacturing. So what’s the solution to this catch 22?

The paradox of thrift will hurt an economy only where the reduction in spending affects jobs in the domestic economy.

For example, if everyone around me stops buying meals in the local restaurant, it will be out of business within a week. However, if I stop going on foreign holidays, my reduction in expenditure will have minimal impact on Irish jobs.

Better still, if I and everyone around me switch spending from foreign purchases to Irish purchases, it will boost the Irish economy. That’s why it’s time to become a nationalist, if only in economic terms.

Our national debt position also needs to be tackled. Ireland is one of the most indebted countries in the world. That’s quite an achievement — and a reflection on those who were silly enough to lend us and our banks that much money in the first place. The statistics released by the central bank show how our debt position doesn’t simply need restructuring; it needs debt relief.

Total national debt is running at €169 billion, and personal private sector debt is running at about €324 billion. These add up to €493 billion.

That sounds like a lot, but let’s breaks it down per person in order to really get a grasp. It’s handy that the Central Bank report also has statistical information on our population demographics. And figures from the CSO show that the labour force is just under 1.8 million.

Revenue figures suggest that about one million are earning more than €32,800 per year. It’s fair to say that those in the lower tax bracket are not in much of a position to shoulder or finance the debt of the country. Based on the one million or so middle and high income earners, the €493 billion debt works out at about €493,000 per person.

The actuarial valuation of the liability that exists for public sector pensions adds about another €100 billion to the pot, but let’s ignore this figure for a while — after all, everyone else does.

A further statistic from the report shows that economic growth is stagnant, wages are stagnant, but yet there is inflation. This means inflation erodes standards of living, and more people have less disposal income to service debts.

In this big picture, the current controversy over Enda Kenny’s meeting with Angela Merkel is insignificant.

In short, what he hoped for was that our existing borrowings to re-capitalise the banks can be wrapped in as borrowings under the new EU bank debt scheme.

In other words, we were hoping for a better interest rate, and a longer term to pay off the loan, not a debt write-down.

In my opinion, it’s not a case of asking for a debt restructuring, it’s a case of stating that we simply don’t have enough money.