Friday, October 9, 2009

Dealing with Recession

There is little doubt that Ireland is in the grips of a deep recession at present. The inflation rate is currently - 6.5% (on an annualised basis) and real output could fall by 10% this year.

Because liquidity is so tight with banks at present many small and medium sized businesses are finding it extremely difficult to survive. In deed it is heartbreaking to hear on programmes like Joe Duffy's "Liveline" the incredible pressures that many of these are now, with unpaid debts mounting and the prospects of survival looking slim.

We all know the reasons why banks are refusing these firms credit. Because of the huge losses they have suffered from wildly speculative lending during the property boom, their balance sheets are now in a bad way. Therefore they have a vested interest in preserving money to meet uncertain future liabilities, rather than lend it to stressed businesses in the midst of a recession. And despite all the efforts of the Government here at capitalisation and taking the riskiest loans off their books, this situation is likely to continue for some time.

To get credit flowing sooner rather than later in the economy, the state itself needs to take responsibility by setting up its own bank precisely for such purposes. It is ironical that we used to have two state banks i.e. ACC and ICC in the economy until quite recently. Though these had become more commercialised in any case before privatisation, their original purpose had been to provide credit to businesses (where full commercial criteria would not apply).

In a sense this is precisely what is required now! The (private) banks will argue that they are open for business and willing to extend credit. However quite clearly in the current economic climate very few enterprises can match the tough criteria they are setting. Therefore many businesses that are starved of credit are on the very brink of failure.

Therefore because the existing banks are not likely to extend such credit, the only way it will be made available is through a government willingness to make up the shortfall. So quite simply an urgent need now exists for such a bank to be created. Though a large number of businesses are probably bad bets at present and should not receive assistance, many others with credit more easily available, could indeed have a reasonable chance of survival.
And we need to consider the multiplier aspects of all this. Each business that fails puts more workers on the dole. So there is a price for the government to be paid through additional social welfare payments and loss in tax revenues.

Once the economy has properly recovered with banks finally returning to "normality", the activity of the state bank could be wound down considerably. However it would be a good idea to keep it in existence in the event of a further baning crisis arising in future.

The other possible option for stimulating economic activity would come through the old Keynesian approach whereby the Government would directly increase its own spending in certain selected areas. However there is a problem for Ireland in all this in that we no longer have our own economic destiny in our hands. So whatever measures we take have to receive the broad approval of our EU masters and international financial markets. And given that state finances are out of control at present with expenditure greatly exceeding revenue, Keynesian prime pumping (however well intentioned) might not meet the necessary approval.

Above all Ireland has to tackle a severe loss in competitiveness due in large part to the excesses of the Celtic tiger. It would be better if we took the necessary courageous steps here in a voluntary manner. Failing this it will indirectly be forced on us in any case through a continued long contraction in our economy.

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