Fiscal Policy in the Global Environment: Case Study on Ireland Economic Policy
The objective of this work is to examine the key aims of fiscal policy and to determine what the appropriate fiscal policy stance is for the Irish economy at the present.
Research questions in this study include those stated as follows:
(1) What are the key aims of fiscal policy?
(2) What is the appropriate fiscal policy stance for the Irish economy at this time?
The Aims of Fiscal Policy
The role played by fiscal policy in economies that are developed include maintaining full employment as well as bringing about stabilization to growth. Also included in the aims of fiscal policy are the following: (1) mobilization of resources; (2) acceleration of economic growth; (3) minimization of the inequalities of income and wealth; (4) increasing employment opportunities; and (5) price stability. (Buzzle.com, 2011) Limitations of fiscal policy in developing countries include tax structures that are inflexible. Other reasons for limitations of fiscal policy include: (1) a great portion of economies in developing countries are "non-monetized" which results in the government fiscal measures being ineffective; (2) a lack of statistical data in relation to income, expenditure, savings, investment and employment creates challenges for public authorities for form a fiscal policy that is rational and effective; (3) there is no chance for success in fiscal policy unless the citizens are able to comprehend the implications of that fiscal policy and to cooperate with the implementation of that fiscal policy; (4) large-scale tax evasion; and (5) the requirement of administration that is efficient is absent. (Buzzle.com, 2011)
II. The Case of Ireland
The work of Dr. Noel Palmer entitled "Macroeconomic Aspects of the Irish Economy" reports that the instruments of macroeconomic policy are those which are available to governments that are economically independent and are of the nature that help in gaining the macroeconomic objectives which include: (1) monetary policy or the control of interest rates and the supply of money; (2) exchange rate policy or the change or allowing of change to the foreign exchange value of Irish currency; and (3) fiscal policy or any conscious action by the government which affects the magnitude, structure, or timing of government revenue (taxation) or expenditure. (Palmer, nd)
Ireland, a member of the European Central Bank has no discretion to pursue economic policies that are independent in nature and additionally reported is that Ireland is now a member of the Euro zone and monetary policy for the Euro zone is set by the EBC. The ECB has as its principal objective the integrity of the currency, which translates into the control of inflation since inflation erodes the value of the currency." (Palmer, nd) Therefore, the general level of interest rates that relates to the Irish economy is determined by the ECB and decisions as to the appropriate levels of interest rates which are based on confining movements in the value of the Euro within non-inflationary limits." (Palmer, nd)
The one fiscal instrument of macroeconomic policy that is still at the government's discretion is that of fiscal policy. There is concern expressed by the ECB that the government may decide to engage in deficit budgeting for the purpose of economic stimulation. Ireland is partner to a Pact that maintains that a national budget deficit is considered excessive when it is in excess of 3% of the GDP of a country and results in the imposition of financial penalties when a country is in violation of these guidelines. (Palmer, nd, paraphrased) The primary features of a monetary union are the following features: (1) The complete liberalization of capital transactions and full integration of banking and other financial markets; (2) The irreversible locking of exchange rates; (3) Complete convertibility of currencies; and (4) The introduction of a single currency; (5) The conduct of a uniform monetary and exchange rate policy. (Palmer, nd)
O'Donnell (1998) states that the "most significant feature of Ireland's adjustment to European market integration was a substantial inter-industry adjustment" and that the nature of this adjustment "is best illustrated by identifying three groups of industries, each of which had a different pattern of response." Those three groups of industries are stated to include: (1) Foreign-owned, grant-aided, export-orientated industries; (2) Industries in which the domestic market is naturally protected; and (3) Internationally traded, relatively large-scale, industries. (O'Donnell, 1998)
O'Donnell states that the first group or that of the chemical, pharmaceutical and electronic machinery are such that "experienced continuous expansion, rapid export growth, throughout the period of EC/EU membership. Because of their reliance on the domestic market, the industries in the second group (which include paper and printing, drink and tobacco, some food industries and small-scale metal and woodworking firms), faired well in the 1970's -- when domestic demand was buoyant -- but suffered severe contraction in the 1980's, when the Irish economy languished in prolonged recession. For example, between 1980 and 1987, employment in furniture declined by 25 per cent, in metal articles by 33 per cent, in dairy products by 25 per cent." (O'Donnell, 1998)
Many of Ireland's large manufacturing firms were in the third group, which included textiles, clothing, footwear, leather, parts of chemicals, motor vehicles and parts, electrical engineering, shipbuilding, bread, biscuits, flower and confectionery and other food industries. When tariff protection was removed, there was rapid import penetration and in an environment that was highly competitive, that resulted in secular decline in these industries. The removal of these industries resulted in them being replaced by firms that were foreign-owned and high-technology segments of chemicals, pharmaceuticals and electrical machinery which is stated to have "constituted a much more significant inter-industry adjustment then was found in the case of the EEC6 or, indeed, in Britain or Denmark." (Palmer, nd)
It created an enormous increase in unemployment, and is the major source of the continuing problem of long-term unemployment and poverty." (O'Donnell, 1998) Stated as the fourth effect of market integration or that of industrial concentration was not something that observed in Ireland's industry and instead there was observed a "...fragmentation of indigenous manufacturing industry. The opening of trade induced a sharp reduction in average manufacturing firm size, thereby reversing a slow process of industry concentration that had operated since the 1930s. This seemed to further reduce the possibility of building a large-scale indigenous industrial sector." (O'Donnell, 1998)
This adjustment was radical in nature and is stated to have been interpreted, "...as the response of firms to European integration." (O'Donnell, 1998) Since the basic scale of the firm in Ireland was very small in comparison to competitors and due to other various competitive disadvantages, the relief of indigenous industries was only temporary in nature. Due to the pressure for further adjustment, there were forced contractions of labor and output and the result is that a long path of decline ensued. Richard Doyle and Junior Sophister report in the work entitled "Fiscal Policy in Post-Independence Ireland" that the past ten years have observed a "restoration of the public finances" in Ireland." (1998) Fiscal policy is stated to be left with "its integrity but in a limited state." (Doyle and Sophister, 1998)
It is reported that the Irish economy presently suffers from three primary challenges, which must be addressed if the economy is to return to a growth path that is sustainable. Those three challenges are: (1) the serious loss of competitiveness, which the economy experienced between 2003 and 2008, reflected in the burgeoning balance of payments deficit; (2) the structural imbalance in the government accounts; and (3) the restoration of order to the banking system. (Bergin, Conefrey, Fitzgerald and Kearney, 2009)
The problems experienced presently in the Irish economy are due to serious problems reported to be "a legacy of past policy mistakes culminating with the building and construction bubble" and which are of the nature that must be addressed by tough measures on fiscal policy and a need for competitiveness to be restored. There are reported to be four main sources from which the reduction in the output growth potential of the Irish economy derives including: (1) reduction in EU and U.S. potential growth; (2) reduction expected capital stock in Ireland due to low investment; (3) the expected higher long-run cost of capital; and (4) the burden of government debt that will be higher due to recession. World recovery, once having gained a momentum will affect Ireland but this is reported to only have the capacity to "reflect a restoration of some of the losses sustained over the period 2008-10." (Bergin, Conefrey, Fitzgerald and Kearney, 2009)
The Irish economy is presently operating within a financial system that is global and the largest part of government funding is stated to be likely "come from abroad while the bulk of debt repayment by the banking system will be to its external creditors." (Bergin, Conefrey, Fitzgerald and Kearney, 2009) Beyond 2010, it is stated that a recovery in the economy of Ireland is likely to occur "through a recovery in the world demand that increases…