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Monday 15 September 2014

Seamus Coffey: Ireland is not in a position to move to zero austerity

Published 24/04/2013 | 12:57

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Finance Ministyer Michael Noonan has ruled out tax cuts in the next Budget

THE economic debate of the recent weeks has centred around arguments that “austerity isn’t working” or claims that “austerity is over”.

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The debate has had national and international contributions. 

Of course, being parochial, many in Ireland infer that all the contributions are applicable to this country.

They are not.

The purpose of austerity is to reduce budget deficits and stabilise public debt ratios.

Austerity is not about reducing unemployment or poverty or about increasing living standards. 

Creating the conditions for improvements in these should be the focus of budgetary policy, but Ireland’s public finances collapsed in 2008 and fixing that became the priority.

In the last five years the cumulative budget deficits sum to nearly €120bn (over 90pc of GNP).

The costly measures introduced in the ill-fated rescue of the Irish banking system have contributed around €40bn to the deficits.

Interest payments over the five years were close to €20bn, with about half due to the debt we carried into the crisis from 2007 (as a result of the last public finance crisis in the 1980s) and the other half due to the debts run up during the current crisis.

Over the past five years government expenditure on making transfer payments to households, paying salaries and pensions to public sector employees, on providing goods and services to the population, and on undertaking public investment has exceeded government revenue by €60bn, €1bn a month.

By far the largest reason for the deficits has been the fact that we are spending more money on government services for ourselves than we are collecting in tax revenue from ourselves, with a significant portion also due to the interest resulting from these deficits.

Future generations will have to service these debts.

The purpose of austerity is to close the gap between revenue and expenditure on government services, known as the primary deficit.

On these grounds austerity is working.  In 2009, the primary deficit was more than €15bn.

This year it will be €4bn.

This improvement is what that austerity was designed to do and it has done so. The remaining €4bn primary deficit also highlights that austerity in Ireland is not over.

We are still overspending on ourselves relative to what we collect in taxes but now it is down to €1bn a quarter.

This has to be eliminated and we have to move to a position where some of the €8bn annual interest bill is covered by current revenue to ensure that the burgeoning debt ratio does not continue to rise.

We can, of course, have a debate in Ireland about how this is achieved but there is no escaping the fact that the budgetary improvement must be continued.

The debate outside Ireland must be viewed in light of the fact that Europe as a whole does not face a budgetary crisis, although some individual countries remain in a precarious position.

For the overall euro area, the primary budget in 2013 will show a surplus of 0.5pc of GDP.

Households in the euro area are paying more in taxes than their governments are spending on services.

The euro area does have a large interest bill to cover but the bloc’s aggregate debt ratio is close to stabilising.

Europe has not reached the limit of austerity.

Europe has reached the point where the goal of austerity has been achieved.

Although some may wish to continue with austerity to reduce debt ratios this need not be the universal priority in the euro area, particularly with a 12pc unemployment rate and moribund economic growth.

The stability achieved allows employment, poverty and living standards to return to their rightful position as the dominant objectives of macroeconomic policy.

These can be helped with a move to a less restrictive budgetary policy which is what Barrosso, and to a lesser extent Economics Commissioner, Olli Rehn, are beginning to promote.

The difficulty is in getting the countries who have the space to increase spending to do so.

As with most things in the euro area the centre of attention is Germany.

This year Germany is expected to run a primary surplus of nearly 2.5pc of GDP.

Germany doesn’t have an unemployment crisis and sees advantages to building up savings and reducing their debt ratio.

The comments by Barrosso, Rehn and others on a shift away from austerity are directed at Europe’s largest economy, Germany.

They are not directed at one of the smallest, Ireland.

In an Irish context there have been claims that the IMF has changed its mind on austerity.

The IMF is undertaking a review of its assumptions on the impact of austerity and has indicated that the negative employment and income effects of austerity are greater than it previously believed.

But this does not mean it believes that the level of austerity in Ireland was too high or that the austerity to come is too much.

In fact, the IMF has repeatedly said that the pace of adjustment is appropriate and that the €3.1bn of expenditure cuts and tax increases planned for Budget 2014 should be introduced as planned and continued with the €2bn planned for Budget 2015.

The IMF does not think there should be any more austerity than this and they are not saying that austerity in Ireland is over.

Former IMF executive and Irish mission chief, Ashoka Mody, created a bit of a stir a couple of weeks ago when discussing the initial design of the EU/IMF/ECB programme.

He did not say that austerity was not working or that it was not necessary.

He correctly lambasted the unwillingness of the ECB and EU to allow burden-sharing with senior bank bondholders in bust Irish banks.

This should have been done and it would have offered debt benefits to Ireland.

However, burden sharing with bank bondholders would have done nothing for the primary deficit.

The space afforded by a lower debt may have increased the timeframe over which the deficit reduction needed to be achieved but it would still have to be done.

This is something Paul Krugman has advocated when he calls for “a softening of austerity demands on the periphery - not zero austerity, but less”.

Ireland is not in a position to move to zero austerity.

We are moving in the right direction but the difficult journey is not yet complete.

Two years ago the economy was staring into the abyss with many holding the view that a sovereign default was inevitable.

The prospect of default no longer casts such a dark shadow and the calls to loosen budgetary policy are a clear symbol of the improved financial outlook for the country.

When we move to a primary balance and have begun to reduce the debt ratio we can be part of the broader international debate.

That will happen in 2015 but we still have a primary deficit and a rising debt ratio that can only be remedied by domestic policy.

Austerity in Ireland is not over but the end is in sight.

Seamus Coffey is an economics lecturer at UCC.

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