We can turn around our economy if we keep on making the hard choices
Published 20/05/2010 | 05:00
IMAGINE the humiliation felt by the average Greek citizen. It cannot be good for the self-confidence of a nation. Yet Ireland avoided the same fate by a slim margin; perhaps 18 months.
If we had not implemented emergency Budgets in October 2008 and April 2009, as well as the public service pension levy of February 2009 we probably would have needed a bailout.
Some may counter that de facto loss of control of fiscal policy (the likely conditions tied to emergency funding in a bailout) would do no harm, given the hole the Government had dug. But household and business sentiment would suffer. And many multinational companies based here may have reassessed their long-term commitment if Ireland had failed to extricate itself without assistance.
Whatever about preventing the concession of full control of public finances to outside agents, all euro area countries are likely to be subject to peer review in future. That is no bad thing.
If adopted, the European Commission's document entitled 'Reinforcing Economic Policy Co-ordination' could be a watershed for the common currency zone. But the political hurdle for full approval is high. And whether it will work in the good times is probably the salient test. European Commission admonishment about Irish fiscal decisions largely disappeared after 2002.
Much nonsense has been written about Ireland's public finances over the last couple of years. It is the case that the deficit has broken records and debt to GDP may reach 100pc for the first time in 2012. But the country is not 'broke' or 'bankrupt'.
Interest payments on government debt will reach 5.2pc of national income (GNP) next year -- exactly half of the peak of 10.4pc in 1985. Nominal interest rates are much lower than back then.
Furthermore, Ireland's dependency ratio (the numbers in the young and old age groups as a percentage of the working age population) is the lowest in the EU and will remain so until at least 2020. Ireland is not exposed to an imminent pension time-bomb.
Reaching debt sustainability is the medium-term goal. Yet it is probably only three years away. The headline deficit numbers will look ugly in 2010 and 2011 thanks mainly to hits from Anglo Irish Bank. But it is the 'primary' deficit -- the deficit excluding interest payments -- that matters.
It is all that we can really control; the rest depends in large part on the vagaries of the bond market. By 2013, the primary deficit may drop to less than 2pc of GDP. At that level, nominal growth in the economy may exceed the interest rate by enough of a margin to stop government debt from rising any further as a share of annual output.
Retaining the confidence of lenders is paramount, as the recent Greek debacle has shown. Nonetheless, Greece is far more dependent on the kindness of strangers than is Ireland. It is running a large current account deficit with the rest of the world (its external trade imbalance rather than its government deficit) of about 11pc of GDP.
The corollary of that is that we need to suck in money from overseas to fund our overextended lifestyle. Ireland has reduced its current account deficit to 3.5pc of GDP. As a result, our ongoing reliance on overseas funding is shrinking. Households and businesses are almost living within their means again.
The private sector cut its spending dramatically in 2008 and early 2009, leaving more room to finance the budget deficit; Greece has to follow suit.
The more that competitiveness is improved, the more the funding situation for Ireland will improve. Large gains have already been made; the Irish price level is 6pc nearer to the euro area average than at the peak of the boom. Compared with the UK, the gap has narrowed by almost 10pc. All that is required now is some strengthening of the pound.
As for the public finances, it is a multi-year challenge to regain ground that was lost to our trading partners.
To reduce trade imbalances between countries in the euro area, and safeguard its future, the EU Commission's new fiscal policy framework rightly highlights the need for major structural reform. In fact, it envisages peer surveillance in this area too. Mediterranean Europe falls down badly on this score, limiting the potential for export-led growth. Labour markets are too inflexible, adoption of new technologies too slow, and the public sector accounts for far too much of the economy.
Ireland has a big head-start in this area. It ranks in the top five in the OECD for labour market flexibility, the cost of setting up a business and product market regulation. These competitive advantages, allied to our attractive corporation tax regime have made Ireland an outstanding performer in the provision of internationally traded services.
But the Irish economy can still function more freely. Many professions are too protected. Bankruptcy laws require reform. And the minimum wage is far too high. The correct objective is more people in employment, even if that means a somewhat lower income for the average worker.
Lastly, there is the small matter of Budget 2011. Complacency is the greatest threat at this point. Politically unpopular measures have been enforced over the last 18 months, but that period cannot yet be consigned to history.
The Government has pledged a €3bn fiscal consolidation for next year. We know that €1bn will be sourced from the capital budget, even though that is the fastest way to cut employment. So where will the other €2bn come from?
It is important that the Government tells us the answer soon, ideally before the summer Dail recess. This year, the bond market has taught harsh lessons about transparency and keeping ahead of events.
Assuming that the Croke Park agreement holds, and the Government, holds the line on no further income tax rate hikes, the menu of best options is threefold.
First, up to €1bn of expenditure savings must be found from outsourcing, changes to work practices and procurement methods -- all of which follow from the outline Croke Park agreement. Many of these possibilities were forensically detailed by Colm McCarthy's group last year.
Second, the property tax has been laid out by the Commission on Taxation, yet we still await the database. It will be fiercely unpopular -- and the older age groups who have the most housing equity also vote the most -- but it is the best taxation option.
Third, broadening the tax base has to be considered given that half of all employees pay no income tax. Reversing policy in this area won't go down well, but up to €1bn in revenue is needed.
At a time when the Spanish, Greek and Portuguese governments are becoming more hardline, Ireland cannot be seen to be going soft.