Business Irish

Saturday 10 December 2016

Worries over cuts being too severe for health of the economy are real

Published 14/10/2010 | 05:00

We are all financial sado-mascohists these days, it seems. The Government wants to reduce spending/raise taxes by a frightening €4.3bn, but a leading member of Fine Gael says throw caution to the wind and go for over €6bn of cuts and tax hikes.

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Does the difference between the two figures make any difference? Surely it is all about convincing the bond market and the more you cut/raise, the more convincing you are doing.

Unfortunately, all the evidence suggests that the scale and pace with which you tackle the deficit matters a great deal.

In fact, the Fine Gael idea of front-loading may not convince those you are trying to convince at all, because they realise that growth will also be needed to solve your long-term budgetary problems and growth would tumble if an overly zealous approach is taken in just one 12-month period, all the international evidence suggests.

The pay-off in terms of winning bond market approval, after all the pain, can also be comparatively small. For example, each 1pc of GDP cut only drops bond yields by 0.15pc, the IMF calculates.

Of course in Ireland's case, there is an overall worry about the whole economy imploding, so any sense that Ireland has pulled back from the brink is likely to produce larger than normal benefits.

Of course the budgetary adjustment has to take place and soon. We shouldn't only do it because of the bond market, we should do it because it is the right thing to do.

But the debate is how much of it should be done this year. The short-term benefits of taking huge pain up front do not seem to be very large. For example, every 1pc of GDP you hack out raises the unemployment rate by 0.3pc, the IMF has also calculated.

Leo Varadkar, the Fine Gael frontbencher, is talking about hacking away almost 5pc of the country's entire GDP, so the rise in unemployment under his scenario would be large.

Of course, the long-term effects of a 'short sharp shock' approach are arguably better, but will the electorate appreciate those? A lot of the arguments in favour of piling on the pain and misery upfront are predicated on Ireland having a far worse deficit than virtually any other nation on earth.

The reality is far more different. Taking out the banks, Ireland's deficit this year will be no worse than 11.5pc of GDP. Shocking yes, unsustainable yes, but we should remember that the average deficit for advanced economies around the world is 9pc of GDP.

As the OECD said last week, there is a danger of over-reaction to the recently high government bond yields. These yields were sending Brian Lenihan and his colleagues a clear signal, but that signal was not a green light for Ireland to become the first European country ever to hack out almost 5pc of GDP from its economy in one go.

Growth strategy

Clever analysts on bond desks will realise that a growth strategy also has to play a part in closing a deficit. In fact, Ireland is already missing two of the normal aids used by countries when closing deficits of this size, a devaluation and reducing interest rates.

Interest rates are already at rock bottom, at least in terms of ECB base rates, and a devaluation is not on the cards due to eurozone membership. A third element is also not present, other countries are not growing rapidly.

In that context cutting at levels never tried before in just one financial year would be reckless in the extreme.

Ultimately it is the long-term plan, the four-year plan, that will do the convincing of the bond market, not the short-term knee jerk statements of some opposition spokespeople.

Irish Independent

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