Tuesday 25 October 2016

On borrowed time: Ireland's deceptive debt numbers

Government debt is back under 100pc of GDP, but with pensions and other liabilities excluded, Dan White asks, how realistic are the stats?

Published 24/01/2016 | 02:30

Ireland's gross government debt fell below 100pc of GDP, according to figures released by the CSO last week. The Irish state owed its creditors €204bn at the end of September 2015, 99.4pc of our GDP.

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While the reduction in Ireland's debt/GDP ratio, which peaked at over 125pc of GDP in the first half of 2013, is welcome, there is unfortunately less to it than meets the eye. When analysing government debt statistics, what is excluded is often just as important as what is included.

The biggest item excluded from the government debt statistics is of course the value of future pension liabilities. These are enormous. The Department of Public Expenditure and Reform estimates that the total accrued liability of public service occupational pension schemes were €98bn at the end of 2012.

While this was down from €116bn at the end of 2009, these future pension liabilities would, on their own, increase gross government debt by almost 50pc and push Ireland's debt/GDP ratio back up to almost 150pc.

However, this might not even be the half of it. While the value of future public service occupational pension schemes has been calculated, the value of future state contributory and non-contributory pensions has not. How much is the value of these liabilities? With the number of over-65s set to increase from 532,000 in 2011 to 861,000 by 2026 and 1.33 million by 2046, we need to know.

Unfortunately we won't find out until at least next year when the CSO is due to publish a figure, but it is already clear that the number will be a large one, a very large one. In 2012, TCD economics professor Brian Lucey calculated that the value of future non-contributory pension liabilities at somewhere between €25bn and €75bn.

And it isn't just public sector pension liabilities that could yet end up on the Government's books. Irish pension funds are in rag order with actuarial consultants LCP estimating that the combined deficits of the largest Irish companies had climbed to €5.8bn by the end of 2014. How much if any of these deficits will the State end up picking up the tab for courtesy of the 2013 Waterford Glass judgment?

When seeking to estimate the extent of the possible liabilities to which the state is exposed, one is confronted by a situation of, to paraphrase former US Defence Secretary Donald Rumsfeld, of known knowns, known unknowns and unknown unknowns.

Future pensions will, after the estimated figure for state contributory and non-contributory pension liabilities are published next year, largely fall into the known knowns category. It will be a very big number but at least we will have some idea of what it is and can begin to plan to meet these obligations in the decades ahead.

Another known known is public private partnerships. For politicians, the beauty of using private sector capital to fund public capital projects such as roads, schools, hospitals, etc is that the cost can be kept off the government's books and, so long as certain not-very-onerous conditions are satisfied, European Statistics agency Eurostat will not include it in state's borrowing figures.

While PPPs allow the cost of such projects to be "parked", the liability doesn't disappear and can, in certain circumstances, come back on to the government's books once again. This isn't an exclusively theoretical concern. In recent years the Government was forced to make payments to some road-building PPPs when toll revenues failed to reach the agreed level.

The State paid the operators of the M3 toll motorway and the Limerick Tunnel a total of €8m in 2013 and €7.5m in 2014 and now expects to pay them a further €48m between 2015 and 2020. How many other such PPP nasties have yet to come to light?

The CSO puts the potential liability to the exchequer from PPPs at €3.7bn with a further €25.1bn of guarantees bringing the total potential exposure from such contingent liabilities to €28.8bn. However, it is important to remember that this is very much a worst-case scenario and all of these potential liabilities would only fall back on the state in the unlikely event of every PPP turning sour.

If we take the €98bn figure for future state occupational pension liabilities, add the €28.8bn of contingent liabilities and the mid-figure for Professor Lucey's €25bn-€75bn estimate for non-contributory pension liabilities, ie €50bn, then gross government debt increases by almost €177bn, raising the debt/GDP ratio from "only" 99.4pc to a totally unsustainable 185pc. It may be scant consolation but Ireland is by no means unique in the potentially misleading way in which it presents its government debt statistics. When pressed on the issue, official sources point out that the format is agreed with Eurostat and the OECD. This ensures that the borrowing statistics produced by all of the EU and other developed countries are comparable.

But surely the fact that everyone else is at it doesn't make it right? The thinking behind not including items such as future pension liabilities in the official government debt statistics is that the money has yet to be borrowed to meet these obligations and that many decades in the future, the government of the day might be able to pay these pensions from its day-to-day revenues.

That's just the known knowns. If we were to seek out known unknowns we wouldn't have far to look. As anyone who has spent the last two months in this country can deduce for themselves, there is something going on with our weather. Unfortunately, instead of the Mediterranean summers that many of us were hoping for, climate change has for Ireland meant wetter, stormier winters instead.

"We are very clearly in a situation where there is some climate change going on. There is going to be a cost to future-proofing the country against climate change. It is already clear that the insurance industry won't be able to do this. The state is going to have to do it", says Professor Lucey.

What might the future costs to Ireland of climate change be? A study published by the University of Cambridge's Centre of Climate Change Mitigation in September 2015 estimated the total global costs of climate change at $369 trillion (€334 trillion at the current exchange rate) by the end of the next century. How much of these costs will have to be borne by this country? Ireland's GDP is about one-third of one per cent of global GDP. If Ireland were to end up paying a similar percentage of global climate change costs then the tab would be an enormous €1.1 trillion, over five times current Irish GDP.

So should the total cost to Ireland of future climate change costs be added to the government debt figure? Almost certainly not. We are taking about a period of 185 years, during which many of these costs will fall on the private sector in the form of improved construction techniques, better building materials, greater energy efficiency and tougher planning regulations. In addition Ireland will almost certainly be a much, much wealthier country, and thus much better able to afford the cost of climate change, by 2200.

A far more realistic way of gauging the likely impact of future climate change costs is almost certainly provided by the EU-funded ClimateCost project which in 2014 put the cost to European countries of climate change at 4pc of GDP. In Ireland's case that would work out at something like €8bn a year.

However, while it would be unrealistic to add the full cost of adapting to climate change to the government debt figure there is little doubt but that the state will be on the hook for a substantial proportion of the costs over the coming decades. Anyone seeking to assess Ireland's true indebtedness level will have to make at least some provision for future climate change costs.

And then there are the unknown unknowns. By their very nature these are unknown; a massive cyber-attack, a shooting war between China and the United States, the Cumbre Vieja volcano in the Canaries collapsing into the ocean triggering a massive Atlantic tsunami perhaps. Before one dismisses these potential risks as fanciful, just remember that anyone who predicted even a decade ago that the Irish banks would go bust and end up costing the taxpayer €64bn would have been dismissed at the time as being crazy.

All of which demonstrates that calculating the true level of any government's indebtedness is very much an inexact science. While it is relatively easy to measure actual government borrowing, quantifying the full extent of other potential liabilities is much, much more difficult.

As Professor Lucey observes, governments almost never repay the nominal amount which they have borrowed. The best we can hope for is that, as happened in this country in the nineties and early-to-mid noughties, economic growth kicks in and the debt gradually withers to an insignificant proportion of the value of economic output.

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