Thursday 29 September 2016

Brendan Keenan: Getting correction course right is nation's most vexing question

Published 30/08/2012 | 05:00

ONCE more unto the breach, dear friends -- and possibly fill it up with the politically dead.

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The latest "understanding" with the EU/ECB/IMF troika makes it clear that the inexorable charge of the fiscal correction programme will continue in December.

But while the amounts involved are not that different from other years -- and less than in the 2009/10 period -- the methods used to extract the money become ever more, um, toxic.

A property tax, more income tax for the lower-paid, and reductions in benefits for pensioners (on which point I should declare an interest) are on the cards. When economists say the tax base should be broadened, people tend to nod sagely. When it actually happens, they dramatically change their tune.

I do not care much for "whatiffery", but there are a lot of facts, and only limited speculation to help imagine what would have happened had Ireland escaped formal bailout, and was dealing with the public finance crisis itself.

The facts are the Coalition's obvious reluctance to go down the road which leads to new kinds of revenues and less generous transfers from one set of citizens to another -- even though, in a crisis like this, the transfers on things like pensions will increasingly be from poorer people to better-off ones.

The reluctance is understandable -- such policies may indeed lead to political death. A reasonable speculation, therefore, is that, left to their own devices, Irish governments would have loaded all the correction on to income and spending taxes and cuts in services. Just like the 1980s.

Some government ministers recognise this, and accept that the troika programme is a better way to go about things. They may even be glad that the bailout allows them to plead innocence before the electorate, blaming it all on the troika.

That is understandable too, but it has dangerous consequences. The consensus view may become that the bailout programme was not only compulsory, but the wrong way to do things. Both theory and the hard evidence of the 1980s say the opposite -- that broadening the tax base and reducing the remarkably high level of transfers is the better way and, if anything, that the proposed changes do not go far enough.

A more difficult question -- where facts are scarce and speculation of little help -- is not about the content of the programme, but the timing. From the beginning, the trade unions and other critics have said that the 2015 target for stabilisation is too tight.

Others have now joined in, and the argument has widened across the eurozone as more countries have got into difficulty.

The Greeks are asking for more time; the Spaniards also, in different ways. Perhaps Ireland is too.

Certainly, the German finance minister seems to think that any reduction in the burden of bank debt might be used to slow the pace of fiscal adjustment.

He might be right, too. Debt cannot be separated from timing. The longer correction takes, the more debt will have accumulated at the end of the process. Lurking behind the timing argument -- and sometimes not even lurking -- is the prospect that the extra debt can be defaulted upon, so that lenders share the burden.

Mr Schaeuble probably has that in mind. It is hard to see why concerns such as his could not be dealt with through negotiation and a revised programme -- although negotiations would have to take place with all the others.

The real question -- especially if there were some reduction in the bank debt burden -- is whether there is any point in prolonging the fiscal agony, just for a bit less agony year by year.

There may well be for governments, in the light of some recent research in Britain. There can be no definite answers to the question of whether to make haste slowly, because of the range of assumptions which have to be made, but researchers at the UK's National Institute of Economic and Social Research made a valiant attempt in their July Economic Review.

They examined the differing effects of waiting until a natural recovery from the crash before starting to correct the budget deficits or, as has been British government policy, getting stuck in at once.

Perhaps the most striking difference between the two approaches -- and the one of most interest to politicians -- is the timescales. Correcting while the economy is depressed means lower growth for the first four years, but higher growth for the following six years, when the delayed correction is in force.

Unemployment lags, as always. It is higher for seven years than under the delayed process, but starts falling after three years, whereas it begins climbing six years from the crash under the slower correction.

It would be a mistake to take such figures too literally, as the authors themselves warn. The UK economy seems to be doing worse than the NIESR model predicts, although unemployment is better. Existing models may not work too well in these unprecedented circumstances; equally, UK growth figures may be eventually revised upwards closer to the forecasts.

But if the trends are roughly right, and (an even bigger assumption) if they applied to the Irish economy, a government which sets about the task quickly may see its successor in the next parliament enjoy the benefits of its efforts. That has happened before too.

British Chancellor George Osborne may well ponder that, but the unfortunate Irish Government has no such luxury. It also faces endemic problems. Recent analysis from the Central Bank found that, because of the differing structures of economies, Ireland and Greece need more correction for a given reduction in the budget deficit than fellow bailouts Cyprus and Portugal, or teetering Spain.

A 10pc of GDP correction produces just a 3pc improvement in the Irish deficit, the research found (Alas for Greece, raising taxes and cutting spending by 23pc of GDP makes almost no difference to the deficit. Berlin and Frankfurt please copy).

This vulnerability of the Irish public finances was identified years ago, but never enshrined in government policy. It still isn't. One implication is that the new eurozone rules, including a maximum 0.5pc of GDP underlying deficit, may not actually be strict enough for the Irish economy.

In such circumstances, the possible advantages of delaying correction seem to fade away into meaninglessness. Keynes was only joking when he said we are all dead in the long run.

Unless it turns out to be a really long run, most of us will still be alive and it falls to us, unfortunately, to deal with it.

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