Coalition must ignore polls and stick to €2bn in cuts
Budget will give Government a real chance to bring deficit in sight of 0pc by 2016 if it resists siren calls to loosen policy
Published 03/08/2014 | 02:30
Given the recent upturn in tax revenues and favourable employment trends, it may be possible for the Government in October's Budget to hit the 2015 target, a deficit below 3pc of GDP, without the full €2bn in expenditure cuts and tax increases that had been pencilled in. This morning's opinion poll from Millward Brown suggests that 45pc of voters think budgetary policy should indeed be relaxed, with only about a quarter in favour of the full €2bn adjustment.
Politicians regularly assert that they pay no attention to opinion polls and they should certainly pay no attention to this one. If the favourable trends continue and the Government sticks to the €2bn figure, the deficit should be under 2pc next year, and in sight of zero the following year. It would be really foolish, on the back of favourable trends that are not yet clearly established, to recoil from the prospect of actually getting ahead of the curve for a change.
It would also be in conflict with advice to the Government from the European Commission, the ECB, the OECD, the IMF, the Central Bank and its own Fiscal Council, all of whom have recommended that the €2bn adjustment be implemented.
The only voices urging a loosening of policy are the employers' group IBEC and the trade unions. As a rule of thumb, experience teaches that it is best to think twice whenever the employers and the unions are in agreement on macroeconomic policy. They are saying, in effect, that any incipient improvement in Ireland's deficit and debt outlook should be choked off instantly through a loosening of policy. Regardless of the debt overhang and myriad downside risks to the economic outlook, the social partners want no unexpected penny in tax revenues to go unspent.
Given the length and depth of the recession since 2007, any country in a position to do so should be contemplating running fiscal deficits for a while. Anybody who thinks that Ireland is in this happy position has not been paying attention to the evolution of the debt burden. With benefit of some data revisions, the Irish state debt using the Eurostat definition has reached about 116pc of Gross Domestic Product (GDP). Unfortunately, there are lots of difficulties with the Eurostat definition of the debt burden, not least the inconvenient fact that Ireland's national income, which measures better the tax base available to finance the debt, is considerably lower than GDP. When the debt is expressed as a percentage of national income (GNP), the number comes out at 136pc. This is the second-highest in the EU after Greece, a country widely expected to require a further debt write-off if it is to regain sustainability in its public finances. Bluntly, it is debatable whether Ireland's debt will prove to be sustainable, notwithstanding the recent reduction in interest rates on government borrowing.
No country can be comfortable with sovereign debt exceeding 100pc of national income and it is not wise to be content with much above 50pc or 60pc. Ireland will need to run actual budget surpluses of at least 2pc or 3pc of income for 15 or 20 years in order to get the debt ratio back to safe harbour. In its recent Fiscal Monitor, the IMF gives calculations for the surpluses required to bring the debt ratio down to 60pc using, interestingly, 2030 as the target date. Once a surplus is achieved, and provided modest surpluses can be delivered year after year, there is no need for continuing "austerity" in the sense of perpetual tightening of budgetary policy, a point widely, and wilfully, misunderstood. Until the objective of budget surplus has been achieved, an outcome which is finally in view, there is something perverse about advising politicians to shy away from a move closer to national solvency.
The appearance of a more relaxed attitude to the Irish debt overhang is related to the extraordinary bull market in European sovereign debt which has been in full flood since the summer of 2012, when the European Central Bank announced its intention to backstop the eurozone government bond market. Investors have been comforted by the perception of a 'Draghi put', that is, an option to sell their government bonds to ECB president Mario Draghi should things go wrong. Their faith in the ECB has yet to be tested however. Draghi's announcement was so effective in restoring confidence that not a single bond has had to be purchased. However, his horse, called Outright Monetary Transactions, is an unraced three-year-old, of impeccable pedigree, expertly trained and with an experienced rider on board. But this horse has yet to see a racecourse.
The last time Ireland found itself with an excessive debt burden, a quarter of a century ago, the lessons were learned and the slow process of regaining balance in the public finances was willingly embraced.
A counter-example, a country which saw the debt burden exceed 100pc of GDP and left it there, is Italy. Today Italy's debt equals about 135pc of GDP and would look very difficult to sustain were it not for the expectation that the ECB would stand ready to buy if things go wrong. One of the things that can go wrong is economic stagnation. High debt burdens are manageable if the economy expands and yields a growing harvest of taxes.
Since state debt is fixed in nominal terms, a little inflation helps too, since it chips away at the real burden of the debt. Italy is going nowhere on both counts. The economy has not shown any real growth for a decade. The most recent annual inflation figure is a nice fat zero. With no growth and no inflation, the budget will not ease into surplus under its own steam. It just so happens that Italy has the largest government bond market in the eurozone and Mario Draghi's backstop to the eurozone bond market will face its first big test if things go wrong in Italy. Any intervention there would have to be on a very large scale and there will be intense opposition from various quarters, particularly in Germany. The unraced three-year-old could be making its first appearance at the Epsom Derby.
A recent paper by two well-known experts on international finance, Barry Eichengreen of the University of California at Berkeley and Ugo Panizza of the University of Geneva, reviews previous episodes in which governments ran large surpluses over long periods, thus reducing sharply their sovereign debt burdens. They conclude that such episodes are rare and often explicable in terms of special circumstances. They note that whenever politicians perceive a budget surplus in the offing they face immediate pressures to spend the money, either on new or established spending programmes or on tax cuts. One of the countries included in their (short) list of those which ran sustained surpluses over a long period was, as it happens, Ireland, which had amassed a huge debt overhang at the end of the 1980s. But surpluses through the 1990s and right up to the onset of crisis in 2007 were enough to bring the debt ratio down to very low levels.
One of the reasons why these large surpluses were allowed to happen is that government revenue was persistently under-estimated through the boom years, so these surpluses were unplanned (or turned out larger than planned). Had they been fully anticipated, it is a fair bet that they would not have been allowed to happen on the scale that they did.
Professors Eichengreen and Panizza conclude, based on the historical record, that the troubled peripheral eurozone countries, Ireland included, will struggle to run sufficiently large surpluses over long enough periods to get their debt burdens decisively under control. There is nothing to add, other than to note that it will be harder still for governments that run for the hills at the first hint of success, which is the advice of IBEC and ICTU.
The Government needs to take a long view. It was elected to stop the rot, which to a degree it has managed to do, and to restore national solvency, which it has only commenced. There will be many other governments before the Irish public finances are properly under control and meaningful financial sovereignty has been restored. For now, it should keep its nerve, stick to the adjustment target and ignore the siren voices.