News Stephen Kinsella

Thursday 2 October 2014

We'll put up with anything, but Budget had better be bungle-free

Published 01/10/2013 | 17:00

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Finance Minister Michael Noonan presenting Budget 2013 last year

The Budget will show us who we really are as a society. October 15 is going to be a big day. We will learn how much austerity the country will have to endure, based on the projections from September's tax and expenditure data. As you read these words, the Departments of Finance and Expenditure and Reform are poring over those numbers to gauge exactly how much pain the economy can take.

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How much can you withdraw from the economy in government expenditure and increased taxes and still have a prayer of growing the economy enough to pay down the debt run up over the past five years? The Government has, in fairness, been careful to understand the distributional consequences of cuts on every level of society. It will be important that in this latest round of cuts we see exactly who is affected, and by how much.

Recent work by Tim Callan of the ESRI has shown the overall reduction in income in Ireland was greatest for the top income groups over Budgets 2009 to 2013, so the collapse and recovery of the economy has been managed in a relatively fair way. The ESRI also found that losses for the bottom income groups were greater than they previously estimated. Everyone has borne some pain.

We are told there is light at the end of the tunnel when it comes to austerity policies; that we are more than 80pc through the painful fiscal adjustment necessary to balance the public finances and get taxation roughly equivalent to expenditure. But what happens if the light at the end of the tunnel turns out to be a big train?

The economy is still weak. Growth over the medium-term has been non-existent, and domestic demand has been flat since 2010. The ESRI forecasts domestic demand will fall this year and next. This means employment growth will be limited, and unemployment will only fall through emigration or people deciding to move out of the workforce. Debt is still high, with the ratio of household disposable income to national output twice as high in 2012 as the US and higher than Germany, Portugal and Spain. Recent surveys by the Central Statistics Office show Irish people have almost no savings, with the young particularly vulnerable to any kind of adverse shock.

Ireland is back in the bond markets, borrowing again as normal. The promissory notes are a thing of the past, as is Anglo Irish Bank, the bondholders and much of what made up what Michael Noonan called "toxic language" is behind us. But the mortgage crisis is very real and the banks are still in trouble, but reducing their loan to deposit ratios quickly.

The seeds of a recovery are there, but the Budget, if it is too harsh or overly impacts consumption and demand, will stall it. Retail figures are not good, and wages in many sectors have fallen. Investment is positive again for the first time in years, so this might represent the first evidence of confidence returning to the economy. Or it may not – these data are very noisy, and it is difficult to see where major trends end and new ones begin. But a Budget that aims for maximum extraction on the basis of what Sebastian Barnes of the Irish Fiscal Advisory Council called "a buffer" should not be contemplated.

As a small open economy, Ireland is subject to shocks it has absolutely no control over, including Italian political turmoil changing our bond yields and interrupting our exit from the bailout; a shutdown of the US government causing a currency spike and a resultant drop in export volume for Irish businesses; a rapidly decelerating Chinese economy; and the UK sliding into a prolonged recession.

Our situation is precarious, so our policy-makers should tread lightly when designing this latest austerity Budget. Brown University's Mark Blyth recently defined austerity as: ". . . cutting the state's budget to stabilise public finances, restore competitiveness through wage cuts and create better investment expectations by lowering future tax burdens".

Ireland's exit velocity from its bailout is based crucially on how it reacts to austerity policies. Has Ireland restored its public finances yet? No, but we're on track. Has it restored its competitiveness through wage cuts? Partially, yes. Have investment expectations been enhanced? Not at all. Ireland's future tax burden is alarmingly high. Robust growth will be needed to service interest costs of all the debt we've run up. In 2012, for example, simply servicing our national debt cost us more than 15pc of our tax revenue.

The next generation will have to bear up under high taxes unless productivity levels shoot up. The real reason Ireland's borrowing costs are down is because international investors believe the Irish will put up with almost anything, and hence they will get their money back if they lend to us.

If the Government gets the forthcoming Budget wrong, we may find out whether the Irish people will, in the end, put up with anything.

Stephen Kinsella is senior lecturer in economics at the University of Limerick

Irish Independent

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