Wednesday 21 March 2018

Dan O'Brien: Government's risk analysis in the Budget is too rosy

Minister for Finance Paschal Donohoe with Budget 2018 last week. Photo: INM
Minister for Finance Paschal Donohoe with Budget 2018 last week. Photo: INM
Dan O'Brien

Dan O'Brien

A good instinct and capacity to assess risks and opportunities is one of the most important abilities a person can have. That is as true in personal life as it is in business, and many other fields besides.

As governments are by nature less entrepreneurial than other actors, the capacity of states to assess risks and threats is more important than the capacity to weigh up opportunities.

The Irish State has not historically been strong on foresight in general, and risk assessment in particular. Too often it has only been when an issue reaches crisis point that the system rouses itself to act. For instance, a big part of the explanation for Ireland's property crash and long recession was risk blindness.

From the bank regulator to the mandarins in the Department of Finance, the long boom gradually sidelined those who raised issues of risk. Politicians, almost by nature, are ill-disposed to being told to be cautious. They prefer announcing the delivery of all manner of projects, services, welfare benefits and tax cuts to voters. Nothing epitomised this quite like the statement of former Taoiseach, Bertie Ahern, that those who had concerns during the Bubble should end their own lives.

The failure to assess risks is one lesson that has been learnt, at least in part, from the crisis. There is now a yearly national risk-assessment study and annual budgets devote considerable attention to the matter. Last week's Budget was no exception. It looked at a very wide range of risks.

Foundational from a budget perspective is what happens to the economy. The Department of Finance adjudges international downside risks to the Irish economy as having declined in recent months. It is hard to disagree. That assessment reflects a commonly held view - just last week the International Monetary Fund upgraded (a little) its near-term forecast for global economic growth.

A combination of factors have contributed to such assessments. The economy of the eurozone has surprised to the upside this year. Although the UK economy cooled in the first half of 2017, a feared recession, following the Brexit referendum, has not materialised. Nor have fears of much greater protectionism from across the Atlantic that might have directly affected the Republic's economy. Northern Ireland's economy could be hit hard by the US-Canada dispute involving Bombardier, but there are two sides to that story and the US decision to slap tariffs on the Canadian plane-maker is not a madcap decision thought up by the current incumbent in the White House.

What seems slightly odd about the Department's 2018 GDP forecast is that it sees the balance of risks - to the upside and to the downside - as being symmetrical. In other words, it sees the chances of growth exceeding expectations next year as being the same as an undershoot. Given that far more of the many risks identified by the mandarins would have negative consequences for the economy if they materialised, that doesn't look right.

As is standard practice with risk assessment, the analysis looks at both the likelihood and the impact of each risk. High probability, high-impact events are the ones you really need to watch.

The department's analysts think that exchange-rate realignment is the biggest threat to economic growth outlook. They believe there is both a high likelihood of such an event and that "the recent appreciation of the euro sterling exchange rate will, if sustained, pose significant challenges for Irish exports to the UK (especially for more 'traditional' sectors)".

If anything, these comments understate the risk. It is very easy to see sterling not just staying where it is vis-a-vis the euro, but moving to parity over the coming year. Britain's large international balance of payments deficit suggests that sterling is still overvalued even at current levels.

If the UK economy were to slow further and/or currency markets began to price in a harder Brexit, there would be further downward pressure on the currency. If an election were to be called, something that looks possible given the madhouse nature of British politics these days, there could well be a run on the pound as a wall of money exits the UK for fear of a Jeremy Corbyn-led government.

Of the high-risk, high-impact threats to the public finances, the department believes only one falls into this category - financial penalties for failing to comply with climate change targets agreed at EU level. On top of that, it assess the risk of further penalties for failing to meet (entirely separate) renewable energy targets as a high probability, but medium risk.

As it happens, Joseph Curtin, my colleague at the Institute for International and European Affairs who specialises in such matters, believes that missing the second target could end up costing the taxpayer more than missing the first.

Risks not included in last week's Budget 2018 analysis are those of a more political nature, understandably enough perhaps. A collapse of the government followed by a hung Dail is not discussed, nor is there any mention of an increasingly erratic US president who might seek to have American companies based in Ireland repatriate jobs (a mention is made of the "highly concentrated production base" centred around a "small number of high-tech sectors").

Another much talked about risk in corporate Ireland and the media also goes undiscussed. Prospects of a Europe-driven change to the corporation tax system are often talked of in Ireland as threatening growth - by driving multinationals away - and the public finances - by reducing the billions of euro foreign companies now pay annually in corporation tax.

The reason the department doesn't include this risk, your columnist was informed upon further enquiry, is because it is official policy to deploy the veto Ireland wields around the table in Brussels if any change is proposed that could cut receipts. That hard-line position is based on a strong position in law - vetoes contained in EU treaties are not just legal niceties.

The department is right to play down the risk to Ireland's corporation tax regime. But it may not be so wise to dismiss it entirely given that some tough trade-offs may be coming down the line.

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