Tuesday 20 November 2018

Debt and deficits diverge as financial Brexit looms

A general recession, perhaps coming from the USA, perhaps caused by a hostile Brexit, might see Ireland’s debt burden actually increase in the next five years
A general recession, perhaps coming from the USA, perhaps caused by a hostile Brexit, might see Ireland’s debt burden actually increase in the next five years
Brendan Keenan

Brendan Keenan

As the old saying goes, there is more than one way to kill a cat, and choking it with cream, while apparently kinder, may not be the most effective.

Some unlikely support for this adage comes in last week's analysis of the public finances by the Fiscal Advisory Council (IFAC). Every country had to deal with the fat-tailed cat that was the Great Recession, but everyone had a different animal and ways of dispatching it differed greatly too.

The international comparisons in the report have particularly telling data on employment. Nobody took a worse mauling in the crash than Ireland, with a 15pc reduction in jobs. Employment fell just as fast in the USA, but for a much shorter period, for a loss of 5pc but there was very little loss in the UK.

American jobs began to grow as early as 2010 and were almost 5pc above their pre-crash peaks at the start of this year. Britain's employment numbers rose from that period as well and the limited impact from the crash has left them more than 5pc higher than in 2007.

In Ireland's case, the damage from the crash delayed recovery until 2013. It has been faster than in the two bigger economies, with a 10pc gain since then. However, it is only now that we are approaching the previous peak, while the others are above it.

In Ireland, one should not really compare current conditions with 2007.

British policy was pretty loose before the crash, if not on an Irish scale, but the big difference has been since then. Ireland had the full eurozone austerity treatment, with a double helping when the rescue of the banks is included.

Britain's banks cost proportionately less and the public finance programme has been, if not actual reflation, then certainly, by the standards of eurozone bailouts, austerity-lite.

The main difficulty with that approach is that, while it may seem easier, it goes on for longer. If things don't pick up in an economy, it can go on for a very long time indeed. As it has in the UK, with an expected budget deficit of 3.3pc of GDP this year.

This is another side of Brexit. Britain's public finances increasingly diverge from those of the euro area, where the overall gap between government revenues and government spending is just 1.3pc of GDP.

That of course hides a multitude of difference between countries but, among the larger ones Spain has a deficit of more than 3pc. France however is close, according to the data compiled by 'The Economist', with a deficit of just under 3pc. To some extent it has followed its great rival in its response to the crash, despite the apparent ideological differences in economic policy. It is on more or less permanent warning from the Commission although, if things do improve, it will be down to President Macron rather President Juncker.

Of more significance perhaps, is the French deficit of 1.2pc of GDP in its day-to-day dealings with the rest of the world. This is less than third of the British figure while Spain, despite its budget being in the red, has a surplus on its foreign dealings. It is still accumulating public debt but, with growth of over 3pc, the debt ratio is not worsening, unlike the UK, and it is not adding to private foreign debt through a current account deficit.

That is the biggest difference between Britain and the euro area, whose €12trn economy runs a 3pc surplus in its external trade and payments. Within the eurozone, the big surpluses are those of Germany and the Netherlands, whose surplus of almost 10pc of GDP puts Germany's 7pc in the relative shade.

That imbalance between members must pose a long-term threat to the stability of the single currency, on the assumption that it will never be a 'transfer union' from the more productive to the less. In the medium term the threat - and the one which matters more here - is market tolerance of the imbalance in Britain, especially if it worsens after Brexit.

At the start of the crash, I suggested that Irish policy should be to get back into the herd as quickly as possible, so as not to be easy game for market predators. In truth, there was no scope for a slow response by Ireland but it now seems to be comfortably in the centre of the herd, with the budget just about in balance and an external surplus, among all the distortions, of around 3pc of national income.

With one exception - debt, where we still languish exposed on the outskirts. In Britain, Chancellor Philip Hammond plans to reduce the underlying (structural) deficit to 2pc of GDP by 2021. Ireland's has all but disappeared already and should be in healthy surplus by 2021. Few believe Mr Hammond's goal is politically credible, but even if he misses it, Ireland will still be more indebted than Britain.

At 64pc of GDP, the debt ratio is the seventh-largest in the EU (including Britain). But no-one takes Irish GDP seriously. On the revised CSO measure of national income, GNI*, the country comes just behind Italy and Portugal, with even net debt - after deducting public assets - of almost 93pc of income. That is a long way from the UK's 65pc.

The British ratio is going to increase, while Ireland's will fall but, IFAC argued, it is not at all clear how fast it will fall - or even how fast the politicians mean it to fall. They might be forgiven - just - for still using GDP, since the figure is largely for foreign consumption, but not if they use it to hide the truth or, worse, frame policy.

As it happens, the target was substantially eased in the Budget, from 45pc of GDP to 55pc - a very handy €30bn - and is to apply "in the mid-to late 2020s", depending perhaps on completion of the capital plan. Not exactly a firm commitment. And 55pc of GDP represents debt at 80pc of national income. The gaps will narrow but Ireland would still be in the highly indebted group.

That's assuming we even get there. A general recession, perhaps coming from the USA, perhaps caused by a hostile Brexit, might see the debt burden actually increase in the next five years, according to IFAC. It could go back to 108pc of national income, which is fifteen percentage points more than the Budget projections.

That would leave uncomfortably little room - if any - for borrowing to offset recession. On the other hand, the alternative risk - an overheating economy fuelled by a construction boom - would see the debt ratio fall more rapidly, especially if the government followed the general advice to cool the economy with more taxes and less spending.

This leaves an interesting question: which would be politically more difficult - cooling a bubbling economy or applying emergency austerity blankets to a sick one? No prizes for the correct answer.

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