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Brendan Keenan: 'EU budget rules not much help in keeping public finances safe'

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Minister Paschal Donohoe

Minister Paschal Donohoe

Minister Paschal Donohoe

BREXIT aside, the most important economic question is whether the public finances are in danger. It may be even more important than the B-word because, if we are not in safe territory, a disorderly UK departure would create an even bigger mess for the Irish economy than current forecasts suggest.

Yet, even as worries grow, it is a question no one can answer definitively. There is no agreed definition of when amber lights turn red. The economy is more complex, with ever greater distortions from the machinations of the multinationals. Finance ministers become more adept at hiding what is going on behind the detail.

The present incumbent is quite the master at making the most of the ambiguities. To the best of my knowledge, Paschal Donohoe has never said a foolish thing. The jury is out, though, on the extent to which he has done wise things.

His methods were on full display in a speech last week at the Institute of International and European Affairs where, as he often does, he used words which all of the economic establishment regards as wise: running budget surpluses over the economic cycle, and reducing public debt, is the best way to reduce the threat posed by a sudden revenue loss from multinational activities or a recession.

Quite rightly wary of the limitations of GDP, he set a new target, based on the more realistic 'modified national income' (GNI*), to bring the ratio of public debt to around 85pc by 2025 - down from the present 100pc, which is the sixth-highest in the OECD.

As a ratio of growth, what needs to be done to achieve these results depends on the economy's performance. Donohoe implied they would not be met without the continued strong performance of recent years leading to growth of around 3pc a year. If one believes in the economic cycle, there is therefore a strong chance the targets will not be met. A disorderly Brexit would also scupper them, reducing the target to 90-95pc of GNI*, according to his department's own forecasts.

The economic cycle is at the root of this. Donohoe has always been a staunch proponent of counter-cyclical policies, where budgets are managed to smooth out the ups and downs, while convincing very few that he has actually done any such thing.

He made much of his intention to have a surplus of 1.7pc of GNI* by 2022 and made it sound very wise. But Davy Research chief economist Conall MacCoille calculates that the surplus this year will be 1pc, rather than the Government's 0.7pc forecast. If so, much of the work of getting to the 2022 target has already been done.

It looks like the real policy of the past many years is still in place: set conservative targets, and if and when they are beaten, stick to the target and recycle the difference in spending and tax cuts (mostly spending). This is not counter-cyclical; quite the reverse. It is the McCreevy doctrine of spend it when you have it, which all his successors have decried but applied whenever they could. Donohoe, who is as sharp as any of them, had an interesting defence in his speech.

The money went on investment, he explained: "I am sometimes asked ... why we are not running larger surpluses at this stage of the economic cycle.

"The answer is simple - if capital expenditure had not been increased in the way it was, Ireland would have a fiscal surplus of over 1.5pc this year."

This is the principle behind the familiar 'golden rule'; that borrowing should be done only for productive investment.

One reason for saying the public finances are still showing amber, at worst, is that very little borrowing was done. But that may not be enough to qualify as smooth economic management.

The problem is that deficit control and counter-cyclical policy are two different, although not entirely separate, things.

It is possible to be doing well in one and not in the other. Arguably, this is what is happening.

In a recent paper, two members of the Fiscal Advisory Council, its chief economist and head of secretariat Eddie Casey, and Sebastian Barnes of the OECD's Economics Department, looked at the impact of EU rules designed, among many other things, to prevent pro-cyclical budgetary policy. They seem to have found that the rules had little impact at all.

They are partly based on average growth in the previous 10 years. Ireland's extraordinary volatility showed growth of less than 2pc in the decade to 2011, and 7pc in the 1990s, but this extreme volatility did not involve a breach of the rules.

On the contrary, analysis of the data suggested that applying the rules in Ireland's case would lead to pro-cyclical public spending and even reinforce it. Hence, their inability to chart governments a different path for the Irish economy than the one actually taken, with all its undesirable results. Donohoe made reference to the difficulties, while saying that the principles behind them must be maintained.

It becomes increasingly difficult to know what these principles are, still less how to apply them.

The commission's explanations, for officials and those sufficiently learned to follow them, run to 176 pages. It is as if all the possible needs of the member states, from Finland to Greece, have been incorporated into all possible responses.

That is not too surprising in view of the lack of trust between northern and southern states in particular. It was nice to be told by a former senior German official that perhaps we had been treated too harshly in 2010. But there was an uneasy feeling that we were being invited into a comfortable club that was not open to more turbulent people.

This club has no particular rules either. It appears to boil down to a requirement not to go bust. As we all should know in Ireland especially, it is frighteningly easy for a country to go bust. Perhaps avoiding bankruptcy is the most that can be expected from a rulebook.

I have long taken inspiration from the fact that the entire US bill of rights fitted on the wall of the walkway at JFK airport. Everything you need to know about running a liberal democracy is in those words. As the US shows only too well, having the words does not mean the democracy will work perfectly. But it is better than trying to cover every eventuality, as the stillborn EU 'constitution' did.

That is the EU way, but its limitations in something as complex as a monetary union are becoming clear.

The plethora of rules makes effective enforcement impossible; the differences between members have dragged the commission into the political sphere. The eurozone itself suffers from pro-cyclicality, with all member states cutting back during the great reversal and bickering over who should do what in better times.

To some extent, the Irish fiscal council, while pronouncing on whether EU rules are being obeyed, has attempted simpler criteria for its own advice to Government.

One sign that this may be working is when Finance replies to council criticism of the budgetary stance by pointing out it complies with EU rules.

The Government itself, though, is aiming for something simpler. Irish law based on the rules concentrates more on deficit control than cyclical concerns.

Donohoe's speech concentrated on what is essentially the golden rule, and made the fair point that more public investment is now the preferred choice of the IMF and OECD, as well as the governments in London and Washington.

The worry is that the new surplus is too little too late, and the target too unambitious, for the public finances to be safe in the event of a serious recession. There is the catch. It is not an Orwellian choice of capital good, current bad.

Much of the capital spending in Ireland before the bust will bring no net return. The cost of the children's hospital means that, while the care may be good, we will need a lot more current spending to pay for it than should have been the case.

Capital spending is also the easiest to cut. And, if current spending grows too fast, cut it will be if things turn down, whatever the fine promises beforehand.

Current spending is more difficult to analyse. When is a pay rise justified? What are reasonable staff numbers? And so on. It is also far more difficult to control.

Donohoe more or less said all of that. It was when he said not just that current spending needs to be kept under control, but that it actually is under control, that one wondered again about the difference between wise words and deeds.

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