Tuesday 20 August 2019

Europe will rein in our politicians borrowing to buy votes

STOP THE PROMISES: ‘One would have to be wary of the promises that will be made by all political parties over the coming months’
STOP THE PROMISES: ‘One would have to be wary of the promises that will be made by all political parties over the coming months’

Dermot O'Leary

It will be no surprise to anyone that pre-election spending splurges have been a recurring feature in Ireland for decades. Current spending rose by 10pc in the year prior to the 1997 election, by 20pc in 2001 and by 11pc in 2006. That is why you may have noticed a growing trickle of good news coming through either your letterbox or through various other channels over recent weeks. It is not just your imagination.

The rearguard action by the Government to win back voters ahead of the General Election next spring has begun in earnest.

The expected 2pc spending growth over the 2015-16 period, announced in the most recent Budget, appears modest in the context of previous splurges. With debt levels falling significantly this year, the decision to spend more will do very little to damage Ireland's credibility in sovereign debt markets.

Yet it doesn't appear that the politicians and the general public have quite grasped how little scope there is for further fiscal largesse over the coming years.

While there is an expectation that the public will be given "something back" after the sacrifices made during the crisis years, the available room for manoeuvre is actually very small. Perhaps this is why the electorate isn't exactly jumping for joy.

It has been somewhat of a mystery to some observers, particularly international ones, as to why voter support for the Government has not followed the trajectory of the economy overall since the recovery began in 2013.

When one explains to international investors that the introduction of water charges was a source of much of this voter dismay, the reaction ranges from amusement to puzzlement, given that such a policy is engrained in much of the developed world for some time. This was part of a general feeling that the recovery was not being felt on the ground, but this is starting to change.

Latest polls suggest that the Government is recovering from the soft patch of 2014, with approval ratings recently rising to the highest level since late-2011, a time when the Government was still glowing in a post-election halo.

One would have to think that, with Christmas bonuses for welfare recipients coming in December and lower tax bills due for workers in their January pay packets, the upward trend in support for the Government will continue over the coming months.

More important for the overall economy is what the next government, whoever it might be, will do in the early years of its term.

Unlike in 2015, spending increases from 2016 onwards will be subject to more rigorous checks.

In the fiscal jargon, this is called the 'expenditure benchmark'. Spending over-runs of the kind just sanctioned will thus not be able to occur without experiencing the wrath of the European Commission. Sanctions for breach can be anything from a verbal warning to a monetary fine.

Given this constraint, one would have to be wary of the promises that will be made by all political parties over the coming months. It's not exactly a vote-grabber to campaign on a platform of meeting rules set out in the Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union (the Fiscal Treaty), but that is exactly what Ireland signed up to when the referendum was passed in 2012.

While the general public may approve, not everyone is a fan of the course that the Government has decided to take ahead of the election. In its latest 'Fiscal Assessment Report', the Irish Fiscal Advisory Council (IFAC) states that the Government's decision to ramp up spending by an additional €1.5bn over the final months of the year represents a "deviation from prudent economic and budgetary management". In other words: "You were doing so well and now you are after ruining it."

IFAC is a relatively new institution and one might argue that it has had a rather inauspicious start, with the Government deciding to ignore its advice on a number of occasions.

Nevertheless, its analysis of the public finances is thoughtful, independent and thorough - its latest tome amounts to 100 pages - and thus its views should be taken seriously. Are its latest concerns justified?

Some background to its assessment is required first. Based upon its views prior to Budget 2016 in October, IFAC was happy that significant progress was being made in reducing the budget deficit and debt levels. This improvement was being helped in no small part by the boom in tax revenues this year, particularly the €2bn overshoot in corporation tax.

In the Budget, the Government then decided to spend part of this windfall on hospitals, schools, roads and welfare, among other things. IFAC notes that the deviation from previously set targets will now be larger than any other in the past 15 years.

Taking my economist hat off for a second, this was an inspired move from a political perspective: Despite this apparent fiscal largesse, the Government can still trumpet that it has beaten its budget deficit targets by a significant margin, reduced the debt level below the psychologically important 100pc of GDP, while complying with EU fiscal rules (the European Commission gave its approval this week).

IFAC is, however, correct that while the Budget respects the letter of the rules, the Government is not respecting the spirit of the rules through the sleight of hand that was announced.

Budget 2016 was indeed a missed opportunity for the Government to put the State's debt on a firmer downward trajectory. However, the scale of this "error" must be put in context.

The fiscal constraints, coupled with the effects of an ageing population and a return to pay growth in the public sector imply a very small amount of fiscal space over the coming years.

In the first budget of the new government next October, there will be a sum total of €1bn in available fiscal "space", amounting to just 0.4pc of GDP. That, one might say, will not butter many parsnips.

A worrying aspect of the Government's spending plans over the coming years relates to capital expenditure.

Despite much fanfare surrounding the announcement of the €42bn investment plan recently, capital spending plans over the coming years are unambitious.

As a percentage of GDP, exchequer capital spending will remain close to all-time lows. Indeed, capital spending is forecast to fall in 2016 relative to 2015 levels.

All spending is not equal. Spending on capital projects, done in the correct way, can bring about significant medium- and long-term benefits to the economy's productive potential. This should be prioritised over ill-thought-out and sometimes universal current spending giveaways.

The bottom line is whether we like it or not, the public finances are still recovering from the trauma of the crisis years. This means that resources are tight and must be prioritised.

When politicians turn up at your door over the coming months, be sure to ask them how much their promises cost and what must be sacrificed to fund them.

Dermot O'Leary is chief economist with Goodbody

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