Tuesday 20 March 2018

The Government must be wary of the lure of borrowing

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Brendan Keenan

Brendan Keenan

FOOL'S gold, they used to call it. Many an old Western ended with the guy in the black hat discovering that the stolen poke contained, not the precious metal but the worthless lookalike (some kind of pyrites I believe).

Now the same thing is happening to the Golden Rule; the principle that governments should borrow only for worthwhile investments, not for regular spending.

A rule for fools, says the EU Commission, on behalf of the more creditworthy countries. Gold is to be found only in the hard digging of not taking on more debt at all.

It's a tough call, but there have been a lot of guys in black hats around. One of the most unlikely was Britain's Gordon Brown, who swore by his prudent golden rule but turned out to be one of the most profligate of Chancellors of the Exchequer.

Not that we can gloat, of course. There have been various fiscal rules down the years, with various levels of credibility, but we seem to have settled for the idea that all will be well if revenues exceed spending.

In 2007, that turned out to be worthless dross as well.

It seems still to be the fundamental Irish position; although in theory it has been superseded by the EU's Carbon Rule - always in the black - although this may turn out to be little better than what went before.

It is certainly less popular, and more difficult to explain but, given the dross we ended up with using the golden rule, perhaps there is a flaw in the whole idea of treating one kind of government spending as different from another.

All this was highlighted, in a confused sort of way, in the spat over what to do with €3bn proceeds from the sale of AIB shares (and presumably the hoped-for remaining €9bn, although that was barely mentioned).

Using the AIB money to fund extra government spending, as demanded so vociferously by so many, is not a free ride. If it were used to replace expensive debt it would save the taxpayers €10m a year, at present rates, every year.

Perhaps more in the end. The long-term historical rate on safe government bonds has been is around 5pc. Last week the NTMA was able to borrow at three-quarters of a per cent.

Who is to say what last week's loans will cost to replace when they fall due in 2026? All one can say is that it would as well to assume it will be a good deal more than in 2017.

In his first press conference, the new Taoiseach formally espoused the golden rule; saying he would lead an effort in Europe to allow borrowing for investment to be treated differently than borrowing for current spending.

He has in mind to increase in capital spending by 10pc of "leprechaun" GDP (the official figure).

That is a very tasty €25bn - admittedly spread over several years. By a coincidence of timing, that put Mr Varadkar on an immediate collision course with the Irish Fiscal Advisory Council.

It said Michael Noonan's adjustment to remove leprechaun magic, implying that actual GDP is about €50bn less than the official figures is not, in fact, enough.

Were Mr Varadkar to continue wearing a red beard and green hat, there could be a pretty serious collision between government and council.

Then came the reports that Mr Varadkar intends abandoning Michael Noonan's 'rainy day' fund - the only anti-boom/bust bit of fiscal policy, even though it is not yet in existence.

This may explain the bluntness of Mr Noonan's departing warning not to ease up on debt reduction.

But note that caveat in the incoming Taoiseach's comment. He will lead the way in trying to persuade Europe to change its stance. There was no suggestion that, if it did not, he would press on regardless.

The EU rules are complicated, and therefore open to some adjustment and fudging.

Last year, for reasons which need not detain us, the commission increased the permitted spending by an estimated €1.5bn - but they do not include the golden rule that Mr Varadkar admires. Nor will they.

There may even be room for some more from Mr Varadkar, but there will be no return to the golden rule. As a result, the rainy day fund, even if abandoned will not be available for "investment," as distinct from pay, welfare and tax cuts.

The rules which apply to Ireland from next year are intended to moderate booms and busts. Ireland will therefore be under keen scrutiny.

Apart from spreading out the cost over a few years, there is no distinction drawn between "investment" and day-to-day spending.

One reason is that, whereas in business, investment is something which is intended to produce a defined financial return to offset the borrowing costs, no strict definition of that kind is possible with public money.

One can make some kind of calculation where there is an actual financial return, such as tolls on roads.

On that basis, hardly any Irish motorway pays its way. But one ought to add the economic benefits of shorter journey times, and perhaps the "welfare" of less stress and strain from congestion.

Unfortunately, all of that is a bit of a guess; although given how much the Irish motorways cost to build, no plausible guess would make them a sound investment.

If roads are so difficult to assess, there is no chance with things like education, health, or the latest crisis area, housing. It is an unpalatable fact that even where there are productivity gains from government capital spending, they will not show up in time to make a difference to the public finances of today. The immediate costs will.

Most capital spending calls forth more current spending. A new school or hospital requires teachers and nurses to staff it. The case for treating them differently in terms of the overall government budget becomes even more doubtful.

A final reason to beware the golden rule is that, in Ireland anyway, capital spending in reality is what is left over - if anything - when current demands have been met.

It fell by an average 5pc from 2008-16 and the fiscal council thinks the planned increase of 9pc a year over the next five years may not be enough to maintain existing facilities and provide new ones - especially houses.

Those increases are incorporated in the overall, EU-approved debt reduction programme.

If more investment is needed, can we expect government to say that means less for pay and welfare, as well as tax increases? Answers on a postcard please.

For politicians and their demanding public, the golden rule is not that capital spending should pay for itself, but that it should not be counted.

It is certainly a glittering prospect; just don't try spending it in the Bond Market saloon.

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