Friday 24 May 2019

The sums will only work if our luck holds

Calls for caution are going to be ignored as the manifesto factories leak voter-friendly titbits, writes Colm McCarthy

HOPEFUL: Enda Kenny’s government can’t predict performance. Photo: Gareth Chaney Collins
HOPEFUL: Enda Kenny’s government can’t predict performance. Photo: Gareth Chaney Collins
Colm McCarthy

Colm McCarthy

When the economy entered recession in the final quarter of 2007, the budget was in surplus: indeed a surplus had been recorded for nine of the preceding ten years. Public debt was just 25pc of GDP, amongst the healthiest figures of any developed country. But the international downturn, accentuated by the domestic banking bust, was so severe that large tax increases and spending cuts ensued and a pro-cyclical adjustment, deepening the downturn, had to be pursued until 2014 when the austerity phase could finally be relaxed.

Something similar happened in Spain, whose public finances also appeared to be solid before the crisis struck. In a globalised world, but constrained through the absence of an independent currency, both Ireland and Spain were forced to retrench even though the public finances appeared to be in rude health and public debt had been brought under control. Today "our public finances are in rude health and our public debt has been brought under control," according to Tanaiste Joan Burton writing in the Irish Independent a couple of weeks back.

Unfortunately this is not really the case. The budget will still be in deficit in 2016, for the ninth straight year, and public debt is still almost 100pc of GDP. Moreover this enormous debt figure flatters to deceive: sizeable liabilities, notably for unfunded pension schemes, are hidden off the balance sheet.

The sharp reduction in the deficit is largely due to the unexpected speed of recovery, reflecting unrepeatable good luck factors, including the weak Euro, the collapse in oil prices and record low costs of government debt service. It is also due to the puzzling buoyancy of corporation tax receipts during 2015: total tax revenue came in €3.3bn ahead of target but two-thirds of the excess was in the form of corporation tax, traditionally a volatile and unpredictable tax heading. Expenditure control weakened across the board, with government spending above target on health - the perennial offender - and an overshoot also in social protection, despite the fall in unemployment.

But not to worry. The Tanaiste was so encouraged by the public finance numbers that she promised "... to progressively increase the state pension, deliver the smallest class sizes in the history of the State, provide high-quality childcare at much lower cost to parents and deliver free GP care for all". There will also be full employment and a minimum wage at €11.50 per hour, 33pc ahead of the 2014 figure.

The debutante Renua party released an upbeat election manifesto the week before last, the first party to do so, promising a top income tax rate of 23pc. The other parties have been leaking voter-friendly titbits from the manifesto factories. The Universal Social Charge, a major source of revenue, will be eliminated for most (or all) people: on this every party seems to be agreed. Some have also promised that the property tax will go and that water charges will be dropped. All parties promise that various cuts will be restored. The messaging is clear: every party looks set to offer a combination of lower taxes for almost everyone combined with substantial extra spending on favoured programmes.

No detailed analysis is possible until the full manifestos are available, but a preliminary conclusion can be drawn at this stage: the sums will work only if economic growth, which has been impressive these last two years, continues at a decent rate right through the next five. Given the weak starting position, particularly the high debt burden, the promises will have to be abandoned fairly smartly if the economy hits another rocky patch.

The Department of Finance has predicted economic growth at 4.3pc in 2016 and 3.5pc the following year. They could be right and a continued expansion at those kind of rates would be enough to finance some tax cuts and spending increases without blowing up the deficit again. But neither the Department of Finance, or anyone else, can predict Irish economic performance with even modest accuracy. Indeed the forecasting record of the Department, the Central Bank, the ESRI and various international bodies has been terrible over the last decade. Nobody foresaw the depth of the downturn from 2008 and nobody expected the current recovery to be so vigorous. Typical errors in Irish growth forecasts can be 2pc in either direction or even more. If someone reckons next year's growth rate will be 3pc, it could be 1pc (or less) or it could be 5pc (or even more). Nothing can be done about this - the Irish economy just happens to be pretty volatile and sophisticated computer models, the first of which was built at the Central Bank all of 40 years ago, have not been much help.

The likelihood that the economy will grow at some steady rate like 3.5pc or 4pc in each of the next five years is close to zero. It could do better - there have been sustained periods of rapid growth - but it could also face a serious dip at any stage, the contingency that cannot be handled unless caution is exercised now. It would be premature to describe the plans of the parties as reckless or irresponsible, particularly since the details are mainly not available. But it looks like the calls for caution are going to be ignored.

The Government has been trumpeting the sharp reduction in the deficit which has already occurred. There have been three pure good luck factors contributing to the improvement. Any one of them, or all three, could reverse along the way. Debt service costs: Low international interest rates and the effect of debt management changes agreed with Ireland's official lenders have cut billions off the annual bill for debt service. This can only happen once. Oil Prices: The price of a barrel of oil has fallen from over €80 to just over €30 since early 2014. The price would have to go negative for this to be repeated. Most industry observers expect prices to recover at some stage over the next few years. The Euro exchange rate: the soft Euro is a boon to Ireland, since so much of our external trade is priced in dollars and sterling. There have been episodes of a rising Euro and there could be another one.

There are some further banana skins. International agencies like the IMF and the World Bank have been revising downwards their forecasts for the international economy, concerned about the slowdown in China and in emerging markets generally. The growth outlook in continental Europe remains poor and some Cassandras are worried about a renewed Eurozone crisis. Closer to home the referendum on EU membership in Britain could be held as soon as the summer and recent opinion polls suggest the result could be close. A British decision to quit would be a further headache for this country. There are good reasons for discipline and caution in Irish policy.

I first met PJ Mara as a teenager on the north side of Dublin and will miss him as will so many others. He was invariably a pleasure to work with, effective, courteous and famously good company. My sympathies to his son John, partner Sheila and young daughter Elena. Ni fheicimid a leitheid aris.

Sunday Independent

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