A seven-week election campaign has commenced and seems certain to produce a change of government. Aside from the evident need to reform the political and public administration structures, there are just three main issues for economic policy.
Stop the borrowing as soon as possible
It is not in Ireland's interest to continue borrowing heavily over the next few years. Borrowing costs are just too high. We have already discovered that we cannot borrow from the markets on reasonable terms, and must borrow from the IMF and the EU on theirs. The rate of interest being charged is almost 6 per cent, the inflation rate roughly zero. This is a crushing real interest burden, and it is no consolation to be informed that the EU and IMF funds are cheaper than rates on Irish government debt in the secondary bond market. Some people who should know better are already talking about the four-year austerity plan as if it has been imposed on us against our better judgment by the IMF. Any sane country in our circumstances would choose to close the budget gap as quickly as possible, without having to be instructed to do so by our good friends in the Fund. There is no conflict that I can see between the best interests of this country and the advice on deficit reduction emerging from the IMF.
While the Government has earned some plaudits for the budgetary measures taken since July 2008, these have done no more than arrest the spiralling deficit and have failed to keep Ireland credit-worthy. This failure in the end was due to the shockingly high costs of the banking rescue; had those costs been contained within the early estimates, it is likely that access to the markets would have been maintained. But we are still borrowing to fund everyday government spending at an unsustainable rate, and at punishing real interest rates.
With the benefit of hindsight, perhaps we should have done more by way of budgetary correction by now. It is surprising to find commentators still arguing that the pace of budgetary adjustment has been too rapid. This is like arguing we should have lost access to the markets and gone into bail-out sooner than we actually did and with a larger mountain left to climb.
The new Conservative/Liberal coalition in the UK chose to introduce a quick mid-year budget shortly after their election success last year.
Here, the opinion polls predict a large majority for Fine Gael and Labour, and perhaps they would be wise to consider early fiscal measures too, exploiting whatever honeymoon they are accorded by the public. This would provide the opportunity to get ahead of the curve in terms of compliance with the memorandum of understanding with the troika of IMF, EU and European Central Bank. The target of reducing the borrowing rate to 3 per cent of GDP by 2014 implies further massive borrowing and an enormous debt mountain by that date. At some stage the debt mountain will have to be reduced, which means budget surpluses will need to be run later this decade. It is difficult to see what is gained by long-fingering the inevitable.
Progress to date in the restoration of competitiveness has been limited. The 'Great Irish Bubble' consisted principally of a rapid escalation in bank credit and hence property prices, inducing a secondary bubble in public expenditure justified on the basis of apparent buoyancy in tax revenues ('When you have it, you spend it'). But there was also a bubble in the demand for labour, sucking in migrant workers into the real estate, financial, construction and retail sectors and bidding up the price of labour in exporting businesses. These businesses are now uncompetitive in many cases, and this matters greatly, since recovery cannot be based on construction of buildings we do not need, or the importation of consumer products we can no longer afford. Sectors such as manufacturing, tourism, agri-business and software need to achieve quickly a cost base which permits them to create sustainable employment through exports.
The aggregate figures on labour costs flatter to deceive: there are shifts under way in the composition of output which make things look a little better than they really are, and private sector pay rates have fallen by less than many economists expected. Non-pay costs also need to be driven down. Since Ireland abolished its independent currency back in 1999, we cannot restore competitiveness through devaluation, although we should certainly celebrate Euro weakness, particularly beneficial to Ireland since much of our external trade is conducted outside the euro area in sterling and dollars. We can, however, act on domestic costs, the imperative of so-called 'internal devaluation'. This requires downward pressure on labour costs to business but also reductions in local authority charges, property rents, regulated industry pricing and the cost of regulatory compliance and professional services. Growth in the blue-collar sectors such as manufacturing and tourism, necessary to replace the job losses which have been blue-collar in the main, will not resume unless and until costs of adding value in Ireland can be reduced to levels comparable to those in the UK and in our other major competitors. The National Competitiveness Council has been engaged in a dialogue-of-the-deaf with government on this issue for the last decade.
In addition to a cull of job-promotion quangos, the new Government could usefully engage in a rapid re-allocation of the job-promotion spend, cutting budgets for under-performing areas and directing the proceeds to activities which can demonstrate some hard evidence of effectiveness. The reduction in the minimum wage needs to be followed by an end to statutory wage-fixing in the private sector of the economy and racketeering in the professions. The necessary policy measures have long since been identified by the Competition Authority.
Working capital for business should begin to flow again once the restructuring of the banking industry is finally completed but the destruction of wealth in the country has created a famine in areas such as private equity and venture capital. Banks cannot (and should not) plug this gap and there needs to be a policy review.
Seek a Better Deal from Official Lenders
The terms of the deal with the IMF and our European partners have rightly been criticised for failing to provide a visible exit strategy for Ireland's public finances. As the months slide by the bank bondholders are being repaid, mostly at par, and the benefit to Ireland of any ultimate Europe-wide bank resolution will be limited the longer it is delayed. A moratorium on lectures from ECB officials in Irish national newspapers would be helpful.
The element in the deal with official lenders which needs to be addressed most urgently is the rate of interest being charged. Lending money to distressed member-states at 3 per cent on top of the cost of funds is helpful where they have no other financing option, but it is stretching it more than a little to pretend that this is either generous or sustainable. The EU and the ECB are presiding over a process in Greece and Ireland, and prospectively in other member states, which runs a high risk of sovereign default. An observer from Mars would conclude that European policymakers are indifferent, or even that they regard sovereign default, something which has not happened in Europe since the immediate aftermath of the Second World War, as less damaging than haircuts for private lenders to private banks. This is a political judgment in the end but those making it should be denied the pretence that no choice is being made.
As a practical matter, haircuts for bank creditors may arrive too late to be helpful to Ireland and the interest rate on official debt is a more promising area in which to seek a workable revised deal. The IMF unsurprisingly has been first to hint at interest rate revision for Ireland and the new government should be unapologetic in campaigning in the international media on this issue. Expecting distressed member states to achieve economic recovery while facing borrowing costs five or six per cent ahead of the inflation rate is not credible as a crisis resolution strategy.
Colm McCarthy lectures in Economics at University College, Dublin. He has headed an expert group examining state assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua