Monday 25 March 2019

Chance to cut debt is being squandered

Public spending rising more quickly than inflation and tax giveaways - that's not what you'd call prudence

The problem of economic management in Ireland has a straightforward backstory. Stock image
The problem of economic management in Ireland has a straightforward backstory. Stock image
Colm McCarthy

Colm McCarthy

Despite heavy indebtedness of both State and households, the Government plans to run another budget deficit next year - even though it expects 2019 to be the seventh straight year of a vigorous economic expansion. Meanwhile it professes commitment to "budget balance over the cycle" and ministerial speeches are sprinkled with genuflections to Prudence, the current goddess of economic management.

If seven years of expansion and clear evidence of tight capacity are not enough to propel the budget into surplus, how long precisely is the cycle over which surpluses and deficits are to balance out? Ten years, or 20?

The problem of economic management in Ireland has a straightforward backstory. This small, open and volatile economy has no currency of its own and hence no control over monetary and exchange rate policy. It has once again become heavily indebted and has a miserable record of macroeconomic mismanagement stretching back 40 years. Downturns have regularly been exacerbated by the incapacity of government to pursue countercyclical policies when most needed.

The source has been careless budgetary policy in the good times, with the additional burden in the most recent iteration of careless management and supervision of the banks. The result is the imperative, for the want of lenders, to tighten policy when the downturn strikes. This pathology is sufficiently common to have earned its very own economists' jargon - it is called pro-cyclical fiscal policy.

The budget is the only effective instrument available to the governments of Eurozone countries to maintain economic activity in difficult times. But it is only available if they have manageable debt burdens, the condition for which is the early elimination of deficits and the reduction of debt overhang when things have been going well.

Ireland found itself unable to borrow in 2010 for the want of lenders, not because of EU borrowing limits. Sovereignty was sacrificed, not to the rule-book (regularly ignored in all versions), but to the accumulation of debt sufficient to scare off potential lenders. The banks went bust, but the preceding decade had also seen a public expenditure explosion accompanied by a narrowing of the tax base. The credit bubble concealed the budget policy failure, creating transient fiscal revenues and a false sense of security about bond market access. The State spiralled into its first IMF bailout as, in just a few years, employment fell by 300,000.

Those on what they imagine to be the progressive and caring side of national politics, and who profess concern about the impact of austerity on the vulnerable, promote fiscal expansion and debt accumulation in all weathers - maximising risk of repeat austerity the next time trouble strikes.

Caution, and the preservation of fiscal capacity, is routinely caricatured with the unwillingness to be careless portrayed as an absence of compassion. The political parties, in some cases the specific individuals, drawing these caricatures have a less-than-stellar record during previous episodes of fiscal adventurism.

The Central Bank governor, Philip Lane, objected to the planned 2019 deficit last week in a public disagreement with Finance Minister Paschal Donohoe. Lane thinks there should be a surplus next year and he could have gone further. Had the Government been following the dictates of its chosen goddess Prudence, the budget would already be well into a period of steady surplus.

This was his advice to Paschal Donohoe: "If fiscal buffers are not built up, there is a risk of repeating the historical patterns by which economic downturns have been amplified by pro-cyclical fiscal austerity."

The report from the Fiscal Council last Friday expresses, diplomatically, the same unease at the drift in budget plans.

Lane's comments followed publication of the annual Report on Public Debt from the Department of Finance, which monitors the evolution of the State's financial liabilities and assesses the risk buried in the State balance sheet. It includes a debt sustainability analysis, a check on whether the huge legacy debt can be re-borrowed as it comes due for repayment and whether the annual drag of interest payments could get more painful.

There is good news and bad news: the debt is, in relative terms, among the highest of any developed country and the absolute amount is still rising. But much of it is longer term and at low rates. The annual interest cost is unlikely to shoot up suddenly, even if worldwide interest rates continue the up-trend which has already commenced.

But last time round, in 2010, the sovereign bond market closed down altogether for the more indebted Eurozone countries, including Ireland. The Government could not borrow at any interest rate, either to finance the deficit or to replace maturing debt. If that were to happen again, the Government would have to rely on official lenders - the Eurozone rescue fund and the IMF - which would mean a repeat loss of sovereignty and immediate pressure for cutbacks.

The only protection against this eventuality is to get the debt on a downward trajectory and that means putting the budget into surplus. The opportunity to do so these past few years has been squandered - public spending has been permitted to rise more quickly than the rate of inflation, there have been tax give-aways and more deficits.

A debt sustainability analysis which assumes that there will never be another European sovereign debt crisis is just too rosy. It amounts to saying "if things work out OK, then we will be OK". The next crisis, if there is one, could be triggered outside Ireland, say by a banking implosion in Italy or a Trump-induced trade war.

Ireland has not graduated from the back of the Eurozone debt class as decisively as the recovery has made possible. The debt metrics will look uncomfortably similar to those of Italy whenever the bond markets decide to take a closer look.

All the signs are that next month's Budget will accept spending over-runs in the health department and elsewhere, retrospectively sanctioned through more borrowing rather than tax increases. Instead there have been commitments to more reliefs from income taxation and there are insistent pressures for public service pay increases, including explicit threats of strike action.

Opposition deputies and supposed government allies from the independent ranks have been promoting a cornucopia of completely new spending wheezes - everything from the granny grant to a second stadium for Galway on the site of the abandoned regional airport, the Bertie Bowl West.

The atmosphere in which these half-baked schemes take wings has been created by the false impression, encouraged by the Government itself, that Ireland's financial crisis is over and that politics-as-usual can safely resume.

History rarely repeats itself and the surviving Irish banks look to have sustainable balance sheets as well as more attentive supervisors. The next public finance crisis will hopefully have nothing to do with bank failures in Ireland. The biggest threat is external, a nervous sovereign debt market in the Eurozone for which there are plentiful potential catalysts. The currency union's architecture has not been overhauled sufficiently to reassure anyone that indebted members, especially smaller ones, will not face trouble when the next sovereign debt scare emerges. The Irish Government should already have seized the opportunity to take evasive action.

Sunday Independent

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