Tuesday 20 August 2019

Colm McCarthy: 'We must prepare now for the inevitable crisis ahead'

Ireland could have been another Greece but survived. That won't stop everything going wrong again in the future

'There will be another downturn in due course and with 100pc certainty, according to Conor O'Kelly, chief executive of the National Treasury Management Agency in evidence at the Dail Committee of Public Accounts a fortnight ago.' (stock image)
'There will be another downturn in due course and with 100pc certainty, according to Conor O'Kelly, chief executive of the National Treasury Management Agency in evidence at the Dail Committee of Public Accounts a fortnight ago.' (stock image)
Colm McCarthy

Colm McCarthy

If generals expect the next war to resemble the last, economic policymakers are exposed to the same temptation. There have been two periods of serious budget crisis in Ireland in modern times, at the end of the 1980s and 20 years later following the banking bust of 2008. The two episodes had different origins but there is never much variation in the response - if the budget must be restored to balance, government must increase taxes and cut spending.

On both occasions a big budget deficit had emerged, slowly in the 1980s and with frightening speed in 2008. The annual deficit and the outstanding level of debt had risen to the point where drastic action had to be taken.

The recent crisis was not caused by poor fiscal management alone. The banks had stayed solvent during the 1980s but weighed in with a monster systemic failure in 2008. This caused the outstanding debt level to rise dramatically due to bank rescue costs (private debts of bust banks were transferred to the public balance sheet) and the plunge into annual deficit was rapid, since the crisis coincided with a deep international recession and a collapse in tax revenues.

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The 1980s crisis was finally addressed in a more benign external climate and without bust banks to bail out. But the causes don't matter - when you can no longer finance the budget gap it must somehow be closed and state solvency restored, preferably without the humiliation of resort to the IMF.

There will be another downturn in due course and with 100pc certainty, according to Conor O'Kelly, chief executive of the National Treasury Management Agency in evidence at the Dail Committee of Public Accounts a fortnight ago.

O'Kelly did not have to say when it might happen or what might be the cause or causes, but his prediction has history on its side. The next crisis will hardly be a re-run of the 2008 episode - the banks are fewer, smaller and better supervised for a start, so it should be less severe if it happens at all. But a downturn there will be, some fine day. And when it comes the best preparation is to have an impeccable credit rating, so that the government will be able to let the budget go into deficit for a few years without an untimely imposition of austerity. The alternative is a downturn exacerbated by government policy, by a pro-cyclical fiscal policy in the jargon. When a downturn comes along for whatever reason, an unprepared Irish government, lacking the capacity to borrow, must make it worse.

A country which has no currency of its own cannot finance the government through the central bank when the markets decline to lend - it does not have a currency to print. Without the capacity to borrow there is no alternative to austerity and, if that fails, another resort to the IMF.

All of the efforts made from July 2008, which saw the first emergency cutbacks introduced by the late Brian Lenihan, through an accelerated budget in October of that year and the long procession of tax increases and further cuts in 2009 and 2010, ultimately failed, and Ireland could no longer finance itself for the first time since 1922.

The speed of the recovery in recent years and especially the decline in unemployment back to the 4 to 5pc zone, having reached 16pc at the worst point, has dimmed people's memories of those awful years.

All the efforts to stabilise the public finances, including the Bord Snip report released 10 years ago this week, ended in failure and the effective insolvency of the State. The bail-out plan agreed in November 2010 with the official lenders, the troika of the IMF, the ECB and the European Commission, was largely a continuation of policies on which the Irish government had already embarked. But through 2011, as the full horror of the banking disaster unfolded, there was deep pessimism in Merrion Street that a second bail-out would be avoided, not least because of the hostile attitude adopted by the ECB.

Ireland could have been another Greece. After a few more difficult years things came together, due to a combination of good luck and good management. There has, more recently, been a recrudescence of an utterly unjustified euphoria about the limits to budget policy. Patients discharged from surgery are advised to avoid strenuous athletic pursuits straight away, and it is equally risky for the Irish government to get too cocky, too soon, about the public finances. This country is over-borrowed, in the sense that its capacity to run deficits when they might be needed is problematic. Conor O'Kelly was a valuable witness for the Dail committee (his job is to borrow money on behalf of the Government) because he is best placed to understand that the capacity to borrow in recent years has been flattered by the external environment. The world's central banks have been making it easy, and cheap, by flooding the markets with liquidity. If the wind changes direction, Ireland could quickly lose poster-child status and get re-classified as a riskier credit.

The case for caution in Irish budget policy today is essentially about the balance sheet of the Exchequer, including its potential, as well as its actual, liabilities. The contingent liability for another banking disaster looks low but the actual, here-and-now, liability is, at €205bn, one of the largest relative to the size of the economy in the Eurozone.

The public finance crisis of the late 1980s was followed by a decade of careful budget policy by successive governments which restored Ireland to AAA credit status, just in time to blow it all over again. The AAA status was achieved through a steady delivery of small budget surpluses against the background of an expanding economy. The recent expansion has not been used as wisely, and the budget should have been restored to surplus several years ago. The capacity to borrow, especially for a country which has chosen to give up its independent currency, is a marker of economic sovereignty.

The last three budgets have been expansionary, in the sense that the combination of expenditure growth and tax cuts have had a net stimulatory effect on the economy. This is known as spending your way out of a boom. What's done is done and the outstanding debt would be only a little smaller had a more cautious path been chosen. But the message to credit markets would have been powerful. These Irish guys are serious and have learned lessons and the risk of untimely austerity, making a bad job worse, would have been reduced, whenever Conor O'Kelly's prediction materialises.

There will be a general election in due course, maybe early next year. The political parties have short memories and are already promising tax cuts, conceding pay increases for public servants and extra capital spending on local projects, as if the last disaster happened 100 years ago. It was only 10 years ago, largely home-grown. The next one will most likely be triggered by events outside our control.

If a woman called Prudence is on the ticket in my neighbourhood, she's got my vote.

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