Which businesses to save will be a dilemma for Government
IF ONLY we had a crystal ball and could have seen the coronavirus coming. How we would have managed our public finances and economic policy differently is hard to figure.
Now everybody would love a crystal ball to see how will all of this play out for Ireland’s future and the global economy in the next few years. Whatever about the hazardous business of predicting the future, some core truths are emerging.
There won’t be a V-shaped recovery. The economic shock was more severe than the last financial crisis but the impact may not last as long. Despite our massive national debt of €200bn, we are in a reasonably good position to borrow our way through some of this.
Low interest rates are likely to stay for a while, which is a relief for our ability to borrow. So that isn’t too bad. But then comes the bit that is hardest to swallow.
We should borrow only for one-off crisis-related or economic investment purposes. More permanent pandemic-related spending will have to be clawed back by the exchequer. That means higher taxes.
Former Central Bank governor Patrick Honohan put a realistic shape on many of these issues when he presented at a webinar yesterday organised by the Royal Irish Academy.
One graph he produced showed how it took us a decade to get unemployment back to its low 2007 level of under 5pc. It may not take that long this time, but Honohan’s possible scenarios up to 2022 envisage an unemployment rate of around 10pc in two years’ time or maybe 8pc, depending on various factors.
Excluding the extraordinary events of recent months, the last time we had unemployment as high as 10pc was in 2015. Our social welfare bill that year was just under €20bn. Incredibly, due to higher spending, a bigger population and the housing crisis, the estimated spend for 2020 before coronavirus broke was €21.2bn, even though our unemployment rate had fallen to just 5pc.
So, even when the exceptional social welfare measures wind down, and we end up with an unemployment rate of 10pc, the cost still will be high. This money will have to be clawed back somehow. We can’t borrow to fund our longterm unemployment social welfare payments.
Other serious outlays beckon for which we should not and cannot borrow to fund. A higher public sector pay bill is one. Pay increases, due under existing agreements, will have to be funded through normal taxation.
Against a backdrop of higher unemployment and the folly of borrowing to fund it, cutbacks or higher taxes are likely. This is a recipe for greater inequality. Honohan says this will have to be contained.
Funding ongoing higher expenditure from exchequer revenues is difficult, especially when some of those revenues are under pressure.
Honohan used a wonderful word to describe the nature of some of our more recent boom-time tax windfalls – evanescent.
Evanescent is defined as “soon passing out of sight, memory or existence; quickly fading or disappearing”. He clearly has corporate taxes in mind here, but other tax categories could come under pressure if the economy does not bounce back quickly.
But it isn’t all bad news on the horizon. Some tailwinds are in our favour. It appears that the interest rate environment is supportive when it comes to borrowing to get through the crisis.
As Honohan showed in one slide, the decline in global interest rates is a long-term trend, with a clear downward trajectory running since 1980. Previous low interest rate periods have lasted a long time too.
But how much is left in this low interest-rate cycle? Aside from cheap loans we may be able to get from the EU or the ECB’s bond buying programme, we could borrow 10-year money right now at very low rates.
While our national debt shot up in the wake of the financial crisis, our interest rate repayments, as a percentage of how much tax we take in, behaved differently.
At its worst point in 2014 we were handing over 20pc of our tax take to fund our debt. That has nearly halved to closer to 10pc, despite not having paid back any of the debt.
Honohan’s message was not one of despair, but measured realism. We may well bounce back quickly, but there will be lasting economic effects from this. Heavy public spending is needed both for defensive measures and for recovery and repositioning.
We need to keep our borrowing risk premium low. The best way to do that is to use borrowing to fund one-off or temporary projects.
Perhaps the toughest message in his presentation is not to ‘waste’ public funds on creditors and rentiers of non-viable firms. But equally we should avoid the collapse of firms with viable business models.
Making a determination like this will prove extremely difficult. It will be divisive political dynamite for the new threeparty Government.
We can’t borrow to fund long-term social welfare payments
Heavy public spending will be needed for defensive measures and for recovery