IT’S GOING TO COST US
IRELAND CAN’T AFFORD TO ABANDON PRUDENT TARGETS POSTCOVID-19
LAST Tuesday the UK’s Office for Budget Responsibility (OBR), an independent fiscal watchdog, finally injected some seriousness into the debate about the economic impact of the pandemic.
The downturn is extreme, recovery will be neither swift nor automatic and there will be a monster hit to the public finances, far bigger than the fallout from the post-2008 financial crash.
The early estimates of economic cost in all European countries, Ireland included, have been too small and forecasts of a rapid V-shaped recovery looked naive when they were made a few weeks ago. Comparisons with the 1930s are not overblown — the OBR thinks the budget deficit in the UK will reach 20pc of GDP and will persist beyond the current year even if lockdown is lifted early.
The Bank of England thinks output could fall by a third in the April-June quarter, while the unemployment rate has soared and will not fall quickly either. The magnitude of the economic shock will be similar in every European country, many of which had high public debt to begin with.
Any exit strategy which fails to address the public finance dimension is irresponsible, especially in eurozone countries which have limited autonomy in financial policy.
Last week also saw the publication of the joint Fianna Fail/Fine Gael framework document on a programme for a new government. It has been breezily touted as the end to ‘austerity’, as if the country had been afflicted with spending cutbacks and tax increases until yesterday.
Every year since 2014 has seen increased allocations to public spending under virtually all headings, often exceeded in unbudgeted overshoots, and an annual diet of tax reliefs.
Unbudgeted overshoots have been matched with unexpected revenues from corporation tax and declining interest costs on the public debt. The attainment of budget balance has owed more to good luck than to prudent management and the debt overhang remains unaddressed.
There was indeed a period of austerity from 2009 onwards (cuts in public spending in real terms and increases in rates of tax) but it ended six years ago.
Deploying ‘austerity’ to describe policy since 2014 is just political rhetoric, a term of abuse for any failure to expand spending and deliver tax giveaways on demand.
The Fianna Fail/Fine Gael document cannot be the National Economic Plan which will be formulated only once the new government can see the shape of the exit strategy from the coronavirus downturn.
The outgoing Government’s immediate priorities have been the support of those losing their jobs, wage subsidies to firms unable to operate and whatever-it-takes funding for the health service.
The budget this current year was intended to produce a modest surplus. With the open-ended expenditure commitments and the inevitable collapse in tax revenue, there will instead be a deficit, all to be borrowed, of perhaps €20bn, possibly much more and likely to be followed with another sizeable deficit in 2021.
There has been no adverse effect yet on Ireland’s capacity to borrow but Ireland is not the weak link: the weak link is Italy.
Last Friday the yield spread against Germany on Italian 10-year bonds closed at 2.25pc, notwithstanding support from the European Central Bank’s bond-buying programme. If this yield spread, which measures the market’s fears about Italy’s capacity to service debt and ultimately about the survival of Italy in the eurozone, were to blow out badly there would be a rerun of the sovereign debt crisis which almost sundered the common currency area in 2012.
The bears are being kept at bay by the willingness of the ECB to peg the Italian government’s borrowing costs at an affordable level. This willingness is kept continually in doubt by the inability of eurozone leaders to agree publicly on a longer-term commitment to stable bond yields, reflecting fears in Germany, the Netherlands and elsewhere about the sharing of financial risk.
Meanwhile central banks in Japan, the United Kingdom, the USA, Australia and elsewhere have done what central banks must do in a national emergency: make sure to fund the government through pegging borrowing costs if needs be.
There might be trouble down the road if money creation gets out of hand but that is not today’s problem. Ireland’s borrowing costs are not an immediate concern but will suffer if there is a failure by the ECB to support Italy.
That looks unlikely in the near term but public bickering between European politicians has revived memories of the last eurozone crisis when the weaknesses in the architecture of the common currency were revealed.
The decision to abolish the national currencies in 1999 was taken without the political will to see through a full monetary union and the fragilities remain.
What this means for Ireland is that there can be no abandonment of prudent targets for the public finances. Eurozone governments can borrow only whatever the markets will lend, they have no national central bank with authority to fund them and the markets are currently benign because the ECB is buying bonds.
Once the crisis has passed, countries in the eurozone will have to survive on their own debt and budget fundamentals. Those with high legacy debts, a category which includes Ireland, will need to borrow with caution through the crisis and return quickly to budget balance.
The FF/FG document is silent on finance but contains uncosted post-crisis commitments about a universal health service, affordable housing, greater access to childcare, a living wage and priority for capital spending. But it promises “no increases in income tax and/or Universal Social Charge (USC) and no cuts to established core social welfare rates”.
These are not crisis-fighting proposals, they are commitments for the sunny uplands which beckon once the exit from crisis has been somehow accomplished, when the only certainty is that the public debt will be substantially higher.
National income and the tax base are not guaranteed to recover quickly, and the ECB will be impatient to withdraw support from the bond market. Are Fianna Fail and Fine Gael proposing an indefinite reliance on borrowing for the life of the next government? What if lenders are unavailable?
The Social Democrats were the first of the potential coalition partners to respond and, reasonably enough, asked where the money was supposed to come from.
When the National Economic Plan comes to be written it needs to contain credible budget targets, preserving national economic sovereignty and minimising the risk of trouble in the sovereign debt market.
It will need some fast-acting job-creating initiatives and some space for the preservation of capital spending through what could be a period of greater spare capacity in construction.
The small business sector could reasonably expect rebates on commercial rates from local authorities — these firms were shut down and not consuming local authority services — and there is room for new investment programmes to pick up labour market slack.
Why not build a network of fast-charging points for electric vehicles around rural Ireland, a job for the ESB perhaps?
They will hardly be built by the private operators, more interested in urban areas and the motorways, and rural dwellers, the high-mileage road users in Ireland, are unlikely to buy expensive electric cars without the reassurance of a decent local charging network.
‘Countries in the eurozone will have to survive on their own debt and budget fundamentals after the crisis’ ‘There has been no adverse effect yet on our capacity to borrow but the weak link is Italy’