RECOVERY WON’T COME WITHOUT PAIN

Government cannot promise that all jobs will be restored or pretend there are no consequences for public finances, writes Colm McCarthy

NO soft option for the response to the Covid recession goes without a champion. The Government, the banks, the insurance companies, the European Union, all presumed to possess resources to burn, will ride to the rescue of firms in trouble and the assistance forthcoming will depend solely on self-assessed need.

The Government is encouraged to contemplate expenditure programmes deemed unaffordable six months ago, before the downturn commenced. The logic apparently is that various schemes have become affordable because the country’s economic prospects have worsened.

The banks can forgo interest income on their lending, the insurance companies can pay out on risks they have not underwritten, the EU will donate to one of its more prosperous members. One business leader asserted last week that the viability of firms should not be a factor in assessing their entitlement to State aid. There have already been complaints that banks have been slow to lend to firms without collateral. More lending to firms with poor collateral — that went splendidly last time round...

The supply shock has been severe, household income has suffered, business investment and private consumer demand have weakened, unemployment has soared. It is timely Government should borrow to supplement the private economy. But it is extraordinary to hear so many influential voices urge policies which are dangerous even if the epidemic is contained, even if there is a vaccine and 2021 sees an end to the worst of the economic crisis.

It is 10 years ago this summer that Ireland ran out of road, had to withdraw from the bond market and ended up in an IMF programme. There were two contributory factors. There had been poor control on government spending going back 10 years, and a banking system careless about lending for almost as long.

The Government will borrow somewhere between €25bn and €30bn this year on recent estimates and is right to do so. There will, if things go well, be a lower requirement to borrow next year and the economic plan, to be released alongside the 2021 budget in October, will need to include a medium-term framework providing realistic targets for a return to budget balance.

Ireland’s prospects have been substantially diminished over the last six months. The willingness of governments around Europe to expand budget deficits, and of the European Central Bank to support the debt markets, has not turned the Covid recession into a release from economic reality. It is simply not the case that the pandemic has furnished the country with a Magic Money Tree, unavailable six months ago.

The chart shows the cost to the Irish Government of borrowing 10year money was roughly zero a year ago. It is roughly zero today and has not fallen. The sole difference is that, because the European Central Bank has chosen to backstop the eurozone bond markets, governments have market permission to go ahead and borrow, at affordable interest cost, to fight the fallout from the pandemic.

There was no such permission a year ago, there was no pandemic, and had the Irish Government tried to borrow vast amounts a year ago because interest rates were low, it would have been unable to do so. The ‘permission to borrow’ is conditional on the realisation that this is an emergency, not a new Jerusalem for politicians, free at last from the bothersome constraint that deficits must eventually be contained and public debt cannot increase without limit.

The demands for extra corporate welfare have not, until recently, been accompanied by demands for tax reductions, but the UK government’s willingness to dispense money (it cut VAT on hospitality from 20pc to 5pc) has encouraged Ireland’s hospitality trade to discover a corresponding opportunity. The UK has a currency, and thus the prerogative of expanding the Bank of England’s balance sheet until the limits are located. Ireland uses someone else’s money, and there are terms and conditions.

There will be an announcement of ‘July measures’ early next week and the Government will likely provide assurances that the emergency spending will continue for many months to come. The key economic policy decisions will be contained in the economic plan to accompany the October budget. It will have a three- or four-year time horizon and will seek to plot a course to economic recovery, particularly to recovery in employment.

It will be important to avoid promises that all jobs will be restored and that none of the recent job losses will be permanent. It is already clear consumer preferences have altered and that several areas of retailing, for example, have moved to a more online model. The hospitality sector, depending on the course of the virus, could see a long-term increase in its cost base and a diminution in demand. The airline business is already going through a brutal restructuring and public transport could suffer if vehicle capacities are affected in the long term.

It is too much to expect that the Irish, or any other, Government will see the exit strategy clearly three months from now.

There should be a premium on the avoidance of mistakes, firstly in the management of the public health response. A resurgence of the virus, requiring the re-imposition of lockdown, will damage an already weakened economy, especially those sectors most vociferous in demanding a rapid easing of restrictions. Any action which weakens financial institutions invites a re-run of 2009 and 2010, when the failure of banks, not forgetting Quinn Insurance, worsened the public finance crisis. Recent calls for banks, which belong substantially to the State anyway, to forgo normal interest on a portion of their assets, risk their capacity to withstand the loan losses for which they need to provide. Insurance companies which go bust also become a charge on the public through the compensation fund.

The protection of the state capital programme should be a priority. Last time the capital budget was permitted to shrink rapidly, at a time when private demand was weak, and its defence will require a willingness to expand the tax base and to control current spending.

The failure to charge urban householders has deprived Irish Water of the wherewithal to fund a necessary capital programme. The carbon charge will have to increase if there is to be a serious climate policy.

Above all, the political leadership needs to understand, and to communicate to the public, that recovery cannot be delivered painlessly as an act of State generosity. Covid has weakened the Irish economy. Politicians in government or opposition who pretend there are no consequences for the public finances are being irresponsible.