Notes on the Front

Thank god – some common sense courtesy of Paul Sweeney (his performance on Saturday Review is worth listening to if you missed it). What other countries are doing – the US, Germany, UK, France, Australia, etc. – is what we should be doing: providing ‘smart’ stimulus to the economy, growing ourselves out of the recession, investing for the long-term to put ourselves on the path of a European ‘stakeholder model; this is the ticket. But there is one issue we must confront head on lest we lose the argument, lest our goals, our strategies remain inspirational.

Borrowing.

A number of commentators warn of plague-times if we don’t reduce our borrowing. Some say this out of ideological glee, others in sorrow (John McHale lamenting the breaking of the Keynesian Compact but, hey, what can you do). It all comes down to borrowing – for clearly if we are to mount an expansionary programme, we won’t be able to do this from tax revenue and/or public expenditure cuts alone. But if we can’t borrow, ergo, we can’t expand. So what’s the real story?

Overall Debt

One of the very assets we had entering into this recession was our low overall debt. In 2007, our gross debt level was 25 percent of GDP (approximately 15 percent if we include the Pension Reserve Fund monies). The average for the EU-27 was just under 60 percent. That asset is quickly being written down. The Government’s newest projections show gross debt rising to 66 percent of GDP by 2011. That’s an increase of more than 2 ½ times in just four years.

But the fiscal conservatives would have us panic. They point to the 1980s when our exchequer debt was 107 percent of our GDP. If we drift we will drift over the fiscal abyss. Never mind that 66 percent is a long way from 107 percent – let’s expose this fear-mongering for what it is.

Compared to other EU countries our debt level is nothing to get excited about. The EU Commission projects Eurozone debt rising to 76 percent by next year. The Government projects Irish borrowing to be 62 percent. The difference comes to approximately €26 billion. In other words, we could borrow an extra €26 billion and we’d only be at the Eurozone average. But that’s not all.

The National Treasury Management Agency (NTMA), which manages our debt, has over €20 billion on hand owing to a far-sighted policy of ‘pre-borrowing’ (though €5 billion will be used to redeem debt in April). This cash balance is not reflected in the EU numbers since it measures gross, not net). But this means that our real net debt ratio is even further below the Eurozone average In short, we can avail of an extra €40 billion and we would still be just below the Eurozone average. That’s a mighty big war chest.

Debt Service Costs

Back in the bad old 1908s the cost of servicing the debt came to nearly 10 percent of our GDP – unquestionably a burden. Are we getting close to that? Not a bit. In 2008, debt service came to less than 1 percent of our GDP. Over the next few years this will no doubt rise (in part, a function of the GDP falling). But let’s get a grip – debt service costs could quadruple and we would still be a long ways away from the bad ol’ 1980s.

In 2007, the total EU-15 figure was 3 percent. Coming into the recession, our debt service costs were 1/3 of the EU’s costs. Even at our current borrowing levels, debt service costs in 2012 will still only reach what other EU countries were paying in 2007. Given that these costs will rise everywhere, we will continue to be well behind the average.

Annual Deficits

What the Government is fixated on, though, is not the overall debt level or debt servicing costs EU but, rather, the annual Government deficit. There is no question that our annual deficits have gone stratospheric. In 2007, the annual debt was less than 1 percent. This year it will be over 9 percent. And with job losses mounting it could go higher. The annual deficit has been driven up by two factors:

• One part of the annual deficit results from the loss of economic activity resulting in higher social welfare bills, reduced tax revenue, etc. This could be called a ‘cyclical’ deficit and, in principle, this deficit should disappear when normal economic activity returns.

• Another component is the ‘structural’ deficit. This refers to our narrow tax revenue base which was reliant on windfalls from the property/construction sector – windfalls that will not return. The Government estimates the structural deficit to be 70 percent of our overall annual deficit. In other words, had we not engaged in irresponsible tax cutting, this deficit would be considerably lower, with a resulting overall lower annual deficit. We are paying for Fianna Fail’s recklessness.

These are important distinctions. An economic stimulus is intended to confront the cyclical part of the deficit in order to limit the depth and duration of the recession and to quickly restore us back to trend growth. To address the structural part of the deficit necessitates either cutting expenditure or raising taxes.

The issue is not how quickly we can eliminate the structural deficit (we could do it tomorrow if we cut social welfare rates by 75 percent). The issue is, first, what are the long-term reforms to eliminate this part of the deficit in the medium term, and, second, how can we start implementing that reform programme without damaging private consumption (demand) and Government expenditure / investment – including a large-scale stimulus package. In other words, it is a road-map, a process that is imperative; otherwise we will be cutting and slashing without strategic purpose – a sure recipe to depress investor confidence.  For instance,

• Levying all income will harm private consumption as it impacts on low-average income groups that have a higher propensity to spend.

• Phasing out all non-productive tax relief for incomes over €100,000 per year, however, won’t as this will come primarily out of savings.

• A once-off levy on capital assets (which will primarily hit property assets both here and abroad) is unlikely to hit consumption.

• Abolishing subsidies to private fee-paying schools will not affect Government investment or, again, consumption.

• However, increasing the top tax rate substantially in the short-term, unless reformed, would hit many below-average income earners – thus harming consumption and confidence.

Creating a road-map requires a far-reaching progressive reform – focused on both the structural deficit and the increased debt servicing costs arising from increased borrowing – with a Government that knows exactly what it’s about. It will also require the political courage to tell people the plain truth – that taxes will have to rise eventually and permanently.  This is about challenging our historical low-tax, low-spend model. It’s also about people having confidence that the Government will only engage in this when consistent with economic growth. Which combination of parties, and in which hierarchical order, will produce a Government capable of that – I leave that to your imagination.

The Stimulus-Deficit Dynamic

The NTMA put it in a provocative way:

'Thanks to the budget surpluses of recent years, Ireland has indeed some room to manoeuvre, even under the current circumstances. Moody's assessment of "very high" government financial strength reflects the country's still relatively low level of government debt. At the same time, Moody's observes that Ireland's pronounced weakness in economic activity is translating into a distinct reversal of public finance dynamics.'

Moody calls it right – the economic decline is causing the fiscal problems. With a ‘smart’ stimulus programme – aimed at upgrading our physical and social infrastructure while engaging in redundancy-avoidance programmes, as well as stimulating spending among low-average income groups – we can begin to slow and, eventually, reverse the economic contraction. Put simply, job creation and retention – through either direct or indirect public subsidy – will ease unemployment, reduce social welfare, increase tax revenue and encourage spending. All these have real fiscal benefits. Much more so than removing demand from the economy from generalised tax increases or harmful public spending cuts.

In other words, let’s address the cause of the fiscal crisis. Let's provide stimulus while at the same time laying down a new infrastructural base that provide us a chance to grow once the international conditions recover. If we recapitalise banks, let’s recapitalise the economy. If we aim to kick-start the flow of credit, let’s kick-start economic activity.

For the Right, borrowing is a burden. For progressives, however, borrowing is an instrument – a weapon if you will. Yes, a dangerous weapon if in the wrong hands. But just because the current wielder hasn’t a clue, doesn’t negate the principle.

Just put in place those know what they’re doing and how to find the right target.