So another European summit has ground to an inconclusive conclusion. It is still not clear whether or not the decision by David Cameron to walk out was due to a principled stand on behalf of the one square mile of the UK that is the city of London or whether it was that he found himself tactically outmaneuvered and beat a retreat. In any case a Weakened United Kingdom is not good news for a country which exports 16% of its exports to the UK. There is a strong sense reading the communiqué that it is highly aspirational, and designed along the lines of : we must do something, this is a thing.
In terms of these aspirations what we appear to have on on the table is a promise of neither a fiscal nor a transfer union but an austerity union. We are all to adhere to even stricter guidelines than were in the Stability and Growth Pact, in relation to government spending. In fact, if we take the proposal for a 0.5% budget deficit, and put in any reasonable levels of growth, a long-term Irish debt to GDP ratio of 20% would be implied. As has been pointed out by a number of commentators (see Karl Whelan here and Com McCarthy here ) this is likely to take a very long time, and in any case would result in the perverse situation of too low a level of long-term government bonds, which among other things would have implications for the ability of insurance and pension companies to hedge their long-term liabilities.
It is noteworthy that the issue of fiscal responsibility is one that is significantly greater than that of mere rules. In the Seanad Senator Sean Barrett tabled a bill this week on Fiscal Responsibility which was generally welcomed by the Government (they wont accept the bill of course). More information on that bill can be found here and see the response by Brian Hayes TD here which gives a good outline of the sort of issues comprehensive fiscal responsibility involves.
It is not clear, despite the existence of a proposal to have advance warning systems, if the compact now proposed had been in place that it would have materially slowed the descent into sovereign debt crisis. In any case, the stability and growth pact was breached repeatedly by France and Germany without compunction.
Neither did the summit solve the vexed issue of whether or not the European Central bank will in fact be an effective lender of last resort. While there is a proposal to have a medium-term liquidity function, highly desirable in the Irish context of banks being dependent for over €100 billion worth of liquidity from the ECB (albeit a large but unknown proportion of this being IFSC banks) the system seems to be resorting to ever more convoluted mechanisms by which the ECB can in effect but not in fact purchase bonds of member states. As I have stated previously this is a policy of treating the problem as one of liquidity when it is more likely one of solvency.
More starkly the summit does not address the issue of growth. Successive predictions for euro area growth issued over the last year have relentlessly ratcheted down expectations. The OECD prediction for 2012 for the Eurozone are for an anemic 0.6% growth in GDP, absent any significant shock.
In the context of this we should then examine the Irish budget. Although there is a perception abroad that we have had significant austerity, and certainly people are beginning to feel the pinch, when one examines the actual figures, as Seamus Coffey from University College Cork has done, it’s very clear that the actual level of money that has been taken out the economy is significantly less than the “€21 billion” figure much bandied around. The reality is that we have only just begun the process of adjusting for the difference between government expenditure and revenue. This may seem startling after four years of continued “austerity” budgets but the reality is that even on the basis of the government’s own figures we are still likely to run a deficit of 8.6% of GDP, over 10% of GNP. It’s worth remembering that in the initial November 2010 four-year plan deficit for 2012 was to be 7% of GDP, which slipped to 7.5% in the 2010 budget and slid further to 8.6% by April of this year. And of course this 8.6% is contingent on what may now seem to be a reasonably optimistic growth prospect. The ESRI predicted GDP growth in 2012 of .9%, Department of Finance 1.3%, or 1.6% depending on which document you read, and the Commission 1%. All suggest that the domestic economy will remain stagnant at very best. The Commission were as late as summer 2011 suggesting a real GDP growth rate of 1.9%, which they had consistently done since 2010. Clearly a corner has been turned in forecasts.
The budget therefore, set against the context of a dysfunctional European Union, facing into stormy international growth waters in 2012, is unlikely to significantly affect the dynamics of the Irish government debt. Much of the adjustment to date has been on the basis of capital projects, in particular by the cancellation of projected capital projects, in other words equating not spending planned money with Actually making savings. The largest items and current expenditure are social protection at 40% of government expenditure Health at 27% and education at 17%. Cuts in these are politically sensitive and socially difficult.
There is a meme in Irish political discourse that somehow or other we can solve our budgetary problems by simply cutting public sector pay and social protection. On its own projections the government will next year run a current budget deficit of €13.1 billion, and will borrow €8.4 billion for capital expenditure, a total borrowing requirement of over €21 billion. This gap cannot be closed by changes in any one sector on its own. It will take a mixture of increased tax take, reduced expenditure, and must especially economic growth.
if we were to cut public sector pay by 20%, whether across-the-board or by targeted cuts, this would result in a gross saving of .2* €18.6 billion, €3.7 billion in gross terms. The average public sector wage is €47,000, but of course there are fewer people in total earning That than there are public sector workers. More probably the median public sector worker earns closer to €35,000. Based on 2009 revenue data this would imply that their average 22%. This would imply that a cut of 20% in public sector wages in gross terms would yield net savings of the order of €3 billion, but of course that ignores the billions of Euro of lost VAT, excise, etc, not to mention the second-order effects of reduced economic growth resulting in reduced tax take overall. Cutting public sector wages is not a panacea.
Nor is cutting social protection. The largest part of the social protection budget is the €4.3b spent on income supports, some €2.7b of which is the dole. Cutting this by 20% will yield €540m, at a pretty high social cost. Contributory old age and widows pensions, paid for over a lifetime through PRSI, amount for some €5b, and the ghost of Ernest Blyth hangs heavy over any cut there, but again a cut of 20% will yield €1b, dare any government so do.
The government is in a massive hole, and there are no simple solutions, although simplistic solutions abound. A return to growth is a sine qua non for our salvation and neither the budget nor the eu summit promise same.