Will the budget be overtaken by events?
Dan White investigates whether the Irish government will manage to pass a budget next December and, even if it does, will such a budget pass the test of time?
Print17 October 2012
The admission by the IMF that it had massively under-estimated the impact of austerity on the peripheral eurozone economies was the intellectual equivalent of lobbing a hand grenade into the debate on Europe’s financial crisis.
In effect the IMF was saying that not only have the policies which have been dictated to the so-called PIIGS – Portugal, Ireland, Italy, Greece and Spain – by the EU/ECB/IMF troika since the crisis first erupted more than three years ago not worked, they have made the problem even worse.
The mea culpa from the IMF came in its most recent World Economic Outlook. Traditionally the IMF had employed a multiplier of 0.5 when analysing austerity programmes. In other words, for every 1% of GDP by which taxes were raised or spending cut, GDP would be reduced by 0.5%.
Unfortunately, in the case of the eurozone periphery, including Ireland, this multiplier was way, way too low. The IMF now reckons that the actual multiplier has been somewhere between 0.9 and 1.7. This means that, for every 1% of GDP by which taxes have been raised or spending cut, GDP has fallen by between 0.9% and 1.7%.
Austerity isn’t working
You don’t need to be an econometrician with a PhD in advanced maths to work out the implications of the IMF’s admission. Austerity isn’t working and current policies are in fact counter-productive.
This multiplier has almost certainly been highest in Ireland. While the IMF doesn’t break down its calculations by country, ratings agency Standard & Poors, which performed a similar exercise recently, does. S&P estimates that if the IMF’s traditional 0.5 multiplier had been accurate then the Spanish economy would have shrunk by 1.7% between 2009 and 2011, the Greek economy by 5.9% and the Portuguese economy by 3.7%.
Ireland off the scale
In reality the Spanish economy contracted by 7.1%, the Greek economy by 18.1% and the Portuguese economy by 4.8% over this period. While the example of these three countries could be shown to demonstrate that the multiplier previously employed by the IMF was far too low, they pale by comparison with what has happened in Ireland.
During the three years from 2009 to 2011 the Irish government cut the cyclically-adjusted budget deficit by 4.1%. If the traditional multiplier of 0.5 had applied that would have translated into a 2% reduction in GDP. Except that actual Irish GDP fell by 13.5%, implying an actual multiplier of 3.4. Even by the comparison with the actual multipliers experienced by other peripheral eurozone countries such as Spain (2.0) and Greece (1.5), the Irish multiplier wasn’t so much very high as completely off the scale.
While traditional versus actual multipliers might seem like a subject best confined to arcane academic debate, it is a subject of vital importance to this country. If the IMF is right then all of the pain and sacrifice of the past four years has been in vain.
This in turn has major implications for next December’s budget. With the coalition’s ability to pass a budget already suspect, the IMF’s volte face will give succour to those, not least within the Labour Party, who are sceptical about the troika-dictated budgetary strategy which has been pursued by this government and its predecessor since 2008.
While most of the skirmishing between the coalition partners has been ostensibly over minor issues such as primary care, to which €20m was allocated in last December’s budget out of a total health budget of almost €14bn, or state payments to private schools, €100m out of a total education budget of €8bn, it is not difficult to detect deeper underlying tensions within the government.
Hard choices for the budget
With no quick fix such as last year’s VAT increase readily available, the government will be unable to duck the hard choices it so studiously avoided in its December 2011 budget.
Cuts in social welfare rates, higher income tax rates, a property tax, water charges, a reversal of the December 2009 cuts in alcohol excise duties, higher excise duties on tobacco and fuel, an increase in the PRSI rates, all of the sacred cows that have up to now been protected are all at least at risk of being slaughtered on 5 December.
All it seems except one. Nineteen months after it first took office it seems as if this government is as inextricably wedded to the infamous Croke Park agreement as its predecessor. The coalition partners, particularly the Labour Party which relies on the public sector trade unions for the bulk of its funding, seem curiously reluctant to tackle the thorny issue of public sector pay and pensions.
The poor can have their benefits cut, the sick can wait on trollies and our kids’ education can be compromised, all so that the pay and conditions of our pampered public service, where average earnings are 49% higher than in the private sector, can remain untouched. By any yardstick this represents a grotesque misallocation of resources.
Worrying about the wrong country
However, there is a growing likelihood that, even if the coalition partners can somehow cobble together a budget, it will quickly be overtaken by events.
For most of the first three years of the eurozone crisis, all eyes were on Greece. What, many people worried, would be the implications for the eurozone if Greece was forced to quit the single currency.
Turns out we were worrying about the wrong country. With only 2% of eurozone GDP "Grexit" was probably always a manageable event. The same can’t be said about Spain. It is the fourth-largest eurozone economy accounting for over a tenth of its total output. A Spanish return to the peseta would surely rip the eurozone apart.
With Spain visibly coming apart at the seams with 25% unemployment, a broken banking system and Catalan regional elections – which look set to become a proxy independence referendum – due to take place on 25 November, it is difficult to see how the country can remain united while remaining within the eurozone.
If, or more likely when, Spain returns to the peseta, the pressure for a clearout of the single currency’s other weak links could prove irresistible. What are the chances of Ireland staying in the eurozone if that happens?
Despite all of the pain and angst which preceded its birth, is the 5 December budget destined to become a mere historical footnote as events elsewhere quickly render it irrelevant?
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