Friday, January 4, 2013

Irish Examiner 02/01/13

The unedited text of a recent article from The Irish Examiner is continued below the fold.

UPDATE: The published text is here.

Counting up the myriad costs of five years of running a budget deficit

The last year in which Ireland did not run a budget deficit was 2007. In that year, general government expenditure was €68 billion which was matched by revenue of €68 billion, giving a balanced budget overall.

The outlook for 2008 was described as “uncertain” but the budget announced by Brian Cowen on the 5th of December 2007 allowed for an eight percent increase of spending in 2008, with increases across all areas, as well as reductions in income tax through changes to tax bands and credits. All of this was supposed to result in a budget deficit of less than 1% of GDP because the assumed growth rate facilitated such largesse.

Just five months later Brian Cowen became Taoiseach and Brian Lenihan took over as Minister for Finance. Within two months he introduced the first austerity package with €1 billion of expenditure measures, as the assumptions of Budget 2008 unravelled at an alarming pace.

Budget 2009 was brought forward to October 2008 but by then the damage was done. The hole in the public finances that was covered up by the inflows of huge tax revenues from the constructions and property sectors quickly became apparent and steps had to be taken to address it.

But even at this stage it appears that the extent of what was unfolding was not fully accepted. Brian Lenihan began the process of austerity in July 2008, but in his first budget two months later he announced a package of increases in social welfare spending.

The state pension, which was €209 in 2007, was further increased by Brian Lenihan to €230 for 2009. Social welfare rates such as Jobseeker’s, Illness, Injury and Disability Benefits were increased from €186 to €204 over the two budgets.

The deterioration in the public finances was startling. From a position of balance in 2007 there was a deficit of almost €20 billion in 2009. From €68 billion, government revenue fell to €56 billion in just two years, while expenditure in 2009 had risen to more than €75 billion.

This represented a deficit of more than 12% of GDP. Borrowing at this level cannot be sustained, particularly when you cannot print your own currency, and steps had to be taken to reduce the deficit.

Since peaking in 2009, the deficit has fallen in each year since. The rate of progress is slow and under official targets Ireland has to get the deficit down to 3% of GDP by 2015. This will be eight years after the deficit emerged in 2008 by which time the deficit will still be €5 billion per annum. It is likely to be more than a decade between the last balanced budget and the next.

In 2010 the deficit edged down to 11% of GDP, in 2011 it fell to 9% of GDP and this year it looks like the outturn will be around 8% of GDP and a deficit of around 7% of GDP is projected for next year. While no one can doubt the efforts being made to reduce the deficit through a series of painful annual and supplementary budgets, the pace of deficit reduction is still slow.

For 2012 government revenue will be €56 billion just as it was in 2009, while government expenditure will have declined to €69 billion. All of this reduction can be explained by cuts in capital expenditure which has been slashed by two-thirds. Current expenditure has been contained rather than reduced.

If we do achieve the 3% of GDP deficit target by 2015 the plan is that revenue will have risen to €63 billion and while expenditure will be largely unchanged €68 billion, the level it was when the economy peaked in 2007.

This is not to say that there will not have been expenditure changes. The composition of government expenditure will change and inflation will reduce the real value of the expenditure.

There are many claims that austerity is not working because the deficit reductions are small relative to the size of the measures that are being introduced. Since Brian Lenihan’s first package of expenditure measures in July 2008 about €28 billion of austerity measures have been announced.

Some reasons for the seemed failure of these to reduce the deficit is announcement repetition, implementation failure, subsequent reversal in some cases, in many cases a gross overestimation of the impact of the measures actually introduced, and some have been offset by other measures such as the increases in social welfare expenditure in October 2008.

Another reason is that the focus tends to be on the policy changes announced in the budget but the deficit outcome is also the result of underlying dynamics in the public finances and the economy in general.

Since 2008, the cost of providing state and public sector pensions has risen by an average of €380 million each year. More than €1.5 billion of the improvements made in the deficit elsewhere has gone to fund increased expenditures on pensions.

In the main, this is as a result of demographics rather than any policy decision. The number of over 65s increases by around 20,000 each year while the number of public sector pensioners has been increasing by around 7,000 a year recently.

This demographic trend has also put pressure on the health service but there are more fundamental reasons for the expenditures overruns there. The record numbers of births affects expenditure in health, education and social welfare.

It is also the case that borrowing for these massive deficits has added to the interest bill. From 2008 to 2012, the combined deficits sum to nearly €80 billion. This is not including any monies provided to our delinquent banks. To borrow this money at 5% has added €4 billion to the annual interest bill. Paying the interest on previous deficits makes reducing the current deficit harder.

The deficit is falling. This is the objective of austerity. To judge it relative to another measure is incorrect. Austerity is not about generating growth, expanding employment or preventing poverty. These should be the goals of budgetary policy but such is the disrepair of our public finances that the instrument has become the target.

We cannot continue to borrow huge amounts of money to fund the day-to-day operations of the government. If anything the money from the Troika has slowed the rate at which the public finances must be brought back on track. When order is restored to the public finances the emphasis can rightfully be put on growth, employment and poverty. That day is still a way off but at least it is clear now that we are moving in the right direction.

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