December 9, 2001

Scary insight into rulers' heads

Posted in Politics · 2 comments ·
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Although a budget has ceased to matter materially to the performance of the economy, it still gives us a great insight into the heads of our rulers. The picture revealed on Wednesday was rather frightening.

The natural aspirations of a minister faced with an election are fair enough, but political wishful thinking, economic inconsistency, statistical incompetence and technical confusion run much deeper.

Taken together, these four observations suggest that we should be quite worried about the ability of our leaders to govern in anything but the most fortunate economic circumstances.

Let’s begin with politics. Irish politicians are schizophrenic in claiming that they can deliver the tax system of Texas and the social welfare system of Sweden.

You can have one or the other but not both. The roots of this dichotomy are old and hark back to the fact that over the past 30 years, Ireland has positioned itself politically at the heart of Europe (initially to move out of London’s orbit) but economically we have moved away from the European model to become the 51st state of the US.

The European political move has meant that our politicians adopt the language of the European left-of-centre consensus, with its ultimate promise of a strong state providing a functioning safety net. Yet this rhetoric is in direct contrast to the realities of being part of the US economic space.

We have adopted American policy on taxation, investment, trade, employment law and business attitudes. We have stopped short of the American “get-a-job-bum” attitude to the poor, preferring the European “the-state-will-provide-from-cradle-to-grave” approach to poverty.

These contrasting aspirations are only a remote possibility in short periods of exceptional economic growth. Over the longer term they cannot be reconciled. Now that growth is faltering, the inconsistencies of our political schizophrenia are emerging.

There are five major inconsistencies facing the government and the electorate. Wednesday’s budget and the reaction to it have brought them into stark relief:

* the promise not to raises taxes

* the promise not to borrow

* the promise not to cut expenditure

* the acknowledgment of lower growth in the future

* the aim to remain members of the euro area.

This inconsistent quintet, which was reiterated by both the Tanaiste and the Minister for Finance this week, reduces the government’s economic analysis to the realms of fantasy.

If you want to keep expenditure high you have to raise taxes or borrowing. Alternatively, you can cut spending and keep taxes low. Another option is to keep spending rising above 13 per cent (as was the case in Wednesday’s budget), keep taxes low and increase borrowing. But our EMU commitment dictates that we cannot borrow over 3 per cent of GNP in any year. So we would have to leave the euro to deliver on higher spending, lower taxes and higher borrowing.

Another permutation could be to cut spending and taxes and retire the national debt. No matter which way you look at it, you can’t please all the people all of the time. So barring a huge upswing in growth (which the government is not expecting) you can’t have no borrowing, no tax increases and strong state spending, and remain committed Europeans.

A back-of-the-envelope calculation reveals a shocking level of statistical incompetence underpinning some of the government’s policies. If the government fights an election based on the `inconsistent quintet’ and wins, the budgetary arithmetic becomes interesting.

Let us say that the government promises to keep spending as it is, and not to raise taxes or borrowing for every year of a new term out to 2006. This would imply, using today’s numbers, that the exchequer borrowing requirement in 2006 would be over �9 billion. According to the government’s new moderate growth projections, total Irish GNP will be around �105 billion in 2006.

This implies that the state will be running a deficit of close to 7 per cent of GDP. However, the stability pact that governs euro membership states clearly that we can’t borrow above 3 per cent of GNP. The only way the government’s figures add up (which would prevent us doing what we want and remaining part of the EU club) is if economic growth is above 8 per cent for every year until 2006. Welcome to the world of fantasy economics.

On Wednesday a shocking level of confusion inside the heads of our rulers was revealed. All parties got their knickers in a twist over borrowing. Were we borrowing? Was taking from the funds borrowing in disguise? Was the government waltzing us down the 1980s cul-de-sac again?

In the context of EMU these concerns show a lamentable grasp of what a monetary union means. A monetary union does exactly what it says on the tin — it unites all the moneys of the member countries — implying that state borrowing from a small entity like Ireland probably won’t even register on EMU-wide radar screens.

EMU gives us a great opportunity to free-ride. We can borrow at no cost. That is the beauty and difficulty of EMU. States can play beggar-my-neighbour with each other because the pool of total European savings is so big that no one state, particularly a small one, will have any effect on EMU-wide interest rates.

Taking the McCreevy-Harney fantasy example above, even if our deficit were 7 per cent of Irish GDP in 2006 that would amount to under 0.1 per cent of total European GDP. Therefore, there is an incentive to free-ride in a monetary union, and it was because of this flaw in the blueprint that the central bankers insisted on the ‘stability pact’ in the Maastricht Treaty. So state borrowing is not the problem anymore.

It is interesting to see how differently personal private sector borrowing is regarded. Borrowing is borrowing no matter who is doing it. One of the great confusions of the past few years is how the so-called prudent politicians whooped with delight when figures for car sales and personal spending were released — most of which were financed by a private sector borrowing binge, while they solemnly shook their heads at the thought of state borrowing.

Debt is debt, and in a downturn the impact on the economy from too much personal borrowing in good times will be just as negative as too much state debt. Taken together, developments in Wednesday’s budget serve to expose just how tenuous our politicians’ grasp on reality is. Philosophically, the idea that we can have Swedish hospitals and Texan taxes is a cod exposed by the numbers that show that GNP would have to grow by at least 8 per cent every year for the government to achieve its objective.

Yet McCreevy said in his budget speech that the government has based its calculations on 5 per cent on average. Finally, we have the confusion over borrowing and EMU, which implies that, for all the rhetoric, our political class is still thinking as they did when Johnny Logan was winning Eurovisions.

Speaking of Eurovisions, dropping our EMU commitment is a way out of the ‘inconsistent quintet’. Now, even if something as dramatic as this were not seriously entertained, wouldn’t it be nice to have someone else to blame for not being able to please everyone all the time?

Kicking off with the Nice referendum Mark 2, expect much more euroscepticism in the years ahead, some of it from the most unlikely quarters.


  1. Louis Hoffman

    Maybe if we had been controlled centrally from Europe back in 2001 we would not have got into such a big debt mess?

  2. MK1

    Hi David,

    > However, the stability pact that governs euro membership states clearly that we can’t borrow above 3 per cent of GNP.

    All very well in theory, but in practice no country was held liable for going above 3% and the first two countries to break that rule way back were Germany and France, others may have done so then as well.

    A point I have been making all along is that the rules of 60% debt and 3% max per year are all well and dandy, and indeed if countries did stick to them they would be good, but the ‘rules’ aren’t based on solid economic theory. Indeed, 5% or 10% in any single year may be required to handle a ‘shock’, and 60% could be broken.

    What is clear from the start with the euro ‘project’ is that these targets were being broken left right and centre. Belgium was never on a trajectory to get to 60%, nor was Italy, nor has Greece ever been. We were doing well on total debt (was it as low as 22%?) only for us to wallow in the mudbath that was the global credit bubble and we binged on that, with our government idly standing by whether through ineptitude or otherwise.

    We didnt have to take the full debt onto the countries books from the toxic banks, we SHOULD have reformed the banks majorly, but we still havent. Time has ticked by and we are in one holy mess. The euro project, which only had aspirational rules, is now being put to the test. The countries either need to join the euro/EMU for real, or get out of it.

    MK1

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