John FitzGerald: Tackling the housing crisis requires economic sacrifices

While success may bring its own rewards, for the Government it brings new headaches.

The economic recovery since 2012 has transformed the Irish labour market: unemployment has fallen consistently. This labour market success has been based on rapid growth in the economy. This year will be the fourth in which growth in the real economy has equalled or exceeded 5 per cent, and it may well continue next year.

However, because the government in the period 2012-2014 was unsure about how successful it would be in turning the economy round, it did not prepare for success by focusing on building homes. The result has been that, while growth is very rapid, those finding jobs all need somewhere to live and building still lags far behind.

One of the failures in the run-up to the 2008 crash was that governments did not recognise that there were limits to how much goods and services an economy could produce in the medium-term.

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Lost years

In the period 2003-2007, the economy was asked to produce massive numbers of new homes as well as an ever-growing range of consumer goods and services. If the priority was investment, as the then government asserted, fiscal policy should have made space in the economy for that investment by a combination of raising taxes and cutting expenditure elsewhere. The failure to take such action resulted in very painful lost years when the economy exploded.

Today the situation is rather like what it was in 2003-2004. The economy is growing very rapidly and the clear priority is investment in infrastructure, especially homes.

However, the economy is already close to capacity. To make space for the necessary increase in homebuilding, other activity will have to be curtailed.

Every increase in homebuilding of about 10,000 units adds about 1 per cent to the level of economic activity.

If the Government succeeds by 2019 in raising housing output to 35,000 homes a year from a level of under 20,000, that is likely to add an extra 1.5 per cent or so to the level of GNP. With the economy already growing at capacity this would pose serious economic strains. It would echo the overheating we experienced from 2004-2007.

The lesson of the pre-crisis years is that, in a fully employed economy, if the Government wants to deliver on its investment programme, it will need to cut back on overall consumption. Cutting public expenditure on current services is politically challenging, particularly when the economy is booming. Private consumption may be best slowed through raising taxes.

Unpalatable advice

The Irish Fiscal Advisory Council report, published on Tuesday, provides very sound but unpalatable advice for the political system. The council recommends a broadly neutral budget with very limited giveaways for 2018. Yet many citizens expect that the fruits of the undoubted growth will be returned to them through tax cuts, allowing household consumption to rise rather than fall.

The council stresses that there are strong prudential reasons for their recommendation. While the current cost of our very large debt is low, it leaves us very vulnerable to a future economic shock. Hence they recommend fiscal caution.

Given their remit is fiscal sustainability, they suggest that, if growth continues, Ireland should begin a programme of modest repayment of national debt.

In my view, tackling the housing shortage should be an overriding policy priority – to reverse the continued inflow into homelessness, provide our young adults with access to stable and affordable housing, and ensure we can house an expanding workforce.

If we are serious about this, we need to temporarily pare back overall consumption to prevent additional housing investment from overheating the economy. To achieve that, taxes need to rise temporarily, both to discourage consumption and to help fund additional housing investment.

The “temporary” low VAT rate on hotels and restaurants should be returned to its original level, reducing consumption. Reductions in taxes on income should be postponed until the economy slows.

In making changes to our tax system, we should use the opportunity to promote reductions in greenhouse gas emissions and tackle pollution. Carbon taxes should be increased to encourage investment in clean technologies. Raising the tax on diesel to the same level as petrol would also bring improvements in air quality and people’s health.

A budget on the lines I suggest would be even tougher than that recommended by the fiscal advisory council. However, by preventing overheating and avoiding the pre-2008 mistakes, it would provide for a more secure future for us all.