Patrick Kinsella: There's more austerity on the way

Despite the giddiness around growth rates we are not out of the woods

Everything we know about the economy is based on estimates, and all estimates must be treated with caution.

The latest revised CSO figures show the economy turned a corner in the summer of 2013, since when they’ve recorded four quarters of solid growth - the first such continuous growth since 2006, and the first time the domestic economy improved along with exports.

But Ireland’s national accounts are subject to more doubt than most countries. The economy is dominated by our export trade - which earns more than we spend each year on household consumption, government services and domestic investment combined.

That's problematic because a huge proportion of exports are generated by foreign companies who for tax reasons route profits through Ireland that are not actually earned here.

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We've known that for years, but what's relatively new is the trend of 'redomiciled' companies: global giants who have their headquarters here but whose business is elsewhere, perhaps manufacturing in Asia, selling in America, and paying taxes (if any) in the Caribbean.

That’s been calculated to overstate our national income by as much as 5 per cent, and because these are accounting transactions driven by tax law, they vary considerably from quarter to quarter and are frequently revised later. So it’s wise not to get giddy over headline annual growth rates of an apparent 9 per cent.

Solid evidence More solid evidence of recovery is to be found by looking at tax revenue, and the number of people at work. So far this year, taxes on income and taxes on spending are both up by 7-8 per cent. That's due to a combination of higher tax rates, slightly higher prices and incomes, slightly higher domestic spending, and more people at work. Indeed, until recently ministers focused mainly on employment as the best sign of a growing economy, but even here the signs are mixed.

In the past two years, the number at work has grown by 65,000, most of them in full-time jobs. But more than a third of the increase are self-employed, suggesting business start-ups that will not all survive.

Furthermore, the scale of unemployment is greater than the headline figure: to the 250,000 or so people actively seeking work, we should add about 45,000 in short-term government schemes who are counted as employed, 50,000 or so who have given up looking for work but would like a job, and another 130,000 part-timers who want to work full-time. That’s almost half a million people, not counting emigrants who’d like to return.

The weak labour market is reflected in earnings: although some sectors - particularly manufacturing, transport, and financial services – have seen pay rises averaging 1-3 per cent in the last year, and working hours are up, overall private sector pay is more or less static, and it’s still declining in the public sector and professional services.

That helps explains why the retail sales figures show such patchy evidence of recovery, bouncing up and down from month to month since Christmas.

Nor will living standards be back to boom levels for some years to come. More of our rising national income is being absorbed by taxes and interest payments on government debt, and unemployment will remain high – well above 6 per cent until 2020 at the earliest, according to the current ESRI medium term review, which sees only slow growth in disposable incomes under the most favourable assumptions.

Even that scenario is at risk from the renewed slow-down in the economies of our Euro-zone partners.

The long squeeze Let's suppose national income is now truly on an upward trend, and tax revenues remain buoyant reflecting the slow but steady return to work of the unemployed, what scope for relief in the form of general pay increases, or reductions in tax rates? The options are strictly limited by the constraints of our EU membership.

The first objective of the cutbacks that started in 2008 was to get the government budget back in balance – to stop spending borrowed money and stop adding to the burden of debt.

We aren’t there yet, and on current plans the government will go on borrowing (though reduced amounts) until 2017, with a balanced budget hoped for in 2018 – the culmination of a ten-year squeeze. Tax concessions or additional public spending now would postpone the return to balance and would require additional borrowing.

But there’s a second objective, imposed by our membership of the EU: as soon as we have attained a balanced government budget we have to start reducing the total debt to no more than 60 per cent of GDP – about half our current ratio. Under the Fiscal Stability Treaty we approved by referendum in 2012, we can cut the ratio in steps of one-twentieth, but we must make progress every year.

Once the budget is balanced, much of the required improvement in the debt ratio will, with luck, come from economic growth (GDP up, debt ratio down). But under current EU law, easing up on austerity with tax concessions would make as much sense as coming off a weight-loss diet early just because you are no longer gaining weight.

Having reached a sensible balance between calories and exercise, the doctor advises us to continue until we reach our target level of fitness. Of course the bigger question is why the target debt-ratio is 60 per cent rather than some other number. But unless there’s a change in the fiscal treaty we approved, Operation Transformation has just begun.

Fiscal treaty All EU member states have been bound by rules on budget deficits and borrowing since the adoption of the Treaty of Maastricht in 1992. The enforcement procedure was set out in the Stability and Growth Pact adopted by the Council of Ministers in 1997. At first the Pact was more honoured in the breach - including by Germany - but it has since been strengthened several times with provisions for supervision of national governments by the European Commission and fines in the event of continued misbehaviour. These terms were confirmed by the Fiscal Stability treaty which was approved by referendum in Ireland in 2012.

The Maastricht rules and the treaty require government budgets to be in balance or in surplus - more tax revenue than government spending - with limited exceptions, including times of ‘severe economic downturn’.

To account for normal economic ups and downs, 'balance' is generally defined to include a deficit of up to 0.5 per cent of GDP (or 1 per cent in the case of countries with very low debt burdens). In severe downturns the deficit can be more, but the maximum permitted is no more than 3 per cent of GDP, or else special enforcement procedures come into play – procedures that Ireland is currently observing, along with France, Britain and eight other countries. Countries are also obliged to bring their government debt down to 60 per cent or less of GDP, but can achieve this in steps of one-twentieth once they have achieved a balanced budget.