Public spending's great rise and fall: what lessons learnt?

Fri, Jul 22, 2011, 01:00

Uncontrolled growth in government spending is guaranteed to end badly in every case

HOW A government spends citizens’ money says a great deal about a country’s economy, and its politics.

The amounts of public money spent, and how the cash is divvied out, tell much about the degree to which governments boost or dampen growth and what their long-term investment priorities are. Spending indicators can also provide insights into such diverse things as the power of interest groups; the left-right orientation of an administration; how blatantly governments try to buy elections; and the degree to which spending, and policy-making more widely, is informed by evidence of effectiveness and value-for-money considerations.

This State’s fiscal history over the past decade has been eventful. In the 2000-08 period, there was a massive and unprecedented increase in spending. By 2009 the sharpest of U-turns had to be conducted.

With full details of Government spending in 2010 now available, a clearer picture is emerging of this State’s first two years of what is likely to be a long era of austerity.

In the weeks ahead and as the publication in September of the Government’s comprehensive spending review approaches, this column will look in depth at the main public expenditure areas. By way of introduction, this column makes six general observations on expenditure patterns since 2000.

1) Chart 1 rebases Irish and agregate EU-27 public spending* to the year 2000 to illustrate the comparative trends. In 2008 the Irish State spent €77 billion. This was 144 per cent up on 2000 and exceeded the EU aggregate 41 per cent increase by a factor of 3.5.

In the current fraught European political context it may also be worth noting that Irish public spending grew by more than eight times the rate of the country with the smallest increase over the period - Germany.

In the 2000-08 period, public spending growth in Ireland was the fourth highest among the 27 members of the EU. Two of the three countries registering higher growth – Romania and Latvia – have, like Ireland, been bailed out. The third, Estonia, suffered a depression- sized crash, but mananged to struggle through unaided, in part by cutting spending more drastically than Ireland has done to date.

The lesson of all this is glaring: runaway spending growth invariably comes to a crashing end.

2) As is now undisputed, much of the growth in the Irish economy in the half-decade to 2007 was illusory. Despite the warning lights that flashed ever more urgently as the boom reached its peak, the previous government not only continued to allow expenditure to match economic growth, it ramped up spending even more rapidly than the rate at which the credit- fuelled economy was expanding, whether measured by GDP or GNP. The divergence between the growth in spending and of the economy is illustrated in Chart 1.

And boomtime complacency was not quickly shaken off when the bubble burst. The property market began turning down in 2007, and many indicators, including tax receipts, started heading south in the same year. By the first half of 2008 the economy was already in full-blown recession. Despite this, expenditure growth remained in double digits for full-year 2008, with the government only waking up to the scale of the crisis in the second half of that year.

New fiscal rules, which have to be in place by the end of this year under the terms of the EU-IMF bailout, could usefully include limits on how much spending growth can exceed economic growth when the latter is above sustainable levels.

3) Governments bribe voters with their own money. This will come as no surprise to readers, although just how blatantly it happened in Ireland in the last decade is depressing.

The most rapid rate of annaul expenditure growth, of 18 per cent, took place in 2001. An election was held in May 2002. The second highest rate of growth, of 14 per cent, occured in 2007, an election year.

Fiscal rules, and the newly established Fiscal Council which will oversee those rules, should address - perhaps explicitly - the problem of governments using the public purse to influence elections.

4) As Chart 2 shows, spending on social welfare grew more rapidly than any of the three other major spending items, tripling over a decade. Last year the welfare bill came in just short of €30 billion and accounted for the largest share of public spending by a distance.

These long-standing patterns had little influence on public discourse. Rightists applauded the 1997-2007 Fianna Fail-PD administrations for their supposedly small-government, market-based policy orientation. Leftists exorciated them for the same reason. Neither side paid heed to actual policy choices.

5) Vested interests in Ireland are not as powerful as is usually claimed. Public sector trade unions are influential everywhere because their members are informed, well organised and cohesive. Welfare recipients are less influential because they are disparate, largely unorganised and often among the least educated in society. In spite of the inherent difference in the two groups’ clout, Chart 2 shows that growth in welfare spending exceeded that of public sector pay and pensions spending in every year over the past decade. What’s more, the last administration was more willing to cut public servants pay sooner and more deeply than welfare benefits post-2008.

6) Politicians almost always slash investment spending more than other areas of spending when they run into budgetary problems. This is so because it is politically easier to stop building roads than to cut public pay and welfare. That is exactly what happened on the two occasions in the last decade when problems arose, as Chart 2 shows.

This may also provide further evidence to support the point made above regarding interest groups. Fianna Fail’s close links to the construction industry are well known. That industry, which has been decimated by the property collapse, has been most affected by the cutting of capital spending. It lobbied to maintain public investment so that builders might benefit. It got short shrift from its Fianna Fail friends as investment spending was almost halved in 2008-09.

If good can come from the current crisis, it will be the instituting of a more rigorous and thoughtful approach to the use of taxpayers’ money to replace the if-I-have-it-I’ll-spend-it idiocy of boom-era administrations. If done seriously, the comprehensive spending review currently being undertaken could be the foundation upon which to build a more intelligent approach to budgetary management.

*All figures cited here are nominal and based on the General Government accounting standard