Budget may cut wages and raise taxes to restore competitiveness

ANALYSIS:Today's emergency budget will bear the imprint of Alan Ahearne, Minister for Finance Brian Lenihan's economic adviser. So what do his recent writings tell us about what to expect? asks COLM KEENA

THE VIEWS of Alan Ahearne on what needs to be done to sort out our economic woes have been aired in newspaper articles in recent months. Business needs to regain its competitive edge and to achieve that, wages and prices have to be cut across the board, he has argued. This can be done in a quick co-ordinated manner, or it can be done more slowly, forced upon the economy as unemployment shoots upwards.

As Ahearne put it in an article in The Irish Times on January 27th last: “The choice we have to make as a nation is whether the adjustment happens quickly through a co-ordinated, across the board cut in nominal wages, or slowly and brutally through downward pressure on wages stemming from soaring unemployment.” On September 16th last year, he wrote that Ireland will over the coming years “record the largest cumulative drop in national income in an advanced economy since the second World War”.

Ahearne has made it clear he believes the crisis in the economy is the fault of the Government and in particular of Government policy since 2000. By implication this points the finger at the former minister for finance and now Taoiseach, Brian Cowen.

“Our economy is home to many outstanding businesses with huge potential for growth. Such firms formed the backbone of our extraordinary export-led growth in the 1990s. Tragically, this success was hijacked by property interests around the turn of the century and exports faltered,” he wrote on January 27th.

Ahearne has said membership of the euro zone has greatly assisted Ireland, but we cannot devalue our currency to reverse the loss of competitiveness incurred during “the housing bubble”. The only way to restore competitiveness, then, is to bring about a decline in wages and prices.

Another consequence of the housing bubble is the associated damage to the public finances that occurred when the bubble burst and property-related taxes disappeared.

Ahearne has said public sector pay cuts are a necessary part of correcting the damage caused by the construction bubble. However, he has noted: “The mess in which the Irish economy finds itself largely stems from the house price bubble, not from problems in the public sector. It is probably not a coincidence that some of the most vocal critics of the public sector today were among the most conspicuous cheerleaders for the housing boom,” he wrote on January 27th.

He has said the crisis should be used to introduce public sector reform. Restoring health to the public finances will require tax increases and cuts in public expenditure. On the latter, he has written that cuts in current expenditure, including “transfer payments” (welfare payments, etc), have been shown internationally to bring about the fastest recovery in national finances. Spending on capital projects that can be justified on cost benefit grounds should continue.

On taxes, he has written that there is a strong argument for broadening the tax base using a property tax. He has cautioned on the effect increases in income tax might have on employment, but sees such rises as inevitable. “Income tax rates should not have been cut during the boom when the economy was overheating and will now need to rise. The higher tax band will likely have to be increased to a level well beyond the 48 per cent rate favoured by the Irish Congress of Trade Unions”.

To deter social unrest, the Government’s effort to undo the damage it has done will have to be explained and introduced in a comprehensive way, he has written. Those who benefited most from the bubble must pay the most, while political leaders and other figures of authority “who oversaw the bubble and whose misguided policies contributed to the current crisis” need to make “extraordinary gestures of sacrifice”.

In a 2005 paper in the Economic and Social Review called Ireland’s Great Depression, he argued that Ireland experienced a depression in the 1980s comparable to that of the US in the 1930s. Their analysis indicated that “shocks to government spending” were not a first order cause but that “increases in taxes in the early 1980s is a good candidate for explaining the economic slump”.

Ahearne has been notably hard on the banks. In particular, he questioned the Government’s decision not to wind down Anglo Irish Bank. Deposits and good loans could be moved to other banks, and bad loans could be transferred to a special asset management company or “bad bank”, he wrote in The Irish Times on January 22nd.

Closing down the bank could enhance the State’s reputation as it would be seen as good policy. “It would at the very least put a stop to rumours that the Government is keeping Anglo in operation for political reasons.”

He has argued that attempts by banks during other property busts not to tackle insolvent developers who had loans on their books prolonged the difficulties of the affected economies. He also said the Government guarantee for bank deposits could promote bad banking practices and that the Government should get away from the current model as soon as possible.

The banking sector grew during the property bubble years and must shrink in size, he believes. There is a huge amount of excess housing stock and any efforts to artificially stimulate housing will prolong the adjustment process, he wrote in The Irish Times on September 6th last. Likewise, measures to stimulate trade in houses or purchases by first-time buyers, should be avoided.

However, he believes there is an economic and environmental argument for subsidising measures to make homes energy-efficient.

“Fiscal consolidations in other countries have often faltered in the face of pressure from interest groups. Stamina is required because the Government’s fiscal plan must be carried through fully over the next several years to bear fruit,” he wrote on September 6th last.

The Government must make courageous decisions. “Most important will be the courage to slash spending to restore order to the public finances, the courage not to interfere with the housing market and the courage to say no to vested interests.”

This presumably is what he’s been telling Brian Lenihan for weeks. We’ll find out later today if the Minister has been listening.

Colm Keena is Public Affairs Correspondent of The Irish Times