Assess Budget by its impact on competitiveness

Next week's Budget will undoubtedly be the most difficult one that the current Government has had to frame. But this certainly does not mean that Minister for Finance, Mr McCreevy, and the Government do not have important decisions to make, nor does it mean that the Budget doesn't matter this year just because the finances are tight.

On the contrary, it is in these times that the decisions made will have more influence on the economy than usual.

Let us seek to lay out a set of criteria on which this year's Budget may be judged. Firstly, let us look at a way in which the Budget should not be judged.

This Budget should not be judged on whether the Minister plans to run a deficit next year. Many people remember the borrowing excesses of the 1980s with a shudder and hate the idea of the country living beyond its means. But there is a huge difference between the circumstances then, when borrowing got out of control, and the current situation.

In the 1980s, in general, the borrowing was being done to finance day-to-day government spending, not capital expenditure. The public sector expanded rapidly, as the response by governments to rising unemployment was to employ more people in the public sector.

Later, the government had to pay out large sums of money to encourage many of those same workers to leave the public sector, as the government simply could not afford the huge wage bills that had been built up.

Next year, however, it is virtually certain that, if the minister decides to run a deficit, it will not be for day-to-day spending but will be for spending on the National Development Plan.

Economists are generally far more relaxed about borrowing for capital spending than they are for current spending. If we think of the government's finances as analogous to the finances of a household, it's acceptable to get a mortgage to buy a house but it is unwise to be running up ever-increasing overdrafts to pay the groceries bill.

Another key difference is the national debt is far lower now, relative to the size of the economy, than it was in the 1980s. In any case, even the largest estimates of any deficit that the minister might run next year would still be only a fraction of the enormous amounts of money that were being borrowed then.

We should also note that the Government is setting aside large sums of money each year to pay its future pension bill (just as every employer with a pension fund for its staff must do), but it was not doing so in the 1980s.

Taking all of these differences into account, we should not judge the Budget by how much, if anything, he plans to borrow next year.

How then should we judge it?

From a political viewpoint, this Budget will obviously be most concerned with setting up a platform from which to win the forthcoming election. That probably means making sure that health spending is increased rapidly once more. (A cynic might note that vast sums of extra spending have been allocated to the health service already in recent years, without anyone noticing much of an improvement in the service provided - but that's a different debate.)

From an economic viewpoint, the Budget's main priority must be to maintain and improve the Republic's competitiveness.

Over the past couple of years, Irish wage costs have been rising about twice as fast as those of most other European countries. We can get away with this for a couple of years, partly because our wage costs started from a point where they were lower than in most other European countries, but obviously we can't keep rising our costs far faster than our competitors indefinitely.

Unfortunately, higher government spending usually takes the form of higher wages in the public sector (the Exchequer wage bill will rise by 11 per cent next year), which, even if entirely merited, does have the effect of pushing up wages in the private sector and, therefore, reducing our competitiveness.

Competitiveness is not just about wages, though. It's also about all types of other costs, including energy, transport, communications and taxes of all sorts including PRSI. Some of these are not directly determined by the Budget but most are at least indirectly affected.

Transport costs, for example, are not just about fares on public transport.

They also include delays caused to hauliers by the poor state of the roads and the extra costs involved in transporting goods by road given that our railway network isn't used efficiently for freight transport.

A Budget that slashes capital spending on, for example, road and public transport improvements, will be a Budget that hurts our competitiveness and should not be welcomed.

The same could be said of a Budget that increases PRSI or other taxes, or which reduces the incentive for people to enter the workforce in any way.

The bottom line is that this budget will be assessed by its impact on three things: competitiveness, competitiveness and competitiveness.

Mr Eoin Fahy is chief economist, KBC Asset Management Ltd. The views expressed in this article are personal and not necessarily those of KBC Asset Management.