Backsliding on austerity would risk another crisis

Unsurprisingly, recent statements from the European Commission to the effect that further fiscal consolidation is necessary were not well received. It is not just the Irish Government that has been sent a warning: many other countries have been given reminder notices from Brussels.

Calls for yet more austerity emanating from the Belgian bubble should not have come as a big shock, but the way in which the commission seems to have become tone deaf when it comes to domestic politics is, on the face of it, remarkable.

The resounding raspberry sent Brussels way by a chunk of the European electorate might have given thinner skinned civil servants pause for thought, but not the Eurocrats. Austerity fatigue seems to have set in all over Europe’s periphery but it has yet to reach its core.

Perhaps the logic is this: austerity is a process that was bound to hit political speed bumps. But while the speed of travel can vary, the ultimate destination is all that matters. If the masses say that they have had enough, they need to be reminded that economic logic is relentless. Borrowing levels remain too high and current benign bond market conditions can disappear in a heartbeat.

While doubts persist over whether or not the euro crisis is truly over, we have to assume that another flare-up is just a matter of time.

Indeed, one thing guaranteed to run the risk of another crisis is backsliding on austerity. When that next crisis hits, the only survivors will be the ones with few favours to ask of markets, countries whose borrowing levels have reached sustainable levels.

We are still far from sustainability, so there is more travelling to be done along austerity road. Some voters don’t like this but that is simply tough: this is about arithmetic and nothing can get in the way of making sure the numbers add up. If we ease up on austerity now, those same complaining voters will at some point in the future have even more to moan about when the next fiscal crisis is upon us.

Continue to borrow

Just what is fiscally sustainable depends on a relatively straightforward relationship between the rate of interest on our debt, our GDP growth rate and how much we continue to borrow. Right now, because of our very low interest rate and modestly positive growth rate we could, just about, claim sustainability. But it is a bit of a stretch and leaves us vulnerable to slowing growth and/or a rise in bond yields.

The sustainability question can be framed in a different way. If the economy has returned to a pre-Tiger structure, has the public sector adjusted in a similar way? On a number of levels, the answer is an emphatic no. In real GDP/GNP terms we are back to somewhere roughly around 2005. Since the end of 2004, the population has risen by approximately 13 per cent.

Over the period 2000-2007, public sector finances were in broad balance or surplus (yes, really). National debt in 2007 was down to 20 per cent of GDP. It is currently about 120 per cent.

In 2004/5, government expenditure was roughly 36 per cent of GNP. After years of expenditure cutbacks, in 2013 it was about 50 per cent of GNP. Cuts have fallen mainly on the capital budget; government investment spending peaked at nearly 13 per cent of the economy and is now down to 3-4 per cent, a level not seen since the last fiscal crisis of the 1980s. In 2004/5, taxation revenues came in at about 35 per cent of GNP; last year they were roughly 38 per cent.

Total employment is roughly back to where it was at the end of 2004. Construction employment has halved since then. For industry and construction as a whole, it is down by a third. Public administration employment is up by nearly 5 per cent; employment in education is up by 25 per cent and by 34 per cent in the health care sector.

Comparing data in this way does run the risk of oversimplifying. We have yet to stage a proper cyclical recovery that would facilitate a better like-for-like comparison. There is no way to know the optimal size of government. Nevertheless, the suggestion remains that while there has been much adjustment, there is still plenty to do, not least in terms of the overall (and relative) size of the public sector. And this is without commenting on public/private sector pay gaps.

The austerity arguments still come in many forms.