Patrick Kinsella: How the economy was wrecked

Government figures have been ‘managing expectations’ on the Budget . What’s likely to happen? The first in a three-part series

Everybody wants to know when the government will really ease up on austerity and let us live a little. The latest official figures – showing sparkling economic growth this year and tax revenues well ahead of target – seem to leave room for manoeuvre. But the Government is busy ‘managing expectations’.

Early this month, Enda Kenny said the there would be 'no large cheques' written in the budget. But in almost the same breath he told the business group Ibec that the Government intends to start cutting the top rate of income tax.

Michael Noonan has moved from planning budget cuts of €2 billion to a 'neutral' budget – meaning that income tax cuts for one must be matched by spending cuts or a rise in other taxes. The Fiscal Advisory Council is still banging the drum for the full €2 billion of cuts.

So what scope for relief is there? Are we out of the woods yet?

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It’s important to see that the Irish economy was in trouble even before the banking crash of 2008. That unmitigated disaster had its roots partly in the international financial crisis that started in the US, and partly in the underlying failure of Irish economic and regulatory policy to adjust to new circumstances as we dragged ourselves from relative poverty to relative wealth in the EU.

In the true 'Celtic Tiger' period from about 1993 to 2001, our backward economy powered ahead with stunning growth rates in the range 5-10 per cent a year, led by export sales. It was the payoff for years of investment in education, low taxes for multi-national companies, and generous EU funds for investment in agriculture, roads and other infrastructure.

By the turn of the millennium, Ireland had caught up with rich Europe, and incomes per head surpassed the average in the EU. The biggest single change in our fortunes was the extra jobs: as unemployment fell, more than a century of mass emigration was reversed, and women were drawn into the workforce in unprecedented numbers.

In the middle of the 1980s there had been barely a million people at work – 20 years later it was almost two million. Incomes rose spectacularly too, and the extra earnings meant there was more to go around within families, as well as more people to share the cost of public services: governments took opportunities to cut taxes and increase transfers like child benefit.

Naturally, a more mature economy loses momentum. The early years of the new millennium witnessed a sharp reduction in the expansion of exports, and overall economic growth slowed to around 5 per cent a year – still healthy, and perhaps sustainable – except that some people lost the run of themselves.

The establishment of the euro as a common currency in 1999 had reduced the apparent risks of cross-border bank lending, and interest rates were falling. With good incomes and low taxes it was a good time to borrow, and many did, pouring money into housing for themselves, or speculative developments.

Fever As prices rose, a fever set in. The boom was getting boomier, as Bertie Ahern remarked. Remember those shopping trips in Boston and New York, the long weekends in Las Vegas? Well, may you didn't, but many did, and most of it was borrowed money.

So when the banking system collapsed in 2008, and our construction industry shuddered to a halt, the economy had already undergone another profound change, every bit as remarkable as the fifteen-year leap to modernity.

We were saddled with two enormous piles of debt. First, Irish households had run up their mortgages, overdrafts and credit card accounts: total personal debt doubled in the five years to 2007: the average household owed more than two years’ income.

Second, the bursting of the property bubble left the banks with around €85bn that speculators were unable to repay. The government decision that banks could not be allowed to collapse eventually transferred more than half of this debt to the taxpayer. That was on top the explosion of government borrowing for social welfare and day-to-day services when tax revenue collapsed from 2007 - before the bank crash. Now the Government has debts worth 120 per cent of the economy’s total output for a year – and only one third of that is due to the bank rescue.

Those two great piles of debt – Government and households – changed everything. When the jobs in construction went, retail spending crashed too, and with it every type of business depending on the domestic market. The effect continued long after the jobs had gone, because the unemployed have lost their spending power, and because many businesses and households that can afford it are busy paying off debt as fast as they can.

Even in the last year, households were still reducing their bank debts by over €500 million a month. Some of that is money that in better times people would have spent in the shops.

Retrenchment by households mirrored and amplified – the Government’s efforts to get the national debt under control by spending cuts and tax rises. The impact on the economy has been enormous: from the best of years to the worst of years, total national income was down more than 11 per cent; after tax, household income per person was down 16 per cent, retail sales were down 24 per cent, and the unemployment rate peaked at 15 per cent.

Depending on which of these measures you choose as your headline, we have have clawed back no more than two-thirds of what we lost, and the knock-on effects are seen in renewed emigration, homelessness, and shortcomings in health, education and other public services.

The bailout and the banks The central problem for the government is the scale of the Irish public debt, currently standing at well over €200 billion, almost four times what it was before the crisis.

In much public rhetoric, the increase in debt is blamed largely on the bank bailout, but that wasn’t the biggest factor. In the 2010 EU/IMF rescue, the government borrowed €67.5 billionn, and added a further €17.5 billion of national pension savings and other funds. Of the €85bn total, €35 billion went to stabilise the banks, and €50 billion went to cover the budget deficits – funding public services – expected in the three years to 2013.

Although the government had to raise its banking commitment to €62.8 billion as a result of the balance sheet stress tests in 2011, it’s clear that almost two thirds of the total increase in government debt since 2007 is related to routine government spending in a deep recession.