Getting more credit than they deserve

Economics: With an election about eight months away, both Government and Opposition will be trying to convince us who can best manage the State's finances. But what does the evidence say?

The years between 1993 and 2007 is an appropriate period to look at the evidence on this matter. As well as spanning the present "Golden Age" of growth, it gives us three five-year periods of alternative governments: Labour dominated from 1993 to 1997, followed by one minority and then a majority Fianna Fáil/ Progressive Democrat coalition between the periods of 1998 to 2002 and 2003 to 2007 - the time of the next election.

The politically initiated will note that the periods mentioned don't exactly fit the terms of office of the governments described. This is because time lags delay the implementation of fiscal policy, so the budgetary performance of any full year should be attributed to the outgoing government, even if it left office mid-year.

The first variable to look at might be the national debt. From €36 billion in 1993, its nominal value rose to just under €40 billion in 1999, before falling back to about €36 billion this year. From about 93 per cent of gross national product (GNP) in 1993, the ratio of debt fell to 66 per cent by 1997. In the subsequent five years the ratio halved to 32 per cent and now stands at 27 per cent of GNP.

But this wasn't much of a credit to any of the governments in power during the period: from €59.4 billion in 1993, the value of GNP will - according to most recent forecasts - have more than doubled between then and 2007. Merely keeping national debt stable in nominal value terms would make a sharp fall in the ratio inevitable.

The budgetary balance is a more accurate concept for measuring government intentions. But the standard general government balance measure needs to be adjusted in several ways before it can do the job.

The amount spent on servicing the national debt must first be excluded to give the primary balance. Otherwise any particular government's performance is flattered by the debt reduction efforts of a preceding government.

Secondly, Ireland has benefited more from EU transfers than most other EU countries. Having varied significantly since 1993, we need to strip them out of any figures.

Finally, as in the present year, an actual budgetary surplus may not reflect prudence on behalf of the Government but extraordinary good fortune for which it deserves no credit. But, in bad years such as 2002, tax revenue can dry up through no fault of the government.

Stripping out these surprise effects gives the "cyclically adjusted" fiscal balance. This measure has been calculated by the European Commission since 1985 and also forecasts some years ahead.

For statistical reasons these balance measures are, unlike the debt figures, measured as a percentage of gross domestic product (GDP) rather than GNP. Unlike the latter, the former includes multinational-owned activity in Ireland, while GNP includes Irish-owned activity abroad not covered by GDP. For our purposes the difference is negligible (for completeness and consistency data referred to were those avaible at the time of the last budget).

The results of these adjustments are revealing. Between 1993 and 1997 the government ran an average general government deficit of 2.7 per cent of GDP. But for generous net EU transfers in the period, the average yearly deficit would have been 5.2 per cent. But as growth was still below trend, these performances were actually better than they looked.

Applying the commission's cyclical balance to the primary deficit and making the same adjustment for EU transfers, would suggest that the government averaged a surplus of two percentage points of GDP.

In another way, that figure might give a little too much credit to governments of that period. The need to improve budgetary balances in the run-up to EMU entry acted as training wheels which forced the then government to be virtuous. That this constraint was curbing sinful inclinations is revealed by the repeated breach of spending growth targets in those years.

The performance of the second period of government was also better than it looked. Adjusted for the impact of EU transfers, the general government balance averaged a surplus of 0.3 per cent of GDP. Accounting for the impact of the cycle and accounting for EU transfers suggests a slightly stronger performance for the primary balance of 0.9 per cent of GDP.

Using commission forecasts for the cyclically adjusted primary balance and adjusting for government estimates of net EU transfers suggests that the present Government has moved a little to the left and will run a lower average surplus of 0.4 per cent of GDP over its course.

As well as average performance, the figures give a guide to what economists call discretionary changes in policy. Take for instance Bertie Ahern's claim, made in 2004, to be a socialist. The figures suggest he backed it up with action. According to the Government's own figures and accounting for net EU transfers, the cyclical adjusted primary balance deteriorated sharply from a surplus of 1.3 per cent of GDP in 2004 to just 0.2 per cent the following year, a fiscal loosening of more than a full percentage point.

Between 2000 and 2001 an even sharper loosening happened - from a surplus of 2.8 per cent to a deficit of 0.6 per cent - pointing clearly to a strong pre-election effect on the budgetary balance. In both cases the changes were pro-cyclical; that is, they loosened the purse strings at a time when the economy was growing above trend. The more worrying distortion of the fiscal balance does not arise from cyclical developments, but from more permanent structural change in the economy.

From a sustainable level in the mid-1990s, the construction sector has grown to account for about 24 per cent of GDP. It would be a prudent exercise for the Government to stress test present budgetary balances: ie those commonly used for budget preparation and Stability Pact reporting requirements against a sudden and unforeseen return to "sustainable" activity.