Keeping EMU rules an acceptable price to pay for economic benefits

ECONOMICS:IRELAND'S EMU (economic and monetary union) membership means that tough budgets are unavoidable for next year and the year after, probably also for 2011 and maybe 2012.

The large fall-off in tax revenues following the bursting of the housing bubble will result in Ireland breaching the EMU budget deficit limit of 3 per cent of GDP, and the deficit will probably remain above 3 per cent for a few years. Inevitably, some taxes will have to be increased to bridge the gap.

Some economic commentators have suggested ignoring Brussels. This is nonsense. Ireland is a member of the EU and participates in EMU.

Each year, every member state submits to a consultation process in the Council of Ministers on its economic and budgetary strategy under the broad economic policy guidelines procedure.

In addition, EMU participants must get approval from the Council of Ministers for their fiscal strategies under the Stability Pact laws.

Everyone in Brussels and most of those at the highest levels in the member states keenly understand the centrality of the Stability Pact and the 3 per cent deficit rule to the long-term future of EMU.

With no political union in Europe, the long-term future of monetary union is questionable. Without the Stability Pact, EMU doesn’t have a long-term future.

An inevitable collapse after some crisis or other would make most Europeans poorer, and probably have a disproportionately negative effect in small peripheral states like Ireland.

Any member state in Ireland’s emerging budget deficit situation has no option but to frame its budgets to stay within the 3 per cent deficit limit or agree a short timeframe and deficit milestones to bring its deficit back below 3 per cent. Realistically, the negotiating position of a small member state in the economics/finance format of the Council of Ministers (which makes the final decisions on these matters) will always be much weaker than that of a large state.

The main reason the Budget was brought forward by almost two months was to give the Government room for manoeuvre in its negotiations with Brussels on the 2009 Budget. In October, it can use tax and spending projections for 2009 that will probably turn out to be a bit optimistic compared to the picture that would emerge if the Government waited until December, given the ongoing fall-off in economic activity.

At this economic juncture, it is important to maintain a proper perspective. Ireland has relatively low interest rates, a stable world currency and a low national debt. The budgetary problems are essentially short-term in nature.

While not attempting to underestimate short-term loss of income or economic inconvenience to many, the pressure from Brussels will probably lead to better value for money in public services in the medium term.

In the real world of political economy, governments don’t usually force public spending efficiencies and tough prioritisation when tax revenues are buoyant. However, some longer-term problems could be created if the Government short-changes on investment (defined broadly to include education and research) to make the books half-balance. Some would argue the wrong type of tax increases might be damaging for the economy as well.

Economic research is rarely available to support most policy assertions that distinguish between tax increases. All taxes distort the economy and tend to reduce economic growth, if the economic stimulus that comes from public spending is ignored.

For what it is worth, the least damaging taxes are those which tax windfalls – most notably inheritances. Most of the rest of the argument is pure politics, but wrapped in economic jargon.

The alluring alternative to tax increases is so-called reform of public expenditure. In practically every country in the world, there is undoubtedly plenty of scope for greater efficiency and value for money in public expenditure.

Therefore, a short-term fiscal crisis will hopefully lead to a reduction, at least, of the worst excesses – but it is unrealistic to think that so-called reform of public expenditure is likely to solve the fiscal problem.

Of course, political choices could be made to achieve major savings by reducing or eliminating large public expenditure programmes in health and education, making substantial numbers of public servants redundant or eliminating some social welfare programmes.

However, it is very unlikely that many, or indeed any, such political choices will be made.

The Government’s dominant budget priority should be to avoid damaging medium-term prospects for traded sector investment in the economy.

The Government would be foolish if it did not remind voters that we would never have achieved our current level of living standards without EMU participation thanks to low interest rates, having a world currency and the additional IFSC projects that EMU participation helped bring to Ireland.

Having to play by the EMU rules is an acceptable long term price to pay for EMU’s economic benefits.

Brendan Lynch is an economist and author of EMU: Ireland’s Dream Start – the Political and Economic Impact of EMU on Ireland. It was published by the Institute of International and European Affairs earlier this year