The Central Bank's recent warning of rising inflation underscores the risk that the present expansionary policies will undermine competitiveness and possibly bump the Irish economy from its steep growth path.
Underlying the expansionary policy are soaring expectations that have led to understandable claims for fairer shares of the growth; claims that had been partly bottled up by previous national agreements. The acrimony over the division of gains following the recent Budget is a hint of how hard it will be to negotiate a new agreement.
In the dark days of the 1980s, high unemployment kept wage demands in line with what employers could afford to pay. The burden of this unemployment fell most heavily on the poor. Wage restraint - resulting in large measure from the enlightened leadership of the unions - and sharply rising productivity have allowed the unemployment rate to fall to one of the lowest in Europe.
Given the difficulties that the Government has in squaring the circle between rising expectations and the need for restraint, it is odd that a fortuitous opportunity for giving concrete but deferred compensation is being squandered. On December 16th the Dail debated and passed, with apparently little notice, a Bill read by the Minister of Finance to provide a temporary holding fund for 1 per cent of GDP (£582 million) and £2.417 billion of the proceeds from the sale of Telecom Eireann. The money is being "held" pending "substantive legislation" later in the year to establish permanent arrangements for a centrally-managed fund for the State's future pension obligations.
Mr McCreevy's foresight in making provision for benefits to be received by generations hence is praiseworthy. Longer life spans combined with the Republic's somewhat delayed baby boom means that the ratio of those 65 and over to the working age population will fall from one in five at present to just one in two by the middle of the century.
The combination of more generous State pensions and earlier population ageing means that many of the Republic's European partners, most notably Germany and Italy, face earlier and more serious shortfalls. These trends imply that without pre-funding there will be sharp increases in payroll taxes or cuts in benefits. Although the problem is less immediate for the Republic, the same choice eventually applies. Thus credit goes to Mr McCreevy for tackling the issue now.
The problem is that Mr McCreevy is missing a chance to use the Budget surplus to help ensure prosperity is not threatened by inflationary wage rises and tax cut concessions.
Instead of pre-funding existing obligations, he could build on existing plans for voluntary Personal Retirement Savings Accounts (PRSAs). Although the details would have to be worked out in consultation with the social partners, the alternative could work along the following lines.
Accounts are established for each adult in the State. The Government makes an annual contribution (in return for wage restraint and in lieu of tax cuts) to each investment account. The individual is free to make supplemental (possibly tax-favoured) contributions.
The Government's contribution consists of a flat amount and a percentage of earnings up to some ceiling. A high flat contribution would be to the relative advantage of those who are not working or on low pay, whereas a high percentage would have good incentive effects by increasing the overall return to work. This trade-off would undoubtedly be the subject of difficult negotiations.
Individuals would manage their own investments with the help of financial advisers. There would also be regulation of the investment alternatives. For those not wanting the bother of self direction there could be a default investment in a well diversified index-linked portfolio. Individual control has the added advantages of deepening the Republic's financial markets and sidestepping the inevitable politicalisation of investing the Government's fund.
Since the contributions substitute for tax cuts, the total affordable annual cost to the exchequer in present circumstances could be as high as 2 to 3 per cent of GDP. The amount, of course, should be subject to periodic renegotiation reflecting the state of the economy.
The balance between using the proceeds to fund benefits promised under current law and funding additional benefits would also have to be decided.
For example, half the proceeds of an individual's account could be used to replace part of the promised flat-rate benefit, and half to provide additional retirement income. No pensioner would do worse than under the current system, with or without the current pre-funding proposal.
Replacement reduces the tax burden on future workers, which is the goal of the current prefunding plan. Additional benefits, however, provide the crucial bargaining instrument in negotiations with the social partners.
In making this choice it needs to be remembered that existing flat-rate benefits are likely to fall further and further behind average wages. This means that workers will not be able to maintain their standard of living in retirement if they don't have substantial private saving or generous occupational pensions.
In a high-growth economy, lifetime savings tend to be low relative to earnings in the years just prior to retirement. Thus there is a need to make additional provision to ensure retirement incomes that are adequate to maintain living standards.
Lacking the old tools of monetary policy, unable to maintain fiscal restraint in the face of large budget surpluses and facing growing demands from the social partners, the Government is allowing the economy to overheat and thereby risking an abrupt end to growing prosperity. We need imaginative solutions.
Negotiating government contributions to retirement saving accounts is one possible solution. It provides a means of saving the surpluses while meeting the legitimate demands of workers after years of sacrifice. It also provides a critical strengthening of the retirement income system. Such rare opportunities should not be passed up without adequate debate.
John McHale is assistant professor of economics, Harvard University. jmchale@harvard.edu
