State must restore credibility in financial markets and minimise damage to economy
THE CURRENT financial crisis reminds me of my own experience when, as taoiseach between June 1981 and January 1983 in two separate governments, I faced a similar financial challenge. In 1977, the Lynch government had blown the economy off its course, by abolishing rates and road tax and by huge public spending increases – including, as I recall, expanding public service employment by 5 per cent in 1979, and simultaneously raising average public service pay by no less than 29 per cent.
Charles Haughey took over in December 1979 but, despite warning TV about the critical financial situation, he then lost his nerve and took no action to deal with the crisis – until a year later in the 1981 budget when he announced €145 million spending cuts (over €500 million in today’s terms), without, however taking any steps to implement these promised reductions.
After the defeat of our 1982 budget and a subsequent nine months in opposition, we returned to power at the end of 1982, facing a very grim financial situation – with the Department of Finance insisting that the deficit must be reduced to £750 million to restore confidence in financial markets.
Recalling the damage done by over-deflation of our economy on two earlier occasions, and anxious to avoid a repetition of those mistakes, I decided to check out the financial view. Accordingly, I asked Henry Kissinger, whether the consultancy he had established could, on a pro bono basis, sound out for me the views of New York financial houses on whether a deficit reduction down to £750 million would, as the department had insisted was needed, restore confidence in our financial stability – or whether the markets could live with and continue to lend to us on the basis of a less damaging cut to a current deficit of £900 million.
Kissinger reported back to me a few days later that, as I had suspected, these finance houses believed, and accepted, that we would go for the higher £900 million figure. They felt, indeed, that in this way we would have a programme that we would stick with, rather than an over-ambitious one that would fall apart.
Armed with that advice, I rejected the department’s more stringent view. They had not previously been challenged in this way, and were furious – even persuading their minister, Alan Dukes, to challenge my decision publicly.
Against the background of that experience a quarter of a century ago, I do not envy the Government its task next Tuesday. To deal with the consequences of their policy mistakes in the recent past, they have to perform a similar high-wire act, seeking to reconcile two conflicting imperatives: first the need to restore the State’s badly damaged credibility in financial markets, but also a contrasting need to minimise the damage to the economy that spending cuts and tax increases in the midst of a recession are bound to inflict.
In seeking such a balance, the Government has been the recipient of a wide range of advice, from its own department but also that publicly offered by independent sources of economic and financial expertise, such as the Economic and Social Research Institute and other academic economists.
In this situation, the Government has not been helped by the way the financial situation evolved since last September. The department was too optimistic in assuming last October that the decline in revenue since early in the year would halt after September. But the fact is that since then, the revenue side of the account and expenditure on unemployment relief have deteriorated much faster than anyone could have foreseen. Even today, the Minister still has no firm ground on which to stand in preparing the budget.
It was not helpful to have published some weeks ago the department’s over-ambitious target of a reduction in this year’s borrowing to 9.5 per cent of GDP (gross domestic product). Thus was done at a time when the final pre-budget estimates of revenue had yet to be calculated, which will now have to take account of the first-quarter tax returns published the day before yesterday. Since then, the Government has decided for a number of different reasons that it will not seek in this budget to reduce borrowing to that level.
First of all, this year’s GDP looks like being lower than expected at the time when that commitment was announced and, as the revenue projections for the year have had to be reduced, it would now require bigger than expected cuts in spending and/or tax increases to meet this 9.5 per cent target.
Next, the Government received advice from the ESRI and academic economists that it should be careful not to over-deflate the economy. Finally, the Government has been anxious to bring the social partners back into the equation, thus getting the trade unions off the hook after they unwisely threatened a one-day general strike. Agreement not to insist on the 9.5 per cent borrowing figure was a means of securing the reopening of discussions with the unions.
I believe the Government is right to abandon the 9.5 per cent of GDP borrowing target. However the fact that that figure was published some weeks ago as an official borrowing commitment makes its current upward revision – hopefully to something less than 11 per cent – embarrassing because it carries the danger of weakening our fragile credibility in financial markets.
That danger may, however, have been reduced by the Government’s St Patrick’s Day efforts to remove some of the negative preconceptions about the state of our finances in most external financial markets.
PS: Can anyone persuade the media to abandon the lazy and misleading tendency to treat our Live Register figures as a measure of unemployment – despite the fact that every month the data includes the statement that: “The Live Register is not designed to measure unemployment”.
Last December the media was brandishing Live Register data to claim that unemployment then exceeded 275,000 – at a time when the internationally recognised unemployment figure was 170,000. The difference between these figures is accounted for by part-time seasonal and casual workers.