Competitive recovery key to rebuilding the future

 

An international upturn will not translate into a recovery here unless Ireland cuts costs

IT SEEMS hard to believe now that little more than a year ago, many were in denial that there was something amiss with the Irish economy. Indeed, there were some who suggested that we were simply talking ourselves into a recession, and that if we did not use the R-word, we would be fine.

As the year progressed, the extent to which we had been living in a “bubble” became clearer by the day, as banks came to require massive Government support, tax revenues collapsed, exports fell, investment dwindled and unemployment rose sharply. Ireland had to come to terms with having lived beyond its collective means since the early 2000s, and as a consequence most people today have lower living standards than they had a year or more ago.

It is important to recognise that the effects of the downturn are very uneven. Consequently, while average GNP per head may be similar today to what it was in 2003, the distribution of income is very different. The big losers are those entering the labour force now, those who have lost their jobs, those whose pensions or incomes come from equity- or property-based sources and, of course, the next generation which will inherit higher debt levels.

The extent of the burden on the next generation depends on how quickly this generation moves from minimising pain to setting the economy on track.

Ireland will recover but, even in the most optimistic scenarios, it will be the latter part of the next decade before we return to the average post-tax income levels we experienced in 2007.

Our recovery depends to a considerable extent on recovery in the major markets with which we trade. International recovery will not automatically translate into a recovery for Ireland unless Ireland is competitive, and, as the recent NCC report demonstrates, our cost base in many areas is still very high internationally. Benefits to Ireland of an international recovery depend on confidence growing so we receive needed financial support from abroad.

Additional fiscal stimulus is not an option for the Government. Since reducing the general government deficit is key to re-establishing international and domestic confidence, the Government must raise taxes and/or cut spending further. Tax increases can place recovery at risk by undermining competitiveness, while spending cuts place public services at risk, as well as income transfers to those worst hit by the recession.

The extent to which reduced spending leads to a real reduction in services depends crucially on two factors: the cost of the inputs used to provide those services and the efficiency with which services are delivered. This is good news, as it means not all of the reduction in expenditure needs to result in a reduction in services. With regard to input costs, for example, it is still possible, though difficult politically, to achieve further cuts in public sector employee costs, and the cost of produced inputs can be reduced through more effective public procurement.

We have recently seen in the pharmacy sector how the Government can use its role as a buyer of services more effectively in the national interest.

The McCarthy report has made some suggestions as to how inefficiencies might be reduced. It is clear from the report that we need a forensic approach that cuts waste in a way that minimises economic and social damage, rather than cutting mindlessly across the board. A further advantage of such careful cuts is that other necessary cuts will be more acceptable when it can be demonstrated that public money is not being wasted.

The McCarthy report should not be seen as a template for what should necessarily be done – but as a demonstration of what will be done if real alternatives are not found. The report is by no means perfect, but helps to establish the necessary change in mindset for government departments and agencies to one where there are no sacred cows.

Because of inadequate controls on public spending in recent years, one cannot presume that all the capital projects in the NDP pipeline are worthy of support. Since full evaluations cannot be undertaken quickly, expedient analyses need to be conducted to check what should be done.

The challenges facing the Government are considerable in the context of the loss of society’s trust. Inadequate policy design in recent years has in certain instances generated perverse incentives, ie where certain incentives generated by policy run counter to the stated objectives of policy.

These incentives in turn have resulted in “rent-seeking” behaviour, where groups can realise potential gains that were not intended by the policy. Improved policy design will help both our competitiveness and improve the real purchasing power of consumer incomes. Long-promised public sector reform has been painfully slow, despite the stated support of numerous governments and of the social partners.

If we start to focus on future generations, we can begin to make progress. Much has been said in recent times about the need for political leadership. What we need is leadership and a commitment to improved governance in several domains – political, the public sector, business (and especially banking), the professions and the media.

In the public sector we urgently need incentive structures that encourage individuals to take the right decisions, which may be difficult, and not merely safe decisions, which cause less disruption.

We urgently need our media to support a more mature and informed national debate – at times it seems the media is struggling to deliver what is needed to inform debate and to move the discussion beyond giving voice boxes to interest groups. This requires the leaders in this sector to look anew at the challenges they now face if they are to serve Ireland well.

Frances Ruane is director of the Economic and Social Research Institute. Vincent Browne is on leave