Downturn may eventually help us recover lost competitiveness

 

Inflationary measures that damaged export growth in past budgets can now be addressed, writes Garret FitzGerald

WITHIN WEEKS of its announcement in the Dáil, the October budget has been shown to have been a double failure.

Firstly, the Government found it necessary to weaken its own credibility by immediately modifying a number of its key revenue-raising provisions.

And, within two months, the Government has also had to admit that the budget measures had in fact been grossly inadequate to address the needs of the financial situation.

The Government has now been forced to admit that next year's drop in national output is likely to be between 3 and 4 per cent, much greater than the 1 per cent fall upon which it unwisely based its budget only two months ago.

Two factors contributed to this blunder. The first was the decision, never adequately explained, to launch the budget in mid-October, in advance of the availability of the crucial November tax returns, which effectively include all annual tax payments by self-employed workers and which were almost 25 per cent down on the same month last year.

The second mistake was making an unwarranted and improbable assumption that the months-old pattern of declining tax revenue, reflecting the trend of national output, would cease after September. That assumption must have had a major impact upon the unfortunate prediction that in 2009 national output would fall by only 1 per cent.

In the Dáil last Thursday, Minister for Finance Brian Lenihan stated that this further decline of 2 to 3 per cent in national output would increase the general Government borrowing rate to "at least 7.25 per cent of GDP [gross domestic product], which would be at least €13.5 billion".

The double use of the word "at least" is significant, and the €13.5 billion borrowing estimate must be taken with many grains of salt. Figures of 8 to 9 per cent of GDP - ie €14.5 billion to €16 billion - have been projected by some commentators. It would be wise to assume that the figure will not be lower than €15 billion.

The 2011 borrowing target set by the Government after consultations with the European Commission involved a reduction of the general Government borrowing rate to 3 per cent of GDP, or about €6 billion in that year. This would now imply cuts averaging about €4.5 billion a year in each of the next two years, ie more than three times the €1.3 billion borrowing reduction effected in last October's budget.

Neither in economic nor political terms does that seem practicable. We must assume the Government's "plan", announced for January, will spread the burden of this borrowing reduction over a longer period. Several months ago Prof Patrick Honohan suggested spreading it over five successive budgets.

But such a long postponement of a return to a normal level of borrowing would need EU approval - and no timescale of that length has hitherto been conceded by the commission to any other state faced with excessive deficits.

Equally worrying is the Government's apparent determination to rely on spending cuts alone to achieve this outcome. Of course it makes sense to give preference to the elimination of wasteful expenditure - and there are bound to be areas where cuts can be made without damaging the services provided to the public or the provision of financial transfers to the less well-off.

The Government seems at present to be relying on "An Bord Snip Nua" to solve its financial problems. But it ought to be clear that, even if it recommends the cancellation of next September's public service pay increases, there is no way, without undermining completely our education and health services and making huge social welfare cuts, that spending cuts on their own could bridge a gap of some €9 billion.

The scale of our public spending is modest - generally below even that of European neighbours with lower output and income levels. Our principal problem is not overspending, but rather an inadequate level of income from taxes.

Between 2000 and 2006 this was aggravated by the imprudent replacement of income tax revenue with essentially temporary asset-based taxes on transactions involving dwellings.

To fill the gap left by those imprudent income tax cuts, major tax increases are now inevitable. For those cuts reduced the share of gross national product deriving from this source by €6.5 billion.

Some two-thirds of that was offset by an essentially temporary increase in receipts from capital taxes and stamp duty payments related to property taxes - most of which is now disappearing.

Much of this lost €6.5 billion will now need to be restored if we are to get our finances in order.

Meanwhile, our credit rating and our general financial credibility have already been reduced to the point where we have to pay about one-quarter more interest than Germany for what we are borrowing.

Long after our delayed return to normal budgeting, probably in 2013 or later, we will still have to allocate a disproportionate share of our tax revenue to the payment of interest on a hugely increased level of borrowing.

I am sorry to inflict such gloom on Irish Times readers in my last article of the year, just before Christmas, but if the Government won't come clean, someone has to.

Is there any upside to all this? Yes, there is. Charlie McCreevy's inflationary budgets doubled our rate of inflation (with the result that our consumer prices are now one-quarter higher than much of the rest of Europe), as well as our rate of wage increases. This halted in its tracks the phenomenal growth of Irish goods exports, losing us one-quarter of our share of world markets.

The present downturn may turn out to have been the only way in which this disastrous loss of competitiveness could be redressed. But, in terms of the human cost, the price to be paid for recovering unnecessarily lost ground in competitiveness will have been huge.