Less painful cuts might yet be possible

 

The damage done by government policy between 2000 and 2003 must be undone, writes GARRET FitzGERALD

I WAS glad to be invited by the EU Commission to visit Brussels earlier this week, for two reasons.

The first was sentimental. I have been to Brussels scores of times during the past half-century, in a wide variety of capacities: Aer Lingus official; economist; consultant; vice-chairman of the Irish Council of the European Movement; opposition spokesman; vice-president of the European People’s Party; minister for foreign affairs; and as taoiseach. But I don’t think I have been there as a journalist since 1961.

On behalf of the government back then I was privately asked to combine my journalistic role with sounding out commission officials on their attitude to a possible surprise Irish application for membership – upon which I then reported confidentially to Ken Whitaker.

My two fellow journalists chided me for asking such silly questions – but three months later Seán Lemass as taoiseach astonished everyone by announcing we were indeed applying for membership.

Apart from the sentimental aspect, I benefited greatly this time around from the excellent briefings by commission officials, including secretary general Catherine Day who, like the other officials, was intensively quizzed by Irish journalists.

At a press conference on changes in the fiscal adjustments required of several member states, including Ireland, Commissioner Joaquín Almunia said Ireland, together with Spain, France, and the UK, “have taken effective action”, in contrast to Greece, which had not done so. However, Almunia added that “due to unexpected economic events . . . which impacted the budget balance beyond the control of the governments, the existing deadlines and implied annual adjustments have become unrealistic”.

Consequently, all four states are required to increase their fiscal adjustments – and the extra year we have been given to complete the task reflects the fact it is now proposed that we do a lot more than originally required.

For Spain, the UK and Ireland the increase in their annual adjustments is by 0.5 per cent of GDP each year, which at first sight may not seem much.

But in our case this raises the scale of our adjustment from 6 per cent of GDP (1.5 per cent over four years) to 10 per cent of GDP (2 per cent over five years) – the biggest adjustment being sought from any member state, except perhaps Greece.

That sounds rather depressing. But there is a possibility that we shall not have to make such a large adjustment as the commission has now proposed.

One senior official said the commission believes that when our recovery starts, perhaps in 2011, it will be slow.

(The Department of Finance has estimated growth in 2011 at 2.6 per cent but its estimates of growth in subsequent years have not been published.)

That cautious view has clearly communicated itself to the commission as well as to the OECD. But are they all correct in taking such a pessimistic view?

In a recent ESRI working paper (for the content of which at this stage, he, rather than the ESRI, is responsible), John FitzGerald takes a different view.

Having pointed out that half our fiscal deficit is cyclical, and ultimately self-correcting, he argues that when applied to Ireland, the EU methodology (also used by the Department of Finance) is “highly questionable” because of our uniquely high elasticity of labour due to migration.

He concludes that by next year output may have fallen to almost 20 per cent below what it would have been without the crisis. We will not recover all of that lost potential, but if we start by effecting the €4 billion adjustment proposed in this budget, then he believes that, temporarily, we would have a potential for growth of 5-6 per cent a year between 2010 and 2015.

The job of public policy, he says, is to ensure the economy realises this potential by addressing the obstacles to its achievement, including in particular our loss of competitiveness earlier in the decade (when, well before the housing bubble, for several years excessive public spending pushed our prices and wages up 2½ times faster than in the rest of the euro zone).

A huge amount thus depends on our capacity to reduce costs – pay costs in particular – in the immediate future. The damage done by government policy between 2000 and 2003 must, however painfully, be undone.

On that basis FitzGerald concludes that whilst there will have to be “some moderate tightening of fiscal policy” between 2011 and 2015, this would be more limited than that envisaged by the Department of Finance – and thus a lot more limited than that suggested by the commission last Wednesday.

So there is a possible gleam of light at the end of our tunnel!