No silver bullet rescue from fiscal predicament


ANALYSIS:Some headline-grabbing budget options would unfortunately make no overall difference to the task to hand for Brian Lenihan, writes PAT McARDLE

THERE IS even more confusion than usual about the budget this year but the one thing which should be clear is that notwithstanding the measures already put in place, the need for further remedial action is critical. It may help to stand back and try to gain some perspective on the current fiscal situation.

Probably, the first thing to do is to try to disentangle the two crises that confront us, namely, the bailout of the banking system and the budget. The two are inextricably but incorrectly linked in the public mind.

Frequently, one hears statements like “why should we pay more taxes” and/or “accept spending cuts” to bail out the banks. These come from a variety of sources.

Over the past six months I have heard them uttered by Opposition politicians, academic economists, journalists, trade unions and an assortment of other interests. One assumes the politicians were being mischievous, the academics, particularly lecturers in finance, should know better and the majority of the rest are simply unaware of the true situation.

For example, only last week, Anne Costello of the Community Platform, writing in The Irish Times, asserted that a commitment not to invest any more in Anglo would reduce borrowing next year by the exact amount needed to tackle the deficit. In fact, her suggestion would not make a single cent of difference to the amount of spending “cuts” required in the budget.

The usual source of these errors is confusion between the Exchequer Borrowing Requirement (EBR) and the General Government Deficit (GGD) and the failure of successive governments to reform our archaic system of budgetary accounting.

The EBR is an ad hoc measure that has evolved over the decades. It covers the receipts, expenditure and borrowings of the exchequer, a concept which we inherited from the British and which incorporates the main family account but ignores numerous other parts of government such as the Social Insurance Fund, into which all employer and employee PRSI payments go, the Pensions Reserve Fund, etc.

The EBR is an important but very partial measure of the overall situation. Unfortunately, it gets most of the attention given that the budget-day presentation focuses on it and the monthly exchequer figures, as the name implies, provide data on the exchequer only.

The GGD, on the other hand, is an economic concept designed to capture the interaction with and impact of government on the broader economy. It incorporates the whole government sector including a myriad of extra budgetary funds, the National Pensions Reserve Fund, the social security sector, non-commercial State bodies and local authorities.

The GGD is the critical measure used by economists to assess the stance of fiscal policy and by the EU to monitor our compliance with the Stability and Growth Pact. It is, therefore, the ultimate focus of budget policy irrespective of how this is presented. Moreover, it is in such a dire state that something has to be done about it.

The GGD rules and definitions are laid down by Eurostat, the Statistical Office of the European Communities, with, in turn, links to the United Nations System of National Accounts. Last summer, for example, Eurostat spent several months deciding how Nama and similar bodies in other member states should be classified. They provisionally concluded that Nama would not be part of the government sector which is why recorded gross debt will not rise when Nama becomes operational.

If the exchequer were to inject another €4 billion capital into Anglo Irish Bank in the morning, this would increase the EBR by an equivalent amount but would have no impact whatsoever on the GGD.

This is because the international rules treat such capitalisation as a “below the line” transaction, ie investment in a commercial State body which is outside the government sector, rather than current expenditure which affects the deficit.

The €4 billion of “cuts” is required to stabilise the GGD in 2010 at the alarmingly high level of 12 per cent of GDP; without them, the deficit would rise to 14 per cent, the highest in the euro zone. It is unlikely that this would be tolerated by either the markets or the EU.

Whether we “raid” the pensions fund, scrape the money together from surplus balances in the exchequer or, indeed, borrow anew to recapitalise the banks has no impact on the GGD or, by extension, on the size of the medicine that is required in the 2010 budget.

Incidentally, it should by now be clear that suspending contributions to the National Pensions Reserve Fund, a tactic recommended by Irish Times columnist Fintan O’Toole, and which has merit in its own right, is no help on the GGD front.

This is because contributions to the pensions fund represent shifts between different parts of government, ie the equivalent of transferring money from one pocket to another. They net out to zero when the broader concept is used. By the same token, terminating such contributions does not lower the GGD.

The estimates given in the April budget, namely €4 billion for the scale of the action needed to prevent the 2010 GGD worsening, stand, irrespective of whether or not the banks are bailed out or the pension fund terminated.

Unfortunately, there is no easy way out of the current fiscal dilemma; fortunately, this seems now to be increasingly realised inside the Dáil. However, the communication of this message to the public at large remains a challenge.

Pat McArdle writes economic commentaries for The Irish Times. He is a former chief economist with Ulster Bank. This is the first of a number of pieces he will write between now and budget day, teasing out the options facing the Government and their implications.