7/10/2013: Taking an Easy Road Out of Budget 2014? Sunday Times, September 22

This is an unedited version of my Sunday Times column from September 22, 2013.


The upcoming Budget 2014 will be one of the toughest since the beginning of the crisis in terms of the overall levels of cuts and tax increases. It also promises to cut across the psychological barrier of austerity fatigue. The latter aspect of Budget 2014 is more pernicious. Two other factors will add to the national distress, comes October 15th. Reinforcing our national sense of exhaustion with endless austerity, this week, the IMF published a staff research paper on fiscal adjustments undertaken during the current Great Recession. According to some, the IMF study reinforces the argument that Ireland should have been allowed to spread the austerity over a longer period time. In addition to this, Ireland’s planned 2014 cuts are set to be well in excess of the deficit reduction targets for any other euro area country.

The superficial reading of the IMF statement, the nascent sense of social distress brewing underneath the surface of public calm, and the tangible and very real pain felt by many in the society suggest that the Government should take it easier in 2014-2015. The policy option, consistent with such a choice would be to cut less than committed to under the multi-annual fiscal plans agreed with the Troika. This is being proposed by a number of senior Ministers and TDs, the Opposition and the Unions.

Alas, Ministers Noonan and Howlin have little choice when it comes to the actual volumes of fiscal adjustments they will have to implement next year. Like it or not, we will need to stick very close to the EUR3.1 billion deficit reduction targets irrespective of the IMF working papers conclusions, or the volume of outcries coming from the Government backbenchers and the opposition ranks.

Here's how the brutal logic of our budgetary position stacks up against an idea of easing on deficit reductions.

If everything goes according to the plan, Ireland will end 2013 with a second or a third highest deficit in the EU, depending on how we account for the one-off spending measures across the peripheral states. We will also have the second highest primary deficit (that is deficit excluding cost of interest payments on Government debt) in the euro area. In 2014 this abysmal performance will replay once again, assuming we meet the targets. Greece and Italy are set to finish 2013 with a primary surplus. Portugal is expected to post a primary deficit of less than one half that of Ireland's. Should Ireland deliver on the targets for 2014, our gap between the Government revenues and spending will still stand at around 4.3-4.6 percent of GDP at the end of December 2014. Not a great position to be in, especially for a country that claims to be different from the rest of the euro periphery.

In this environment, talking about any change in the course on austerity or attempting to enact a fiscal stimulus will be equivalent to accelerating into a blind corner on a one-lane road.

In order to stabilise government debt, Ireland will require cumulative deficits cuts of 11.6% of GDP between January 2013 and December 2018 with quarter of these cuts scheduled for 2014-2015. This is the largest volume of cuts for any economy in the euro area - more than 20 percent greater than the one to be undertaken by Greece and more than 50 percent in excess of Spain’s requirement.

Any delay in cuts today will only multiply pain tomorrow with higher debt to deflate in 2016-2018. As things stand under the agreed plans, Ireland will be spending 4.9 percent of its GDP annually on funding debt interest payments from through 2018. This is more than one and a half times greater than what we will be allocating to gross public investment. The interest bill, over the next five years, will be at least EUR46 billion. Lowering 2014 adjustment target by EUR1 billion can result in the above cost rising to over EUR50 billion, based on my estimates using the IMF forecast models.

The reason for this is that any departure from the committed fiscal adjustment path is likely to have consequences.

Firstly, with the ongoing sell-offs of bonds in the global investment markets, it is highly likely that the cost of funding Government debt for Ireland will rise over the medium term even absent any delays in fiscal adjustments. The long-term interest rates are already showing sharper rising of yields on longer maturity bonds compared to short-dated bonds. Year to date, German 10-year yields are up 64 basis points, UK are up 105 bps and the US ones are up 111 bps. The effects of these changes on Irish debt and deficit dynamics are not yet fully priced in the latest IMF forecasts. A mild steepening of the maturity curve for Ireland can significantly increase our interest bill. This risk becomes even more pronounced if we are to delay the Troika programme.

Secondly, failure to fulfill our commitments is unlikely to help us in our transition from Troika funding. Ireland will require a precautionary standby arrangement of at least EUR10 billion in cheaply priced funds. The European Stability Mechanism (ESM) funds to cover this come on foot of good will of our EU 'partners'. These partners, in turn, are seeking to redraft EU tax policies, as well as banking, financial and ICT services regulations. In virtually all of these proposals, Ireland is at odds with the European consensus. Good will of Paris and Berlin is a hard commodity, requiring hard currency of appeasement. Whether we like it or not, by stepping into the euro system, we committed ourselves to this position.

The long run financial arithmetic also presents a major problem for those who misread the latest IMF research on austerity as a sign that the Fund is advocating easing of the 2014-2015 adjustments for Ireland. The IMF clearly shows that Ireland has already delayed required fiscal cuts more than any other euro area economy. In all euro area peripheral economies, other than Ireland, fiscal adjustments for 2014-2015 are set at less than one fifth of the total adjustment required for 2010-2015 period. In Ireland they are set at one third. Which means that, having taken more medicine upfront, Italy, Greece, Portugal and Iceland can now afford to ease on cutting future primary imbalances.


With this in mind, there is not a snowballs chance in hell that we can substantively deviate from the plan to cut EUR3.1 billion, gross, from 2014 deficit without facing steep bill for doing so. Which leaves us with the only pertinent question to be asked: how such an adjustment should be spread across three areas of fiscal policy: Government revenues, current expenditure and capital expenditure.

This year, through August, Government finances have been running ahead of both 2012 levels and we are perfuming well relative to what was planned in the budget 2013 profile. However, the headline numbers conceal some worrying sub-currents.

This year's current primary expenditure in 8 months through August stood at over EUR36.6 billion, more than targeted in the 2013 profile and ahead on the same period last year. This deterioration was caused by the one off payment made on winding down the IBRC, plus the increase in contributions to the EU budget. Nonetheless, while tax and Government revenues increases in the 8 moths of 2013 were running at almost EUR3.4 billion compared to the same period of 2012, spending reductions are down only EUR823 million.

To-date, only 17 percent of the entire annual adjustment came via current voted spending cuts and over 57 percent came from increases in Government revenues. The balance of savings was achieved by slashing further already decimated capital investment programmes.  Given the overall capital investment profile from 1994 through forecast 2013 levels, as provided by the Department of Public Expenditure and Reform, this year's net capital spending is likely to come below the amount required to cover amortisation and depreciation of the current stock of Government capital. Put simply, we are just about keeping the windows on our public buildings and doors on our public schools in working order.

In this environment, Labour Party and opposition calls for undoing 'the savage cuts to our frontline services' - or current spending side of the Government balance sheet - are about as good as Doctor Nick Rivera's cheerfully internecine surgical exploits in the Simpsons.

The adjustments to be taken over the next two years will have to fall heavily on current spending side. This is a very painful task. To-date, much of the savings achieved on the expenditure side involved either transforming public spending into private sector fees, which can be called a hidden form of taxation, or by achieving short term temporary savings.

The former is best exemplified by continued hikes of hospitals' charges which have all but decimated the markets for health insurance. The result is a simultaneous reduction in health insurance coverage, an increase in demand for public health services and costly emergency treatments. The 'savings' achieved are most likely costing us more than they bring in.

The latter is exemplified by temporary pay moderation agreements and staff reductions in the public sector. This presents a problem to be faced comes 2015-2016: with growth picking up, many savings delivered by staff reductions and pay moderation measures will be the first to be reversed under the pressure from the unions.

In short, the Government has no choice, but to largely follow the prescribed course of action. Like it or not, it also has no choice but to cut deeper into current spending. This is going to be an ugly budget by all measures possible, but the real cause of the pain it will inflict rests not with the Troika insistence on austerity. Instead, the real drivers for Ireland’s deep cuts in public spending are the internal imbalances in our public expenditure and the lack of deeper reforms in the earlier years of the crisis.

Via @IMF

Box-out: 

Recent data from the CSO on Irish goods exports painted a picture of significant gains in one indigenous economy sector: agri-food exports. The exports of Food and live animals increased by EUR101 million or 15 percent in July 2013, compared to July 2012. In seven months from January 2013, agri-food exports rose to EUR4,911 million, up 8.8 percent. Most of the increases related to exports of animals-related products, live animals, eggs and milk. The new data caused a small avalanche of press releases from various representative bodies extolling the virtues of agri-food sector in Ireland and posting claims that the sector is poised to drive Ireland out of the recession. Alas, the data on agricultural prices, also covering the period through July 2013, released just three days after the publication of exports statistics, poured some cold water over the hot coals of agri-food sector egos. From January through July 2013, the main driver for improved exports performance of our agriculture and food sectors was not some indigenous productivity growth or innovation, but the price inflation in the globally-set agricultural output prices. On an annual basis, the agricultural output prices rose 10.7 percent in July 2013. Over the same period of time, the agricultural input price index was up 5.2 percent in July 2013. This means that Irish exports uptick in 2013 to-date was built on the pain of consumers elsewhere. So good news is that our agri-food exports were up. Bad news is that we have preciously little, if anything, to do with causing this rise.

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12/8/2013: Sunday Times August 4, 2013: Troika Programme Exit vs Fiscal Reforms

This is an unedited version of my article for Sunday Times August 4, 2013.


Irish political leaders are not exactly known for making logically consistent policy pronouncements. The current budgetary debates are case-in-point. On the one hand, minister after minister from both sides of the coalition benches are repeating ad nausea the tired cliches about their successes in managing the economy. On the other hand, the very same ministers are talking tough about the need for more pain, more adjustments, and more 'reforms' to secure the said recovery and deliver us from the clutches of the Troika. Only to turn around and start praising Troika support as the source of our recovery.

In reality, there are good, if only rarely voiced, reasons for these exhortations: seven hard budgets down, we are not really close to shaking off past legacy of wasteful fiscal practices. The state is still insolvent. The structure of the state policies formation is still dysfunctional. The legacy of pork barrel party politics continues unreformed.

Nothing exemplifies this better than the stalled structural reforms of social welfare and the resulting temporary, risk-loaded nature of much of our fiscal adjustments to-date.


Take a look at the top-line data coming from the Merrion Street.

In the first six months of 2013 tax revenues collected by the Government were EUR3.17 billion ahead of the same period three years ago, while the total voted current expenditure by the Exchequer was up EUR391 million. In other words, the only difference between the current budgetary approach and that practiced by Bertie Ahearn is that today's tax collections are starting from the low levels. Aside from that, current spending continues to ride well ahead of our economy’s capacity to fund it. The 'boom is not getting “boomier”, but the two main current spending lines: social protection and health, are still running at 65.2 percent of the total voted current expenditure, up more than 4 percentage points on 2010.

Things have changed, over the years, to be fair. There have been reductions in current expenditure during the crisis, overshadowed by tax hikes and dramatic cuts to capital spending. Thanks to tax hikes, in H1 2013, Ireland marked the first half-year period when the current spending by the Super-3 Departments: Education and Skills, Health and Social Protection, combined, was below the total tax revenue collected by the State. A significant milestone, but hardly a salvation, as three departments' current expenditure in January-June 2013 still counted for 95 percent of total tax receipts. Thus, even with all the cuts to-date, shutting down all current voted expenditure, excluding the Super-3, will only half our Exchequer deficit from EUR6.59 billion to EUR3.31 billion.

Which exposes once again the five-years-old policy dilemma: to balance the books, Ireland will require at least a EUR2.7 billion worth of further cuts on the spending side on top of what is being planned for 2014-2015. Most, if not all of these will have to come from the Social Protection and Health

Sustainability of savings achieved to-date presents a further risk. So far, cuts to the Exchequer spending that dominated the last five years were heavily concentrated on the sides of capital expenditure and public payrolls. Both are at a risk of reversal in the future.

Any return to growth will require heavier capital investment in public infrastructure, schools, medical equipment and facilities and so on. In other words, capital savings are an illusion on the longer time scale.

Meanwhile, much of the current spending cuts fell onto the shoulders of temporary and contract staff, leaving permanent and more expensive staff protected. This protection came at a cost of increased demands on their productivity. With staff feeling the bite of higher taxes and pensions contributions, while being forced to work more and outside their comfort zone of life-long assignments, public sector unions are already itching to get a new wave of wages increases going.

Back in December 2012, the Troika has pointed out that the savings delivered in public sector pay bills under the Croke Park Agreement cannot be deemed sustainable in the long run. The Haddington Road Agreement for 2013-2016 further confirms this assessment. The insolvent state is now fully committed to more rounds of increments payments, no matter what happens to the economy or exchequer finances. Virtually all ‘savings’ to be delivered under the Haddington Road Agreement are to be automatically reversed at the end of the agreement term or earlier.

The risks of policies reversals on capital and public sector pay, relating to the above measures, are non-trivial. IMF forecasts through 2021 showed the current path of fiscal adjustments taking us to a debt to GDP ratio of just over 95 percent in 2021 from the peak of 2013. Using IMF assumptions, my own estimates suggests that reversing budgetary policies to 2013 levels after 2015 can result in our Government debt to GDP ratio stuck at 108 percent in 2021.


All of which points to a simple but uncomfortable fact: to achieve long-term sustainability of our fiscal policies, Ireland requires a longer term reduction in public spending well in excess of what can be delivered without significantly cutting into current health and social welfare expenditures. Given the fact that health spending is already stretched, the above cuts will have to happen on welfare side.

The reforms, to be undertaken across a period of, say 2015-2016 will have to be sweeping and permanent, building in part on some of the piecemeal changes already in place.

To reduce the risk of replay of the devastating 2008-2010 effects of unemployment shocks on exchequer and economy at large, we need to separate unemployment benefits from other welfare supports.

Unemployment Insurance (UI) should provide a temporary, but generous safety net, sufficient to sustain reasonable family commitments to mortgages and children- and health-related expenditures. Thus, UI should be paid as a percentage of the end-of-employment salary, starting with 2/3rds of the salary up to a maximum of the median wage, with payments declining with duration of unemployment. Payments should terminate after 9 months.

Social welfare payments (SWP) to able-bodied adults can kick in following the expiration of the UI scheme on a means-tested basis. A low monthly personal SWP rate should be supplemented with access to childcare and healthcare, as well as educational grants for children, but only in the cases where recipients engage in training and/or active job searching. A recipient cannot turn down a reasonable offer of a job without facing a financial penalty. All benefits should be subject to a life-time cap of 6-7 years to prevent formation of permanent welfare dependency, while providing a broadly sufficient safety net..

All benefits payments above the monthly personal SWP rate, benchmarked for provision under the scheme, such as health, public services and transport allowance, should be cashless to reduce potential misuse of funds. To encourage better health attitudes and more careful utilisation of public services, a share of unused allowances, say 10-20 percent, accumulated in the account at the end of each year can be paid out as an annual bonus.

We also need to reform our state pensions. Given the fallout from the property bust, large numbers of Irish families are facing the prospect of pension-less retirement. They will require significant state supports - something we cannot afford while carrying the burden of unfunded state pensions.

All statutory state pensions should be means-tested to generate immediate savings and remove absurd subsidisation of the better-off at the expense of those in genuine need. Ditto for age-linked medical cards.

Automatic benchmarking of legacy public sector pensions should end and all current public employees’ pensions should be converted into defined contribution schemes. This will require a legislative decision to alter employment contracts. It will also require recapitalization of the public pensions fund, which can be done gradually over the period of, say, 10 years.

Savings to be targeted in the above measures should apply gradually, over 2014-2017, to generate new substitutes for temporary measures adopted in previous budgets.

However, even with gradual improvements in the labour markets and economy from 2014 on, implementing the above reforms will be nearly impossible. Current political system, with policy decisions based on consensus of the interest groups, is subject to stalling on big reforms and the risk of future reversals by governments seeking popular mandates. This means that we need to take a National Unity approach to structuring and enacting the new legislation dealing with reforms of the social welfare and pensions. Such a consensus is feasible, once all political parties in the Dail realise that Ireland will continue to face subdued economic recovery, elevated unemployment and anemic asset markets well into 2020-2021. With these headwinds, the pressure to carry on with prudent fiscal policies will remain. Thus, the only way of avoiding the contagion from the current long-term economic crisis to the political and state balance of power is to enact irreversible, legislatively protected structural reforms of the social welfare on the basis of bi-partisan legislative engagement.

Box-out:

A note from Davy Research on Mortgages Arrears, published this week, represents a good summary of the current crisis and draws some sensible and well-argued policy conclusions on the subject. Alas, the report commits one common, unnecessary and unfortunate error. Strategic non-payment of mortgages debt is cited in the report eighteen times. Yet, there is no direct evidence presented in the report, or in any study cited in the report, as to the true extent of the problem in Ireland. Instead, like all other analysts, Davy team references unsubstantiated statements by the banks and banking authorities, and simplistic extrapolations of other countries’ studies to the case of Ireland as evidence that "mortgage delinquency has continued to grow despite better-than-expected labour market  conditions” and that “strategic default is now a problem." Like other researchers, Davy team cites increases in employment in Q1 2013 as the evidence of a 'growing problem' with strategic non-payments.  Alas, in Q1 2013, seasonally-adjusted full-time employment (jobs that can sustain payment of mortgages) dropped 4,500 year on year. Broader measures of unemployment reported by CSO also posted increases. This hardly constitutes a material improvement on households' ability to fund mortgages repayments and it certainly does not support the thesis of significant and growing strategic defaults. Of course, absence of evidence is not evidence of absence; the employment data cited above does not prove that there are no strategic defaults in Ireland. It simply shows that absent real, direct evidence, one should take care not to fall into the trap of convincing oneself that an oft-repeated conjecture must invariably be true.

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