Severe budget unveiled for Ireland

Tuesday, December, 2010

This afternoon saw the beleagured Irish government unveil probably the toughest, and most feared, budget in the country’s history.  It is the sixth deflationary budget since July 2008 and there will be further harsh budgets over the next three years (at least).  Growth is likely to be difficult to achieve in the next two years; income inequalities will grow; and uncertainty will remain.

The latest budget represents a fiscal contraction of €6 billion in 2011, the first instalment of a ‘national recovery plan’, which will entail a total fiscal consolidation or austerity package of €15 billion taken out of the economy between now and 2014.  The €6 billion package announced today, heralded as a ‘front-loading’ of the pain, comprises €2 billion in revenue-raising measures and €4 billion in spending cuts.

The aim of the new recovery plan is to reduce the budget deficit to 3% of GDP by 2014.  The gap between government spending and revenue in 2010 is estimated to be approximately €19 billion or about 12% of GDP.  Thus, the task facing Ireland is truly monumental. 

The scale of the task facing the country begs a number of key questions:

  • is the fiscal consolidation package, beginning with the €6 billion announced today, credible?  Can it help to facilitate economic growth?
  • what will be the distributional effects of the austerity package?
  • will today’s budget help matters by reducing uncertainty?

First, the new recovery plan may be said to be ‘credible’ in the sense that it has the support of the EU, the ECB and the IMF, the institutions that are now effectively running the economy. 

However, it is highly debatable that the plan can facilitate growth over the next couple of years for at least two reasons.  One, the five budgets preceding today’s budget have already seen €14.6 billion taken out of the economy since July 2008, so that the troubled Irish economy has already taken a severe fiscal pounding.  Two, the IMF’s own analysis regarding the short-term effects of fiscal consolidation packages is noteworthy.  According to its latest World Economic Outlook (October 2010), the IMF calculates that a fiscal consolidation equal to 1% of GDP typically reduces GDP by about 0.5% within two years and raises the unemployment rate by about 0.3 percentage points. Domestic demand – consumption and investment – falls by about 1%, according to the IMF.  (Ireland was included in the panel of countries that forms the basis of the IMF’s analysis in this regard.)  The fiscal contraction of €6 billion announced today represents approximately 3.5% of GDP, which, applying the IMF’s estimates, is likely to result in a further contraction in the Irish economy of 1.75% over the next couple of years.  Given the pounding that the economy has taken over the last three years, it is difficult to see growth returning to the Irish economy in 2011, at least; the government’s most recent growth forecasts for the next two years, which represent a significant downward revision from its initial projections, appear optimistic. 

Supporting this view is the whole banking crisis in Ireland, not to mention the potential unwinding of the eurozone, which are all in addition to today’s fiscal drama.  Further, there are little or no real stimulus measures in today’s budget – the continuation of the car scrappage scheme to the middle of next year is unlikely to create much employment and is effectively a subsidy to car dealers and overseas car manufacturers.

The best hope for economic growth are Ireland’s exports.  According to the November 2010 PMCA Economic Commentary, growth in exports has a potentially substantial employment impact in Ireland: a 10% increase in the value of exports of goods and services is associated with a 4% increase in employment, which translates into potentially 76,000+ new jobs.  The relationship is found to be strongest among associate professional and technical workers, where a 10% increase in exports implies a 6.3% increase in employment or potentially 12,000+ new jobs.  This new evidence implies that rising exports not only serve to maintain jobs but also have the capacity to create appreciable new employment.  The challenge of Irish economic policy is to convert as much as possible of the employment potential of exports growth.  PMCA believes that this can be facilitated by further assisting Irish-based enterprises to expand and diversify into overseas markets, including the newly emerging markets where growth prospects will be greatest in the coming years.

Turning to the distributional implications of today’s budget and the wider national recovery plan to 2014, it is almost certain that income inequalities in Ireland will rise. 

Contrary to what some might believe or choose to think, the gap between the ‘haves’ and the ‘have-nots’ actually narrowed in Ireland between the mid-1980s and the mid-2000s, based on Gini coefficients published by the OECD (OECD Factbook 2009).  (The Gini coefficient is the statistical index used for measuring a country’s income inequality.)  The lowering of income inequalities in Ireland during the ‘good times’, before the onset of the crisis, reflected the public sector wage growth and rising social welfare payments during the period (see, for example, the article by Dr. Pat McCloughan of PMCA Economic Consulting entitled ‘Welfare and public pay reduced income inequality in Tiger years’, Sunday Independent, 26 July 2009).

Today’s budget sees the beginning of the reversal of this wage and social welfare growth that characterised the boom times in Ireland.  There will be cuts in unemployment benefit, child benefit and the minimum wage. 

The significance of the likely rising income inequalities is that it will make it harder for the next government to sustain the national revovery, making the challenge facing Ireland in reducing its budget deficit to 3% of GDP even tougher.  Rising income inequalities will raise questions over the ‘fairness’ of the recovery plan and will increase the risk of social unrest.

Finally, will today’s budget help matters by reducing uncertainty?  The simple answer is no.  By definition, there is a lot more pain to come and the banking crisis, which has been described elsewhere as being “soldered” to the public finance crisis, coupled with the escalating crisis in the eurozone, mean that a high level of uncertainty will continue to be a feature of the Irish economy.

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