The Irish economic crisis: let’s rephrase the question to how can we create the next Celtic Tiger?

November 28, 2010

(I apologise, this is a long one)

I want to put down some ideas with regard to redrafting the questions being currently asked in Ireland. There is an end game for this situation and that will be a period of economic growth which will result in increased GDP, increased employment thus lowering the amount of social-welfare payments and increasing the number of people paying tax creating a virtuous circle: a second Celtic Tiger. The question that should be asked is what conditions need to be created to allow for the development of this period of economic growth and what actions do we need to take now in order to create the circumstances under which this can happen. I wish to outline a road map to economic growth and then propose some ideas, actually pretty radical and possibly unpopular immediate actions necessary to fix the problem. I am not suggesting that this be forced on anybody but rather I would like to contribute to a real discussion on how to progress Ireland out of its current malaise. Between now and the General Election to be held early in the new year the Irish people need to do some hard thinking and give the next government a real mandate to fix the situation or alternatively, the current malaise will continue and we will pay the consequences of this for many years to come. Before I outline an endgame I need to explain just how deep the situation is.

The Irish economic crisis has been headline news across the world for the last few weeks. The Government’s 4-year plan to reduce public expenditure was launched this week with a clear focus on taking some actions to address our public-sector current account deficit between 2011 and 2015 by reducing €15 billion in expenditure over that period, even though the deficit in 2011 alone is €19 billion. €19 billion is €19 thousand million for those who have lost perspective on these things and by cutting €6 billion next year the government will only borrow €13 thousand million more than it will take in from taxation to pay for public-sector pay, social welfare payments and running the public sector and, of course, pay interest on that sum. Incidentally, 5% interest over 10 years means that the interest on the sum borrowed will by 50% in total or €28.5 billion to be paid back over 10 years or €2.85 billion a years in repayments per years for the next 10 years. Remembering that we have borrowed something like €40 billion last year and this already and at an average 4.5% would mean interest of €18 billion on these sums meaning €58 billion over 10 years or €5.8 billion in servicing every year for the next 10 years. To add insult to injury, the government intends to borrow slightly less every year for the following 3 years and after 2015 we will only be borrowing 3% of GDP on an annual basis to fund the public sector…and the public want to know why the markets don’t take the 4-year package seriously.

Since the start of 2007, unemployment rates have gone from just over 5% of the labour market to over 13% with some roughly 250,000 people moving from paying tax contributions to be forced to take social-welfare payments. There are also a significant number of people who have emigrated during this time that do not appear on the live register of unemployment. This situation is compounded by the need to bail out our banks who are now suffering from over lending during the housing bubble, a bubble that has now well and truly burst. As I write, the Irish government is in negotiations with the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Union Commission to arrange a large multi-billion euro fund that Ireland can access to stabilise our banks and keep the public sector afloat. A right royal (or in this case republican) mess.

There is an endgame for this and there are grounds for optimism, although you would be hard pressed to find much around the general public at the moment. The reasons for optimism: Ireland is still a relatively wealthy country, we have a strong entrepreneurial culture and, surprisingly, Ireland is having one of its most successful years in a while with regard to foreign-direct investment (FDI). Why? Because as our cost base comes down and we flush our the overblown excess of the bubble period, Ireland is becoming more competitive and the fundamental strengths that created the Celtic Tiger period (1995-2001) is reasserting themselves. We have a highly-educated young workforce that is now much cheaper to hire, we have far more young, educated, English-speaking people from all across Central and Eastern Europe, as well as, Africa, the Middle-East and Asia. Ireland is becoming competitive again. So what does the endgame, a Celtic Tiger II, look like?

Well, if there is one thing we can get general agreement on is that the public sector is over sized and that the numbers in the public sector will have to be reduced, slowly, over a period of time by natural wastage and voluntary redundancy. So the 250,000 jobs to address the employment problem (and also increase the tax take and reduce the high social welfare bill) can only be addressed by private-sector employers creating new positions. So what are the conditions under which the private sector will increase investment and employment to meet the identified need? The classic economic answer is confidence but let’s break that down to something more concrete. If I am an employer and I am looking at expanding my business, when should I invest? If I invest now, under the current uncertainty, investing money would be the equivalent of playing Russian roulette. I know I have 4 years of increasing taxes, reduced spending and demand and worse, I cannot quantify what effect these will have. Also, it is clear that interest rates will increase over the next 2-3 years as the unnaturally low rates that the ECB and Federal Reserve have imposed to counter the recession are raised, so my money in the bank will earn more in the bank and the interest I pay on loans will increase. What I need to know is that the situation will be sorted more quickly and allow me some certainty in my business planning. This is a fundamental point if we are to create the new employment positions for those on the live register to take up.

So, I am advocating that the Irish government takes a far more aggressive approach to reducing the deficit on the current account than it has to date proposed. In fact, I would propose that we should take a very deep breath and as a national accept that the government should cut out all excess spending in 2011 and, where at all possible, run a balanced budget in 2012. I am suggesting a €19 billion adjustment in the public-sector current account next year. This would be made up from a reduction in spending and an increase in taxation. Now, the first reaction of many to this proposal in Ireland will be one of shock and horror and to some extent it is necessary for people to take the shock and get passed it so that we can have a serious conversation about the relative outcomes and effects of the different policies. The agenda for the next election should not be whether we cut or not but, rather, whether we cut in one year or over 4-5 years. However, let me be clear, that I am advocating this not to assist banks, bond holders, the ECB or IMF, I am advocating this so that we can get our own house in order and create an internal economic platform to allow for a more rapid rate of economic growth in the years 2012 onwards. I accept that this will have a negative economic effect in 2011 but so will dragging the adjustment over 4-5 years. At least this way we get the pain out of the way and we all know that the worst of the situation is behind us in 2012 rather than still ahead of us for 3-4 years. This is in our self interest as a nation.

Let me now turn to address one of the key objections that someone might raise to this course of action: that pulling €19 billion out of the economy in 2011 would have detrimental effects to the economy and we simply cannot afford to do this. Well, whereas I accept that there would be a short-term negative effect in 2011, I believe that balancing the budget in 2012 would have short-medium term benefits. Let me explain what is actually going to happen. The Irish government will spend €52 billion in 2011 on public-sector pay, social welfare payments and the other costs of running the public sector. It will only take in €33 billion in taxes and revenue and will have to borrow from somewhere the other €19 billion. Thus, for every 3 euros the government spends on public services next year it will have to borrow 1 euro. Worse again is the way the taxes are collected. As preliminary tax from the self employed, full year-tax returns and capital gains tax returns are predominantly taken in during November, we have to borrow most in the first half of the year and for the first 6 month of the year our borrowing is more like 50% of expenditure with us not having to borrow much in the last quarter. Thus, we are most vulnerable to the markets in the first half of the year.

Now, to the amount borrowed. We actually are not cutting €19 billion out of the economy as that would require us to have the €19 billion and not spent it. What will actually happen is that we will borrow €19 billion from external bodies, we will spend it on public services and then the money will have to be taken out of the economy plus the interest. So the money is not really in the economy but is rather flowing through the system. The problem is that the interest charged on the money is high and thus the cost of the money is more than the benefit we get in the economy. Let us take 6.7% as it is being bandied about this week. €19 billion at 6.7% over 10 years means that the interest alone that we need to pay to access the €19 billion is an additional €12.73 billion over the life of the loan. So we borrow €19 billion, we spend it on the public service and we pay back €31.73 billion at a rate of €3.173 billion per year, every year for 10 years starting in 2011.

We simply need to come to realise that the cost to the nation of borrowing to pay for public services is costing us far more than any beneficial effect that the spent money will accrue. Remember that we have already borrowed like this in 2008, 2009 and 2010. I believe that this simply cannot continue and that Ireland must stop borrowing for day-to-day expenditure and only spend what we can afford (from taxes and other revenues). The idea that we will continue doing this on a slightly reducing scale in 2011, 2012, 2013, 2014 and 2015 is financial insanity and potential economic suicide.

Now, I stress again that I advocate a quick, hard adjustment in the fiscal position in order to create a foundation for economic growth which will create business, increase GDP and create employment. I do not advocate this to assist external bodies. In fact, quite the opposite. Ireland’s negotiating position is incredibly weak. Our government have spent the last 3 years talking austerity but, in practice, doing very little to make the necessary cuts to fix the problem. The bond markets have lost belief in official statements and we now are forced to deal with the IMF and ECB. Now ask, what would happen if we made the cuts and ran a balanced budget in 2012? First, our credibility would climb and people would take what we say seriously again. We would not have to borrow for day-to-day expenditure and this would put us in a very strong position to negotiate, or renegotiate with the IMF, ECB and senior bond holders. Remember, as soon as our bond costs fall below the IMF/ECB rate we can go back to the markets at a lower rate. Regarding the bond holders, it is not a question of whether we ‘burn’ them or not, it is a question of reaching an agreement with the senior bond holders as to the level of the haircut. Senior bond holders are serious financiers and live in the real world. At some stage, particularly if we are in a stronger negotiating position, we can do a deal with the bond holders. The main point is this; if the bond holders feel that they have been dealt with fairly in these negotiations they will take a haircut and still do business with us. If the bond holders feel that they have been unfairly dealt with then they will not do business with us again. The bond holders understand risk and moral hazard better than most people and this becomes a question of when and how we negotiate a deal rather than ‘no deal’ or ‘burn’ strategies.

There is an endgame to this situation. The endgame is created by a period of economic growth that will have the following effects:
• GDP will increase as will taxes to address the problems we face
• Employment will increase, thus more people will be paying tax into the central kitty
• Unemployment will fall, thus less people will be taking payments from the public budget
• We will run budget surpluses and our credit rating will improve and our borrowing costs will fall to normal rates
• At that stage the NTMA will enter the market and will arrange a large loan at the much lower rates, we will use this loan to pay off all the high-rate loans and commitments and we will reschedule our debt over a 10-12 year period at much lower rates that allow us pay off the debt and have funds to invest in capital projects. This is what we did in the late 1990’s and it will happen again eventually
• The value of property will rise gradually (and I stress gradually) which will cause house prices to rise over time. This addresses much of the negative equity in private dwellings (but not all)
• This will have a positive psychological effect on consumers and we will create a stronger domestic demand as a result
• The increased property prices will mean that the assets on the banks balance sheets will be written back up based on the real prices in the market place. This addresses the hole in the banks balance sheets and will allow the banks be sold back into the private market and allow the government get back the money it has invested (but probably not in Anglo Irish Bank). This reduces the governments debt significantly
• NAMA will see the actual market value of their property portfolio raise above the haircut prices they paid for them. Over time NAMA will sell on the open market much of its portfolio at a profit. NAMA should be able to be wound up in a 10-12 years period at a profit. The overall effect of this, will be that the government gets back the money it invested in NAMA, it reduces the government’s debt and the profits are ploughed back into the National Pension Fund
• As our prices have been reduced, our labour market has many skilled, young workers available, our FDI efforts will continue and this maintains our exports

The overall effect, a period of economic growth and a Celtic Tiger II. If anybody believes that this cannot happen then just remember it is exactly what we did in the 1990’s. In fact, I am confident that if we take the necessary action that we can fix this and our future is quite bright. But, it only happens if we take responsibility for our own mess and take the necessary action to fix it quickly. That is the difference between talking about sovereignty and exercising sovereignty.

So let me state what needs to happen to fix the problem. Let me start my saying that the public sector is NOT the problem but the public-account deficit. I wish to acknowledge the work done by public servants across the country and this is not a reflection on the contribution they make but a comment on what the country can actually afford at this stage in our economic development. Fixing a current-account deficit is a process of cutting spending as far as is possible and raising taxes to bridge the difference. The necessary actions are:
• The Croke Park Agreement needs to be abandoned and benchmarking needs to be reapplied. Let us remember what happened with benchmarking. In the early 2000’s when the private sector were having really good years and pay levels were at their highest, the government introduced (with the agreement of the public sector and negotiated by the public-sector trade unions) a process where public-service grades were ‘benchmarked’ with private-sector pay scales of a comparative level. Since 2007, the private-sector pay scales have collapsed by anything from 30-50% but the public-sector pay scales with which they have been benchmarked have remained at the boom level highs. Thus, the public sector is now being paid significantly higher pay levels than those in the private sector, or the real economy. The Croke Park Agreement is a mechanism to maintain these artificially-high pay levels in the public sector and is unsustainable in the current economic situation. The benchmarking process now needs to be reapplied and the public-sector pay scales need to be adjusted down to the comparative private-sector pay scales with which they are linked. Benchmarking is a cyclical process; pay goes up in the good times and comes down in the bad times but remember that it is the same process by which public-sector pay scales will be increased again during the next period of economic growth. Thus, the pay reductions are cyclical not permanent.
• Our social welfare payments need to be reduced in certain categories. I would make a distinction between entitlements and subsistence payments. For example, Job-seeker Benefit is paid to people for their first 9-12 months of unemployment and is based upon the contributions they have made in PRSI (social insurance). This is an entitlement and should remain as near as its current level as is reasonable. However, Job-seeker Allowance is a means-tested subsistence payment and is in effect, to use a derogatory term, a ‘hand out’ to maintain the person at a basic level whilst they seek employment. Let us give an accurate comparison. If you are on ‘assistance’ in Newry you will get a maximum payment of the equivalent of €80 per week. If you are in Dundalk, 15 miles away, you get a maximum equivalent payment of €196 per week. Now the cost of living is higher in Dundalk than in Newry. Forfas estimated that the difference was around 8% in 2009. But even taking a liberal estimate of 15% difference, then the equivalent payment in Dundalk would be €92 per week. We simply cannot continue to pay the levels of social welfare at the current levels. Other payments need to be examined in a similar fashion with Child Benefit also in line for review. However, I would try to protect pension payments as far as is practicable. Pensioners have already paid into the tax take for many years and have an entitlement to some degree of protection.
• Our system of running budgets needs to be changed. At the moment we encourage managers across the public service to deliver their targets at the maximum possible budget. The unspoken rule is ‘if you don’t spend it you will not get it next year’. By creating a system that incentivises managers to achieve their targets at the lowest possible cost we can cut 10% at least out of the non-wage and social welfare budget. The system simply needs to be redesigned.
• All budget managers should be made responsible for ensuring value for money. Agencies need to be necessary and if they are not then they should be done away with. Programmes that have passed their sell-by date need to be eliminated. We need to deliver what is necessary, not what we would like to have in an ideal world; we are not living in an ideal world. In short, we need to spend what we can afford and no more.
• With regard to public-sector pay at the top end, as far as I am concerned nobody in the public-sector should be paid more than €150,000 per year until Ireland is back in surplus. This to include the government. I would advise the next government to take only their TD salaries until the budget is in surplus. This will not make a massive significance financially but it will at least give the government and senior public-sector management the moral authority to take the necessary actions over the next few years.
• Taxes need to be increased, especially the lower tax band. The exact rates by which the upper and lower bands and VAT are increased are a matter for calculation but if it is necessary then it is necessary. However, I would like to see the government state that their priority in the recovery will be to reduce the lower tax level as quickly as possible.
• We need to bring back into the tax system those that were exempted since 2003. During the boom Ireland ran surpluses and simply did not need to have all the lowest paid paying tax and, in effect, the lowest paid got a tax break. This, like most other tax breaks, need to be done away with and those who were exempted need to bear their share of the increased tax burden.
• The minimum wage needs to be brought down. Currently around €8.50 per hour and believed to be reduced to €7.50 per hour in the next budget, there should be situations where the minimum wage is reduced further. 2 specific cases come to mind. One is to address the many thousand of people of the live register but are on short-time work. They are working 3-day weeks and are signing on for the rest. A programme to help employers bring these people back to full-time work and move them off the live register needs to be developed. Even if the employer could pay €6.50 per hour to the employees to bring them back into full-time employment this would allow employers get their employees back full time at a reduced cost, the employee would get €6.50 per hour rather than €5 per hour on the live register and the social-welfare budget would be saved the part-time payments and the live register would actually start to get smaller. Even if this was for an initial 1-year period and then the official minimum wage would be applied. The second circumstance is where an employer creates a new job and hires someone directly from the live register. Again if a €6.50 per hour rate applied for the first year, the employer gets a break in the first year and makes creating the position more attractive, the new employee gets a job and an initial €1.50 per hour more than on the live register and the social-welfare budget is saved up to €10,000 per year for every position filled. Both of these are win-win situations and need to be examined. One final comment; the fact that we have a National Minimum Wage is making a social statement that there is a level below which we are not willing to let employees work but the actual level of the minimum wage is an economic issue and needs to be set with respect to the prevailing economic circumstances. The minimum wage is akin to benchmarking; when things are good they go up but when things are bad they must come down.

I get that these actions will cause pain. Public-sector employees have mortgages and other bills, those on the live register are living on a small sum but we also have to weigh these against another legitimate question; how much can we afford to pay. There would be an economic hit next year if we do what I advocate but we would get a serious economic benefit from 2012 on if we take the necessary action.

I do not suggest that we force this set of actions on anybody. I advocate that we have a serious discussion as a nation and give the next government a mandate to take action. If we decide not to take the ‘bitter pill’ then we have no grounds to complain if this period of economic downturn continues and unemployment remains at a high level for many years, above 10% for at least 5 years. We need to focus on the endgame; a period of economic growth and I believe that we need to take the necessary actions to bring about this period of economic growth as quickly as possible.

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6 Responses to “The Irish economic crisis: let’s rephrase the question to how can we create the next Celtic Tiger?”

  1. Willie H Maxwell Says:

    Ken

    Great stuff

    I had to cancel Rodge and Pdge and Sex and the city to get through it though

    Willie H Maxwell

  2. Jim Fitzsimons Says:

    All very logical but there seems to be a fundamental lack of belief in our ability to change both politically and economically. Worse still there seems to be a lack of belief in our nation that a change in governemnt will make any difference to the lives of people. Where do we see any political will to do what you suggest with this governement or any alternative one? Are we politically bankrupt?? This is very worrying!

    • kengermaine Says:

      Hi Jim,

      That is the problem. There is currently a sheer lack of political will to even discuss the possibility of a more aggressive approach to the current account deficit. But 2 months ago there was a sheer unwillingness to accept that an IMF/ECB package was required. Things I suspect will move on quickly with Portugal and possibly Spain needing assistance. This will require a restructuring of the Euro support infrastrcuture and from that will come the need to balance budgets far more quickly. So give it until March with a new government having to take action whether they like it or not. Ken

  3. P.J Says:

    Hi Ken,
    Agree with most of what you say.
    Hit the top big time!When you have the top end of the public sector paid large amounts of money then it just shows their resistance to what you propose.Government must lead by example and now that they are beginning to understand how money works they should should take better buget measures.
    1.Cut the Dail seats from 166 to 106.
    2.Hold only half of state cars for 10yrs of more.
    3.1 yr budget cut of 19billion is an ambitious severe cut.Why not spread it for 2 to 2and half yrs?This would reach your targets without risking overkill of the economy.Sadly we are stuck with high bills,mortgages which needs adequate money to pay personal debts.
    4.Tackle the bond holders first!Pay them the first 50c in the Euro.Therefore we would have a 12Billion to spare.A extra 10c in the Euro would be paid to them in a few years time if economy improves over time,
    Looking foward to your response,
    P.J.

    • kengermaine Says:

      Hi PJ

      Thanks for your comments. Whether we cut over 1 year or 2, I think my main point was that we need to realise that more aggressive action needs to be taken to get us to a balanced budget in a relatively short period of time. As I said, I believe that this should not be forced on the Irish people but rather we need to accept that we get our own house in order and give a government a mandate. The actual time period is open to discussion. Cutting the bond holders on our own would not be a good idea. First, we are about to borrow another €13,000 million next year to keep the public services alive so we cannot ignore the reality of both the markets and the IMF/ECB requirements. However, it is only a matter of time before this issue is dealt with at a European level, this is not just an Irish issue. On our own we are not in a good negotiating position but this is on the German agenda and the bond holders know it.

      Re cutting the number of Dail seats etc. then we should be asking actually how many TDs do we need to make the system function rather than making arbitary cuts. We need 15 cabinet members and 12 junior ministers just to oversee government departments. The main opposition party needs to shadow this and the second party needs to shadow at least the cabinet. That is 69. There are 19 Joint Oireachtas Committees that do the work of scrutinising legislation in detail and oversee relevent issues within the remit of the committee and each committee needs around 6 members and then there are 2 other powerful committes: the Public Accounts Committee and the Procedures Committee for internal issues. Thus, we actually need a lot more TDs than people realise but there would seem to be scope to reduce numbers somewhat. But remember that the money saved will be a drop in the ocean to reduce the overall deficit, this is an issue relating to optics rather than anything else.

      My general issue is that we could do a lot more than we are and that we need to do more, more quickly, Ken


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