ESRI must wake up to reality

For those who have chosen to believe that the economy would never emerge from its calamitous collapse after 2008, these continue to be challenging times, writes Jim Power.

This week, the latest prognostications from the IMF and ESRI are pretty upbeat on the prospects. No surprises there, because only the unwilling would fail to recognise that there is a gradual but very real recovery taking hold.

However, there are some nuanced differences in the advice being offered to Finance Minister Michael Noonan in relation to budgetary policy in the near future.

The ESRI is clearly concerned by recent suggestions from Mr Noonan and other ministers that Budget 2016 will contain a mixture of generous tax cuts and expenditure increases. Given that the economic cycle is now on a firm upward trajectory, the worry is that fiscal stimulus would just serve to push the economy back into overheated territory.

Pro-cyclical policy is always dangerous and the ESRI is sensibly advocating that surpluses should be built up in good times in order to have the resources available to deal with more difficult times. This type of counter-cyclical policy is exactly what the textbooks would recommend, but it ignores political realities.

The political reality today is that an election must be held by April 2016. Although the fortunes of the coalition parties have started to improve somewhat in recent polls, it is still far from clear that re-election will be achieved. Populist left-wing parties and groupings that have strong anti-business biases and which promise to abolish water charges and the like could well make it to power.

To have any chance of preventing such a situation, the Government clearly needs to put money back into the pockets of hard-pressed taxpayers and convince them that the economic recovery will actually make a difference to their lives. Hence the Government appears to have little political option other than to pursue an expansionary approach to the budget in October.

If it doesn’t, the policies that are promised by many in opposition could actually do even more damage to the economy than the pro-cyclical fiscal stance that the ESRI is warning against. Many of those policies, taken together, simply do not make economic sense.

The IMF is equally upbeat about Ireland’s prospects but is concerned about the potential impact of EU rules that now guide economic policy in this and other countries. It is a complicated policy framework; one element in the so-called expenditure benchmark implies that growth in nominal government expenditure should be capped below the potential GDP growth until the medium-term objective of eliminating the structural budget deficit is achieved. The problem is that measuring potential output and the structural deficit is far from an exact science.

The IMF is concerned that the EU rules to control public spending based on the potential growth rate of the economy could be too restrictive. It believes Ireland should be given some flexibility from the EU to increase spending. However, it is specifically not referring to increased spending on public sector pay nor social welfare, but rather on areas of capital expenditure. The IMF clearly recognises the need for increased capital expenditure and appreciates the benefits that this can bring to longer-term growth and living conditions.

Those on the left who are looking for increased social expenditure and the public-sector unions pushing for pay increases do not have the same appreciation of the issues that the IMF is highlighting.

In relation to taxation, the IMF also has an appreciation of the benefits of reducing taxes on labour, but specifies that the taxbase should be broadened through measures such as expanding the Vat system and increasing housing valuations for property tax purposes.

At the end of the day, the Government is not obliged to take advice from either the ESRI or the IMF.

The reality is that it will be driven by the near-term political agenda which involves getting re-elected and hence an expansionary and pro-cyclical budget looks inevitable in October.


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