Politics determined the €2.5bn budget figure

Next Tuesday Michael Noonan will stand up to deliver the latest in a long line of austerity budgets that stretches back to 2008. There has been considerable speculation and argument in recent months about the desirable size of the budget adjustment.

The Government originally committed to an adjustment of €3.1bn, but the Minister for Finance made it clear this week the adjustment would be €2.5bn. This figure is based on the fact that even with the lower adjustment, the deficit in 2014 is still forecast to come in at 4.8% of GDP, lower than the target of 5.1% in the troika agreement.

The logic behind this thinking is fair enough on the surface. If the deficit is still projected to come in below the 5.1% target, then running with the lower adjustment is justified.

Furthermore, the minister is arguing that the lower adjustment will provide some boost to growth in 2014, which in itself would make the targets easier to achieve.

At the end of the day, economic growth generates tax revenues and exerts downward pressure on certain elements of government expenditure.

Not everybody agrees with that logic, however. The ESRI, the IMF, the Central Bank and the Irish Fiscal Advisory Council believe the minister should go the whole hog and deliver the promised €3.1bn. The logic is that if growth turns out lower than expected and the borrowing target is missed, a bigger adjustment would then be necessary in Budget 2015. The argument goes that if growth turns out as anticipated and the full €3.1bn adjustment is delivered, the minister could deliver a neutral budget this time next year. My reservation with this line of thinking is that if growth does turn out lower than expected in 2014, an adjustment of €3.1bn would just exacerbate the economic weakness, because the withdrawal of an additional €600m from the economy would not be insignificant.

There are others of a less orthodox variety who believe that the lower adjustment would be more than enough. The logic here is that if the targets are going to be surpassed in any event, why risk growth by pushing for a more painful adjustment than is absolutely necessary. This line of thinking has prevailed and we are now going to get an adjustment of just €2.5bn. However, one should not underestimate the impact that a withdrawal of €2.5bn will have on the economy.

It is equally clear that the decision to go with the lower adjustment total has a lot more to do with politics than economics. Following the collapse in opinion poll support for the Labour Party and the humiliating defeat for the Government in the Seanad referendum, there is clearly a belief in government that delivery of the full fiscal adjustment would not be in the best political interests of the parties of government. As is normally the case, politics has won out over economics.

The victory for political pragmatism that next week’s budget will represent is a further cause for concern for those who believe that the full adjustment of €3.1bn should be delivered. There is a correct belief that the only time one will ever see a real attempt to improve the structure of the public finances is in the midst of a deep fiscal crisis, which is exactly what we have at the moment. The risk and fear is that once we get some growth back and the fiscal crisis becomes less pressing, the political system will revert to its old ways and allow expenditure go out of control again to win political popularity.

I have certain sympathy with that view of the world. The fact remains that we have been promised fiscal adjustment of €2.5bn and all that remains to be seen is how that adjustment will be achieved. Despite the lower figure, it will still be very painful because one cannot make omelettes without breaking eggs.