Time does not heal all wounds. It is one year on from the date of our bailout by the EU, IMF, UK, Denmark, and Sweden. Ireland is effectively a client state with little power to decide anything of importance in the search for a path out of our present difficulties. The decision to raise VAT is a case in point. The choice Michael Noonan had was to increase it by 1% a year over 2 years, or to increase it by 2% in one year.
The decision to increase VAT was actually made by the EU/IMF in 2010, and the Minister was obliged to carry it through. Neither the Minister nor the cabinet can make any substantive changes to the agreement with the EU and the IMF, and their role really is to execute a plan of controlled descent for the Irish economy as it returns to a roughly balanced budget from year to year, with a large level of government debt relative to the country's national output, a high level of long term unemployment, and large levels of personal indebtedness.
The EU/IMF programe has three main pillars. First, to restore balance to the State’s budget by cutting current and capital expenditure by 3.9 billion euros in 2011, and by increasing taxes by 1.4 billion euros in 2011. Second, to reduce the size of our banking system and its bloated balance sheets by ‘deleveraging’, which is French for selling assets, getting rid of old loans, and not giving out any new ones, while trying to attract deposits. Third, there are a series of structural reforms to the labour market mooted where the government will introduce legislative changes to remove restrictions to trade and competition in sheltered sectors like the legal, pharmaceutical, and medical professions.
The scale of the changes to Irish society cannot be underestimated, but we must consider the alternative to these policies. Doing nothing clearly isn’t an option, because we cannot spend more than we make continuously, unless we have our own currency. We must at some point begin to pay down our debts, and this process has begun. Leaving the Eurozone would in my opinion be much more costly than the austerity policies we are engaged in because introducing a new currency (which I vote we call the ‘Anglo’ so we never forget the mistakes of the recent past) would almost certainly damage the long run growth prospects for the Irish economy. Almost all of the private bondholders have been repaid at this stage, with the only game to play for in terms of debt relief being the ‘promissory notes’ worth 31 billion euros written to cover the losses in Anglo Irish Bank and INBS. This debt is to be repaid over 10 years. The repayment schedule for this debt could be changed to 20, or even 50 years, and the debt servicing costs correspondingly reduced. Debt relief, of a sort, is still possible.
The National Recovery Plan is based entirely on export-led growth. Export-led growth relies on two pillars. First we have to make our stuff cheaper than our competitors’ stuff. Second, there has to be someone out there willing to buy our stuff. With world growth prospects looking increasingly dubious, the strategy of export-led growth may not work. This would undo, at a stroke, all of the efforts of the Irish government, the EU, the IMF, and most importantly, the Irish people.
The prospect of a grim few years ahead with national output growing at close to zero or one percent is quite likely. Readers should know that economists have a rule of thumb called the rule of 70: if the economy grows by 10 percent a year, then it takes 70/10 = 7 years for living standards to double. If growth takes place at 1%, then it will take 70/1- = 70 years for living standards to double. What is being lost is the potential for increased standards of living, and all the ancillary benefits to our society that increased wealth brings.
Finally, I feel it is a mistake to assume Ireland will return to borrowing on the private bond markets this year or next year. The situation in Europe is so volatile that sovereign debt markets are all but frozen. Even if the economy were healthy enough to take on more debt, no one would be willing to hold it. Also, the true test of fiscal sustainability is not the ability to borrow but the ability to attain a high standard of living without borrowing. The primary objective of the EU and IMF authorities and their Irish subordinates should be the attainment of a large positive primary balance in government expenditure coupled with a positive current account balance, where we sell more to the world in services than we receive. This will allow us to pay down our debts quickly and ensure the economy is robust to the inevitable shocks the world economy will experience in the future.
Published in the Irish Examiner, Monday November 28th.