Fiscal Policy

The concept of ‘legitimate expectations’

The Irish  Times reported in yesterday’s edition on the debate in government over whether to try to effect savings in child benefit expenditure (which currently costs almost €2.5 billion per annum) through means testing or through taxing benefit payments. The report concluded that “briefing notes released under the Freedom of Information Act show senior officials are concerned about the legal implications of major changes to benefit payments. Concern has been expressed that the State could be vulnerable to legal action where recipients may have had a legitimate expectation a welfare benefit would continue.”

It seems to me that to claim a legitimate expectation that a welfare payment (or, presumably, any government payment) would continue would make government decision-making, whether in fiscal policy or welfare policy, totally unmanageable. At face value, it would seem to make any change to a government expenditure scheme, once introduced, impossible (and why stop at expenditure – did we not also have a legitimate expectation that the government would refrain from introducing an income levy?).

It is interesting to contrast this with payments which were actually cut in the budget. In agriculture, for example, annual payments for those farmers enrolled in the Rural Environment Protection Scheme (REPS) were cut by 17% in 2009. There is a much stronger argument against cutting these payments as these are contractual payments – farmers enter into an agreeement to follow certain environmentally-sensitive farming practices for a five year period, in return for a payment from  the State. However, the State has inserted a clause into the Regulation (away towards the end under Paragraph 28) that “The Minister reserves the right to vary, where occasion so demands, the amount of financial aid wherever specified in the Scheme subject at all times to the provisions of any relevant European Union legislation.” Given that farmers incur costly obligations on entering REPS, this unilateral right  on the part of the State to vary the amount of payments may appear rather extraordinary. Particularly given that if a farmer were to decide to leave the  Scheme in response to a change in payments, then aid already paid must be re-imbursed. If these farmers had no legitimate expectation that payments would continue at the level agreed at the start of the 5-year scheme despite a contractual agreement with the Department of Agriculture Fisheries and Food, it seems extraordinary that officials are fearful that any change to welfare payments might be challenged on the basis of ‘what we have, we hold’.

Economic Performance Environment

Irish trade statistics still looking good, but…

Kevin O’Rourke has drawn our attention on a number of occasions in this blog to the collapse in world trade and its implications for the depth of the recession. Yesterday, the Financial Times reported that the World Trade Organisation was predicting a 9% drop in the volume of world goods trade this year, the largest drop since the second world war. Today, it reported that Japanese exports have halved compared to a year ago.

Against this backdrop, Irish external trade statistics have been remarkably healthy, albeit two caveats are in order. First, although Japan can report its February trade statistics today, the latest trade statistics on the CSO website (last updated 27 February) refer to December 2008. Presumably the January figures should be published in the next few days. Second, we only get monthly trade statistics for merchandise trade, even though the value of services exports is now about 75% of the value of merchandise exports, so the merchandise trade statistics only tell half the story.

Economic Performance

NESC report advocates integrated national response to the crisis

The NESC has just produced a paper Ireland’s Five-Part Crisis: An Integrated National Response which sets out to assist government in developing an integrated response to the current crisis. The paper stresses the urgency of a holistic and joined-up plan within which we can see how the individual measures required to get us out of the problems we are in relate together. It is hard to argue with this proposition, even if we are a long way from seeing a recognisable plan from the authorities at this point in time.

The paper deliberately eschews making specific policy recommendations (p. 9), though some are discussed in an appendix to the paper. Its argument is that the more important task at this stage is to gain agreement around an overall analysis of the problem and a vision of the way forward. However, while the paper contains many useful insights and observations, my overall impression is that it remains too rhetorical and would have benefited from a harder edge, perhaps in the form of some specific targets to address some of the key imbalances which it identifies.

The paper has a short but useful overview of the position in which Ireland now finds itself and how we got here. It goes on to argue that there are five dimensions to Ireland’s current crisis:

  • A banking crisis
  • A fiscal crisis
  • An economic crisis
  • A social crisis
  • A reputational crisis

The core argument of the paper is that partial, piecemeal and sequential responses to these individual crises will not be sufficient or effective. This is only partly because of the inter-relationships between these individual dimensions of the crisis, but largely because citizens need to be able to see how any sacrifices they are asked to bear fit into the overall response to the crisis.

A key feature of a recovery plan is some statement of how the government intends to allocate the inevitable costs of adjustment across groups in the population, and the mechanisms for achieving this. Beyond some well-meaning statements on the need for social solidarity, the paper is silent on this issue.

The paper’s own list of desirable elements in a recovery plan (p. 40) are very high-level and fail largely to address the distributional issues which will be key to its public acceptability. It is also disappointing that the paper does not address more directly some of the operational issues on which economic and political opinion remains divided, e.g. the optimal balance and speed between addressing the yawning fiscal deficit and maintaining domestic demand, or how to bring about the required adjustments in nominal wages and prices to restore competitiveness.

To be fair, the paper states that it did not set out to get into  this level of detail, and it is more of an essay than a plan. But a plan is needed, and it is to be hoped that the government can produce it in the context of its budget measures on April 7th next.

Economic Performance

Latest CSO figures underline vulnerability of Irish agriculture

The CSO released its preliminary estimate of agricultural output and income for 2008 two days ago.  The figures underline yet again the highly vulnerable position of Irish farming to possible changes in the EU’s Common Agricultural Policy (CAP) payments after 2013 when the new EU financial perspective is negotiated. Family farm income before direct payments was slightly negative in 2008, indicating that Irish farmers received no market remuneration for their contribution to agricultural production last year.

To understand the extent of this vulnerability and the justification for this conclusion, we need a short introduction to the economic accounts for agriculture. The net value added in agriculture at basic prices (these are the prices farmers actually receive for their output, adjusted by any product-specific subsidies or taxes) in 2008 was €830 million. This value added is divided four ways:

  • Some goes to hired labour in agriculture, €450m
  • Some goes as interest on borrowed capital, €398m
  • Some goes as rent for rented land, €144m
  • And the remainder is available for farm families to remunerate their labour, the use of their own land and the return on their own capital invested in farming.

Doing the sum, family farm income at basic prices in 2008 was minus €162 million. Even if we ignore land rental as the transfer of income within the farming community, family farm income last year was slightly negative.  These means that the work of  most of the estimated 155,000 people working in agriculture (measured in annual work units) as well as the use of 4.3 million hectares of agricultural land and billions of euro of farmer-owned capital stock (the stock of agricultural machinery alone was valued at over €2 billion, see Keeney 2007) added precisely nothing at basic prices to Irish GNP last year.

And we should remember that, for the major commodity outputs of Irish agriculture of beef and milk, these basic prices are artificially inflated by import protection against third country exporters of between 40 and 80 per cent.

So the only income which farm families had from their farm enterprises last year came from direct payments. These totalled €1.9 billion, paid for mainly by the EU CAP but also with contributions from the national exchequer.  In addition, there were substantial capital grants paid to farmers particularly under the Farm Waste Management Scheme which is now likely to cost a total of €900 million over the period 2006-2008. This cost was so far above the budgeted estimate that the Minister has announced that payments will have to be phased in over the period to 2011, leading the farm organisations to demand that the government should in addition bear the cost of the interest payments to which farmers are exposed as a result of the late payment.

Some of these subsidies, such as environmental payments under the REPS scheme, have a justified rationale in public welfare terms, even if the schemes are not always well designed to deliver those benefits. On the other hand, if environmental services are being paid for, then the pollution costs of agriculture should also be factored in (particularly water pollution even if this has been significantly reduced in recent years, but also the greenhouse gas emissions from livestock farming). In the case of some other direct payments, there may be a rationale for maintaining farming activity in some marginal farming regions for landscape protection and biodiversity reasons. But there is little clear rationale or justification for continuing the bulk of direct payments to Irish farmers, which were introduced to compensate for price reductions which, in some cases, took place 15 years ago!

As at least some reduction in these payments must be expected following the negotiations on a new EU budget for the period after 2013, these latest CSO figures show just how dangerously Irish agriculture will be left exposed in the years ahead.

World Economy

Is the EU fiscal stimulus sufficient?

Much of the recent comment on this blog has understandably focused on the specifically Irish angles in saving the banks and getting credit flowing again, getting on top of the government deficit and improving competitiveness. But any progress towards these goals in a purely Irish context will be set at naught if the global economy continues to head south. We thus have a vital interest in the success of the various stimulus packages intended to reverse, or at least reduce, the slide into global recession.

The IMF’s most recent World Economic Outlook update (published January 28th last) presented its third downward revision of its economic forecasts in just four months. It now projects global growth of just ½ per cent in 2009, with advanced economies expected to suffer their deepest recession since World War II. Collectively, advanced economies are expected to contract by 2 per cent in 2009 – the first annual contraction in the post-war period.

Economic Performance

Price competitiveness deteriorates sharply in December

An indication of the pressures on Ireland’s competitiveness is provided by the Harmonised Competitiveness Index, the December figure for which has recently been released on the Central Bank website. While the real HCI had been falling gradually since the early part of the last year (a rise in the indicator implies a disimprovement in competitiveness, while a fall in the indicator indicates an improvement), the December figure jumped upwards by 4.0% over the previous month, largely due to the appreciation of the euro particularly against sterling. The Dec 2008 value of 126 puts us back where we were at the beginning of last year.


The cost of carbon targets

While the macroeconomic crisis is all-consuming, there are other important economic policy issues on the agenda. Let me add to Richard Tol’s earlier post on the implications of the EU‘s Climate Change and Energy package formally adopted in December 2008. This sets demanding targets for reductions in Irish greenhouse gas emissions by 2020, and particularly for the non-ETS sector of which Irish agriculture is a major part. How agriculture, and the non-ETS sector generally, is to meet these targets remains largely uncharted. The targets, and the policies implemented to meet them, will have major economic implications over the next decade. Like Richard, I agree that achieving the non-ETS targets for Ireland set out in the Effort Sharing Directive agreed in December 2008 now looks to be considerably less costly than earlier thought.


Electricity cost puzzles

Alan Ahearne in his post on the recent National Competitiveness Council report draws attention to the high electricity costs in Ireland relative to our trading partners documented in the report. Malore in his/her comment on Alan’s post suggested some reasons for this. These and other reasons are further explored in the Sustainable Energy Ireland 2008 report Understanding Electricity and Gas Prices in Ireland.


2008 CSO agricultural output and income data disappoint

The CSO recently published its advance estimate for output, input and income in agriculture. Despite world prices for food hitting record highs in the early part of this year, the CSO estimates that GVA at basic prices fell by 17 per cent and that the operating surplus generated in the sector fell by 13 per cent in 2008.

The main reason is that, although agricultural output prices have risen by 20 per cent since the beginning of 2007, input prices driven by higher energy prices have risen even faster. As a result, Irish farmers have experienced a sharp deterioration in their terms of trade from its recent peak in September 2007. Output prices relative to input prices fell by 20 per cent between September 2007 and October 2008.


Gross value added at basic prices in primary agriculture is estimated to amount to €1,579.6 million in 2008. When interest on borrowing, wages to farm workers, land rental payments and capital depreciation are netted out, the amount left to remunerate farmers for their own labour, land and capital input is the princely sum of … -€186 million! (if you want to do the calculation yourselves, the raw data is provided in the CSO release).

Fortunately, farmers don’t depend on the market for their income (even the supported EU market in which , thanks to the Common Agricultural Policy, they can sell beef and dairy products for up to 75 per cent higher than third country competitors). Thanks to direct payments (which amounted to €1,995 million last year and will top the €2 billion mark this year because of the introduction of a new Suckler Cow Welfare Scheme), farm incomes will remain in positive territory. While some of these payments reflect the role of farming in producing valued public goods, their distribution across farmers is hardly equitable and their future in the light of the 2013 EU budget debate is hardly secure.