Here‘s a column I wrote for Business and Finance on the challenges facing the new government.
The Policy Institute and the Institute for International Integration Studies (IIIS) at TCD are pleased to announce that Andres Velasco (ex Minister of Finance for Chile) will give a seminar at TCD on Monday March 14 on “The Fiscal Framework: Lessons from Chile”. As has been flagged on this blog before, Chile was able to run very sizeable surpluses in the pre-crisis period, such that it could enjoy a big fiscal swing during the crisis without threatening fiscal sustainability. This seminar provides an opportunity to learn how Chile was able to achieve this counter-cyclical fiscal policy.
Andrés Velasco: Short Bio
Andrés Velasco was the Minister of Finance of Chile between March 2006 and March 2010. During his tenure he was recognized as Latin American Finance Minister of the Year by several international publications. His work to save Chile´s copper windfall and create a rainy-day fund was highlighted in the Financial Times, the Economist, the Wall Street Journal and Bloomberg, among many others.
Mr. Velasco is currently a Fellow at the Center for International Development at Harvard University.
He holds a Ph.D. in economics from Columbia University and was a postdoctoral fellow in political economy at Harvard University and the Massachusetts Institute of Technology (MIT). He received an B.A. in economics and philosophy and an M.A. in international relations from Yale University.
Pior to entering government, Mr. Velasco was Sumitomo-FASID Professor of Development and International Finance at Harvard University’s John F. Kennedy School of Government, an appointment he had held since 2000. Earlier he was Associate Professor of Economics and Director of the Center for Latin American and Caribbean Studies at New York University and Assistant Professor at Columbia University.
Mr. Velasco was a Research Associate of the National Bureau of Economic Research in Cambridge, Massachusetts, an International Research Fellow at the Kiel Institute for World Economics in Kiel, Germany, and the President of Expansiva, a think-tank in Santiago, Chile. He has been a consultant to the International Monetary Fund, the Inter-American Development Bank, the World Bank and ECLAC.
He was president of the Latin American and Caribbean Economic Association (LACEA) from 2005 to 2007. In February 2006 he received the Award for Excellence in Research granted by the Inter-American Development Bank.
In addition to ninety academic papers and three academic books, he has published two works of fiction in Spanish: Vox Populi (Editorial Sudamericana, 1995) and Lugares Comunes (Editorial Planeta, 2003).
The basis for the debates about fiscal policy in the election has been the Four Year Plan agreed with the EU and the IMF. This plan outlined measures that cumulated to have a €15 billion effect on the level of the deficit by 2014.
It is widely believed that the timing of the adjustment in this plan involved €6 billion in adjustment in 2011 and €9 billion in further adjustments over 2012-2014. In fact, this is not the case. The widely-cited €6 billion figure in relation to the current year’s budget includes €700 million in temporary measures due to once-off asset sales.
Thus, looking at page 19 of the Four Year Plan, we see that the adjustments planned for future years are €3.6 billion in 2012 and €3.1 billion in 2013 and 2014. This adds up to €9.8 billion. (I’m guessing there is some rounding going on here so that additional adjustments over €9 billion don’t appear to add up to the €700 million in once-off measures for 2011.)
Coming back to the election campaign, Fine Gael say their figures are from the Department of Finance, so they are presumably using the Four Year Plan figures. And they are aiming for the same 2.8% deficit that Fianna Fail are. This means that will also need to make €9.8 billion in adjustments. However, going to the back of Fine Gael’s budget document, one finds €6.444 in spending adjustments and €2.441 billion in tax measures, for a combined €8.9 billion.
So, on the face of it, Fine Gael’s proposed adjustment is about €900 million too low to achieve their targeted budget deficit, even if one accepts the Department of Finance growth rates. If this figure is added to FG’s tax measures, you would get €3.3 billion in additional taxes over 2012-2014, just €300 million lower than in the Four Year Plan. (I’d also note that €750 million of FG’s spending savings are actually due to transferring water provision to private firms that will collect these funds in water charges—these are spending savings that will feel like tax increases.)
During the campaign, Brian Lenihan has raised the issue of FG treating the current temporary asset sale measures as though they are permanent. However, this appears to be another case of glasshouses and stones. The Fianna Fail manifesto now claims that 2011 will see €5.9 billion in permanent deficit-reducing measures and only €110 in once-off other measures. And the FF manifesto now promises a figure for tax increases over 2012-2014 that is €650 million less than in the four year plan.
All of this raises a few questions: Have €600 million in once-off revenue raising measures been abandoned? If so, what are the permanent revenue raising measures that have been put in place to make up for them? If there are still €700 million in temporary measures in place, as Brian Lenihan seems to believe, then why are these not accounted for in Fine Gael’s plans or, indeed, those of his own party?
Update: From comment exchanges with FG officials below, I now see that I had missed that FG’s €8.8 billion omitted €1.2 billion in adjustments that occur in future years as a consequence of decisions taken in the 2011 budget. This additional €1.2 billion splits equally between spending cuts and tax increases. I don’t much like the way FG have presented the figures or calculated the tax\spend mix. Still, I’m going to score this one for FG and against Brian Lenihan.
I was accused yesterday in the comments of being biased against Fine Gael and for Labour. However, today I’m going to have to wave the yellow card at Labour for their role in the ongoing rumble about fiscal plans, specifically the supposed €5 billion “black hole” (e.g. here and here) in Fine Gael’s budgetary plans.
The issue relates to the following statement on page 29 of European Commission’s report on Ireland:
If the consolidation to reduce the deficit to 3% of GDP needed to be achieved by 2014, this would risk choking the recovery and further weakening the banking sector, possibly resulting in additional budgetary costs. The necessary additional budgetary effort in 2011-14 would amount to around €4 ½ to €5 bn, according to the Commission services forecast.
Fine Gael’s plans use what they call “the Department of Finance’s forecasts”, which presumably means the growth projections in the four-year plan (though it would be nice if they said that and produced a table being explicit about how their growth assumptions and other spending and tax promises translate into deficit ratios.) Based on this, they project reaching a deficit of 2.8% in 2014, just like the Four Year Plan.
Since FG are promising to deliver a deficit below 3% in 2014, does the Commission’s statement mean there is a €5 billion “black hole” in FG’s plans? Well, no. The additional adjustments that the Commission believe would be necessary to reach the 3% target stem from the Commission’s lower forecasts for the growth rate of nominal GDP. The Commission projects an average growth rate of 3.1% for nominal GDP over 2011-2014, compared with 3.9% in the Four Year Plan (and 3.85% in Labour’s projections.)
This means lower GDP and higher deficits in 2014 than are projected by the government and FG. However, FG are explicit that they will not introduce additional cuts to meet the 3% target in 2014:
We will review the pace and timeframe of the fiscal adjustment with the EU and IMF on an annual basis to take into account developments in the real economy. Should growth rates disappoint, we will continue with the same level of fiscal adjustment, but will avail of the extra year to reduce the deficit to under 3% of GDP offered by the EU-IMF Programme of Support.
Of course, it’s questionable whether the 3% target can be achieved by 2015 either and the IMF, freed from the strictures of having to pretend the Stability and Growth Pact matters, forecast that it won’t be.
Anyway, the black hole business is unfair to FG and the truth is that the differences between the overall stance of fiscal policy being proposed by FG and Labour are fairly small. FG planning to implement €9 billion in adjustments over the next three years, while Labour are planning to implement €7 billion. One can debate whether a slightly slower pace of adjustment is a better idea but the fact remains that policy will be severely contractionary whichever party gets its way.
When looking for black holes in the Fine Gael plan, one would be better off focusing on whether the promised efficiency improvements can really generate the predicting savings on the spending side.
I found last night’s debate a bit depressing. Many people had suspected that the five-way debate would prove to be an unsatisfactory format for useful discussion. In the event, it was worse than I had expected. In particular, the combination of poorly phrased questions from the audience (two of the first three questions were essentially “what are you going to do about emigration?”) and ad hoc and unevenly distributed follow-ups from Pat Kenny, served the audience at home fairly poorly.
There’s two more debates to go, albeit one of them as Gwaelge (as they say in RTE). How about we open a thread for Irish Economy blog participants to suggest questions that could be used in the remaining debates?
Here’s a few starters for ten:
1. Fine Gael are planning to reduce public sector employment by 30,000 and Labour by 18,000. Can this be achieved without breaking the Croke Park agreement ruling out involuntary redundancies or without affecting front-line services? (The core administrative civil service only has about 30,000 employees).
2. The European Commission says that it expects Ireland to be borrowing in the bond market again in the second half of next year. Should Ireland look for a bigger lending package from the EU and IMF to delay this return to the bond market or, if you accept this timeline, how do you plan to raise these funds?
3. It appears that the EU authorities want the Irish banks to repay the almost €100 billion they have borrowed from the ECB and the €50 billion that they have borrowed from the Irish Central Bank and to do this soon. How do you plan to deal with these requests?