John Bruton

Opinions & Ideas

Category: budget

THE CONSTANT SEARCH FOR NOVELTY IN ANNUAL BUDGETS LED TO THE 2008 CRISIS, AND IS NOT THE WAY FORWARD NOW… EXPENTITURE CEILINGS SHOULD BE REALISTIC AND MEANINGFUL

The Spring Economic statement by the Irish Government  has come in for criticism, mainly that it contains “nothing new”.

This sort of criticism is understandable from the point of view of a media ,for whom novelty is what gets attention. 

But  a search for novelty  is what got Ireland got into difficulty in the first place.

The persistent search for novelty and “new initiatives” in annual budgets, every year from 2000 to 2007,was one of the reasons Ireland overspent, and got itself into a crash. Novelties in annual budgets eviscerated the tax base, and led to unsustainable spending commitments. 

At that time, if the budget had not contained some sort of big new announcement every year , the Minister would have been open to the criticism that he lacked “vision” or “imagination”. 
Now the same chorus is beginning to be heard again. Memories are indeed short.

The Spring Statement does not contain any such novelties,  but from the point of view of the public, if not the media,  that is a very good thing. It restores an important sense of perspective.

The important perspectives  in the Spring Statement are that 

  • Growth in Ireland was 4.8% last year and will probably be 4% this year. This is the highest growth rate in Europe
  • 95000 new jobs have been added since 2012, and the IDA plans to attract a further 900 new investments by 2019, adding 80000 new jobs
  • net emigration is likely to cease next year, on present trends
  • The government deficit of spending over revenue was 15 billion euros, and it is now 4.5 billion euros

In his contribution o the Spring Statement, the Minister for Public Expenditure said again that the government is “now planning expenditures on a multiyear basis”, and  that Departments are operating under “multi annual expenditure ceilings”.

He also drew attention to the fact that the ageing of Irish society will add 200 million euros per year to health costs, and that the high birth rate will necessitate the appointment of 3500 extra teachers by 2021.

In fact, next year, the natural growth in demand for existing services public spending will on its own increase spending by 300 million euros, without ANY change in policy

This natural upward pressure on spending will mean that the setting of expenditure ceilings  for each Department will be a difficult task, requiring honesty and courage. 

This natural increase in spending, without policy change, needs to be spelled out for each Department, and separated completely from any increase that is due to a policy change.

In recent years, the expenditure ceilings for one or two major services have been repeatedly breached. A ceiling that can be too easily breached will not keep out the rain!  It certainly imposes no discipline on local management.

This sort of breach in an expenditure ceiling can, of course, be easily explained, if there has, for example,  been an unexpected increase in unemployment. It is less understandable if the demand for, or the cost of, normal health services has been underestimated .

It should be possible to predict the level of demand for, and the cost of, health services a few years ahead, on the basis of known facts about the age structure of the population, and to separate that from increases in spending that arise from unexpected one off factors. 

The budget system should incentivise local managements, who know their services best, to make the necessary savings and reallocations in time.  That job cannot be done as easily by Merrion Street.

If a Department exceeds its agreed annual expenditure ceiling, there ought to be a special procedure whereby both the Minister, and the Secretary General, of a Department, provides an early special statement to the Dail. This could be provided for in Standing Orders .

The Minister would account for, and quantify any policy changes, unexpected events, or recalculations that account for an excess, and the Secretary Genera would account for any lapses in expenditure management.

That procedure would ensure that future expenditure allocations would  be “evidence based”,  which is one of the  goals of the Minister for Public Expenditure and Reform.  It would add to the seriousness of the Estimates process and impose better accountability.

WHO BENEFITS FROM GOVERNMENT SOCIAL SPENDING?

There is an ongoing debate about budget cutting in the world today, because revenue coming in is not matching the promise Governments made to their people of availability of pensions, unemployment support, and health services. 

This problem is particularly acute in countries whose populations are getting older faster, like Finland and Germany.

Who would suffer most if  crude across the board cuts in Government social spending were made were made? 

The table below, which appeared in a recent OECD report, shows up some surprising results.


In some countries the top fifth of income earners are the biggest beneficiaries of social supports in the form of cash payments from Government!

In fact, France, Italy, Austria, Portugal, Ireland and Spain give a higher share of their cash social supports (pensions, unemployment and disability supports) to the top fifth of their population than to the bottom fifth.

In contrast, Sweden, the UK, Finland and Belgium, and the US give more to the bottom fifth
The share of cash benefits paid to households in the lowest income fifth of the population is highest in Norway and Australia at 40%, compared to around 10% in Mediterranean countries and 5% in Turkey.

In these latter countries, social transfers often go to richer households, because these benefit payments are often related to a work-history in the formal sector, and often concern pension payments to retired workers. Earnings-related social insurance payments also underlie substantial cash transfers to the top income fifth in Austria, France and Luxembourg.

Perhaps the most striking thing about this chart is that the average OECD country distributes almost exactly 20 per cent of cash benefits to both the top and bottom fifth of the income distribution

Some governments do less “social spending” in places where the private sector fills in the gap, particularly when it comes to pensions and health insurance.

In the Netherlands, Denmark, the US, and the UK, for example, private pension payments are worth about 5 per cent of GDP each year, while American spending on private health insurance is worth nearly 6 per cent of GDP.

SOME COUNTRIES SPEND MORE ON THOSE OF PENSION AGE, OTHERS SPEND MORE ON THOSE OF WORKING AGE

There are interesting contrasts in where the money goes 

Pensions paid by government are 5.3% of GDP in Ireland, and 5.6% of GDP in the UK, but they are 13.8% of GDP in France, 14.8% in Greece and 10.6% in Germany.

In contrast, income support  by Government for those of working age  are 8.3% of GDP in Ireland, as against  just 4.7% in France, , 5.1% in the UK, 3.8% in Germany and a mere 3% in Greece(notwithstanding that country’s high unemployment). 

In Ireland’s case, it is worth noting that 40% of the unemployed who receive income support from government are long term unemployed (ie.more than a year out of work). The OECD has said that their skill levels are inadequate to the modern economy, which is a big long term concern. The longer people are out of work, the harder it is for them to get a job. I heard one person describe the experience of long term unemployment as worse than losing a spouse. 

Meanwhile the number claiming various forms of illness benefit has increased by 47% in the last 14 years from 150,000 to 220,000. This is surprising in light of the improvements in spending on health services in Ireland in recent years.

Health spending as a percentage of GDP is 8.6% in France, and 8% in Germany as against 5.8% of GDP in Ireland, which is below the OECD average of  6.2%..But health spending is rising in Ireland and the  National Competitiveness Council  says that, since 2001, Ireland has had the fastest rate of inflation in health insurance costs of 17 Euro area countries.

THESE CONTRASTS MAKE IT HARDER TO DEVISE A COMMON POLICY FOR THE EURO AREA

These contrasts between countries make it harder to devise a common economic policy, even for the countries who share the euro as their currency.

They lie behind some of the arguments about immigration in the European Union and the accusations of “welfare tourism”, These accusations are mostly wrong

For example, a recent study in Germany showed that the average immigrant to that country pays 3300 euros more in taxes and social contributions than he/she takes out in benefits. In fact immigration yields a 22 billion euro surplus to the German taxpayer. Yet 66% of Germans believe immigrants are a burden! 

The same applies to the UK.

In countries where government spending goes to the well off, one can expect well placed interest groups to be particularly effective in resisting changes or reductions in expenditure.

Another conflict of interest will be between households with high debts, who are finding it hard to meet their obligations, and households who have made significant savings over the years, and who wish to protect the value of those savings. 

Household debt, as a percentage of household disposable income, is 326% in Denmark, 288% in the Netherlands, and  230% in Ireland..as aginst 58% in Poland, 90% in Austria,  and 94% in Germany.

For example, a policy that favoured low interest rates and inflation would benefit the debtors, but hurt the savers. The savers would also have an interest in protecting the value of the bonds issued by banks, companies and governments in which their pension and insurance funds are invested. Debtors, on the other hand, would be more relaxed about “burning “ these bondholders. 

These genuine differences of interest need to be brought out into the open because there are reasonable concerns on both sides of the argument.

THE EU’S SYSTEM FOR KEEPING EURO STATE BUDGETS ON TRACK IS AS IMPORTANT AS EVER NOW…..ESPECIALLY WHEN INTEREST RATES ARE LOW

Bond markets are notoriously fickle. They often seem to be driven by sentiment rather than deep analysis. The experience of 2006-2008 shows that they are not infallible. They are not a good guide to long term economic prospects. Rating agencies seem to follow sentiment rather than lead it. They are like a bus driver who is looking out the back window of the bus rather that at the road in front.

This is the context in which France and Italy should be assessing the wisdom of submitting draft budgets this month to the European Commission, in accordance with the Stability and Growth Pact,  that go back on commitments they had previously given to reduce their budget deficits to below 3% of GDP.

The low rate of interest at which most European governments can borrow at the moment can be explained by two factors, which are not necessarily permanent

1.) Sovereign bonds, that is bonds issued to allow governments to borrow, are treated as entirely risk free assets in the balance sheets of banks under the rules the EU has set for calculating the solvency and adequacy of capital of banks.  This is a somewhat artificial assumption, in that it implies that there is a ZERO risk that a European Government will ever default on its bonds ie. fail to pay all the interest due and repay the bond in full and on time. The scale of debt relative to income of some European countries might lead some to question this assumption, unless of course there is a big surge in either inflation or economic growth

2.) Prevailing interest rates are now so low, the amount of money seeking a home is so great, and high yielding investments are so scarce, that it is not surprising that investors are turning to government bonds, and thus driving down their interest rate. But if the flow of funds slowed, or if the availability alternative better yielding investments were to increase, the demand for government bonds would immediately slow. Then the interest on government bonds would have to increase, if governments were to sustain their borrowing levels.

It is against this background that the budget plans to be submitted by member governments of the euro  on 15 October will have to be assessed. The European Commission, in assessing the draft budgets of member states, would be unwise to assume that present low interest rates on government bonds are a permanent condition.

Ironically, while governments may defy the European Commission, they would not be able to defy the bond markets, if, for any reason, bond markets were to change their minds about sovereign bonds, and look for a higher interest rate. Bond markets can be less forgiving and less attentive to rhetoric or political argument than the European Commission or Ministerial colleagues in the European Council of Ministers.

That could happen quickly, leaving little time for adjustment. 

It is less likely to happen if the EU’s system for coordinating the budget policies of the 18 euro area states (the Two Pack and the Six Pack) are seen to be respected, especially by the big countries like France and Italy. This is backed up in a very specific way by Article 126 of the European Treaties.

If the system is defied, or reinterpreted in a way that removes its meaning, the fickle bond markets could get nervous again.

Ireland knows, better than most, how difficult that can be for a state that needs to borrow to fund services, or repay maturing debts. 

COPYRIGHT JOHN BRUTON & CONTENT

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