A need to support a tentative Irish economic recovery informed the recent Budget, writes Austin Hughes, chief economist with KBC.
Budget 2014 is the seventh successive package of painful fiscal medicine. It also marks a subtle but important shift from its predecessors. There is an increased emphasis on growth and jobs and a slightly less aggressive focus on reducing the deficit.
As such, it might be regarded as the first post-bailout Budget. The shift of emphasis in Budget 2014 marks an evolution rather than revolution. The broad contours of the adjustment remain firmly along the lines agreed with the Troika and anointed by the markets in the form of a sustained drop in Irish bond yields. The measures announced in the Budget last month bring the cumulative adjustment since 2008 to some €30bn or 19% of GDP.
Most of the heavy lifting to reduce the deficit has been done but most of the legacy of the crisis in terms of unemployment remains.
Policy is unlikely to change dramatically in the coming years because of a still large deficit and debt overhang and the looming return to market funding, but some rebalancing of priorities is warranted.
Indeed, the major threat to the outlook for Ireland’s public finances isn’t the risk of a reversal of the commitment to make difficult adjustments. It’s the risk that prolonged economic weakness would undermine the capacity to sustain such adjustments.
Progress in terms of Irish economic policy now depends on the Irish economy returning to a healthy and sustainable growth path. By avoiding unpleasant shocks to fragile domestic demand and by helping job intensive areas such as tourism and construction, Budget 2014 should support Irish growth prospects for 2014.
A key consideration in regard to the stance taken in Budget 2014 is the health of domestic economic activity in Ireland.
Each of the previous two budgets envisaged much stronger GDP growth in the following year than materialised. Although jobs and housing market data point in an encouraging direction, most spending indicators remain fairly weak and while confidence has improved, it remains fragile. In such circumstances, avoiding a renewed downturn in domestic demand argued for a less severe adjustment than some had proposed.
It remains the case that a substantial amount of money is being taken out of the Irish economy in 2014. A not unreasonable view that ‘payday’ shocks are more damaging to sentiment and spending meant that hikes in income taxes and cuts to the main benefit rates were ruled out.
This implies the Government sees the channels through which revenue adjustment is coming, such as the bank levy, higher DIRT, the pensions levy and the cut in medical insurance tax relief, as less threatening in terms of immediate consequences for jobs and spending. A similarly nuanced view likely informed the decision to raise duties on tobacco and alcohol while leaving petrol and motor taxes unchanged.
KBC projections for GDP growth in 2014 are similar to those of the Department of Finance but we are not quite as optimistic on the outlook for consumer spending.
The Department sees consumer spending growing at a relatively robust 1.8% pace. This may require some positive confidence effects entailing some displacement of saving. However, with significant uncertainty about the future and adverse changes to pensions and medical insurance tax relief, the precautionary motive for saving remains in place.
In his Budget speech, the Minister of Finance, Michael Noonan TD, announced he was ‘introducing 25 pro-business and pro-jobs measures at a cost in excess of €500mn a year.
In broad terms, these developments suggest the Minister is open to new ideas in relation to initiatives that might spur activity and employment. He is also willing to make permanent the more successful ones even if that success is measured in terms of macro or sectoral developments rather than the impact on exchequer revenues. This may herald a range of ‘micro’ initiatives in coming Budgets. This hints at changing policy priorities as well as a renewed sense that policy interventions can make a decisive difference to economic outcomes.
If Budget 2014 is in part ‘a gamble on growth’, this seems preferable to relying on greater pain to deliver progress at this particular juncture.
Encouragingly, a somewhat healthier trend in economic activity abroad lessens the risk of a global relapse that might require Budget 2015 to be harsher. Probably even more important is a marked easing in financial market fears that an apocalyptic event might strike any moment. This easing in ‘tail-risk’ reflects a belief that the ECB (and other policy makers) can and will do ‘whatever it takes’ to avoid destabilising outcomes. As a result, markets handled botched interventions in Cyprus and the recent circus in relation to the US Government finances, without significant trauma.
These developments suggest that ‘contagion’ threats to the Irish public finances have eased somewhat. This implies that any ‘war chest’ whether judged in terms of the amount of pre-funding needed by the Irish Government or the appropriate scale of adjustment in Budget 2014 could be slightly smaller than might have been envisaged a year ago. In turn, this justifies an approach that seeks to limit fiscal damage to an emerging recovery in the Irish economy.