Fiscal Treaty Files: The Fiscal Treaty is Unsafe, Uncertain and Unnecessary

The following is my presentation to the Dail Committee on European Affairs.

On behalf of UNITE the Union I would like to put forward seven points regarding the Fiscal Treaty.

1.            The Fiscal Treaty will require substantially more austerity measures in the medium-term.

The Government estimates the structural deficit will be 3.7 percent in 2015.  We will have to reduce this to 0.5 percent.  This could require fiscal adjustments of over €8 billion on top of the current fiscal consolidation schedule. Therefore, we could be looking into a doubling of the austerity measures the Government has planned over the next three years. 

This continued austerity could result in economic growth being cut by over 2 percent of nominal GDP.  This will reduce employment, drive up the Live Register, and cut wages and incomes.

2.            This Fiscal Treaty will depress growth in the Eurozone.  This will have an impact on our external demand.

Most Eurozone countries will have to undergo substantial fiscal consolidation to meet the Treaty’s targets.  The German Institute for Macroeconomic and Economic Research estimates that the effect of this will be to drive down Eurozone growth to a mere ½ percent average annual growth up to 2016, depending on the timing of the fiscal consolidation. 

It is essential, therefore, that the Government provide its own estimate of (a) the additional fiscal contraction to meet the structural deficit target, (b) the impact this will have on the domestic economy, and (c) the impact on our exports, from sustained fiscal consolidation in the Eurozone. 

3.            Even the Government regards the structural deficit as unrealistic. 

The structural deficit is a hypothetical.  It is derived, first, by comparing actual GDP with the hypothetical potential GDP.  From this the output gap is derived – another hypothetical.  Finally, to determine the structural deficit, a cyclical sensitivity measurement is applied – yet, again, a hypothetical.   The structural deficit rests on layers of hypothetical measurements inside a model with variables that cannot be observed in the real world.  This is why it is said that if you ask 10 economists to determine the structural deficit, you will get 20 different methodologies and forty different results.

Little wonder, then, that the Government has labelled the EU Commission’s method for measuring the structural deficit as ‘highly uncertain’ and ‘unrealistic’.  And for good reason.  The EU projects that by 2014, the Irish economy will actually be overheating, that we will back in a boom.  This is not only ‘unrealistic’, it is absurd. 

The government, however, should explain why it is calling upon people to give constitutional force to measurements and hypotheticals which the Government itself has dismissed as ‘highly uncertain’ and ‘unrealistic’.

4.            The Fiscal Treaty will limit the amount of counter-cyclical measures future Governments can employ during downturns. 

Let’s take the example of the Irish economy falling back into a recession later in this decade.  Under the Fiscal Treaty, we would be required to run primary surpluses – that is, a budget surplus excluding interest payments.  Given this constraint, it is unlikely that automatic stabilisers would be allowed to run their full course, never mind allow for pro-active fiscal measures to counter the downturn.

Nor should we rely on provisions for a ‘temporary’ departure in the eventuality of a ‘severe economic downturn’.  Look at Spain.  It is heading back into a full-blown depression; yet no temporary departure is being allowed.  The Treaty has little to do with a sustainable counter-cyclical macro-economic framework and all to do with self-defeating deficit reduction via deflationary fiscal adjustments. 

5.            The Fiscal Treaty will perpetuate instability in the Eurozone.

First, depressing economic growth during a period of stagnation will undermine confidence in an economy’s ability to generate the future revenue needed to repay its debts.  Again, witness Spain – increased austerity measures are only pushing it into, not away from, a bail-out as market confidence is drained.

Second, if a number of ‘temporary’ departures are granted out of necessity, combined with changes in structural deficit measurement so as to allow countries to more easily achieve targets, this will undermine confidence in the actual framework itself.  We witnessed this with the stress-testing on European banks.  Market investors had no confidence in these measurements and eventually the ECB was forced into an unprecedented release of €1 trillion to prevent the European banking system from freezing up.   If investors believe the Fiscal Compact is being similarly manipulated, the process will perpetuate the crisis.

Third the debt-reduction rule will lead to an unsustainably low level of Government debt – falling to levels of 20 percent of GDP or less.  Government debt provides a secure investment for financial institutions – in particular, pension funds.  If this is removed, such funds will be forced to introduce higher risks into their portfolios and may end up creating bubbles in equities and property.

6.            The Fiscal Treaty will undermine productive economic growth.

Let’s assume the Fiscal Treaty was in place at the start of the Irish economic boom.  Between 1990 and 1997, the Irish economy suffered from severe structural deficits –up to 10 times the threshold allowed under the Treaty.  However, during this period, the Government ran budget surpluses and reduced overall debt at a faster rate than required under the Fiscal Treaty.

However, in the period between 2000 and 2007, the Government ran structural balances and even surpluses.  Under the Fiscal Compact rules the Government could have increased public spending and/or cut taxes even further and still remained compliant.  We know the outcome of that.

This clearly shows the incongruity of the Fiscal Compact rules.  During a period of productive economic growth, the Treaty would have depressed growth and employment.  However, this same Treaty would have validated an economy which was over-heating on speculative growth. 

7.            Regardless of a Yes or No Vote, Ireland has guaranteed access to institutional funding

First, the main source of future institutional funding is the programme we are currently in – the European Financial Stability Facility.  Ireland has until July 2013 to make application for a further round of funding.  This legal right to this funding is guaranteed by intergovernmental agreement and reaffirmed by the Heads of Eurozone governments only a few weeks ago when they stated Ireland would remain funded until we return to the market.

Second, though Ireland has exceeded its quota of financing under IMF rules, we comply with all four conditions for an exceptional waiver.  This would clear the way for a second round of funding from the IMF.

Third, the drafters of the European Stability Mechanism Treaty wisely inserted clauses that provide manoeuvrability in negotiations with any Eurozone country in need of financing, regardless of the Fiscal Treaty.  In particular, they inserted references to ‘new’ financing under the ESM, which would have been unnecessary if all financing under the ESM were strictly conditional on a yes vote.  Clearly, they factored in a situation whereby a second bail-out for Ireland would constitute ‘rolled-over’ financing, rather than ‘new’ financing. 

For these reasons – and the obvious one:  namely that European governments are not going to risk the financial stability of the Eurozone by isolating any member-state from both market and institutional funding (for this would contain incalculable contagion effect, even the hint that this might happen would have severe destabilising consequences); for these combined reasons the doubt is not whether Ireland will continue to access institutional funding. 

The doubt is whether we can avoid a second bail-out under the current deflationary policies that the Government is pursuing.  In this regard, the signs are not good.

Thank you.

Comments

[CMK]

All very cogent, all very rational and well argued. Completely undermined by SIPTU's treacherous endorsement of the Treaty. Likely to be followed by ICTU.

I've followed the evolution of SIPTU's thinking on the treaty, as far as a plebian member can, and I don't think I've seen a sorrier stream of delusional thinking in my entire life. It rests on the entirely delusional premise that THIS government, of all governments, are going to pluck 10 bn euro out of thin air between now and 31 May for a stimulus package. And, moreover, that after 31 May should the Treaty be safely to bed (almost certain now) SIPTU seem to think a FG led government are going to find 10bn euros for stimulus. I can see FG TDs having a hearty laugh over a few pints at SIPTUs naiveity.

SIPTU have effectively backed the injection of the present austerity with angel dust and it ain't gonna be the bureaucrats in Liberty Hall feeling the pain. Shame, shame, shame.

[Dave M]

Hi Michael,

Good article. You had previously used the figure of an 'adjustment' of €5.7 billion to reach the 0.5% target. You now say it could be as high as €8 billion. You had said it could be higher than the 5.7, is 8 billion now the more realistic figure? Is this based on latest figures released by CSO or the gov?

[Michael Taft]

Dave - I had used the €5.7 billion as a 'static' measurement. In other words, you just take difference between the Government's projected structural deficit of 3.7 percent in 2015 and subtract the target of 0.5 percent. That leaves a 3.2 percent gap, or €5.7 billion in 2015.

However, to reduce the structural deficit will mean more than €5.7 billion in cuts. This is because fiscal adjustment will lower the actual GDP and possibly the potential GDP (the output gap) from which the structural deficit is derived. It is hard to give an estimate. I am currently doing a follow-up paper for the Committee on the different fiscal adjustment estimates to close that gap. When I have sent this in, I will publish it.

But these will be only estimates based on historical trends.