The Irish Times headline had a familiar, ominous ring:
“We must not forget coronavirus bill will have to be paid someday”
Donal Donovan went on:
‘Clearly, the deficit will be a huge number and likely to be followed by more significant red ink in 2021. Who will pay for this? . . . at some stage Ireland will have to pay the bill associated with the virus . . . Payment will come in the form of higher taxes or postponement of otherwise planned expenditures.’
We’ve been here before. Who will pay for this? The question is framed in the wrong way. It is not about who will pay but what will pay. Cliff Taylor talks about the ‘tough choices to be faced on tax and spending’. But the real issue is making the right choices. Neither tax increases nor spending cuts are going to ‘pay’ for the substantial debts arising from the crisis, unless we want to risk an extended period of stagnation.
The ESRI has projected a deficit of €12.7 billion for this year, or 4.3 percent of GDP – but that was early on in the crisis. The Central Bank has estimated a deficit of 6 percent of GDP, which could work out close to €18 billion.
We are likely to see a significant reduction in the deficit in 2021 as people return to work. However, much will depend on to what extent employment and enterprises are permanently destroyed, the pace of the return to work, and progress towards a vaccine.
There are few estimates about what the economy might look like next year; understandable given the unprecedented nature of the crisis. The OECD claims that Ireland will be one of the least affected economically by the crisis, given the presence of medical and big-tech multinationals. However, there could be significant sectoral and regional variations.
The IMF produced a set of projections which look promising if they turn out to be true:
Irish output levels will nearly recover in 2021. The deficit will return to nearly a balanced budget situation. And unemployment, while high, will be reduced to single figures.
There is a major caveat. The IMF uses a global GDP model applied to all countries. It is not an analysis of the detailed conditions for each country. So this GDP model could well over-estimate the Irish economy’s resilience.
Even if the deficit recovers quickly in 2021, we will hear calls to reduce our overall debt levels. There are few projections for these, but with a €15 to €20 billion deficit this year, and the likelihood of this continuing into 2021, debt will rise.
In the short term, general tax increases and spending cuts of the type we saw in the last crisis will only make the recovery more difficult. Unemployment will still be high after the emergency. Households and businesses could fall into debt. Disposable incomes will be reduced. And this doesn’t count the demand to maintain the positive features of the Government’s response to the crisis: a more equitable healthcare system, a fully subsidised childcare system, enhanced income supports.
Rushing to a balanced budget, never mind a surplus, to pay down this debt would be a mistake. The best way to repair the economy, build on social equity, and reduce the debt would be to embark on a medium-term strategy of deficit spending. This might seem counter-intuitive – deficit spending to reduce the debt – but that’s exactly what Ireland did coming out of the stagnation of the 1980s.
Even though the Government ran a continuous deficit over this decade, and the actual amount of debt rose by 25 percent, the debt burden (debt measured as a percentage of GNP) fell substantially. Of course, one can’t make straight-forward comparisons. In the 1988/97 decade, government revenue was boosted by a tax amnesty, privatisation proceeds (which actually flattered the deficit), EU funds, and growth rates, especially in the latter half. Nonetheless, while running deficits, the debt burden fell by 46 percent even as the actual debt pile grew. Even if growth rates were a third less, the debt would have fallen in excess of what the fiscal rules would have required, if they were operating back then.
It’s actually just common sense. If growth rises faster than the deficit, the debt burden falls. Let’s run this through an extremely simple exercise. Let’s assume that GDP falls back to 2018 levels (€325 billion) and debt increases to €250 billion (or 20 percent above 2018 levels). Further, let’s assume the deficit runs at 2 percent per year while GDP growth rates are 4 percent (between 2012 and 2018 GNI* averaged nearly 8 percent annual growth).
Over a 10-year period, with an accumulated deficit of nearly €50 billion, the debt burden still falls; and that’s with a subdued growth rate. One would hope for higher growth, obviating the need for a deficit in each of these 10 years. Nonetheless, this simple illustration shows that you can reduce the debt burden while running deficits.
And we should also note that the Fiscal Rules, which are for the time being suspended (thankfully), still allow for deficit spending. And that suspension, along with continued ECB interventions, is likely to continue. In 2021, the IMF predicts a deficit of nearly 4 percent for the Eurozone as a whole.
Fiscal policy, however, cannot rely on deficits alone. It needs to encompass other initiatives such as productive investment, judicious use of our cash balances (estimated to be over €20 billion), shifting taxation on to assets, and increasing employers’ social insurance (but only when we are fully out of the emergency), and collective bargaining rights to raise wage floors.
If we fall back on fiscal clichés, the recovery will be harder, the social damage will be greater, and our ability to vindicate people’s desire for stronger public services and income supports will be greatly reduced.
And if that happens we should at least know that it will be a political, not an economic choice.
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