Foundation for Further Development

Martin O'Donoghue defends the economic policy of the Lynch government. 

While there are many points on which I would agree with the analysis put forward last month by Joe Durkan, not surprisingly perhaps there are also some differences between us. The easiest way to summarise these would be to say that I would place more emphasis on longer-run trends and influences and also on the political as well as the economic forces at work.

Joe Durkan's opening paragraph provides a neat illustration of these points. He tells us that 'rarely can it have been so easy to pinpoint so precisely when the shape of this month's budget was cast - December 3, when figures for retail sales for the first half of 1979, were published'. If asked to choose a date in early December when the shape of the Budget was decided, I suspect that more people would opt for December 7, when Mr. Haughey was elected leader of Fianna Fail - a reminder perhaps that in Ireland, political economy is usually spelled with a large P and a small e.

But did one month's retail sales figures shape the Budget, or more importantly should they? On both counts I would say no. The work of framing the Budget takes place over several months; its basic shape is decided by longer-run trends in the economy, while the precise details are adjusted up to the eleventh hour, so that the most recent information can be incorporated. Insofar as the 1980 Budget was concerned, it was apparent from the Spring of last year that the 1979 Budget was going to be off course because of external events such as the oil crisis, and domestic events such as the postal strike. In the final analysis, it did not make much difference for one month's statistics to suggest that say the balance of payments deficit would be closer to £800 than to £700 millions - it was already clear that the deficit would be unacceptably high, whatever the precise figure.

Having cleared the ground, let me take up the main policy problems with which Joe Durkan was concerned. First and foremost was the balance of payments. Here let me say that I agree with the need to correct this situation, but there are a number of points which may give the issue a somewhat different perspective.

First, it should be noted that balance of payments deficits were expected during the period from 1978, into the early 1980's, as a consequence of a rapid growth in output, and in fact the White Paper of January 1978, indicated that the largest deficit was expected in 1979. In the event the deficit for 1978 was lower than anticipated, and that for 1979 above expectations. Hence while the excessive deficit of last year must be lowered it is not necessarily the case that balance must be aimed at in the immediate future.

The expectation is that, substantial capital inflows would arise from both private and public investment projects.

True, these inflows may now be lower than anticipated before the oil crisis, but they should nonetheless continue to be significant. During this recession period, it would be inappropriate for the Western World to deflate on the scale needed to wipe out their balance of payments deficits. A more sensible course would be to recycle the surplus revenues of the oil exporting nations, to help finance these deficits. It would even be more sensible of course, to use such borrowings to fund investment, since the future income from these investments, can help to repay the initial borrowing.

A major objective of government policy during the past three years has been to boost investment, and one of the most encouraging features of recent economic behaviour, has been the healthy results achieved. In 1978, the volume of investment rose by about 15 per cent - twice as fast as the growth in consumer spending, while last year the increase appears to have been about 13 per cent - about four times greater than the rise in consumption. A slowdown is very much on the cards this year, but again investment is likely to be the more buoyant area of domestic demand, especially industrial investment.

The purpose of these remarks is not to suggest that the balance of payments deficit is not a subject for concern and for action, but rather to place the problem in a longer-term perspective. The 1979 deficit which would have been high in any event was further aggravated by the impact of higher oil prices and the effects of the postal and other disputes.

We cannot escape the former; hence we must curb our use of oil and also boost exports to help cope with the problem of rapidly rising oil bills. We can do something about domestic disruption - which last year worsened our balance of payments account by the best part of £100 million. A year of industrial peace would be a positive contribution, and this could be reinforced by the build-up of what is usually described as the 'Buy Irish' campaign, but which might be viewed more accurately as a 'Sell Irish' and 'Make Irish' programme.

The IDA for example have been having considerable success in identifying imported products which could be manufactured in Ireland, and this programme is estimated to produce £20 to £30 million. Not in itself a cure for our balance of payments, but a useful step in the right direction.'

In addition to selective action for switching spending away from imported to home products, there is the contribution which more general deflation in spending can make. Here Joe Durkan dealt with the importance of reducing the level of government borrowing. Again I would agree, as indeed most people would, with the need for some cutback. But again there is the question of how much, how quickly. The problem of heavy borrowing has been with us for many years; the original intention was to restore balance to the current Budget over the three years 1979 to 198I, but that timetable has been setback by events in 1979.

This year's Budget envisages a cutback from about 7 per cent last year, to about 4 per cent of GNP in the current deficit, but the scale of future reductions should be decided in the light of the actual circumstances prevailing in 1981 and 1982, rather than on any predetermined formula. The reasons for such flexibility stem not from any narrow political considerations but from the desire to have budgets that are appropriate to actual conditions rather than a routine application of an academic formula.

Reference to academic formulae raises the question of the role which monetary policy should play. This is an area totally excluded from Joe Durkan's discussion - an omission which may strike some readers as curious, given the extent to which 'monetarism' is fashionable across the water! While by no means subscribing to a full-blooded monetarist approach, equally I do not feel that it should be ignored completely.

In my view the growth of credit was excessive in 1978 and early 1979, and contributed not alone to the import excess but also to an unnecessarily sharp rise in land and property prices. Happily, the Central Bank has been adopting a more firm approach since last Summer, and their guidelines for 1980, indicated that they will continue this policy, which is necessary to choke off some of the inflationary pressures at work. Monetary policy must be consistent with budgetary action - there would be little point in having severe budget measures if the effects of this could be quickly cancelled by excessive credit creation.

In addition to budgetary and monetary steps, a further area of major importance is that of income increases. The contribution which tighter fiscal and monetary conditions would make to reducing our balance of payments deficit could be quickly offset if there were to be excessive income increases or prolonged strikes in support of claims for such rises. Each of these would have the effect of making Irish products less competitive on both home and export markets.

At the mention of income restraint many will groan and say 'not again, we've heard that cry dozens of times'. However, the fact that something has been said many times does not make it any the less true, and the reason why the message has to be repeated so often is because of the reluctance to accept its validity.

The traditional approach to pay rises would be to begin by seeking increases which at least compensate for price rises. However, there are two reasons why this approach should not apply in 1980. First the price increases arising from the tax changes in the Budget should be deducted because these indirect taxes were mainly used, to pay for cuts in PAYE income tax, and to a lesser extent to finance social welfare improvements.

It would be ironic if having marched to win a shift in taxes from PAYE to other tax-payers; workers were now to seek a pay rise for this very change! The placards were saying that PAYE earners had 70 per cent of total income, but were paying 88 per cent of income tax. This means that they would only pay 70 per cent of indirect taxes on spending, so the Budget will lower their overall tax burden and shift some of it to the other groups. And since the PAYE group will get the benefit of this shift in the form of lower tax deductions from their pay packets, the money is not there to reward them a second time by a pay rise. Since the Budget is estimated to add about 4 per cent to prices, a deduction of this amount would be appropriate in deciding pay rises.

The second deduction relates to the effect of higher oil prices. Since these price increases make us poorer as a nation, there is no way in which everybody can be compensated for them. This is an argument which has to be accepted, not only in Ireland, but in every oil-importing nation. The extent of the deduction under this heading is still not clear since we do not yet know what the full extent of oil price increases this year will be, but a figure of at least 2 to 3 per cent seems inevitable.

These arguments may be difficult to accept but they are essential if we are to make a rapid return to the path of financial stability, increased employment and rising living standards.

The problems confronting us in the economic area may seem formidable, and it would be foolish to be naively optimistic about their solution. But neither should we be unduly defeatist in our approach. Joe Durkan expressed his concern at the over-ambitious nature of people's expectations. It is only a few short years since they were plunged in pessimism, and people felt that nothing could be done to overcome the awesome unemployment problem. If people's expectations today are very different to those of three years ago, it is partly because we have made dramatic progress on the employment and other fronts during this period, and have generated an investment momentum, which can be the foundation for further rapid progress in the years ahead.

During the present time, when the international economy is going through choppy waters, we need to steer a middle course between the rocks of excessive optimism or pessimism. In short we need to 'play it cool' and keep it that way for some time ahead.