In The Valley of the Shadow of Debt

Brian Donaghy on everything you always wanted to know about why the country is going broke.

The Irish economy is in serious recession, aggravated considerably by a series of political miscalculations and indecisions which will probably affect the prosperity of the country for several years.

 

The most immediate and alarming problem is the state of public borrowing. This is currently running at about 14 per cent of Gross National Product, a rate deemed by almost all economists as recklessly high. And the indications are that far from doing what is urgently required to reduce this rate, the Government will opt instead for a further deferment of any action on the matter which might prejudice its electoral chances in the next 18 months.

 

It was one of the prime aims of the Haughey administration, announced in the Taoiseach's January broadcast, and in the Budget, to reduce the borrowing rate from 14 per cent to 10.5 per cent this year and scale it down further to around the EEC average of about 3 per cent. Instead the Haughey Government has flinched at the political repercussions of such a severe cut-back and allowed the rate to remain around the

14 per cent mark.

 

As had recently been written by two of the country's leading economists, Brendan Walsh and Colm McCarthy, of the Economic and Social Research Institute, "If significant progress is to be made towards achieving the reduction in Government borrowing for a much earlier date in the 1977 Manifesto, it is unavoidable that the 1981 Budget will have to be one of the most deflationary ever".

 

However, in the light of the imminence of the next General Election, which must take place before June 1982, the likelihood of the Government resorting to such Draconian measures is slim. It is this fact of political life which has given rise to further concern in the economic establishment. Walsh and McCarthy have written: "The main reason for our concern about Irish public finances is our fear that the current political atmosphere may preclude the kind of action that is needed to stave off a precipitate financial crunch".

 

The nature of this financial crunch, it is feared, may be that the International Monetary Fund (IMF) may intervene in the Irish economy at a time when other financial lenders become apprehensive about the credit-worthiness of the Irish economy, and impose economic measures which would have calamitous effects on Irish society in terms of employment and living standards.

 

For the plain fact is that as a nation we have been living way beyond our means. We have been borrowing huge sums of money from foreign lenders to finance, not just capital programmes which might produce wealth at some later stage, but our current expenditure projects. This borrowing has been undertaken as the alternative to imposing taxes to meet the Government's bills on current expenditure or to cutting this expenditure.

 

Borrowing to finance deficits in current expenditure began in earnest in 1975 when the Coalition Government engaged in what was then quite massive borrowing to offset the recession caused by the oil price increase. The borrowing rate then climbed dramatically to 16.2 per cent but was brought back to 11.2 per cent in 1976 and was targeted to fall to about 8 per cent in 1977.

 

It was then that the new Fianna Fail Government and Martin O'Donoghue intervened. O'Donoghue had postulated the proposal in the 1977 Election Manifesto that the borrowing rate should be pushed back up to 13 per cent in 1978 in order to give the kind of boost to the Irish economy which the high unemployment rate and huge young age group population demanded. Many economists then argued that this policy was misguided because the economy had already lifted itself out of the mid-seventies recession. Such priming exercises could therefore only have an inflationary effect, and another consequence would be that our balance of payments would deteriorate, as much of the extra cash in the economy would be spent not on Irish goods, providing employment, but on foreign imports.

 

The indications so far are that the pessimists were right; but there was another and more worrying development. This was that while the borrowing rate did increase to 13 per cent in 1978 it did not return to 10.5 per cent as projected in 1979 but actually increased to 14 per cent. And the consequence of this was not a declining unemployment figure as projected by O'Donoghue but actually an escalating one.

 

When the Haughey administration took over there were signs that it would deal with the mess that had arisen in the public finances. In his January television broadcast and in the autumn Budget Haughey established as one of the priorities of his administration, the reduction in the borrowing rate in 1980 to 10.5 per cent (the Manifesto target for 1980 had actually been 8 per cent and even this figure was considered too high by many economists) and successive reductions in the following years until a rate of about 3 per cent was established by about 1983.

 

In the event however the borrowing rate has remained at about 14 per cent for 1980, largely because of the increases in the public sector pay which the Haughey administration has found impossible to resist. Therefore, instead of the economic stringency which the Haughey Government promised at the beginning of the year and which was being advocated by most economists, there has instead been a process of drift which has left us as badly off as we were at the beginning of the year, with time running out fast.

 

The size of the Government's borrowing is now quite staggering. From a figure of £95 million in 1971 it rose to £601 million in 1975, to £801 million in 1978 and it will borrow approximately £1,155 million in 1980. The consequence of this is that one quarter of all taxation goes just to pay the interest on the accumulated outstanding debt.

 

While there is general agreement among economists that the size of the Government borrowing may not itself be cause for alarm, provided the borrowing was going towards productive investment - and Mr. Haughey made this point himself on television - the alarming aspect to this is that over half the borrowing is going towards financing the current Budget deficit. It was the aim of the February Budget to reduce the Budget deficit from £522 million last year to £353 million this year but because of political and other pressures the Government has allowed the Budget deficit to slip to an even higher figure than last year's £575 million approximately. The significance of all this is that we are borrowing more and more money each year, not to invest in potentially profitable enterprises or in infrastructure, so favoured by Mr. Haughey, but simply to pay our day to day Government bills.

 

The danger is that within a relatively short period of time we may get to the stage of borrowing money simply to pay interest on the money we have previously borrowed. If and when we arrive at this stage the danger of our creditors calling a halt will be very real - and the way we are going would suggest that this day isn't far off.

 

The total debt incurred by the public sector now is approximately £7,500 million. Of this approximately £2500 million is owed to foreign debtors.

 

About one-third of this debt is repayable within three years and more than a half repayable after five years. While it is possible for Governments to "roll over" debts there are serious implications nowadays in doing so. In the first place interest rates tend to be considerably higher, therefore the cost of servicing these borrowings will rise, and, secondly, the transfer of resources involved in these transactions has serious social consequences.

 

A lot of the interest payments goes towards servicing the foreign debt, so this represents a transfer of resources to outside the country, and even the interest payments to domestic debtors involves a transfer of resources from the poorer sections of the community to these people who are necessarily wealthy people or institutions.

 

There are, of course, other serious problems in the Irish economy, not least in Agriculture - the area which provided most stimulus since Ireland joined the EEC.

 

Since the departure of Mr. Gibbons from Agriculture House, the Government has at least tried to tackle some elements of the farming crisis, with increased head age payments, rates relief, and a partial exchange rate guarantee for yet more foreign borrowing.

 

But the stark facts are that farmers have had to cope with the cost of inputs - feed, fertilisers, fuel, fungicides - rising by anything from 13 to 25 per cent a year, while price increases, fixed in Brussels, have been five per cent or less. In the past, this would not have mattered so much. In those days we were tied to a sterling which was sinking steadily, thereby creating frequent opportunities for devaluation against the fixed unit of account used for setting farm prices. Each devaluation made those prices worth more to the farmer in Ireland. Now that we are in the EMS, and the Irish pound is tied to the EEC's farm currency unit, we no longer have that option. Farmers, caught in a classic cost/price squeeze, have seen their incomes fall by some 45 per cent in real terms over the past two years.

 

The implications, not only for farmers, but for the economy as a whole, are frightening. Ireland's remarkably rapid recovery from the '74/,75 recession was due largely to strong growth in agriculture, fuelled by massive cash injections from Brussels. Farming is still our largest single productive sector, accounting for some 20 per cent of total output. Three out of ten people work either on the land or in food processing and distribution. It still accounts for 33 per cent of our exports, and a particularly valuable percentage, because the import content if, very low. It is true but irrelevant, to point out that the large and efficient farmer can still make a small fortune even now. It is the health of the farming sector as a whole which is still a vital element in the overall economy.

 

The EEC will not come to our rescue this time. On present trends the Common Market Budget will itself run out some time next year, perhaps even by early summer. EEC price support systems have been shown to be largely ineffective. Import controls, subsidised exports, cold storage and even outright destruction of food are the instruments used to deal with oversupply prices to the consumer remain high. The Government has always rejected the British system of deficiency payments - let the farmer sell his produce for what it will fetch, then pay him what he needs to make up a decent price - because it would be "too expensive." Spending Government money to reduce the cost of home produced food while boosting farm incomes directly would stimulate the economy, reduce inflation, and have very little "leakage" into imports. But bad financial management means that such policy options are considered closed.

 

Leakages" into imports are a major problem in this country. We dare not impose direct curbs on imports (even if this were not against EEC rules) for fear of retaliation against the exports on which we depend for roughly half our national income. In any case, Ireland is such a small country that it can never be self-sufficient in many things, it will always have a need for imports.

 

But this means that any boost to the economy is a boost to imports. Research by the Central Bank suggests that if the Government were to pump an extra £10 million in to the economy by buying extra goods, the GNP would eventually increase by £ 16 million but imports would increase by £9 million. If the Government spent the same

amount of money on increased employment, it would boost the GNP by around £ 19 million but add £ 1 0 million to the import bill.

 

A deficit on the balance of payments not only means that there is a transfer of real wealth away from the country, it also means that more Irish pounds are being sold to buy foreign currency than is happening the other way round. The law of supply and demand sooner or later pushes the pound down. This result can be delayed, by borrowing abroad directly or raising domestic interest rates to the point where foreigners will choose to lend us their money - but it doesn't change the rule. If the pound declines, the cost of imports goes up, and with it the inflation rate. Yet at the same time a rise of imports is now not only inevitable but to be hoped for. A rise in imports of raw materials, fuel, machinery, and semi-manufactures would be one of the first signs of economic recovery.

 

The import effect on inflation has already happened. Sterling has risen by around 17 per cent this year against the EMS currencies, including the punt. On average that's increased half our imports by that amount. It represents a substantial hike in costs, and one for which neither Government, unions or management can be blamed.

 

 Far from tackling inflation, however, the Government's policies have made it worse. True, the National Understanding is deflationary. (For a single man earning £6,000 a year, for example, it will mean an increase after tax in the first year of about six per cent, or only a third of the current rate of inflation. His employer's bill for wages and social security will rise by about 11 per cent. The Understanding, incidentally, will cost the Government nothing - the pay increases in the public sector will be paid for by the increased PAYE from the rest of the population.)

 

But the Budget increases in V AT and other indirect taxes at one stroke discriminated against the poorer sections of society, intensified the recession and pushed up prices. It would be difficult to find a worse policy for an economy sliding into recession. Yet the Government had already tied its own hands. As the Labour Party never tires of pointing out, it had eroded the tax base after the election by abolishing or emasculating rates: car tax, wealth tax, and capital acquisitions tax. On top of this it has pegged corporation tax at a maximum rate of 10 per cent until the en d of the century. It was under heavy pressure to make concessions to PAYE workers and married women.

 

The Taoiseach has recently begun to find encouraging trends in the Irish economy which only his own rosy political optimism has been able to perceive. He has referred to the turnaround in our balance of payments situation from the alarming deficit of £720 million last year to a projected £600 million this year - a figure still alarmingly high. However, this has occurred only because of the deep recession that has engulfed the economy at present which has led to a drop in demand for imports rather than any structural turn-around in our trading position.

 

Mr. Haughey has also referred with confidence to our improved foreign reserves situation - a position which has arisen only because we have engaged in further public borrowing. Neither "trend" suggests that we are likely to glide out of the current recession, indeed the indications are that because of the state of our current finances and other factors we are likely to stay in recession longer than most other developed countries.

 

The discipline required to bring our public finances back in order will demand a series of deflationary targets which will have a major dampening effect on the Irish economy for years to come.

 

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