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Memo to Mr. McCreevy on economic and budgetary policy Back  
Do no harm
Do no harm

‘First, do no harm’. This phrase is the first line of the Hippocratic oath traditionally taken by the medical profession. Yet it should also apply to finance ministers! The Irish economy is recovering reasonably well from its sharp slowdown last year, yet the global economic picture remains ‘wobbly’, for want of a better phrase. We cannot take a sustained global recovery for granted, and so we need to make sure that Ireland continues to remain an attractive and competitive place in which to do business. Corporation tax rates remain modest, the workforce is highly trained and the legal and policy context is favourable. So the first piece of advice to the Minister must be to do nothing that would reduce Ireland’s overall competitiveness.

Do not raise taxes
Following the principle of ‘doing no harm’, it is essential that the Minister resists all temptation to raise taxes to address any budgetary gap that may emerge. This would be a highly retrograde step. For well over a decade income tax rates have been cut and it is far from a coincidence that the economy went from strength to strength over that period. Lower income taxes have put money back in people’s pockets and encouraged individuals to invest more, to take risks in setting up new businesses or expanding existing ones, and to spend less time finding elaborate tax shelters which are inefficient from an economic perspective. On the other hand tax revenues have risen very strongly despite the tax cuts (until this year). Our low tax rates should be seen as one of the key building blocks of our economic success, and should on no account be increased.

Get control over public spending
Public spending is rising at a rate that is, quite frankly, absurd. Inflation will be around 4 per cent this year while public spending is growing at about 22 per cent. It’s doubtful that any economy can afford that kind of real spending increase, far less an economy that is emerging from a significant economic slowdown. Some argue that Ireland has a poor level of public services so public spending must be increased rapidly to get better services. But while public services may need to improve, it seems clear that ‘throwing money at the problem’ is not working. Day-to-day public spending HAS been increased very sharply - by around 10 per cent in 1999 and 2000, and by more than 20 per cent last year and this year. Yet has anybody noticed an increase in the quality of public services of the same magnitude over that period? I doubt it very much. In many cases, extra spending on services has led to more spending on agencies, authorities, commissions, task forces, and other administration spending, as well as higher pay for the staff delivering the services, but not on actual improvements in the services to the public. What is required is a far more rigorous challenge to existing spending plans as well as to new ones. Public spending simply cannot keep rising significantly more quickly than the economy is growing.

Enhance competition?
Although competition issues are not necessarily directly relevant to the Budget nonetheless, as far as possible, the Minister should seek to foster greater competition across the economy. And as the private sector is generally a more efficient provider of services than the public sector, greater private sector involvement should be encouraged. A simple example of this was the recent announcement that the government has asked for expressions of interest in building another, competing, terminal at Dublin Airport. Whether this is feasible or not is beyond my competence, but it is in principle an example of something that can be done to increase competition thus potentially leading to lower costs in the economy. The Minister should encourage his colleagues to examine their own areas of responsibility to see where stronger competition can be encouraged.

Press ahead with the economic infrastructure programme
We are, at last, making real progress on the infrastructure programme. By the end of next year Luas should be up and running, the motorway from Dublin to Dundalk should be completed, as should be a number of other road projects, and we should also have a significantly improved rail infrastructure around Heuston and Connolly train stations and far more railcars and DART carriages in service on Dublin suburban routes. In addition, agreement has already been reached on the exact routing of all the motorways in the National Development Plan - a long way from having them all built, but a good start! It would be a shame to back away from these plans now. In many ways the infrastructural bottlenecks that we have seen in the last few years were the result of the spending cuts of the late 1980s. We cannot afford to do this again and so we should press ahead with the National Development Plan, or at least those elements of it that are designed to improve the country’s economic infrastructure. Stadium Ireland may or may not fit in that category!

Benchmarking - all or nothing!
The Benchmarking Report’s awards have now to be discussed between the unions and the Government. At the time of writing the Government’s approach has been to say that all the unions must accept the report’s recommendations or nothing will be paid. This is an approach that should be welcomed by taxpayers. The purpose of the benchmarking report was not to give public sector workers an extra pay increase for the sake of it but to put in place a new framework (benchmark?) for public sector pay, replacing the old relativities between different pay grades that have led to such difficulties in industrial relations over the years. If the government was to pay the benchmarking awards, without acceptance by all unions that the old relativities are now defunct, it will be paying out a large amount of money... for nothing at all in exchange.

Eoin Fahy is senior economist, at KBC Asset Management.

Avoid ‘stop gap’ solutions

Get used to a post-boom economy. It is important to recognise that the current weakness of economic activity in Ireland (and elsewhere) is unlikely to be followed by a return to boom conditions. Certainly, we shouldn’t expect a sustained period of GNP growth in the 5 - 6 per cent region anytime soon. This has important implications for Irish Budget Policy. First of all, the Minister should not respond to the current difficulties in the public finances by attempting to find ‘stop-gap’ sources of extra revenues or delaying public spending commitments. The harsher economic climate isn’t going to disappear overnight, so temporary or once-off measures do little more than briefly camouflage a problem. Indeed, there is a considerable risk that because that approach doesn’t get to the heart of the problem; it could allow any underlying imbalances to deteriorate.
Instead, the public finances must be managed in a manner that can be sustained even if Irish economic growth averages somewhere in a 2 - 3 per cent range over the next four or five years. With a little luck, growth may be a bit stronger than that, but this approach seems altogether more prudent than assuming growth will quickly rebound to and remain at the economy’s maximum potential for the life of the Government. An ‘Always look on the bright side of life’ school of budgetary management is bad both for the health of the public finances and equally importantly, for its impact on the expectation levels of households and businesses.

Decide what the purpose of budget policy should be
This may seem be too obvious to include but the purpose of Irish budget policy has not always been clear. Budget policy should be directed towards improving the functioning of the Irish economy. This broad goal has a number of complementary aspects - (a) - Budget policy should seek to enhance the climate for doing business in Ireland by boosting the incentive to work, to employ and to purchase productive assets - (b) - Budget policy must also ensure that the level of infrastructure is a support rather than an impediment to economic activity and - (c) - Budget policy must ensure that a successful economy doesn’t produce a fractured society. You must now concentrate on ‘managing’ the public finances to achieve this goal.
Lets be clear, Budget Policy is not about balancing the books for the sake of it. Any given budget shouldn’t’ be entirely focused on spending a surplus or avoiding borrowing. The purpose of balancing the books is to avoid a situation in which the public finances cast a shadow over Irish economic prospects. Avoiding a budget deficit this year would be no great achievement. Keeping the public finances on a sustainable trajectory is altogether more important.
A reasonable definition of what might be sustainable is provided by the terminology of the Stability and Growth pact, ‘A position close to balance’. In the case of Ireland, where infrastructural improvement remains a pressing need and public debt is relatively low, I think deficits in the region of one per cent of GDP could reasonably be tolerated for the next few years.

Switch the emphasis to multi-year budgets
OK, the current process means that we get great excitement for a few days in December but there should be a better way of delivering bread and circuses. Greater emphasis on multi-year-budget programmes would make for a more stable economic climate by - (a) - setting out a coherent framework in which public sector managers would be responsible for doing the job their title suggests - (b) - making it easier for the private sector i.e. business and households to plan - (c) - helping shape expectations of business and employers - (d) - not ‘shocking’ the economy.
Of course, circumstances change, so there has to be some leeway to alter policy requirements to reflect changing circumstances. However, even if we allow a little margin to deal with unexpected developments, the central focus of the budget should be on longer- term issues. We need a sequence of fairly dull and predictable budgets. The ‘excitement’ caused by the past couple of budgets hasn’t necessarily been to the benefit of the Irish economy.

Changed economic circumstances mean choices must be made
After a number of years in which it seemed there was sufficient public money to finance every imaginable spending plan or tax cut, economics has reared its ugly head again...but only just. Choices have to be made. The priority of recent years appeared to be to ensure substantial spending increases in all areas of the public sector. Now we must choose what the priority areas should be and ensure they receive sufficient funding. This may well mean cutting other areas of spending.
Making choices shouldn’t be impossibly difficult. The Irish public finances aren’t in crisis. The task is to prevent a slide towards such an outcome. In very round terms, it should be possible to sustain a rise in day-to-day public spending of close to 10 per cent in each of the next four years. This is a fairly sizeable amount of money. Even allowing for a significant rise in public sector pay, it should be possible to find substantial spending increases for areas of high priority.
If we are clear about the purpose and the general parameters of budget policy, we should be able to deal with issues such as benchmarking. The Irish economy and the public finances are in a sufficiently healthy state to allow most obligations be met, whether they be in relation to benchmarking, the National Development Plan, the Pensions Reserve Fund or the Special Savings Scheme. Taking benchmarking as an example, postponement for the sake of postponement doesn’t make sense but the payment terms should be part of the framework of the next pay deal. Private sector conditions in regard to earnings growth and job security have changed dramatically in the past year. The next public sector pay deal must reflect changing economic realities. At the other extreme, an unnecessarily macho stance on the part of the government will probably prompt an industrial relations backlash that will worsen the near-term outlook for the economy.

Be careful, very careful about taxation
One of the major problems with budget policy and the performance of the Irish economy over the early 1980s was that taxation was regarded as a residual. Just before each budget, the Minister for Finance would try to determine how much extra revenue could be squeezed out of the Irish economy to keep government borrowing at a ‘tolerable’ level. The stark contrast between the performance of the Irish economy in the 1980s and 1990s (and perhaps also the more recent deterioration) underlines the importance of getting taxation policy right. That said, you only have leeway to get taxation policy right if you can control public spending.
My worry is that you may start from a view that the burden of taxation is now relatively low and that modest increases would not cause undue problems. However, changes in taxation work in two ways. The first is the direct financial impact on households and/or businesses of changes. The second, whose significance in influencing the decisions of consumers and firms should not be underestimated, is the signal sent by tax changes. Just as a falling trend in taxes encouraged stronger growth and a better budget position in Ireland in the late 1990s than most economists would have envisaged, even modest increases could have powerful and damaging effects on growth prospects. If households and businesses in Ireland and companies and bureaucrats abroad get the impression that Irish taxes are set on a rising trend, the economic effects could be substantial.
You should also think long and hard about the impact higher indirect taxes have on competitiveness. While there may be a rationale in certain circumstances, such as deterring smoking or paying for associated healthcare costs, a general strategy of increasing charges for public services is not a viable alternative to controlling public spending.

Austin Hughes is chief economist, at IIB Bank.

Value for money in public services

As you sit down to sketch the outlines of your sixth Budget, you know that you have already secured an honourable place in modern history books on the grounds of longevity in office. However, the Budget package that you are currently preparing could establish your reputation as a truly radical Minister who was prepared to make difficult decisions in order to protect both the reforms of your first five years in office and the related structural efficiency of the economy. While the 1997-2002 period was characterised by a fundamental overhaul of the taxation system, the 2002-2007 years should be remembered as an era of consolidation.
There is no need to underline the importance of international competitiveness to a small open economy. However, with the euro exhibiting an appreciating tendency and the economy’s income convergence process largely complete, the future drivers of our relative competitiveness will be largely internal in nature. While medium-term competitive advantages are best underpinned by the promotion of innovation through taxation measures and educational support, wages and prices have critical short-term roles to play on this front. It is imperative that behaviours of a wage and price-setting variety reflect the fact that expectations must be adapted to fit the prevailing economic climate. Putting it plainly, wage increases in excess of 5 per cent without productivity enhancements or inflation rates above a similar level in the non-traded sectors of the economy would reduce export buoyancy, investor attractiveness and long-term sustainable growth rates.
After the largesse of the 2000-02 period, you will inevitably encounter resistance to attempts to impose prudent limits on spending. Departments which have been accustomed to spending growth of more than 20 per cent may regard single digit budget increases as parsimonious in the extreme. Spending departments should realise that resources are finite and that their peers in other jurisdictions would be more than happy to receive the quantum of funding increases, which the Irish government should be able to afford.
However, if you fail to limit overall spending growth to 9 per cent at most, you will lay the foundation for an array of growing budget deficits over the coming years and increase the probability of an increase in income taxes or an outright cut in spending being foisted upon you. Keep emphasising that you are proposing a sensible growth limit rather than outright spending cuts.
Don’t be tempted to introduce what is politely described as a temporary budget deficit. History teaches us that such outturns have a tendency to become semi-permanent. Once you get into the red, there is a danger that some colleagues and commentators will regard the 3 per cent Stability and Growth Pact deficit limit as a target. As you are well aware, budgets are subject to substantial variances and a move to deficit territory is the first step to receiving a fine from the European Commission. A GDP disappointment has ample potential to turn a 1 per cent deficit target into a 4 per cent deficit outturn.
Furthermore, when you are balancing the budget, do so on the basis of long-term sustainable measures rather than one-off windfalls. Don’t expose yourself to allegations of financial chicanery.
Your handling of benchmarking will play a crucial role in the negotiations on a successor to the PPF. While sensitive to the realpolitik, you can draw some comfort from the fact that the evolving labour market environment is making the proposed pay increases look more and more appealing. With the premium for job security having expanded significantly since the Benchmarking Body conducted its secretive number crunching, you can afford, in the interests of prudence, to defer full implementation of the report until the global economic outlook is more certain. Also, don’t forget that implementation should be contingent on radical reform of the public sector and that the pay increases should not be awarded until the terms of a service overhaul have been agreed. It may be worth highlighting in some detail the costs of full implementation in terms of higher taxes or reduced spending.
On the inflation front, try to avoid tinkering with excise duties and VAT rates in an attempt to massage the headline rate. I know that you must be under pressure from Miche?l and the lads in the Department of Health to wave a magic wand and produce even more resources. If you are going to increase excise duties on tobacco (or more appropriately alco-pops) on health grounds, do some duty trimming elsewhere to ensure that the net effect of Budget 2003 on the consumer price index is neutral. You don’t want to create a situation where inflation rates of 4 per cent become entrenched in popular expectations.
Minister, don’t take the soft option on spending by relying on the capital side to provide you with the bulk of your budgetary savings. The need for a full and timely rollout of the NDP is as great today as it was two years ago when economic activity was rampant. If you are going to prioritise projects, emphasise the transport side with a particular focus being given to the development of a national motorway network and a cohesive public transport system in Dublin. You might want to have a look at the tendering process to reduce the incidence of cost over-runs while a front-loading of the use of PPPs is now more than appropriate from the viewpoint of efficient project delivery and affordability.
On taxes, give a reprise of your reforming record. It’s worth reminding us of the scale of progress made in recent years. However, make it clear that there is no room for any further relief beyond an expansion of bands and credits. Don’t introduce any stealth taxes or propose increased PRSI contributions in an attempt to balance the books. Remember that the tax system is pretty close to the point of optimal effiency and any changes would run the risk of disturbing the soft landing, which the economy is currently going through.
Give some thought to the introduction of a value-for -money audit of the public services and the subsequent rollout of a performance measurement system for every operating unit of each government department. A modern service requires modern structures, which reward success and efficiency rather than over-spending. Keep her steady as she goes.
Beir bua,

Colin Hunt is chief economist & Head of Research, at Goodbody Stockbrokers.

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