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Green Party Conference, Wexford, March 7 th . 2009.

Stabilising the Public Finances

Colm McCarthy 1 , School of Economics, University College Dublin.

A new set of budgetary measures is due to be announced on April 2 nd ., and is likely to

include action to contain both current and capital spending.

Total Exchequer spending is the sum of gross current voted expenditure, Exchequer capital spending and an item called Central Fund Services, which is mainly the cost of servicing the national debt. The table gives the development in the ratio of total spending

to GNP in recent years (with and without debt service), together with my estimate of the

out-turn for 2008 and a guess at the likely result for 2009 (before the April 2 nd .

measures). 2

Exchequer Spending as a % of GNP

Year

Total Spend

of which Central Fund

Spend net of Interest

1985

55.7

12.7

43.0

1990

44.4

10.3

34.1

1995

43.5

8.1

35.4

2000

34.7

4.4

30.3

2001

36.7

3.7

33.0

2002

37.5

2.6

34.9

2003

36.5

2.8

33.7

2004

36.2

2.8

33.4

2005

37.0

2.8

34.2

2006

36.8

2.7

34.1

2007

38.9

2.4

36.5

2008e

44.0

2.5

41.5

2009f

49.0

4.0

45.0

1 Views expressed are the personal responsibility of the author. 2 The historical data to 2007 are taken from the Department of Finance publication Budgetary and Economic Statistics, available on the Department’s website.

The figures show that the portion of GNP absorbed by Government spending has already returned to late 1980s levels. It is only because debt service is still low, although rising sharply, that the levels of the early 1980s have not re-emerged. Net of interest, spending in 2009 on these figures is now above the mid-1980s level. 3 Of course, part of the reason for these developments is the sharp downturn in GNP. But total spending has been rising rapidly in recent times. Spending doubled between 2000 and 2007, and rose again by roughly 9% in 2008. It is the combination of rapid spending increases and the recent collapse in nominal GNP which has created the pattern shown in the table.

Measures already taken will curtail this trend of spending increase in 2009. But the collapse in Government revenue has been spectacular. About three-quarters of revenue comes from taxes, the rest mainly from PRSI and Health contributions. Even with the October budget increases, tax revenue alone will be down roughly 28%, or about ! 13 billion, in 2009 against 2007, and both PRSI and the Health contribution are weakening as employment in the private sector contracts.

The result is that additional budgetary measures are needed just to keep Government borrowing below 10% of GDP in 2009. The strategy must be to avoid deficits at this level beyond the current year: the deficit for 2010 will need to be reduced decisively back into single figures, with a view to re-attaining something close to a balanced budget within a few years. Given the severity of the worldwide credit crunch and the hostile sovereign debt markets, a repetition of the continuing large deficits which arose in the 1980s is not an available option.

Timing of Exchequer Capital Projects.

There are economic, as well as financial, reasons why capital projects get deferred. The Dublin Airport Authority issued the following statement in December:

‘DAA will be reviewing its proposed capital investment programme for the period from 2010 to 2014, and expects that this will be reduced significantly, reflecting the new, lower growth, forecast of passenger numbers during this period.’

DAA saw declining passenger figures at its airports in the back end of 2008 and expects this to continue for some time. Their expectations of likely volumes into the medium term have accordingly been cut back. Thus the controversial second (Northern) parallel runway may now be built several years later than originally intended.

This problem of capacity-enhancing projects becoming less urgent affects numerous projects in both the public and private sectors. Simply, the economy is on a significantly lower growth path than had been expected when these projects were planned, and

3 I have assumed that nominal GNP fell 2% in 2008 and will fall a further 7% in 2009.

economically optimal just-in-time construction implies deferral. This has nothing to do with financial constraints. It does not affect backlog-elimination projects.

At a macro level, let’s pretend that Exchequer capital projects were planned a few years back on the basis of 3.5% GNP growth into the medium term. I believe that this is probably true of many such projects. Real GNP appears to have fallen 2% in 2008, and will fall by (at least) 4% in 2009 on recent forecasts. Paint now a rosy scenario: zero growth in 2010, followed by two years at 5% and then a resumption of growth at 3.5%. This is rosier than recent projections – it is possible that the real GNP decline over 2008 and 2009 could be a lot more than 6%. But it does dramatic things to the optimal timing of capacity-enhancing projects nonetheless.

Old and New Time-Paths for Real Economic Activity

Year

‘Old’ GNP Path

% Chg

New GNP Path

% Chg

2007

100.0

-

100.0

-

2008

103.5

3.5

98.0

-2.0

2009

107.1

3.5

94.1

-4.0

2010

110.9

3.5

94.1

0.0

2011

114.8

3.5

98.8

5.0

2012

118.8

3.5

103.8

5.0

2013

122.9

3.5

107.4

3.5

2014

127.2

3.5

111.1

3.5

2015

131.7

3.5

115.0

3.5

This is all a bit mechanical and it can be objected that we could get back to an even higher growth path at full employment eventually, with the ‘Old’ stock of productive factors, including foreign labour and borrowed foreign capital, producing exports instead of houses. But that is all academic: over the next five or six years, there is a phase-shift even in a rosy scenario of about four years – for 2011, read 2015. I suspect there are a lot of forecasters whose numbers imply more than a four-year phase-shift.

What all this suggests is that the Exchequer capital programme could be divided into three groups:

(i)

Projects which should go ahead, assuming they are financeable;

(ii)

Projects which should be dropped on the grounds of poor economic value;

(iii)

Projects which have been overtaken by the slowdown, and should now rationally be deferred, but not necessarily cancelled for good.