OK, so according to the Sunday Times Behavioural and attitudes Survey on the 22nd April 50% of the electorate/those intending to vote (not sure which) in the upcoming Fiscal Compact referendum apparently do not fully understand the Fiscal Compact (downloadable here). This is a worry for me because if you are going to vote on something that will have profound implications for your fellow citizens you owe it to yourself and the rest of the country to fully inform yourself as to the implications of the treaty. Afterall, would you sign a contract without knowing it’s terms? Well, I suspect the answer would be no and as such therefore you should be approaching the fiscal compact with the same mindset. It is a contract between this state (through it’s citizens) and the EU.
However with the results of the survey in mind I thought it timely to set out some simple to understand comments about the treaty.
What are the primary purposes of the treaty and how might it affect the economy?
1. The Government Deficit
Governments will be required to ensure that the annual budget deficit (Tax revenues minus current expenditure) does not exceed 3% of Gross Domestic Product (“GDP” which includes multinational profits whereas Gross National Product does not) at “market prices”. The reference to “market prices” is a curious comment for me.
Taking this in isolation from any other objectives of the treaty we need to ask ourselves what was the 2011 budget deficit. According to publicly available data from the Department of Finance the current account budget deficit for the year 2011 was €11.223bn. The detail for this can be found here on the Department of Finance website or here on this blog.
According to data published by the Central Statistics Office (or from this blog here) the 2011 GDP figure was €161.034bn. Therefore, on the face of it, the current account deficit of €11.223bn represents circa 7% of the 2011 GDP figure. However, on the 23rd April 2012 Eurostat issued a briefing document (or downloadable here on this blog) stating that the Irish budgetary deficit for 2011 (including bank recapitalisations) was 13.1%.
However this is a question that you, the reader, should consider when assessing if the focus on the current account deficit as a percentage of GDP is excessive or not:
With emigration at record levels (some of whom were unemployed at the time of emigrating and some who were not) together with unemployment at circa 14.6% what is likely to happen from further “austerity” in the absence of employment growth?
“We” all know that things are difficult in Ireland but not all are “feeling” it and forcing the budget deficit down further through regressive tax increases will probably worsen unemployment with the spiral continuing. So society needs to switch it’s focus from the deficit to employment growth which will go toward reducing the income inequality highlighted in the Survey on Living Conditions for 2010 which the Central Statistics office recently published.
2. The ratio of “Government Debt” to Gross Domestic Product
The compact or treaty requires Governments to reduce “Government Debt”1 to 60% of Gross Domestic Product (at “market prices”) over a period of 20 years “at an average rate of 1/20th per year” where the public debt (general government debt) is not equal to 60% of GDP. Note the use of the phrase “average rate”. This suggests to me that there is scope for the Government of the day to reduce the “debt” by more than the 5% (1/20th) envisaged by the treaty. Indeed it could be less depending on the prior years.
Ireland’s general Government debt, according to a document published by the NTMA (and downloadable here on this blog), as at the end of 2011 stood at 107% of Gross Domestic Product or approximately €172.36bn. This correlates with an information note on Ireland’s Debt published by the NTMA in May 2011 (downloadable from this blog here) where they estimated the final Government Debt figure for 2011 would be €173bn.
The NTMA further estimates in this note that general Government Debt (the figure which must equate to 60% of GDP) in 2015 is expected to be €203.6bn with GDP itself in 2015 being estimated to be €182.7bn. This means an expected GDP growth rate between 1st January 2012 to 31st December 2015 of just under 13.4% (in total when compared to the GDP figure for 2011) whereas a GDP growth rate of 110.7% is needed in order to reach a GDP figure in 2015 of €339.33bn which would mean that the expected debt figure in 2015 would be equal to 60% of the general Government Debt.
For this figure of €203.6bn to equate to 60% of GDP the GDP figure would need to be €339.33bn (note that for 2011 GDP stood at €161.034bn so what is the likelihood of a doubling of GDP in 4 years?). For the debt to GDP ratio to be satisfied one of two things will be necessary. Either GDP savagely grows (this might be achieved by attracting more FDI into the country meaning their profits are counted in the GDP statistic) or the debt is savagely paid down. This latter option can achieved in one of three ways, namely severe expenditure cuts, severe tax increases (which type of tax increases) or a combination of both of these two options. To-date we have seen the direction being taken in relation to the type of taxes being chosen by current and last administrations.
What are the implications of this requirement you may ask.
Well, Gross Domestic Product is a moving target (in theory at least) so when it comes to the budgetary process on an annual basis a Government will not know in advance what the GDP figure for the following 12 month period will be and so this could materially alter how a Finance Minister will frame his/her budget having regard to the ratios. He/she might like to be prudent and push for a greater “adjustment” in achieving the ratio that is required. On the other hand, the Minister of the day might not be that prudent and find that they did not achieve the required rate of adjustment and so you might even see a “mini-budget” mid-year. This will affect, or is likely to affect, those not in employment more than those in employment insofar as those relying on social welfare will be more adversely affected by cuts in expenditure or by regressive tax increases and the response of many Governments in the EU since the onset of the EU crisis in mid 2007 has been to focus on increases in consumption taxes (namely VAT and other such taxes, e.g. property taxes and water taxes in Ireland) rather than increasing either “income tax” or Corporation Tax. The OECD apparently favours this approach as they suggest that increases in these two latter taxes is more harmful to “economic growth” than increases in property taxes or consumption taxes.
Note the increase in VAT at the standard rate to 23% from 21% with many calling for it to be reversed on the basis that it is damaging retail (so is an increase in VAT harmful to economic growth in that context?) Note also the introduction of property and water taxes. These are regressive in the context of high unemployment, and affect those without incomes/employment (these two generally go hand in hand) more than those in employment, more particularly those with high enough incomes so as to not be classified as the “working poor”.
Are there any downside risks to this requirement other than those highlighted above?
Well the answer to that question is yes. Currently, there is debt of the Irish state that is considered off balance sheet (NAMA & it’s Special purpose vehicle for example) meaning that it’s not counted in the figure of €203.6bn mentioned above. If Eurostat were to change the debt measurement rules of the Irish state such that this off balance sheet debt were to be counted in the debt thus INCREASING the debt figure then the affect of such a change would be even greater “budgetary adjustments” in the event that GDP doesn’t savagely increase if the 60% ratio is to be satisfied. It’s difficult to know if many “ordinary” people in Ireland consider this fact.
2.1. The excessive deficit procedure
The fiscal compact incorporates the revised Stability and Growth pact in the context of the “debt brake” rule, i.e. the 60% debt to GDP rule. A consolidated version of the revised stability and growth pact can be found here and downloaded from here. What is an excessive deficit programme you will ask? Well, according to a document issued by the EU in December 2011 Ireland and 22 other member states of the EU are undergoing excessive deficit procedures. In summary, the type of austerity we are “all” experiencing at present is the “excessive deficit procedure”.
According to a document issued to members of the Oireachtas in March 2012 by the Oireachtas Library & Research Service (available here) the excessive deficit procedure is automatic where the general government debt is in excess of 60% of GDP. This appears to be the case regardless of whether the current budget balance is in deficit or surplus. In order words it would appear that Ireland will continue in an “excessive deficit procedure” (i.e. the type of austerity being experienced now together with future predicted cuts) until such time that the general Government Debt to GDP ratio comes back to 60% regardless of whether the annual budget is in surplus or in deficit. It is conceivable that a fiscal year would see the Government in budgetary surplus but with the Fiscal Compact passed there would still be an “excessive deficit procedure” in place due to the general Government debt to GDP ratio being in excess of 60%. In other words the objective of the fiscal compact appears to be to ensure that any future budgetary current surpluses are used to pay down the Government Debt to the 60% ratio. In theory of course this might make perfect sense but does it make sense in light of some of the components of Government Debt? It’s up to you to conclude whether that is a good or bad thing for the Irish economy.
The excessive deficit procedure can only be avoided in the event of a qualified majority vote of the EU Council/Commission NOT to implement such a procedure. In other words, a state is nearly locked into an excessive deficit procedure where the 60% ratio is broken. This seems to be the basis on which some campaigning groups call this treaty the “austerity” treaty.
3. The Structural Budget Balance
A separate element to the fiscal compact is the concept of “the structural budget balance”. Basically, the compact sets a deficit limit of HALF of ONE PERCENT (½%) stating that the requirement to have a “budgetary position of the general government shall be balanced or in surplus” will be treated as satisfied if the deficit is not in excess of the HALF of ONE PERCENT. If you consider that the current account budget deficit for 2011 ranged between 7% and 9% but was revised UPWARD by Eurostat recently as mentioned above it is difficult to envisage how this HALF of ONE PERCENT requirement can reasonably be met.
Generally speaking economic commentators seem to differ on what is meant by “the structural budget balance” of the exchequer, in many circumstances saying that it cannot be definitively defined, but it should be noted (Vincent Browne regularly refers to this on the Tonight with Vincent Browne programme on TV3) that in 2007 the Structural Budget Balance of the Irish State was deemed to be in surplus by the IMF I believe but that they have since revised their assessment to a negative “structural budget balance”, i.e. a deficit. In other words, what this effectively demonstrates is “uncertainty” in the minds of those tasked with measuring the “structural budget balance” and so that means it’s something of a moving target with the consequent effect of budgetary fiscal uncertainty on an ongoing basis. This, in my view, could have the effect of freezing the economy even more. Signing up to such a policy is not wise in my estimation.
Other economic commentators have written on this issue including Tom McDonnell (his background profile can be found here) through TASC and copy of a recent piece of his can be found here. The linked piece essentially states that between 2015 and 2018 there will be further “austerity” of circa €5bn in order to meet the .5% structural budget balance requirement and even then there is no guarantee that with such “adjustments” (more often referred to as cuts in expenditure or tax rises) that this budgetary requirement will be met. Afterall, if GDP falls, tax revenues can fall and so the overall budgetary position at a given point in time is altered.
Despite what our Government says about this treaty not being an “austerity” treaty it is just that. Despite what our Government says about this treaty being a referendum on membership of the European Union it is not that. I think it is fair to say that “austerity”, while “helping” to reduce the deficit in the short term, is actually undermining the entire domestic economy and actually leading to increasing levels of unemployment which will lead to further austerity which in turn will lead to a further deterioration in the economy. The only way that is going to be reversed is for employment growth to recommence. This cannot happen from within the “job-seeking” community itself.
Other commentators within the Irish sphere have written on the topic of the fiscal compact of late, namely Professor Brian Lucey of TCD on his blog here and Cormac Lucey (a former Government advisor) and an accountant (who like me is going to be well versed in these matters) in his blog on two separate occasions of late here and here. In fact the latter Mr. Lucey has declared his intention to vote no in the upcoming referendum. In addition to this commentators have written on the continuous programme of austerity in an open letter to the Irish Times recentlystating that such a policy is going to lead to stagnation. This is not a healthy direction to be heading in but it will only be re-enforced by passing the Fiscal Compact referendum.
I would also direct you to recent Dáil debates on the matter (link here) in which there are frequent references to continuous austerity after 2015.
Professor Terence McDonough of NUIG (National University of Ireland Galway) stated on Morning Ireland on the 27th April 2012 that the European Stability Mechanism (ESM) is not the only source of external funding available to Ireland in the event of a No vote. Furthermore Eamon Gilmore stated on the same programme that “it won’t be possible for new applications to be made to the European Financial Stability Facility (EFSF) after the ESM comes into force”. The ESM cannot come into force until the relevant treaty has been ratified. The ESM treaty has not been ratified and will not be ratified until after the Fiscal Compact treaty meaning that if the ESM treaty is not ratified in the event of a rejection of the Fiscal Compact Treaty then the EFSF would continue to be available as the ESM would not have come into force. Therefore, it is possible to vote No and continue to have access to external funding sources.
If I am honest enough to offer my view of the treaty I would say that it is not something which should be passed by referendum. It deserves a no Vote as it is too restrictive on the Irish economy. It does not offer any form of budgetary flexibility now, or at any time in the future. Such flexibility is required now and into the future and should not be surrendered. It might help you think of the Irish economy like a business for a moment that is looking to grow. Ordinarily a business looking to expand and grow might re-invest a portion of any profit made from it’s activities in order to facilitate that expansion. Under the Fiscal Compact that is not going to be possible. Budgetary surpluses (in their entirety) are going to be required for financing debt repayment until such time as the 60% debt to GDP ratio is satisfied.
It’s now over to you.
The following text was taken from the blogpost by Professor Brian Lucey that I have linked above. I think it is a very useful summary of the treaty.BOX: What is the treaty –
- Budget must be in structural balance or surplus, defined, as structural deficit cannot be higher than 0.5 percent of GDP
- Countries, which have debt/GDP below 60%, can have a structural deficit of 1% or less
- A country with debt/GDP above 60% has to reduce the excess by one-twentieth a year
- If the budget is not in balance, automatic correction rules must be enforced
- If a euro zone country does not write the balanced budget rules into its national law, it can be sued in the European Court of Justice and can be fined 0.1 percent of its GDP.
- The agreement will enter into force once 12-euro zone countries ratify, or on January 1, 2013. – Euro zone countries will coordinate national debt issuance plans in advance.
- Only countries that have ratified the fiscal compact and written balanced budget rule into national law will be eligible for bailouts from the European Stability Mechanism.
- all EU countries, whether in Euro or not, apart from Czech Republic and UK, are signatories to the compact.
1. General Government Debt is a gross measure and does not allow for the offsetting of Exchequer cash balances. As well as the National Debt it includes the promissory notes issued to certain financial institutions, local government debt and debt of non-commercial State bodies. GGD ratios are as published by the Department of Finance in Budget 2012.
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