Like it or not, the budget debate is on. Let’s start by getting the sums right.

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This article appeared Sunday Business Post July 6th 2014

We are now moving into the depths of the summer silly season, with our political classes either heading off to vent at the various summer schools and/or heading off on their summer holidays. The imminent cabinet re-shuffle and the banking enquiry will probably be the key topics of conversation over the coming weeks, but once we return to the harsh realities of back to school rituals and such like in late august, the annual budget will be just over six weeks away. Consequently those poor souls who are involved in the framing of the October document cannot wait until September and will be engrossed in the fractious process of building the budget over the coming weeks.

It is never an easy process, but is probably more complicated than normal this year. The political landscape for the government parties is not particularly favourable at the moment, and having implemented such a savage fiscal adjustment since 2008, all of the low-hanging fruit is now well gone and we are really up in the thick and prickly branches. The marginal pain inflicted by additional budget measures at this stage of the fiscal adjustment cycle is always going to be pretty severe and there are no easy choices. From a political perspective it seems clear that if more pain is to be doled out, it should be done so in a manner that will cost as few votes as possible. The moral, social and economic perspective may be very different, but political considerations generally hold sway in this country.

The debate to date has really been focused on the EU-imposed 3 per cent budget deficit target that is to be achieved by the end of 2015 and the €2 billion fiscal adjustment that was committed to some time back. This €2 billion adjustment figure will most likely dominate budget debate over the coming weeks, but this is missing the point. In the first place a 3 per cent budget deficit target has no scientific basis and was a figure that was effectively pulled out of the air by Ruairi Quinn and his colleagues back in the 1990s when the very flawed Stability & Growth Pact was negotiated. Secondly, the figure of €2 billion is being latched on to by both sides of the divide. Rather than focusing on 3 per cent target and fiscal adjustments of €2 billion, it would be much better to see a debate on the quality of the fiscal parameters rather than the quantity.

Taking €2 billion out of the economy next year will satisfy the fiscal hawks if it gets borrowing down to 3 per cent or lower next year, but we need to consider at what cost. Public expenditure is bad if it is wasteful, in the sense that value for money is not achieved. On the other hand, public expenditure is good if it focuses on the concept of value for money and creating positive structural change. So for example, the politically motivated benchmarking of public sector pay more than a decade ago was wasteful in the main and was not affordable even at the time. Did we get value for money? I think not.

On the other hand expenditure on areas such as IT infrastructure or education and training can improve the longer-term growth potential of the economy and is good expenditure. Likewise expenditure on measures that tackle crime, anti-social behaviour, the quality of healthcare, substance abuse, and social housing shortages can make a very positive contribution to the quality of life if well targeted.

It is clear to me that over the coming weeks we need to consider if we are able to spend public money wisely, and also to think more about outputs than inputs. We do not have a good track record in that regard. On the taxation front, we also need to consider if revenue raising measures would do more harm than good.  It would be good to see more debate on the quality of spending and taxation, rather than getting hung up on spurious targets.

GROWTH PICTURE LOOKING BRIGHTER

The past week has been a good one on the economic data front. The live register experienced a further decline; the Exchequer returns surpassed expectations in the first half of the year; first quarter national accounts showed impressive year-on-year growth rates in all of the key components of expenditure; and thanks to changes in the treatment of R&D expenditure and illicit activities such as prostitution and the illegal drugs trade, 4.7 per cent was added to GDP in 2012 4.82 per cent was added to GDP in 2013. Given that that GDP is the metric against which various debt and borrowing ratios are leveraged off, this is good news. Furthermore, we now know that GDP expanded by 0.2 per cent last year rather than the previously reported decline of 0.3 per cent.

The Exchequer returns for the first half were good.  They showed another significant improvement in borrowing and the tax take is running €221 million ahead of target. When delays in receipts due to SEPA are taken into account, the overshoot is closer to €500 million. Seven out of nine tax headings registered stronger than anticipated. On the expenditure side, net voted expenditure is running €119 million lower than expected. Extrapolating trends such as these is a hazardous exercise, but it could result in spending and revenues numbers up to €1 billion better than expected this year, assuming nothing untoward happens in the second half of the year.

It is certainly possible that the deficit could come close to 4 per cent of GDP this year, rather than the targeted 4.8 per cent. For next year, it could rather comfortably come in under 3 per cent. So while we will continue to debate the €2 billion, we can still achieve the targets we committed to with well less than half that adjustment. Michael Noonan might just be in a position to stand up in October and deliver the least severe budget since 2007. That would be welcome respite for hard-pressed taxpayers.  Meanwhile, it is good to see most economic indicators moving in the right direction. There are obviously still many obstacles to overcome on the road to redemption, but it is getting better.

Many Economic Trends Inconsistent with Political Dissatisfaction

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This article appeared in Sunday Business Post on 3rd July 2014

This week a new leader of the Labour Party will be elected and next week a re-shuffle of the Cabinet will be announced. These two developments spring from the disastrous election results for the government parties in the two May elections and the ongoing decline in the popularity of the government. I recently spent a couple of months doing some door-to-door election canvassing and so it comes as no surprise to me whatsoever that the government is under so much pressure, at least  based on the feedback I was getting on the doorstep.

At one level this is not too difficult to understand. After all, this government has basically carried on with the fiscal adjustment programme inherited from the last government and laid down by the Troika. It has introduced a residential property tax, which is something that would traditionally have been regarded as political suicide, and later this year water charges will be introduced. These are two developments destined to make people very angry, and so it is turning out. There is also a strong sense that despite promises about a ‘democratic revolution’, the current political landscape is anything but. This government is making appointments to state boards on the basis of political loyalties rather than ability to do the job, or at least that is the perception. This is something that the last few governments were absolutely lambasted for, but this government appears to have picked up the baton with some aplomb and has if anything carried on in an accelerated fashion from its predecessors.

On the economic front, it is less easy to understand just how unpopular the government has become. The reality is that back in 2011, it inherited an absolute basket case of an economy that was going nowhere fast. Over the past three years people have taken a lot of further pain and the economic environment on the ground has been very tough and challenging. However, there are palpable signs that things are getting gradually better, in the aggregate at least.

The live register yesterday showed a further improvement in the labour market situation. In June the number of people signing on the live register fell by a further 4,400 to reach 386,200. Over the past year it has declined by 35,600 and has declined by 52,100 over the past two years. Granted, the Live Register is not intended to be a measure of unemployment, but it does reflect what is going on in the labour market. More importantly, the decline in the numbers signing on is consistent with clear signs of job creation in many parts of the economy. Just talk to the majority of recruitment consultants at the moment!

On the consumer expenditure side, there is also evidence of an improvement. In the first 5 months of the year, the value of retail sales was 4.8 per cent higher than the same period in 2013, and the volume of sales increased by 7.0 per cent. However, when the motor trade is excluded, the retail sales performance was somewhat less impressive, although stronger than in previous months. Excluding cars the value of sales increased by 1.4 per cent and the volume of sales increased by 3.3 per cent.

The reality is that while consumer spending is strengthening, the auto industry continues to be the key driver of consumer spending. In the first 6 months of the year new car registrations totalled 65,705, which was 23.4 per cent higher than the first half of 2013. This is a positive trend that is having a very beneficial impact on the public finances.

Consumer confidence has been trending upwards over the past couple of years, and in April reached the highest level since January 2007. However, it dipped in May, suggesting that there is still a significant level of fragility in the strained personal sector. May was the month when local and European elections were held and issues such as the Local Property Tax (LPT) and the water service charge became prominent in public discourse. Consumer confidence dipped as a consequence. However, the overall trend in consumer confidence improved during the first half of 2014. The challenge for policy makers is to convert the improvement in confidence into an even more meaningful recovery in consumer spending activity and more importantly an improvement in the political fortunes of the government. .

Finally, the Exchequer returns yesterday provide further confirmation of improved conditions in the economy. In the first half of 2014, an Exchequer deficit of €4.9 billion was recorded, which was €1.65 billion lower than the first half of 2013. Tax revenues were running €221 million ahead of target and €868 million ahead of the first half of last year. Overall gross Government expenditure was running €95 million lower than expected, with current spending accounting for an over-shoot of €10 million and capital spending accounting for an under-shoot of €105 million. Net voted government expenditure was €119 million lower than budgeted for, with the current spend accounting for an under-shoot of €20 million and capital spending accounted for an under-shoot of €99 million. The government is controlling expenditure and tax revenues are strengthening. This is good.

 

At the end of June, 7 out of the 9 tax headings were running ahead of target. The overall taxation data are consistent with an ongoing improvement in many aspects of the economy. The income tax take is €64 million ahead of profile and is €539 million ahead of last year. This reflects the stronger labour market. The VAT take is €113 million ahead of profile and is €379 million ahead of last year. This reflects stronger consumer spending, but particularly on cars.

 

In overall terms, the Exchequer data for the first half of the year are reflecting reasonable tax revenue buoyancy on the back of a stronger economy, and continued tight control over expenditure. The Minister for Finance remains well on track to deliver a deficit equivalent to 4.8 per cent of GDP, down from 7.2 per cent in 2013.

 

If one believes in the old and oft-quoted adage that ‘it is the economy stupid’, then the fortunes of the government should be better and its prospects more positive than they currently appear. One is inclined to think that ‘it is more than the economy stupid’ is a more accurate quotation.

Some Upside to Rising House Prices

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Sunday Indo June 2014 by Jim Power

It has traditionally been the case in Ireland that the first thing most of us want to do once we go into paid employment is to buy our own house and spend the next 25 or 30 years paying back the mortgage. Such behaviour might seem irrational in a European context, where there is typically much more of an appetite to rent rather than own. Spending one’s life paying back a mortgage does tend to soak up a lot of financial resources that could be used for other more productive purposes. However, we are what we are and it is likely to remain the case that most of us will desire to own our own home once we can remotely afford it. Personally, I bought my first house when I was 23 and had to sell my car in order to service the mortgage, but being typically Irish, I felt that was a price worth paying to own my own bricks and mortar. The creation of a properly functioning rental market where rent controls are in place and where there is real and decent regulation might possibly change our attitude towards owning and renting, but that appears some distance away.

Whether we own or rent where we choose to live does matter. The high level of home ownership has its advantages in a rising property market. As home owners become wealthier on paper, the positive wealth effect encourages more spending and creates a virtuous cycle. This wealth of course is just on paper and is not real as it cannot be realised unless one trades down or exits home ownership altogether. Hence there are dangers involved in spending and borrowing on the back of paper gains. However, the flipside is also true. As house prices fall, there is a negative wealth effect which depresses consumer spending and economic activity. This becomes a particular problem when the value of the property falls below the level of the outstanding mortgage, or in other words, when one moves in to a negative equity situation. At one level, negative equity is not a problem unless one is forced to sell the property, in which case the negative equity loss is crystallised. However, in a real sense going around realising that your mortgage is bigger than it should be and that your mortgage repayments are larger than they should be, is a horrible feeling and one that will undoubtedly impact on one’s economic behaviour in a negative manner.

One of the problems with any analysis of the Irish housing market is the lack of a proper data set, particularly in relation to regional property markets around the country. However, it is still a very interesting exercise to try to analyse the impact that rising property prices will have on the negative equity situation.

According to CSO data, which are based on houses that have sold and on which a mortgage has been granted, national average property prices have increased by 8.5 per cent in the year to April and are now 9.4 per cent off the low point seen in March 2013. Outside of Dublin, property prices have increased by 1.3 per cent in the year to April and are now just 2.6 per cent off the low point in March 2013. Property prices in Dublin have increased by 17.7 per cent in the year to April and are now 20.9 per cent off the low point in August 2012. Hence any discussion of the impact that rising property prices have on negative equity is really only relevant in Dublin at this juncture.

According to the CSO data, average residential property prices in Dublin Declined by 57.2 per cent between the peak of the market in February 2007 and the low point in August 2012. This dramatic decline in prices pushed a lot of mortgage holders in to a negative equity situation. Just how many is difficult to calculate based on data availability, likewise just how many have been lifted out of negative equity since the recovery commenced in August 2012 is also difficult to calculate. However, if one makes certain assumptions, estimates can be made.

I have looked at mortgages taken out by First Time Buyers, Investors and Movers based on IBF data. I have assumed an average Loan to Value (LTV) of 90 per cent between 2003 and 2011, and 80 per cent since 20111; based on Census data I have assumed that 30 per cent of new mortgages drawn down were in Dublin; I have applied a representative mortgage rate to calculate how much of the decline in the outstanding mortgage is due to normal repayment. Based on these and other assumptions, I estimate that the negative equity mortgages peaked at just over 94,000 in 2011 and have subsequently fallen by around 24,000 to stand at around 70,000 at the moment. If one uses different assumptions one will come up with different answers, but it is clear that the trend in house prices in Dublin is lifting a lot of mortgage holders out of a negative equity situation. This is good.

Such a reduction in negative equity is obviously good news for those involved and will have some positive wealth effect on consumption. For the balance sheets of the banks it also represents good news as it does reduce potential loan loss pressures. However, for those who want to buy a house in Dublin, the magnitude of current price rises is not good news. A strong supply side response is necessary in Dublin, but that will be slow to materialise. Hence in a market with significant pent up demand and limited supply, the risk to prices appears to be on the upside over the next couple of years. The good news is that if the price appreciation seen since August 2012 were to be repeated over the next couple of years, the number of mortgage holders in negative equity in Dublin could be almost halved.

The Complexity of the Fiscal Options

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SBP June 19th by Jim Power
Earlier this week the Irish Fiscal Advisory Council (IFAC) published its latest Fiscal Assessment Report. This body was set up as an independent assessor of Irish fiscal management on the back of Ireland’s bailout conditions. The theory is that having an independent overseer of how Government conducts policy in relation to taxation and public expenditure might or should ensure sensible and prudent management of the public finances. In the period between 2000 and 2007 these are two adjectives that could certainly not be used to describe how we managed our public finances. Presumably if such a body had existed during the first seven years of the century we would not have been treated to the debacle of the benchmarking of public sector pay; the total failure to control current expenditure; the removal of thousands of workers from the income tax net; and a fiscal policy that was generally very pro-cyclical. That is the theory at least, but in practice since IFAC was set up, the Government appears to acknowledge what the body is saying and then turns around and basically ignores most of its advice. If it had been set up in 2000, McCreevy and his successor in the Department of Finance would most probably have made a virtue out of ignoring the advice dished out by the body.

As always, the latest report contains a lot of very interesting material, but the headline grabber is the advice to Government to press ahead with the delivery of the planned €2 billion adjustment in Budget 2015, due to be delivered on October 14th. It puts forward three reasons as to why it would be sensible to pursue such a course of action. Firstly, to reduce risks to debt sustainability by putting the debt-to-GDP ratio on a firm downward path; secondly, to provide a reasonable probability that the requirement of a deficit of below 3 per cent of GDP is achieved in 2015; and thirdly, to protect the hard-won credibility of Ireland’s capacity to follow through on adjustment commitments.

To date we have shown an amazing capacity to follow through on adjustment commitments, but ‘austerity fatigue’ is very definitely setting in, as demonstrated very vividly in the recent local and European elections. It is one thing for the Council to issue this advice, but it is a very different and difficult matter to point out where exactly the €2 billion should come from. That is not the job of IFAC, but it would be interesting and instructive to see exactly how the body would envisage a further adjustment of €2 billion being delivered.

The Department of Finance is predicting a deficit just under 3 per cent of GDP by the end of 2015. That projection is heavily predicated on GDP growth of 2.1 per cent in 2014 and 2.7 per cent in 2015. If growth turned out weaker, the GDP part of the budget ratio would be lower and the borrowing percentage higher – this is a case of simple maths. However, tax revenues and expenditure are heavily driven by growth, so if growth turned out to be weaker, obviously tax revenues would be lower and pressure on social expenditure greater. Much does depend on economic growth.

However, economic growth cannot be viewed in isolation. It is actually the product of many factors, not all of which are fully understood by anybody, not to mention economists. Of particular concern at the moment is the impact that the proposed adjustment might have on growth. Given how fragile the economic recovery story is at the moment, and particularly the consumer side of the economy, there is a distinct, but largely unquantifiable risk that such an adjustment coming on top of what we have already endured since 2008, could have a very negative impact on economic activity and end up making the deficit worse rather than better.

There is in my view a simplistic argument to the effect that the Minister for Finance should opt for an adjustment of at least €2 billion in case growth turns out weaker than anticipated and the deficit higher than anticipated as a consequence. Surely there is a danger that if growth turns out weaker than expected, a budget adjustment of €2 billion would just make growth even worse and the deficit higher. An adjustment of €2 billion would not result in a commensurate reduction of €2 billion in the deficit. Fiscal multipliers are important, but such multipliers are not easily calculated, particularly in an economy that has endured such a dramatic shock in recent years and which is only now showing very tentative signs of recovery.

The economic impact of a further €2 billion adjustment would of course be heavily determined by the nature and quality of the adjustment. It is just not clear to me at the moment how such an adjustment would be constituted so as to do the minimum damage to the economy. I would like to see IFAC’s remit be widened to include detailed policy recommendations. Only then would we really be in a position to judge the soundness of its advice.

Department of Health Really is Angolan in its Nature

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Examiner June 20th 2014 by Jim Power

It should come as no surprise to anybody to learn that politics is a very cruel and callous business. This week the Minister for Health, James Reilly was forced to reverse course on the medical card issue. The proposal to issue medical cards on the basis of medical need has been shelved and over 15,000 of the medical cards that were removed on the back of a review process over the past three years are now due to be returned. This is being viewed as a major back down by the Minister for Health and has added to the belief that his term in the current office is now very finite.

Apportioning blame to Minister Reilly for this latest debacle in the Department of Health strikes me as pretty shallow. My understanding is that the Minister for Health was opposed to the policy towards the removal of medical cards, but he was given no choice by the Minister for Public Expenditure and the Cabinet as a whole. I may be wrong about this, but we the public deserve to be told exactly how the policy was decided upon and by whom.

Many bodies currently analysing Ireland’s public finances have identified overruns in the Department of Health as a key risk to the attainment of a budget deficit of 3 per cent of GDP or lower by the end of 2015. Some observers and commentators are prone to vilify Minister Reilly for those overruns, and I can already envisage the media headline when the overrun for the year is published. However, before we rush to judgment, the facts of the matter should be remembered.

The reality is that health is probably the most important public service that the state is tasked with providing. It is also a reality that high quality healthcare is a very expensive and complicated service to provide. No country does it perfectly, and for those that come close to perfection, there are serious question marks over its longer-term sustainability and affordability.

Ireland spends around 8.8 per cent of GDP on health. This compares to 11.6 per cent in France. On the surface one might be tempted to be critical of the lower level of GDP spent by Ireland, but if one considers the age profile of the Irish population, then criticism might be less valid. Ireland has a very young demographic profile. At the moment the median age of the population is around 35 and just over 50 per cent of the population is under the age of 35. In 2011, 11.6 per cent of the population was over the age of 65. This is projected to rise to 16.2 per cent in 2026 and 21.6 per cent by 2046. In France, 23.2 per cent of the population is over 60 years of age, compared to 16.4 per cent in Ireland.

As populations age, the demand for healthcare increases and the amount of resources devoted to it also has to increase. If Ireland was currently spending the same percentage of national income on health as France is, then we would be in a really serious situation, given how much younger our demographic profile actually is.

Another fact is that in 2009, Ireland’s gross current spending on health was around €15.5 billion. This year, it is targeted at €13.3 billion and just €13 billion by 2016. Given that these cuts in health expenditure are occurring against a background of an aging population and a growing incidence of obesity and other lifestyle illnesses, it is no wonder that the quality of health provision is deteriorating so markedly and that draconian measures such as taking medical cards from needy elderly people are being instigated.

One could get very depressed about the future health service here in this country. The fashionable thing to do is to blame and vilify the current Minister for Health, but his immediate predecessors were treated no differently. Regardless of who is in the Department of Health, it is a total no-win situation. What we need to do is focus on preventative measures such as reducing dangerous consumption of alcohol and make smoking even reviled than it currently is. Prevention is better than cure, particularly if the cure is not up to much.