The Fiscal Rules: Heads You Lose, Tails You Lose

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From top: John Fitzgerald; Michael Taft

Ah, the fiscal rules. They brought us fiscal space, the expenditure benchmark and the structural deficit. They were supposed to bring us sustainable and balanced fiscal policy to see us through the good times and the bad.

However, Dr. John Fitzgerald, of the Economic and Social Research Institute [ESRI], is not impressed.

In an Irish Times opinion piece, He writes:

‘ . . . the inadequacy of the rules-based approach may actually provide cover for dangerous pro-cyclical fiscal policy . . .

‘…In the period 2004 to 2007, Irish fiscal policy fully complied with the rules, but it was pro-cyclical, making a major contribution to the growing bubble that subsequently wreaked so much havoc.’

Dr. Fitzgerald continues:

‘ . . . in the Irish case the continuing exceptional growth suggests that the economy will hit full employment next year, and that action will be needed in the 2019 budget to slow the economy.’

In effect, Dr. Fitzgerald is arguing that while we would be compliant with the fiscal rules if we were to increase public expenditure by the full amount allowable under the rules, it would be folly to do so as we are knocking on the door of full capacity – another bubble, inflationary pressures or a deterioration of our current accounts.

Indeed, we may have to increase taxation or cut public spending to keep things on track, something the fiscal rules don’t call for.

There are two ways of approaching this argument.

The first is – yes, yes, yes. The fiscal rules have as much relevance to proper fiscal policy as alchemy (OK, a bit exaggerated but not by much).

Champions of these rules claim that had the coercive element of these rules been in force during our boom years, we would have avoided the excesses of that period.

The fact is Ireland was not only compliant with the rules in the boom period – as Dr. Fitzgerald points out – we had the best public finances of any Eurozone country bar Finland.

The fiscal rules were never empirically-based; they are a political instrument dressed up in complicated formulae.

In the immediate sense, they were the price that German Christian Democracy extracted for participating in bail-out mechanisms. In a larger sense, they are about the de-politicisation of the economy so that regardless of what government people elect, the rules will rule regardless.

So, yes, Ireland and Europe would be far better off without them.

The second way of approaching Dr. Fitzgerald’s argument is to let out a long exasperated sigh: we were told we must become compliant with the fiscal rules; hence, fiscal constraints. Now that we are compliant – in fact, overly-compliant – we are told we must practice . . . fiscal constraints regardless of what the rules allow us.

Heads, fiscal constrictions; tails, fiscal constrictions: it’s a loaded coin.

It’s not just that the fiscal rules are inappropriate to a highly-globalised small open economy. Or that key concepts (e.g. structural deficit) cannot be directly measured. They constitute an inherent irrationality.

Under the rules investment must be paid out of current revenue; that is, the state is largely prevented from borrowing for productive investment. Imagine the impact were this applied to the household sector – people would be forced to pay for a house out of savings, rather than borrowing.

Or applied to the business sector – again, firms would have to pay for investment out of retained earnings, not borrowing. In the former, only the richest could afford a house; in the latter, firms couldn’t expand, modernise or even set up in the first place.

Some people say we should just tell the EU where to get off and ignore ‘their’ rules. However, these are our rules, constitutionally mandated through the Fiscal Treaty referendum. Further, to ignore the rules would be to invite retribution by the international markets, driving up the cost of investment.

In any event, the issue under the rules isn’t that we are prevented from spending. We are allowed a structural deficit of 0.5 percent. By 2021, the Government is targeting an actual surplus of 1 percent. Seems like a small difference but it amounts to an additional €4.8 billion potential fiscal space on a static basis.

The issue is we don’t have a reliable fiscal framework to plan out future priorities and ensure that our annual budgets work with the economy’s grain rather than against.

Without this risk volatile swings  – jumping from pump-priming to austerity, from boom to slumps. And accompanying those swings will be a debate where the loudest voices and most privileged interests will dominate.

So how do we proceed?

Dr. Fitzgerald has a suggestion:

‘Ireland might be better off without these particular rules, relying instead on the wisdom of ministers for finance, overseen by a critical media.’

Hmm. That seems a tad optimistic. We can’t measure our national output, or reliably count how many houses we are building, or calculate how much value-added our export sector actually produces. Wisdom needs evidence.

Let’s admit it – we’re in a fog. And when you’re in a fog, you turn on the high-beams and proceed slowly. We need a new fiscal framework, we need new measurements.

But until such time (and it will take some time) we need to measure best-case and worst-case scenarios. And in that space between the two we should assign resources to urgent investment priorities to support a productive economy.

Housing would be high up the list. So would urban public transport and renewable technologies as we face into an environmentally-problematic future to put mildly.

There are other priorities – hospital beds and childcare facilities. We don’t have much time until the next downswing or to take advantage of ultra-low interest rates.

Because, for example, if we enter into another slump – induced by Brexit or whatever – with high levels of homelessness and housing need, it will only get worse and even more expensive to repair on the other side of the cycle. And the roller-coaster ride will start all over again.

If you have a coin whereby heads you lose, tails you lose, you don’t keep flipping it. You get rid of it. And get another coin.

Michael Taft is a researcher for SIPTU and author of the political economy blog, Notes on the Front. His column appears here every Tuesday

23 thoughts on “The Fiscal Rules: Heads You Lose, Tails You Lose

  1. Cian

    This is interesting, but while “…In the period 2004 to 2007, Irish fiscal policy fully complied with the rules, but it was pro-cyclical, making a major contribution to the growing bubble that subsequently wreaked so much havoc.” this seems to ignore other things that happened in that time.
    The infamous SSIAs matured in 2006/2007 adding some €14bn into an overheated economy between April 2006 and April 2007. This was about 10% of GDP.

      1. Cian

        Both.
        But I don’t know the split between spending and re-investing. It would be interesting to see they split by SSIA and the split by amount – e.g. were people that saved the max each month more likely to re-invest than the people that saved 20/month (or vice versa).

  2. Rob_G

    “The infamous SSIAs… “

    – the whole Celtic Tiger period what such a funny time in Irish history, what were people thinking?

    ‘We have too much money; let’s start giving it away for free to rich people instead of, I don’t know, building a metro’ – madness

    1. b

      the SSIA’s weren’t the problem – encouraging people to save and take heat out of the economy was good policy

      the mistake was not replacing it with a similar scheme as they matured while the economy was booming

      1. Brother Barnabas

        probably not a coincidence that house prices peaked in the year that most SSIAs matured

      2. Frilly Keane

        well there was also the matter of all those SSIAs crystallising at the same time
        which hid the crash until it was too late

        B is right
        they should have introduced a roll over product to take in this cash

        it was another two years – I think btw, so ye know what to do if I’m wrong
        before the National Solidarity Bond was made available

        so all that SSIA cash made it look like the economy was booming with retail sales matching that of 2004-2006
        when in fact it was false
        they then came up with Credit Crunch
        and got away with that for about 6 months

        before in Autumn 08 they finally admitted we’re f..ked

  3. The Dude

    ‘Ireland might be better off without these particular rules, relying instead on the wisdom of ministers for finance, overseen by a critical media.’

    Ah yes, Ireland’s world un-renowned ‘critical media’.

    No snouts in the trough there. No conflicts of interest either in terms of property porn and pumping up prices.

    It’ll be grand. Worked really well the last time.

  4. Fact Checker

    Michael,

    The latest estimate is that capital spending by government was €4,903m in 2016. This is out of a total general government expenditure of €74,552.

    So 6.6%.

    There is absolutely NOTHING in EU fiscal rules that prevents Ireland from spending more on capital and less on everything else. It is a purely national policy choice.

    For example, in 2004 – generally agreed as a point where public finances were in good shape – the ratio was €5,426m/€51,775m = 10.5%

    1. Michael Taft

      Fact Checker – the issue isn’t what we are allowed to spend and what we aren’t. We can spend more on capital and current and remain compliant. The issue is whether compliance with the fiscal rules will prevent pro-cyclicality. fiscal volatility, and boom-and-bust. I’m suggesting it won’t.

      1. Cian

        Michael, I’m not sure where you are going with this: are you suggesting that
        a) the fiscal rules are bad, and we need to break them to prevent fiscal volatility
        b) the fiscal rules are okay, but very broad, and just remaining compliant with them won’t prevent fiscal volatility. So we should remain within their constraints AND be fiscally prudent.

        1. Michael Taft

          Cian – the issue is highly confusing and potentially misleading. The fiscal rules, as rules, are poor and will not save us from pro-cyclicality, fiscal volatility and boom-and-bust. I don’t think there is a need to break them – we have the fiscal space. However, we need to move beyond reliance on these rules without falling into knee-jerk reactions. As to what should replace them – I don’t have any quick solutions. It would be nice to rely on common sense and certain indicators but that didn’t work too well in the past. But in order to have an informed debate there must be a consensus that something is wrong – that’s the first step. As to the second, third, etc. steps – I’m open to suggestions.

      2. Fact Checker

        Apologies Michael – I mis-interpreted.

        Discretionary fiscal policy can do a certain amount in Ireland to dampen booms and weaken troughs. But it is very limited in effect given the openness of the economy.

        In the years 2005 to 2007 net inward migration was over 232k. That is about one in nine of the workforce by the end of the period! This was inevitably going to stretch demand for public services while at the same time bringing in lots of tax revenue to fund it. It wasn’t sustainable of course, and we all know what happened next.

        This is the consequences of the policy choice of being in an economic and migration union with half a billion other humans.

        Tax and spending policy in Ireland can do a little to smooth out the booms and busts. But we will always be uniquely vulnerable to them.

      3. Frilly Keane

        pro-cyclicality

        I’m going to try an use the word today

        haven’t a clue what it means
        I might rename my pizza entry with it

  5. zip

    “The wisdom of ministers for finance!” Ah, it’s to Broadsheet we come for the lolz!

    What happened in the crash happened because of Irish honour; quite correctly the Government moved to back and guarantee Ireland’s banks. Unfortunately, the Government had not been informed that these banks were away with the fairies, and the regulators were dancing around the fairy ring. A sensible, correct decision to protect the banks of a small country ended up – because it was unlimited – guaranteeing billions in international subprime debt that had been insanely brought into Ireland’s financial system.

  6. david

    Here we go again wage rise in the public sector
    Then promises of the private sector getting the same.
    Then after the steeple have swallowed it the public sector gets its rises
    We will see Oxfam ads of soldiers living on the side of the road ,and little Seamus walking a mile to get his food parcel before forced to work a 4 hour shift.
    Then when the budget happens the shafting will happen just like each year.
    Maybe its tome for pay parity with the public sector?
    But sadly your latté will cost 10 euro

    1. Papi

      Thankfully, little Seamus spends 1600 a month on weed, so bolstering the soldiers economy! Huzzah!

      1. david

        We really now know what is in that fiscal space between your ears papi
        What ever lurks there is addled from years of drug abuse
        Maybe it resembled homer Simpsons brain cavity

    2. realPolithicks

      What a miserable person you are, you consistently take the worst interpretation out of every situation.

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