From top: Minister for Fianance, Public Expenditure and Reform Paschal Donohoe at a  Stability Programme Update last week setting out revised macroeconomic and fiscal forecasts for the period 2019-2023; Michael Taft

I doubt there’s anyone out there who really wants a return to out-and-out austerity. Businesses don’t want it, people don’t want it, and for political parties it would be electoral madness (just ask Fianna Fáil, the Greens and Labour).

However, policy inertia could lead us towards soft austerity options (that is, keeping expenditure below inflation or income growth) simply because we are not reading the economy right.

In its recent Fiscal Assessment Report, the Irish Fiscal Advisory Council has put forward three scenarios out to 2025: Mild, Central and Severe. They project economic growth and the paths of the deficit and the debt.

The following focuses on the Central and Severe scenarios; the Mild scenario is too optimistic (I’d like to thank the Fiscal Council for supplying requested data on nominal GDP and GNI*).

In the Central Scenario, the deficit starts out at 7.4 percent of GDP but falls dramatically to 1.5 percent in four years. This is on a no policy change basis (i.e. assumes the policy as contained in the Stability Programme Update 2020 with variations in revenue and expenditure according to the scenario).

Crucially, the current day-to-day budget (excluding capital spending) returns to surplus by 2023. This is my own estimate. This is an important benchmark because it means that in 2023 and afterwards we will not be borrowing in order to fund day-to-day spending. We will be borrowing to fund investment.

This is known as the Golden Rule, whereby you balance current spending and borrow for investment.

With the increase in borrowing, the debt rises. But what is noteworthy is that debt only rises in 2020. After this year it starts to fall – as a percentage of either GDP or GNI*. Though it still remains high relative to pre-crisis levels, it is stabilised (the GDP projections are my own).
Unsurprisingly, the Severe scenario projections are worse. Under this scenario:

* The deficit, while falling (sluggishly), still remains high at nearly 3 percent of GDP by 2025

* The current budget only returns to balance in 2025

* Worryingly, the debt is not stabilised, but is still rising in 2025

The Fiscal Council’s Severe scenario is marked by repeat lockdowns – at the end of this year and the middle of next year – resulting in a protracted recovery. But such a scenario would not be confined to Ireland. It would probably be spread throughout Europe. And, according to the Fiscal Council, a Severe scenario would not automatically mean austerity:

‘ . . . would a Severe scenario imply austerity being needed? Not necessarily. Rather than outright austerity—where involuntary unemployment or a negative output gap results from cuts to existing public spending or tax increases—a Severe scenario might simply mean less ambitious budgetary plans being possible in future, without revenue-raising measures or savings being sought elsewhere.4 It would perhaps mean a slower pace of increase in net government spending and it would be against a backdrop of a recovering economy.’

Here’s the point: when commentators and politicians ask how we are going to reduce the deficit, they are asking the wrong question. Economic growth, even without policy change, will reduce the deficit – significantly so. Tax increases and/or spending cuts – in the name of deficit reduction – will actually slow down the economy’s ability to reduce the deficit, since these fiscal adjustments slow down domestic demand.

If you want to hasten the deficit reduction process you should increase investment. Investment increases the economy’s capacity to grow in the future. This growth will drive further tax revenue and falling unemployment costs.

There is one major caveat. The expenditure projections informing the Fiscal Council’s deficit estimates are tight. Unless there are tax increases or spending cuts (though unemployment costs will come down automatically as employment rises), there will be little scope to fund anything substantial that might be proposed in the new Programme for Government, never mind the type of public services and social protection typical of a continental European country.

That’s the real question. That’s where the real debate begins.

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

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