Although we are currently far from seeing the light at the end of the tunnel, some discussion is already needed as to the implications for Government economic policy whenever the crisis runs its course.
There are several issues to be disentangled. First, what will be the budgetary cost of the precipitous fall in economic activity and the mitigating fiscal measures required? Second, how are these costs to be borne ? Third, what structural changes in fiscal policy (particularly in social expenditures) may or may not be appropriate in a post-virus world? Finally, how will the response and recovery differ from that during the 2008-2009 crisis?
Clearly, the deficit will be a huge number and likely to be followed by more significant red ink in 2021
It is a truism that the eventual fiscal cost of the pandemic is largely unknown. Although the outlays on massively expanded unemployment benefits are calculable, the scheme’s duration is highly uncertain. On the revenue side, the timing and speed of a recovery in domestic consumption and investment (and incomes) depends on that ephemeral variable, “confidence”. Critically for Ireland, a resurgence of exports and tourism is linked to an international recovery over which we have no control.
Notwithstanding these unprecedented uncertainties, a 2020 budget deficit of at least 10 per cent of GDP – maybe as much as 15 per cent – has been suggested by some observers. Personally, I believe that taking “knock-on” effects into account the eventual outcome will be much closer to the top end of the range. It is sobering to recall that during the last crash the budget deficit for 2009 – before any austerity measures – was projected at 18 per cent of GDP (it eventually peaked at 12 per cent). Clearly, the deficit will be a huge number and likely to be followed by more significant red ink in 2021.
Who will pay for this? The Government could raise taxes sharply. This would be a bad idea, at least in the next year or two, as it would discourage individuals and firms trying to get back on their feet. Indeed, some temporary tax reductions may well make sense. The most likely option is borrowing from financial markets where Ireland’s credit rating is good (largely reflecting relatively conservative fiscal policies in recent years) and interest rates are at all-time lows.
After heated discussion the European Union has finally agreed on some common financial steps, mainly liberalised access to existing support facilities and a dedicated EU fund. It seems unlikely that Ireland stands to benefit very significantly since we can borrow relatively easily from the markets and, being a relatively well-off member, we probably would be expected to be a financial contributor to the schemes.
No agreement was reached on the possible issuance of euro “coronabonds” to help finance looming government deficits. Predictably, as in the earlier recession – era debate, the proposal, pushed by “southern” countries (mainly Italy and Spain, backed by France and Ireland), was steadfastly opposed by Germany and the Netherlands who, despite paying lip service to the concept of European solidarity, continue to see it as a “socialisation” of costs that should be borne largely at country level.
Over the coming months, some perhaps strictly limited, a euro-wide bond scheme may yet be put in place for especially hard hit countries whose debt outlook is particularly fragile. However, barring a sea change in thinking, such schemes would probably not make a big difference for Ireland.
Thus, at some stage Ireland will have to pay the bill associated with the virus, largely in the form of increased debt servicing costs which will trend upwards as interest rates rise and the European Central Bank begins to modify its current exceptionally expansive stance. Payment will come in the form of higher taxes or postponement of otherwise planned expenditures.
Unlike the 2008-2009 crisis, which exposed fatal underlying weaknesses in the Irish economy, the current disaster is an entirely exogenous event
In the wake of the crisis, some commentators and politicians have called for sharply increased State intervention on a permanent basis, especially in the health, housing and childcare provision sectors. Such initiatives need to be judged on their underlying merits and affordability in a more “normal” world. It is not obvious that expenditures can or should be permanently ramped up to be able to deal comprehensively with very rare, perhaps once in a hundred years, events. That said, if the probability of a crisis increases significantly, reallocations towards contingency expenditures make clear sense.
In the case of health, undoubtedly many serious systemic weaknesses remain to be fixed. However, the much maligned – often unfairly – HSE is widely judged to have performed at least as well, if not better, than its counterparts in other countries. Credit should be given where credit is due.
Unlike the 2008-2009 crisis, which exposed fatal underlying weaknesses in the Irish economy, the current disaster is an entirely exogenous event. This suggests that economic and social repair can be quicker once domestic and world-wide confidence returns. In 2009 the problems of a huge underlying fiscal deficit, massive household debt and broken banks inevitably took time to address.
Nevertheless, while the trajectory, magnitude and causes may differ, in reality, as before, some difficult, probably painful, economic and financial adjustments over time are likely to be needed. Calls for sweeping new spending initiatives as soon as the crisis passes would do well to bear this in mind.
Donal Donovan is a former Deputy Director at the International Monetary Fund and a former member of the Irish Fiscal Advisory Council