ECONOMICS:A recent analysis by the Department of Finance gives a stark depiction of the scale of the problem, writes Jim O'Leary

LAST WEEK the Department of Finance released its latest analysis of Ireland’s parlous fiscal position. Published with the ungainly title Addendum to the Irish Stability Programme Update, it contained the most realistic official assessment yet of prospects for the economy and the public finances and pushed the forecast horizon out to 2013.

As a plan to restore order to the public finances, it is not without its deficiencies. The methodology is more than a little opaque and there appear to be issues of internal consistency. That said, the exercise is a welcome one, not least because it provides a stark depiction of the scale of the problem that needs to be addressed.

The official prognosis is that, on the basis of unchanged policies, the budget deficit will reach 10.5 per cent of GDP this year and remain in the range 11-12.5 per cent of GDP in each of the next four years.

Assuming that the Government could borrow the amounts involved (an increasingly strong assumption, given what’s happening on international capital markets), this would imply an enormous rise in State indebtedness, with the debt/GDP ratio getting up towards 100 per cent.

To reduce the deficit and the debt to a more sustainable trajectory, the Department estimates that adjustments to spending and/or taxation amounting to a cumulative €16.5 billion over the period will have to be made.

Two things are worth saying about this. The first is that this figure is more likely to be an underestimate than an overestimate. The second is that failure to achieve the requisite adjustment or, more to the point, to convince international lenders that the requisite adjustment will be made, could have catastrophic consequences.

The risk that Ireland would be refused credit may be small (though rising), but the consequences of such a risk crystallising would be awful. Let’s work with the €16.5 billion figure.

To put it in context, consider that it amounts to the equivalent of almost 30 per cent of the gross voted current expenditure total for this year, 45 per cent of total projected tax revenue, or 154 per cent of this year’s total planned capital spending. It is a huge amount of money, even by the standards of the government sector.

Its size is such that it is utterly unrealistic to suggest that it can be achieved without substantial cuts in both current and capital spending and increases in taxes.

Given the proportion of current spending accounted for by pay, the question of whether it might be better to avoid large reductions in payroll costs is redundant. In this connection, the only relevant questions relate to the composition of payroll cuts as between numbers employed and rates of pay and the timing thereof.

There are several arguments for concentrating the adjustment on rates of pay at this stage. One, from a public finance perspective, is that there is no up-front cost to the exchequer in cutting pay in contrast to a redundancy programme where the up-front costs would be considerable. This is an important consideration at a time when there is an elevated risk of the Government running into a credit limit. The second public finance argument is that smart redundancy programmes take time to design and implement. Rolling them out hastily or crudely runs the risk of unnecessarily reducing the quality of public services.

If cutting the number of public servants proves necessary therefore, and the overwhelming likelihood is that it will be, it is much preferable that it is implemented as part of a programme of intelligent public sector reform and when international capital markets are more receptive to Government debt issuance than now.

From a broader economic perspective, there is another argument for pay cuts which I have canvassed several times in recent columns.

Faced with the need to retrieve the sharp loss of competitiveness of recent years, and without the option of using the exchange rate to do so, nominal wage cuts must take place (and are already taking place) in the private sector. Reductions in public sector wages and salaries can greatly facilitate this process.

One of the objections that trade union leaders have raised to cutting public sector pay is that it would have a demonstration effect on the private sector, but that is precisely the point. Another objection, of course, is that it will reduce the living standards of their members. Regrettably, that is also the point. We have collectively been living well beyond our means for some time now and must realign our pay with our productivity.

Nobody is pretending that prospect is pleasant but the fact that it will be tough doesn’t make it any less necessary. Besides, there is every chance, given the trend in interest rates and energy prices, not to mention the knock-on effects of pay cuts on the prices of other goods and services, that the reductions in real incomes will be significantly less than the reductions in nominal incomes.

Advocating public sector pay cuts is not about scapegoating public servants for our problems. Indeed, there is a strong sense in which it is about the very opposite. It is about averting the risk that public servants will be blamed if:

(i) we don’t resolve the problems we have or,

(ii) we do resolve them, but the burden of resolution is borne exclusively by the private sector.

An efficient well-motivated public sector, producing world-class services in areas like education, health and policing, must be a core part of the Ireland that emerges from the current crisis. Reaching that position requires that the public service enjoy the support and respect of the broader community. That will not be forthcoming, however, if public servants are seen to have insulated themselves from the very painful effects of this recession.

In such circumstances, the reservoir of goodwill towards public servants, already diminished by benchmarking, will be further depleted with negative consequences not only for them but the economy as a whole.

Ireland is now embarked on an enterprise that has many of the hallmarks of war, a war against powerfully adverse economic conditions. The last thing we need is to exacerbate those conditions by opening another front – against each other.

Jim O’Leary is a senior fellow of the department of economics, finance and accounting at NUI Maynooth. He can be contacted at jim.oleary@nuim.ie