Ireland’s Budget: living under Draco?

Budget 2011 which is before the Irish parliament now is widely described as draconian. This is the first instalment in the four-year plan to bring the budget deficit to below 3% by 2014. The adjustment is front-loaded to take out €6bn in spending cuts and tax increases in 2011. The total retrenchment will come to €15bn, under the terms of the recent IMF-ECB rescue plan.

The scale of the effort required is massive. The reason is not because the government deficit is so high – by itself, this would be painful but manageable – but because, as part of the loan agreement, no renegotiation of bank debts is possible. The large private deficits in the financial sector have been, in effect, socialized. There is no real distinction any more between the sovereign debt and bank debt. As a result, the government deficit this year stands at 32% of GDP.

Ireland thus becomes an international showcase for a new kind of politics. What happens to a country swallowing the political poison of internal deflation, and trying to grow its way out of trouble when it can neither gain competitive advantage by devaluing, nor inflate away the distributive conflicts that must ensue? Suppose the interest rate payable on its large loan is 5.7%, growth estimates of 2% are deemed too ambitious, and the immediate consequence of the stabilization plan is to be awarded a downgrade by the international bond ratings agencies? Note that national per capita income is already 20% lower in 2010 than it was in 2007. Add in the facts that the ruling coalition is deeply unpopular, the smaller party has declared its plan to withdraw soon, and the slim government majority relies on the votes of two often fractious independent deputies. How might this grim scenario unfold?

Anger is certainly one response. Irish people do not take to the streets as readily as, for example, the Greeks, who will soon hold their seventh general strike this year. Still, the Irish Congress of Trade Unions brought out up to 100,000 people (from a population of some 4.5 million) in a peaceful and largely good-humoured Saturday street protest. But the Irish people are biding their time for the election which will certainly take place in February or March 2011.

Recent polls make devastating reading for the dominant nationalist-populist Fianna Fáil party. It is used to commanding around 40% of the popular vote, more or less evenly spread across all social classes. It rating now stands at 17% (or even 13%) and the personal score of Taoiseach Brian Cowen is in single figures. Instead of being the largest single party, Fianna Fáil’s seat share risks trailing in fourth behind Fine Gael, Labour, and even Sinn Féin. The minority party in the governing coalition, the Greens, face total annihilation as reward for their time in office.

But will Irish citizens take the pain that is promised? The next government will almost certainly be formed by a coalition of Fine Gael and Labour, and both these parties have also signed up to the inevitability of the €15bn adjustment programme. All that is left to argue about is the distributive consequences of the mix of tax increases and spending cuts, and the composition of both. But big cuts have large consequences, so these debates do matter.  Evidence suggests that voters may be willing to endure sizeable spending cuts and tax increases if they believe they are both necessary and fair.

Necessary? Although people flail in despair at the pass we have reached, the main parties are instinctively cautious about assuming responsibility for destabilizing the Euro and risking the reputational damage of unilateral debt default. Besides, they would immediately have to fix the annual fiscal deficit of €19bn, and live without the enormous and recurrent short-term borrowing facility from the ECB to keep the broken Irish banks going which they depended on prior to the structured loan deal.

In the medium term, there is a widely shared awareness that any change in Ireland’s prospects depends on the outcome of the slow crisis unfolding at European level. Ireland is only at the start of the process of implementing the conditions of the IMF-ECB loan agreement. As time goes on, Irish people may become less willing to bear the costs imposed on them by the piecemeal approach to resolving Europe’s wider fiscal and financial crisis. The European Commission, the Eurozone group, the ECB, and the German government continue to tussle over a framework for permanent and orderly default mechanisms to be implemented after 2013. But in the markets, as they say, the future is now; in politics too, people have a limited tolerance for being treated as eggs to ensure the future supply of omelettes.

Fair? The laws of the ancient Athenian Draco became a byword for harsh and merciless practices. Early opinion on Budget 2011 is mixed. Economic modellers argue that the impact is broadly progressive in aggregate, imposing a net average cut of €100 a month per household. Other headlines anticipate monthly cuts of €300. The effects of cutting the hourly minimum wage by €1 to €7.65, to increase low-end labour market flexibility, are contested.  There is no evidence that the old rate had adverse effects on competitiveness. But then again, the rate at which it was set also lacked a clear evidence base.

There will certainly be big increases in most forms of taxation. The income tax net will widen to cover an extra 300,000 people, bringing the total from 45% to 60% of the workforce. During the boom, income tax rates were lowered and many low-paid people were exempted altogether. This was held to be both equitable and efficient as it facilitated labour market flexibility while increasing disposable income at the low end. This particular efficiency-equity trade-off was also ideologically consistent with the wider business-friendly, low-tax, market-conforming orientation Fianna Fáil had adopted since 1997. But the tax base was eroded to such a degree that rapid back-tracking is now essential.

Spending cuts affect almost every programme. This is where most of the political debate is focused, and the opposition parties have zoned in on some strikingly inegalitarian outcomes. Most welfare recipients face cuts of about €8 a week, affecting those who are unemployed, blind, disabled, lone parents, widowed, or carers. In a welfare system that is notably weak on service provision and mainly reliant on cash transfers, this is particularly harsh. Child benefit is cut for everyone regardless of means. Budgets for ongoing vital functions such as road maintenance and landfill remediation are all but abolished. The combined effects of all these cuts and snips will take time to be seen, but they will be real.

This is played out against the backdrop of a political and administrative class ever ready to protect its own interests. Evidently with an eye to gaining some moral credit, top politicians are taking a pay cut of up to €14,000. But since this merely reduces the Taoiseach’s salary to €214,000, he will now be only slightly less well paid than Angela Merkel and Nicolas Sarkozy, and is still considerably better paid than David Cameron, not counting generous pension and other entitlements. Enda Kenny, leader of Fine Gael, remarked in the Dáil that the Budget changes mean that while the Taoiseach used to get 13 times the minimum wage, now he will get 14 times. Some potent veto players remain untouched, such as old age pensioners, whose street protests about medical entitlements frightened the government in 2008. Public sector incomes, subject to direct cuts in 2009, will be up for review again in May 2011, when they will be the next government’s problem.

As if all this were not bad enough, the bankers, who seem to specialize in bad timing to maximize embarrassment to democratic politicians, are in the spotlight again for not mending their bad old remuneration practices. And following a court case, AIB is required to pay out bonuses totalling €40m for 2008. Promises of a super-tax for all new bonuses will do little to counter the bad press.

While all this is going on, the markets have largely lost interest in Ireland: it is ‘done and dusted’, and the action has moved on to Portugal and Spain. Ireland has been parked. Although this and future budgets may not be written in blood, the effects will be severe and will be more palpable as time goes on. Draco’s laws in ancient Athens were eventually repealed and replaced by the proverbially just rule of Solon. But they were in effect for over twenty years. Irish people will be devoutly hoping that a more benign European fiscal regime will not be so long in coming.