I thank the Chair for the invitation to appear before the committee. We are grateful for the opportunity to provide our views on the present economic and fiscal situation and to discuss some key issues and risks which the medium-term fiscal strategy should consider.
Starting with the current economic and fiscal position, the sharp rise in Covid-19 infections through the latter half of quarter 4 of 2020 prompted the Irish authorities to reimpose a series of level 5 restrictions from 30 December 2020 to 5 April 2021, which is the earliest date on which they may cease. Compared with the measures introduced in September 2020, these measures were quite restrictive with all schools closed and construction, for example, included in the general shutdown.
The significant nature of the restrictions, along with the relatively long length of their duration, will have an adverse impact on the economic recovery, and that had been apparent throughout the latter part of 2020. The most obvious manifestation of this adverse impact is in the labour market where the unemployment rate, which had declined to less than 17% in quarter 3 of 2020, is now likely to average over 27% in quarter 1 of 2021. Previous ESRI research has shown that the pandemic unemployment payment, PUP, and the employment wage subsidy scheme, EWSS, have done much to cushion the incomes of those who have suffered pandemic-related job losses.
Young adults and those working in the hospitality and arts sectors would have experienced particularly steep income losses in the absence of these supports. We have quoted some of our own research in our written submission as evidence in this regard. Research has also shown that while the PUP and EWSS represent a significant cost to the Exchequer, much of this cost could have been incurred anyway in the absence of these supports due to automatic stabilisers such as jobseeker's benefit and jobseeker's assistance.
The first table in our written submission depicts the monthly costs to the Exchequer of pandemic-related unemployment and of the accompanying supports in income tax forgone and extra welfare payments, including the PUP and the EWSS. The monthly net Exchequer cost of the pandemic unemployment shock is estimated to be €144 million in the absence of the PUP or the EWSS. With the PUP and the EWSS in place, the monthly Exchequer cost is higher at €193 million per 100,000 people newly unemployed.
It is notable, however, that much of the estimated Exchequer loss would have been experienced in the absence of these policies. This is because in the absence of the PUP and EWSS, the existing tax-benefit system would have helped stabilise incomes, through increased jobseeker’s benefit or assistance payments, for example. The EWSS, by facilitating job retention, also results in higher income tax if employers who receive the subsidy pay employees their pre-pandemic wage.
In our winter 2020 commentary, released in December, we had envisaged a further series of restrictions in 2021 in response to the easing of the measures prior to Christmas 2020. However, these restrictions were not assumed to take place until quarter 2 of 2021. They were also not assumed to be as restrictive as a level 5 lockdown. Consequently, we are now revising downwards our growth expectations for the Irish economy in 2021. We still believe the economy will register positive growth of approximately 4% this year. The expected path for unemployment in 2021 is also revised upward, albeit marginally. We now expect the unemployment rate to peak in quarter 1 of 2021, before falling consistently thereafter. The rate is forecast to be just above 10% by the end of the year. All this assumes vaccines will be rolled out successfully to most of the general population through the latter half of 2021.
The nature of the level 5 restrictions introduced in early 2021 means the fiscal accounts are likely to be in a more adverse state this year than previously thought. This is because more people are likely to be unemployed for longer than originally forecast. Consequently, we now believe a deficit of 4.8% or €18.9 billion is likely this year. That will result in the debt-to-GDP ratio increasing from 58.8% in 2019 to over 62% by the end of 2021. This comes on top of a sizeable deficit in 2020 of €23 billion or 6.2% of GDP. Previously, the State had run slight surpluses in 2018 and 2019 of 0.1% and 0.4% respectively.
In general, it is worth noting that the Irish economy performed much better than expected in 2020. Like most commentators, we had believed at the outset of the pandemic that the economy would contract significantly in 2020. However, it is now likely, and this was confirmed by the Central Statistics Office, CSO, last week, that the economy grew by approximately 3.5% last year. While a large part of that growth was due to the performance of a select number of multinational intensive sectors, it does underscore the point the Irish economy is better placed than most to emerge from the pandemic.
Turning now to the medium-term fiscal strategy, the state of the Government finances over the medium term will be significantly affected by developments in the labour market and how quickly the unemployment rate declines as the economy opens up. Our current forecast for 2022 indicates the unemployment rate is likely to average approximately 8% for the year. To put this in perspective, when the economy last had an unemployment rate of 8% in 2016, there was a general Government balance of almost 2%.
This increase in the debt levels associated with the pandemic has inevitably given rise to questions as to whether a contractionary fiscal policy will be required to pay for the additional costs to the Exchequer of Covid-19. While it is still too early to answer these conclusively, some recent analysis conducted in our winter commentary is informative, in that it assesses the likely implications of different recovery paths for the domestic economy on the sustainability of Irish sovereign debt levels. Drawing off work done by our colleagues, Dr. Adele Bergin and Dr. Abian Garcia Rodriguez, the analysis shows that if the future average interest rate on Irish debt remains constant over the next ten years, then apart from a delayed recovery scenario, the future higher debt levels will be sustainable. However, were the average interest rate to increase, then the debt dynamics would not be as reassuring. The analysis assumes that the State does not run a negative primary balance from 2022 onwards.
Most of the immediate fiscal pressures from the pandemic are tied in with the support payments provided by the Government. In that regard, there is much discussion over how long to continue Covid-related policies such as the pandemic unemployment payment, PUP, and the employment wage subsidy scheme, EWSS.
Should sufficient employment prospects exist, withdrawing the PUP could improve financial incentives for those seeking work to take up employment. So, too, would allowing existing recipients to maintain their payments for a period while taking up paid employment. This could encourage those in non-viable industries to seek employment in other sectors for which they may need additional training. However, if the labour market has not largely recovered, then the withdrawal of the PUP would disproportionately affect low-income, young, single workers. One option available to policymakers is a more gradual tapering of the PUP, which could help the groups most at risk of long-term unemployment after the pandemic to maintain a certain standard of living while searching for work. Existing welfare payments could also be reformed to better target this at-risk group. Much will depend on the post-Covid recovery and the availability of employment for different age cohorts and in different sectors.
Similarly, determining the optimal time to close or withdraw the EWSS will be challenging. In the long run, continuing the subsidy would mean supporting both employment that would exist even if the subsidy was no longer in place, which would be a deadweight cost, and employment that was no longer viable in the long term and where employees should be given the opportunity to retrain in other roles. However, withdrawing it too early may lead to some firms failing that would otherwise be viable. While close monitoring of the speed and scale of the recovery by sector might help inform this difficult decision, there is also a case for examining the design of the subsidy for any sector for which it continues. At present, the sharp cut-off in eligibility imposed by the requirement to be experiencing a 30% reduction in turnover means that some firms might face an incentive to suppress output, therefore inhibiting their recovery.
More generally, there is set to be considerable debate at European level about the future conduct of fiscal policy over the coming months and years. The European Commission is set to review the European fiscal framework following the forthcoming German elections. Recent comments by Dr. Isabel Schnabel, a member of the executive board of the European Central Bank, ECB, are interesting in that regard. She calls for unconventional fiscal policies that support the efforts of the ECB when inflation is below its aim. She points out that, in a European context, increased public investment, for example, has been found to crowd in as opposed to crowd out private investment.
The new European fiscal framework needs to be framed in such a manner that ensures a return to fiscal discipline among member states in the medium term but also enables governments to invest in key physical and social infrastructure over the same period. Fiscal rules could be formulated that allow for member state governments to invest in capital expenditure in areas such as social and affordable housing and green technologies on an ongoing basis but also ensure that, post the pandemic, current expenditure is maintained at a sustainable level.
My colleague, Dr. Doorley, and I will be happy to take members' questions.