What I would like to do is update for the committee what is in volume one of the report. As well as a summary of the detailed recommendations, it contained an initial explanation of why we are in this situation where the Government has committed itself to a pretty severe tightening in fiscal policy stretching out over the next several years. It is important to understand the macroeconomic context, so to speak. I also wish to take the opportunity to update what we have said in volume one of the report, which was released in the middle of July as lots of things have happened since.
By historical standards we are in what is a sudden fiscal crisis. We had a surplus in our annual budget just a couple of years ago. This year it looks as if the deficit will be 12% of GDP. Only a few months ago we thought it might be a little under 11% but tax revenue has been so weak that the deficit has had to be revised upwards. This is a large and sudden deterioration in the fiscal position. In addition, it coincides with the banking crisis, an international credit crunch and a rising exchange rate. We do more trade with non-euro currencies than any other member of the eurozone. We do a lot of trade in sterling and dollars. The rising euro exchange rate, especially against those two currencies, has exacerbated the competitiveness weakness that existed. For all of those reasons we are in the deepest and most serious economic downturn since the Second World War. However, in terms of just the fiscal position it is important to recall that we have been here before.
Many of those present were Members of the Dáil and Seanad in the 1980s when we were in a serious fiscal situation. That started in the mid-1970s and it built up. It was acknowledged by all of the participants in the political system by 1980, but as is evident from the chart in the PowerPoint display, we did not do much about it until the late 1980s. We borrowed 10% and 12% of GDP year in and year out for a decade. That was a decade most people would not like to repeat.
The first table, which is shown on the third slide, shows some of the fiscal ratios from the 1980s. It is interesting to compare the current situation with that in the 1980s because there are lessons to be drawn from that. The fourth row in the table on the right hand side shows the average annual rate of growth in total Government spending over the 1982 to 1987 period, which was a period in which there was just one Government. There had been three general elections in a row in 1981 and 1982 but then a Fine Gael-Labour Party coalition Government got in and lasted until 1987. Through that period total Government spending averaged an increase of 6.4% but the CPI, which is the bottom row in that table, averaged 6.3%. Over those five years, Government spending was not growing significantly in real terms. Exchequer capital spending fell. Current spending rose a bit in real terms. The Central Fund, which is mostly interest payments, rose much more quickly as it inevitably does when one is borrowing a lot.
The eventual correction of that public finance crisis got going in 1987 but there were lots of factors that were different. For example, there was no banking collapse the last time. The Government might have been in trouble financially at the end of the 1980s but the banking system was not. We also had our own exchange rate at that time which is important. There had been a devaluation in the middle of 1986, which helped to restore competitiveness and that had beneficial effects for several years thereafter. The other point is that the international economy was doing okay at that time. There was a tax amnesty in 1988 whose yield exceeded expectations. It yielded 2% of GNP more than the Government at the time had pencilled in. That was a pure bonus, if one likes. The other difference from the current situation is that as we have noted, spending growth had been slow prior to 1987.
The next table is interesting because it shows what happens when one eventually does get a fiscal correction and when one gets on top of a public finance crisis. The figures here might surprise some people because there is a certain amount of mythology about what happened in 1987 when Ray MacSharry was Minister for Finance and there were all those stories about "Mac the Knife" and all that sort of stuff. In reality, Government current spending was never cut in nominal terms. If one looks at the top row in that table, it grew 4.3% in 1987, 1% in 1988, nearly 1% in 1989 and then quite briskly at 8.5% in 1990. It was not the case that current spending was cut in nominal terms in those years. Exchequer capital spending was cut. In retrospect, perhaps it was cut a bit too much. From the inflation figure, which is CPI, one can see that total Government spending, which in real terms was constant in 1987, did fall in 1988 and again in 1989 but it recovered significantly in 1990. The really significant change in those years was the big improvement in revenue. Government revenue increased a great deal in 1987 and 1988. It did not increase considerably in 1989 but increased very dramatically in 1990. The result was that the Exchequer deficit fell to very manageable figures. It is a myth that the cuts were the principle reason. While they were necessary, the recovery in revenue had much to do with it.
The public finances crisis we face now is more difficult to address in many ways. The banking system has collapsed, as we know, and the banks are functioning because the credit of the Exchequer has been made available to them. We must now restore competitiveness without devaluation. The international economy is very weak and the sovereign credit markets are very difficult. In the 1980s there were not many countries borrowing. Ireland was doing so but sovereign credit was readily available. That is not the case now, as we all know.
On the positive side, the difference between now and the 1980s is that there is now scope for spending cuts. Spending growth through the mid-1980s was very modest but it was very rapid in recent years, as shown in the slide depicting the growth in total Exchequer spending. The figures are quite striking. There has been substantial real growth in spending year in, year out. The figures are for the period 2000 to date. In 2008, total spending rose by 9.8% and the CPI rose by 4%. Therefore, there was a sizeable real increase in spending, even though the crisis was manifest.
We do yet not have outturn figures for 2009 but it looks as if total Exchequer spending, which includes current, capital and debt service expenditure, could rise by approximately 7%. We do not yet know. Inflation is negative so there has been a very sizeable real increase in Government spending this year. This may surprise some people because there have been cuts in particular programmes. The Government has taken four sets of measures since last July. The budget was brought forward to October, there was a package of measures in January and an emergency budget in April. There were cuts in respect of what had been planned in respect of each of these measures. However, spending on social welfare has increased very rapidly because there is an increasing number unemployed and claiming various benefits. Our debt service bill has increased very rapidly. Once one starts borrowing at double-digit levels, the interest bill starts clocking up pretty fast. One must cut elsewhere to prevent even faster increases.
Let us consider what has happened to real GNP, the best overall measure of national income. It gives an idea of what is occurring in respect of the real basis for taxation. Improvements stopped early in 2007. There were fluctuations since then but there was basically a sideways trend until the first quarter of 2008. The first quarter of that year represented the peak. Since then, there has been a fall in the order of 13.5%. The figures to hand pertain to the period to the second quarter of 2009. In just five quarters, real GNP has decreased by 13.5%. That is real national income and what is available for the private sector, the Government and everybody else to share. One sometimes gets the impression that people are talking about whether we should have a reduction in our incomes. It has already happened and we can pretend it has not by borrowing. However, real GNP up to the second quarter of this year is 13.5% below the level that obtained five quarters heretofore.
The next chart shows Exchequer spending excluding debt service, that is, Exchequer spending on the current side. The figure for capital expenditure excludes the National Pension Reserve Fund. What is interesting about the chart is that it shows that the percentage of GNP being absorbed by Exchequer spending, excluding debt service, is back to where it was in the early and mid-1980s. People always object when there is pressure to reduce spending but, because of the steady increase in spending we have already witnessed and the reduction in GNP, the percentage of GNP we are absorbing through the Exchequer is now at the level that obtained in the 1980s.
The next chart shows the gap between Government spending and revenue. One can see spending has trundled along at quite a pace into 2009 and that Government revenue has just collapsed over the past few years. Revenue is weak under all headings. There is falling employment, which naturally affects PAYE and PRSI yields. The savings ratio has risen, which affects adversely all consumption taxes. It affects excise duties and VAT. There has been revenue weakness under all headings because of the faltering economy.
Particularly noticeable is the decline in property-related taxes, particularly VAT on new houses, capital gains tax on non-residential property and stamp duties. The yield from these taxes has dropped by €6 billion. This decrease, which can be connected very closely to the bursting of the credit-fuelled property bubble, occurred in just three years. That explains why Government spending and revenue have diverged so rapidly.
The next chart shows what has been happening to the national debt and debt interest as a percentage of tax revenue. The figures looked really fine until 2007 and even 2008, but in the latter year they turned. The national debt in billions of euro and the proportion of debt service as a percentage of tax revenue suddenly headed northwards. It is the suddenness of this that we must note. Obviously, the figure for 2009 is a forecast, as is that for 2010. It is important to understand that, even with the fiscal adjustment measures that have already been adopted and those the Government has proposed for 2010, both the outstanding debt and the interest bill relative to tax revenue are still increasing at a very rapid pace.
The next table is an update of the Stability and Growth Pact update that the Government released in April as part of the emergency budget. The Government's update has been overtaken by events. My figures are not really official but my best guesses at how the figures now look. There will, I am sure, be official projections on 9 December.
The GDP deficit this year will be 12%, or a little more depending on tax revenue. With the adjustment measures the Government is proposing for the budget, which will result in cuts of approximately €4 billion, the deficit will still be 12% next year. Debt as a percentage of GDP according to the EUROSTAT definition will rise substantially – I refer to a gross debt figure – and will eventually stabilise, perhaps by 2013, if we can reduce the deficit as shown in the slide. This is predicated on there being an end to the downturn next year and some reasonable growth figures in 2011, 2012 and 2013.
The numbers are meant to remind us that it is difficult when debt service starts clicking in at a rapid pace and when there is a high rate of social transfers because so many people are relying on the social welfare system during the downturn. We learnt this in the 1980s. It is difficult in the aforementioned circumstances to simply stop expenditure from rising. If tax revenues are depressed, as they are, it is difficult to stop the deficit from becoming greater. We have witnessed this again in recent years.
We are all aware that one can divide gross Government spending in many different ways, including into departmental Votes. A useful way to think of it is the division between social welfare, Exchequer pay and pensions, most of which is incurred in the health and education sectors, and other programmes. Gross current spending, when broken down, works out at social welfare amounting to 37%, Exchequer pay and pension, 35%, and other programmes, 28%. Many argue social welfare should be spared and pay not cut. If one goes down that route then adjustments must take place in a small portion of the overall programmes. Redefining sizeable expenditure programmes means that the proportion of cuts in the rest of them have to be much larger.
The consumer price index has been chugging along with 2% to 4% increases for many years. It has now turned dramatically negative. The falling price level means the real value of rates of payment in the social welfare system has risen in 2009. There were increases in January of between 3% and 3.3% in the various social welfare rates of payment while the consume price index is down 6.5% in the past 12 months.
A better measure of inflation, which excludes mortgage interest payment, is the harmonised index of consumer prices. It is down just under 3%. It follows that the real value of social welfare rates of payment are 6% higher than they were 12 months ago. Something similar has happened to the value of a given level of gross pay. Of course, there have been tax increases in the form of the income levy and increase in the health levy on earned income. It is also true that the real value of credits and allowances in the tax system has gone up because of the decline in the price level.
The special group was asked to examine gross current Exchequer expenditure. It examined a few minor capital items because they were so intimately connected with some current items. It was not asked to review the capital programme. While it did not examine rates of pay, it examined allowances and other issues to do with public service pensions.
Recommendations were made about those but none about rates of pay. The group did not examine the taxation side. In addition to whatever current spending cuts the Government decides upon, it can restrain Exchequer capital spending. There are many reasons why it might do this. The slowdown in economic activity means that in 2013 the level of real GDP in the country could be as much 24% lower than was assumed to be the case when the national development plan was put together. It assumed growth would be at 4.5% in 2008 when it was negative in 2009. We have lost five years in these terms. This means capacity driven projects are less urgent than they were. Accordingly, it makes sense to restrain Exchequer capital. In addition, there has been a 30% decline in tender prices according to the Society of Chartered Surveyors. That means €1 billion is worth more than it used to be in terms of what it can purchase.
It is open to the Government to make changes on the taxation side in the budget. It has indicated it is not much attracted to that. That is where most of the adjustment has come to date. Clearly, the Government can take measures to expand the tax base or change rates of taxation. Finally the pay bill can be reduced through reductions of rates of pay. None of these was considered in our recommendations.
It is important to understand that this is a little bit different from the last Irish fiscal consolidation in the sense that we are now recovering from a bubble in the economy. The economy got unbalanced and too big by 2007. It follows that a return to the pre-crisis year 2007 is desirable. However, 2007 was not a good place to be. There was an iffy banking system, a construction sector that was too large and the economy was uncompetitive. A return to 2007 is not desirable or possible in the sense that there is nobody to finance another bubble. We have to restore competitiveness through costs cuts because it cannot be restored through devaluation. It is also the case that most of the deficit is structural in the sense that it will not automatically be eliminated when recovery eventually comes.
There is too much debt throughout the economy. It is over-leveraged with excessive borrowing from abroad through the banking system, rather than through the Government, which must be eliminated. That explains the increase that has already occurred in the private sector savings rate.
People naturally are resistant to austerity programmes. There is much resistance to the cuts the Government is seeking and were recommended by the special group. It has been suggested we defer adjustments to 2017 or 2018. The first difficulty with that is that Ireland has been given a derogation from the Stability and Growth Pact by the EU. It is not clear it would agree to spinning out adjustment to then. The pact has been suspended because of the depth of the recession but it has not been abandoned.
We must be realistic of our membership of the eurozone. The international debt markets remain very fragile. It is not clear that any peripheral eurozone country which formally abandons its fiscal consolidation programme would find its ability to borrow unaffected by that. Either the markets may become unwilling to lend or the interest rates paid would shoot back up. We are already paying a penalty interest rate. There is also the question of a policy choice of whether a re-run of the 1980s is desirable.
