Economy

Why we can’t throw the kitchen sink at inflation – The Irish Times

Later this month Minister for Finance Paschal Donohoe and Minister for Public Expenditure Michael McGrath will present their budget and the Opposition will round on them for not doing enough.

The Government is programmed to trumpet its own policies: to say it is announcing unprecedented measures in the face of a crisis not of its making. The Opposition’s raison d’être is to attack: to claim the Government is failing to deliver and — crucially for any Opposition — to claim the Government is out of touch. This is just part of the political patter that is the adversarial system. The truth about what the Government is or isn’t doing, or what is actually happening economically tends to get lost in the noise or reveal itself only in retrospect.

We took for granted the rollout of wage supports during the pandemic probably because governments en masse did it but it was unprecedented and in sharp contrast to the austerity policies deployed during the previous crisis. Effectively, the Government nationalised a significant portion of the private sector wage bill to shield the economy from the downturn. The concept of furloughing workers during a crisis was derived from the German “Kurzarbeit” programme, which is credited with limiting the employment shock in Germany after the 2008 crisis and facilitating a swifter recovery. And it has worked here.

The Irish economy has bounced back more quickly than anyone could have forecast precisely because wages were preserved and firms kept afloat. Approximately 4,500 Irish businesses were saved from going bust because of State support, according to business consultancy PwC. And 28 months after unemployment hit a record 30 per cent, we’re now back at near full employment. The jobless rate for August was put at 4.3 per cent.

The Government’s all-in approach to the pandemic has, however, created an expectation that it can step into the same extent in the current energy-driven cost of living crisis or as Goodbody economist Dermot O’Leary said last week throw the kitchen sink at the inflation problem.

But there are a number of reasons why it can’t chase the current price squeeze, and perhaps more importantly why it shouldn’t.

First, we’re already at full employment. Adding more fuel to a tight labour market would trigger further inflation. Estimates suggest that while about half the additional spend placed in the pockets of citizens via the budget would exit the State on energy imports (we import the bulk of our energy), the balance would be channelled into the domestic economy, fuelling further price hikes in service sectors like retail and hospitality but also in construction which would have knock-on consequences for our housing output.

If politically edifying, it would be self-defeating economically. Economics is about trade-offs and the Government has to box clever.

Another reason is we don’t have the resources to help everyone. Open-ended support to cover an inflation crisis would be an extremely costly undertaking and the Republic’s debt burden (at €240 billion and climbing) remains among the highest on the planet. To fully track expected wage and price increases “would entail costs far in excess of what the Government has set aside”, the Irish Fiscal Advisory Council (Ifac) counselled in a pre-budget submission last week.

Expenditure would have to be increased by almost €7.5 billion in Budget 2023, Ifac estimated. Such an outlay would allow the Government to raise core social welfare and pension payments in line with expected inflation while delivering public sector pay increases of 6.6 per cent and implementing planned capital spending increases.

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But it would drive core spending to over €100 billion by 2025, 25 per cent up on last year, and at a time when the State is facing a fiscal time bomb related to funding of pensions and healthcare as the population ages — costs that will dwarf the financial commitment associated with the Covid crisis.

“Holding fire for now is wiser, given the huge uncertainties about what will happen in the winter. Temporary measures provide some flexibility, and the Government should stand ready to provide more support if needed, rather than acting before we know what the situation will be,” the council’s chief economist Eddie Casey says.

The public finances remain in something of a sweet spot at the moment with tax receipts growing strongly on the back of employment growth and increased corporate profitability.

“Perhaps counterintuitively” the narrowness of the State’s tax base is what served to insulate the public finances during the pandemic, the Department of Finance noted in its Annual Taxation Report last week, with increased profitability and rising wages, particularly in the multinational sector, boosting corporate and income tax receipts. We lucked out. A crisis within the multinational sector would have disadvantaged us more than others, similar to the banking crisis of 2008.

The Government can and should tailor the budget to alleviate the pain inflicted on less well-off households. Approximately 90 per cent of the measures to date have been untargeted, according to Ifac. The bulk of the money (€800 million) has gone on an energy credit and a cut in excise duty on fuel.

If the Government somehow removed the top 50 per cent of households from these dig-outs, that would allow it to double the supports going to poorer households. This could make a real difference and is surely better than providing all of us with supports that mean little in the context of €4,000 annual energy bills.

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