The Government’s summer economic statement reflected a political compromise, changing the planned stance of fiscal policy over the course of this Dáil.
It was obviously framed in the context of considerable uncertainty about the nature of the economic recovery that is under way but, from what we now know, the planned relaxation of borrowing constraints out to 2025 looks unwise.
The main change in planned Government expenditure is due to an increased provision for investment in housing. However, the housing supply problem remains the same as it has been for the past few years – the ability of the construction sector to deliver the desired output.
At a time when private buyers, from their pent-up savings, are likely to be spending more, an increased injection of Government housing funds runs the risk of further pushing up house prices, with more money chasing sluggish housing output. This could replicate some of the problems of the 2000s when an ambitious government investment programme was layered on top of a boom in private-sector investment.
This time around, Central Bank action will prevent a knock-on shock to the financial system, but won't keep the lid on house prices.
Savings
Last week, the Central Statistics Office published the latest savings data. This shows that from the onset of the pandemic up to the end of March this year, households have built up exceptional savings of about €27 billion, equivalent to 13 per cent of adjusted gross national income. With continuing restrictions, this had probably reached €30 billion by the end of June.
The Department of Finance’s economic forecasts assume about a quarter of these exceptional savings will be spent in 2022 on consumer goods and services and on increased expenditure on housing.
This would see a temporary boom in the economy, though still not sufficient to restore full employment by the end of next year. However, it is possible that more of these savings could be spent, which would add both to growth and to construction demand, intensifying the pressures on the building sector in 2022 and 2023.
In planning for the next few years, much more attention needs to be paid to matching the stance of fiscal policy to the needs of the economy.
If there is an unexpectedly rapid recovery in the economy, and output reaches capacity in 2022 or 2023, the Government will need to run a surplus, to absorb the excess demand that the economy cannot deliver on. This could mean moving into surplus through either holding back on expenditure or raising taxation.
It is only if the economy continues to display unused capacity in 2023 and 2024 that the planned deficit could be justified.
While the primary need to provide for such a surplus is about preventing overheating, not about the size of the national debt, the impact of a potential future rise in interest rates needs to be taken into account.
Looking to the end of the decade, however, Ireland faces a series of challenges which will require higher public expenditure, not just on housing. Last year, the Irish Fiscal Advisory Council estimated that the increasing health and education costs of ageing will exceed the normal fiscal space available each year after 2025.
Just to keep services at their then current level will require higher taxes or cuts elsewhere.
Health service
The Department of Health has just published its estimates of the likely capacity required in disability services up to 2032, highlighting the impact of demographic change and of unmet needs. Earlier this week the Economic and Social Research Institute published research which highlights the cost implications of implementing Sláintecare – an NHS-type comprehensive health service.
Layering this on top of the needs of an ageing population and housing requirements will call for a further permanent increase in the level of public expenditure.
In addition, the costs of tackling climate change after 2025 will probably require further investment of 1.5 per cent to 2.5 per cent of national income. While some of this additional expenditure could be carried by households, this may prove difficult to implement without causing hardship to those on low incomes. Instead, that much of that bill is likely to fall to the Government.
Faced with these multiple challenges it would not be feasible to free up sufficient resources through cuts in expenditure. Further borrowing, at a time when interest rates may have normalised, will certainly not be the answer.
If we want decent public services that address the demographic and other challenges, the tax take will need to rise to pay for them. Ideally, such taxation would be broad-based, where society as a whole which benefits from better public services contributes to their cost.
