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Green Party Conference, Wexford, March 7th. 2009.

Stabilising the Public Finances

Colm McCarthy1, School of Economics, University College Dublin.

A new set of budgetary measures is due to be announced on April 2nd., and is likely to
include action to contain both current and capital spending.

Total Exchequer spending is the sum of gross current voted expenditure, Exchequer
capital spending and an item called Central Fund Services, which is mainly the cost of
servicing the national debt. The table gives the development in the ratio of total spending
to GNP in recent years (with and without debt service), together with my estimate of the
out-turn for 2008 and a guess at the likely result for 2009 (before the April 2nd.

Exchequer Spending as a % of GNP

Year Total Spend of which Central Fund Spend net of Interest

1985 55.7 12.7 43.0

1990 44.4 10.3 34.1

1995 43.5 8.1 35.4

2000 34.7 4.4 30.3

2001 36.7 3.7 33.0
2002 37.5 2.6 34.9
2003 36.5 2.8 33.7
2004 36.2 2.8 33.4
2005 37.0 2.8 34.2
2006 36.8 2.7 34.1
2007 38.9 2.4 36.5
2008e 44.0 2.5 41.5
2009f 49.0 4.0 45.0

Views expressed are the personal responsibility of the author.
The historical data to 2007 are taken from the Department of Finance publication Budgetary and
Economic Statistics, available on the Department’s website.

The figures show that the portion of GNP absorbed by Government spending has already
returned to late 1980s levels. It is only because debt service is still low, although rising
sharply, that the levels of the early 1980s have not re-emerged. Net of interest, spending
in 2009 on these figures is now above the mid-1980s level.3 Of course, part of the reason
for these developments is the sharp downturn in GNP. But total spending has been rising
rapidly in recent times. Spending doubled between 2000 and 2007, and rose again by
roughly 9% in 2008. It is the combination of rapid spending increases and the recent
collapse in nominal GNP which has created the pattern shown in the table.

Measures already taken will curtail this trend of spending increase in 2009. But the
collapse in Government revenue has been spectacular. About three-quarters of revenue
comes from taxes, the rest mainly from PRSI and Health contributions. Even with the
October budget increases, tax revenue alone will be down roughly 28%, or about !13
billion, in 2009 against 2007, and both PRSI and the Health contribution are weakening
as employment in the private sector contracts.

The result is that additional budgetary measures are needed just to keep Government
borrowing below 10% of GDP in 2009. The strategy must be to avoid deficits at this level
beyond the current year: the deficit for 2010 will need to be reduced decisively back into
single figures, with a view to re-attaining something close to a balanced budget within a
few years. Given the severity of the worldwide credit crunch and the hostile sovereign
debt markets, a repetition of the continuing large deficits which arose in the 1980s is not
an available option.

Timing of Exchequer Capital Projects.

There are economic, as well as financial, reasons why capital projects get deferred. The
Dublin Airport Authority issued the following statement in December:

‘DAA will be reviewing its proposed capital investment programme for the period from
2010 to 2014, and expects that this will be reduced significantly, reflecting the new,
lower growth, forecast of passenger numbers during this period.’

DAA saw declining passenger figures at its airports in the back end of 2008 and expects
this to continue for some time. Their expectations of likely volumes into the medium
term have accordingly been cut back. Thus the controversial second (Northern) parallel
runway may now be built several years later than originally intended.

This problem of capacity-enhancing projects becoming less urgent affects numerous

projects in both the public and private sectors. Simply, the economy is on a significantly
lower growth path than had been expected when these projects were planned, and
I have assumed that nominal GNP fell 2% in 2008 and will fall a further 7% in 2009.

economically optimal just-in-time construction implies deferral. This has nothing to do
with financial constraints. It does not affect backlog-elimination projects.

At a macro level, let’s pretend that Exchequer capital projects were planned a few years
back on the basis of 3.5% GNP growth into the medium term. I believe that this is
probably true of many such projects. Real GNP appears to have fallen 2% in 2008, and
will fall by (at least) 4% in 2009 on recent forecasts. Paint now a rosy scenario: zero
growth in 2010, followed by two years at 5% and then a resumption of growth at 3.5%.
This is rosier than recent projections – it is possible that the real GNP decline over 2008
and 2009 could be a lot more than 6%. But it does dramatic things to the optimal timing
of capacity-enhancing projects nonetheless.

Old and New Time-Paths for Real Economic Activity

Year ‘Old’ GNP Path % Chg New GNP Path % Chg

2007 100.0 - 100.0 -

2008 103.5 3.5 98.0 -2.0
2009 107.1 3.5 94.1 -4.0
2010 110.9 3.5 94.1 0.0
2011 114.8 3.5 98.8 5.0
2012 118.8 3.5 103.8 5.0
2013 122.9 3.5 107.4 3.5
2014 127.2 3.5 111.1 3.5
2015 131.7 3.5 115.0 3.5

This is all a bit mechanical and it can be objected that we could get back to an even
higher growth path at full employment eventually, with the ‘Old’ stock of productive
factors, including foreign labour and borrowed foreign capital, producing exports instead
of houses. But that is all academic: over the next five or six years, there is a phase-shift
even in a rosy scenario of about four years – for 2011, read 2015. I suspect there are a lot
of forecasters whose numbers imply more than a four-year phase-shift.

What all this suggests is that the Exchequer capital programme could be divided into
three groups:

(i) Projects which should go ahead, assuming they are financeable;

(ii) Projects which should be dropped on the grounds of poor economic value;

(iii) Projects which have been overtaken by the slowdown, and should now
rationally be deferred, but not necessarily cancelled for good.