The referendum - what to do?

Jim Stewart09/03/2012

Jim Stewart: The Treaty on Stability, Coordination and Governance is flawed in many respects. Martin Wolf, writing in the Financial Times on 6th March, itemises some of these flaws. The obvious one is the requirement in clause 1b limiting the ‘structural deficit to 0.5% of GDP’. Countries must adjust rapidly to this position as agreed by the European Commission. In addition if the ratio of government debt to GDP is greater than 60%, article 4 requires the excess amount to be reduced over a twenty year period. So that a country where a debt/GDP ratio is currently 100% is required to reduce this amount by 2% per annum. In effect this means running a budget surplus of 1.5%. This is impossible to achieve, without debt writedowns. In the absence of debt writedowns attempting to achieve this target would deepen the current recession in Ireland and other countries, and prevent any economic recovery.

The Treaty states that the rule will be deemed to have been “respected if the annual structural balance of the general government is at its country-specific medium-term objective”. The problem is how can this be known? Both Ireland and Spain would have satisfied this budget criteria before the economic crisis. The key question was whether government finances were stable over time? This means that (1) the financial crisis would have to be forecast, (2) policy responses would have to be forecast, and (3) the effect of both the financial crisis and policy responses on government finances would have to be forecast. Some economists got point (1) right. Official Ireland was spectacularly wrong. No economist forecast all three nor would this be possible. The proposal from Philip Lane (Irish Times Feb. 7) for Ireland to develop a capacity (funded by the State) for “independent, high quality assessments of structural trends in the economy and the public finances” will have the effect of creating jobs for economists but little else.

Further issues arises in relation to the measure of debt. For example, activities transferred to a commercial State owned company, such as the proposed Water Authority, would also have associated debts transferred. Current measures of GDP are favorable to Ireland because GDP is inflated by profit switching transfer pricing by foreign owned firms. This may not always be the case. How can rational economic policy be based on a ratio, in which both the numerator and denominator are subject to revision, especially in the case of GDP?

This does not mean that over a period of time Government expenditure and government revenue, should not be sustainable. Being sustainable does not mean expenditure should be almost identical with revenue. An economy that is growing strongly can have both government deficits and maintain a stable debt/GDP ratio. Successful economies can have widely varying ratios of debt to GDP over long periods of time, for example Japan.

The fiscal treaty can be added to the list of flawed policy making that has helped turn an economic crisis (largely of our own making) into a national catastrophe. It is particularly dangerous because it will be incorporated in the constitution making change very difficult and incorporates the right of another one of the signatories to the treaty to bring a case to the European Court of Justice (article 8.1) and face financial sanctions in the event of non-compliance. It is the same thinking that initially set penal interest rates on Irelands borrowing under the EU/IMF Programme.

Hence the question arises why would rational people vote in favour of a Treaty which has so many flaws. John O’Hagen (Irish Times, 8th March) asks of those opposing ratification to explain “how day-to-day State expenditure will be funded from 2013”. The simple answer is that according to the Government, after the current programme has ended, (that is at the end of 2013, not ‘from 2013’ see EU/IMF Programme, p. 16 ) Ireland will turn to the bond markets for financing (Minister of State Brian Hayes quoted in Irish Times 6 March, 2012), and a point also made by Jean-Claude Juncker, chairman of the Eurozone finance ministers, to the European parliament on Feb 29.

But the point has been made unless the Treaty is ratified financial assistance will not be granted from the European Stability Mechanism at the end of 2013 should it be needed. So the question is how likely is a second bailout and to what extent will it be required? The answer to this question is uncertain. Funding is in place from the existing programme until the end of 2013. While bond redemptions amount to €11 billion in 2014, they will be zero in 2015 (NTMA annual Report 2010, p. 15). In addition, national savings contributed about €4.3 billion in 2011, and could rise further.

A further uncertainty arises from the stated intention of Francois Hollande, the front runner in the French Presidential election to renegotiate the treaty (Hugh Carnegy and Quentin peel, Financial Times, March 4, 2012). At the same time the main architect of the treaty Merkel, has lost credibility in Germany with the resignation of the candidate she supported as President. Because of this and other issues, Der Spiegel (2/21/2012) reports difficulties within the coalition government and states “many are now asking how much longer it can survive”. The second bail out package for Greece required the support of the opposition Social Democrats and Greens (Der Spiegel 2/27/2012). Opposition parties and likely participants in a successor government espouse policies such as emphasising growth rather than austerity to balance budgets, a Eurobond and a Financial Transaction Tax.

Spain recently announced a new higher target for the budget deficit of 5.8% compared with 4.4% agreed with the Commission, some hours after signing the new Treaty. Furthermore the Spanish Prime Minister announced that the budget deficit was a matter for the Spanish Government and not the Commission. It is also interesting to note that there was very little change in yields on Spanish government bonds (benchmark 10 year yields rose from 4.91% to 4.96%) on the first day of trading after this announcement and the signing of the Stability Treaty, indicating, perhaps that markets recognise that increased austerity is bad for economic growth and bad for bond markets. Further budget cutbacks in the Netherlands could result in a general election in which political parties opposed to budgetary cuts would make large gains (Financial Times, March 1, 2012). It is likely that government policy in relation to the financial and economic crisis will change in key EU countries as a result of political change.

The strategy to adopt in the face of this uncertainty is to delay holding a referendum for as long as possible. At government level we in Ireland have ‘world class skills’ in delay. The Department of Justice is especially skilled in this regard. A delay is likely to mean that political change in EU countries, such as France, will result in change to the Stability Treaty. Peripheral countries (Greece, Ireland, Portugal, Italy, Spain) will thus have an opportunity to influence treaty change to their benefit. Writing detailed fiscal stability rules into a constitution is flawed reasoning, and treaty change could remove this threat. Delay will help clarify if and to what extent a second bail out is needed.

What about the promissory notes? If as some have suggested there is an agreement to reduce the cost of the promissory notes, should this influence or decision? On this An Taoiseach is correct: there is no linkage. The cost of the promissory notes can and should be reduced under existing rules and should have no influence on voting intentions on the Treaty for stability.

It is difficult but vital that economic policy is taken from those without any democratic mandate, and without any economic policy other than a dogmatic adherence to the imposition of austerity. It is indeed unfortunate for Ireland and the EU that we have a Commissioner for Economic and Financial Affairs who is bereft of ideas. It is doubly unfortunate for Ireland that those directly responsible for implementing the programme (Mr. Székely, Director and European Commission mission chief to Ireland) are unable to produce a single idea that is growth enhancing (see for example the recently published review of the economic programme for Ireland).

Posted in: InequalityEconomicsFiscal policy

Tagged with: deficitausterityFiscal Stability Treaty

Prof Jim Stewart

James Stewart

Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.

He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).



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