Thursday, 16 July 2009

The suggested cuts and their impact

Paul Sweeney: That the public sector needs constant reform and oversight is a given. It is always on the menu of every government, everywhere. It is useful, especially in times of crisis, to take a hard look at what is being done with our tax Euros in the public sector and by its employees, especially management. There is much low hanging fruit to be picked after 20 years of unparalleled boom and much in savings to be made which will make our public services more efficient.

The merger of many state bodies has been overdue for a long time. In 2004, I was taken aback at the number of quangos and I listed many of them in an appendix in Selling Out; Privatisation in Ireland. Since then, TASC has published on these bodies too, arguing that so many can detract from democracy. The key challenge today after the McCarthy Report will be to merge many of them with the cooperation of employees and to harness their enthusiasm in delivering better public services.

However, many of the recommendations of the McCarthy Committee will impact on the poor.

“The committee will,” Mr Lenihan said in the Irish Times, “be able to hear the opinions of all those affected by the independent report’s recommendations.” The one thing about this committee is that it is not independent. It was carefully selected by the Mandarins in Finance (who should have undertaken the work themselves… though one can see the advantage of outsourcing the manufacture of bitter pills), because all of its members are very conservative. As Vincent Browne has repeatedly said, none of them have a record of the promotion of equality or equity. So it will hear, but it does not have to listen.

The expert group has exceeded the Government’s target recommendation of
€3.5 billion worth of cuts, instead proposing a €5.3 billion package involving an initial, minimum 17,000 State job losses, including a €300 million reduction in the Health Service Executive’s paybill.

At first reading, there are two major criticisms of the report. First, is the lack of an economic analysis of the impact of the report. This is particularly surprising from a report chaired by an economist. And McCarthy is a competent and incisive economist. He was backed by the Department of Finance, with 690 staff (61 more than five years ago!). Finance staff get a substantial pay premium over other civil servants because of the technical nature of their work. There is plenty of talent within the 700 Mandarins to do this work. As it was not on the McCarthy Committee’s terms of reference, the lack of such an Economic Impact Statement of the Cuts is a glaring oversight by Lenihan and the Department of Finance for its work.

The reason there was no economic analysis of the impact of the report is that the extent of the proposals are so potentially deflationary that it may lead to a downward spiral in economic activity, delaying economic growth for some time. It is not beyond the capacity of the Department nor the ESRI to undertake this study now. If €5.3bn is taken out of the economy, on top of other cuts in public spending, including 17,000 state jobs, how many private sector jobs will follow? How will particular cuts hit certain sectors and jobs?

The 5% cut in Welfare is cruel and unjustified and it is particularly deflationary. The poorest spend all the money they have. Take this €850m from them and more jobs losses will follow. Besides, they are not enjoying the fall in the CPI of 4.7% as they don’t have fat mortgages, a point McCarthy himself concedes, albeit indirectly. He takes a longer time span to make the case for such as harsh cut in welfare.

The public/private division is a poor one for most analysis. Many private firms, e.g. economic, management, engineering consultants, lawyers and accountants have varying, but sometimes a high dependency, on the state for their income. There is one large engineering firm which is almost totally dependent on local authorities for almost all of its income. With the negative multiplier, as public spending is cut, many in the private sector will lose their jobs or find their income squeezed as the cuts work through the economy.

Some economists will argue that foreign demand will make up the shortfall, but the IMF reports that advanced economies will decline by a substantial 3.8% this year. The fall in world trade in Q1 09 was the sharpest ever. Thus, domestic demand, which is a complex area in a small open economy, does help in times like this. Cutting it harshly may lead us downward….

The second criticism I have is the lack of poverty-proofing of its recommendations. This is undertaken on the impact of each Budget in the Budget report itself, and there is no reason in the world – except political – that it was not done on the social impact of this major report. This is the equivalent of many Budgets. Many of the recommendations of this report will disproportionately affect the poor. Again Mr Lenihan and the Department should have set this out in the terms of reference.

If this was done, the 5% cut in welfare would not have been recommended (though the McCarthy Committee offer a lesser 3% cut as an option too). The recommendation on overseas aid - that Ireland should abandon its pledge to spend 0.7 per cent of its national budget on overseas aid by 2012 because this can “no longer be afforded” will hit the poor of the world. Instead, a new target date of 2015/16 should be set, McCarthy recommends.

Minister for Finance Brian Lenihan last night insisted the public must accept that there are hard choices ahead, adding that €4 billion must be cut from spending or raised in extra tax next year. “There is no doubt that implementing the scale of adjustments required means that we must all take some very difficult decisions,” he said.

What Lenihan did not say is that most of this pain could and should have been avoided. Had Mr McCreevy and the government not cut direct taxes so much, so pro-cyclically during the boom; not given huge tax breaks to property investors and not allowed the Financial Regulators to allow the banks to go wild lending indiscriminately as if regulation was a bad word, Ireland recession would be far less harsh. We had almost €60bn in surpluses on current account in spite of massive tax cutting over ten years. Who blew this money? Some went in investment, but the rest was “given back to taxpayers” to spend on the boom.

It was free market fundamentalism in the US and importantly, and here in Ireland that led to our crisis. Cutting direct taxes in the boom from 1998-2003 inflated the bubble, especially the construction boom from 2001. Will cutting public spending so harshly and in such ways in this deflate the economy even more? And make things even worse?

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