Friday, 9 March 2012

The referendum - what to do?

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).


Paul Hunt said...

I am pleased that you highlight that there is no linkage between the treatment of these darned PNs and the proposed referendum on this 'fiscal compact' - though I suspect this is not a view that would be shared by many here. These PNs have to be restructured in some way and soon and, as you say, under the current arrangements.

I also agree that Irish people should not be asked to decide on the fiscal compact until such time as ireland is close to exiting from the current official programme of support - when it will be much clearer whether or not a second programme will be required. If such a programme is, a referendum should be delayed until such time as Ireland is close to exiting this further programme.

While Ireland is in an official support programme the conditions of the programme will over-ride any conditions set out in the fiscal compact. In effect the fiscal compact is irrrelevant while Ireland is in a support programme and the irish people should not be asked to decide until Ireland is getting close to a position where the terms of this compact could become applicable if they were to so decide.

Once again, I am pleased to see such a sensible approach to both the PNs and this proposed referendum advanced here and I could not commend them more strongly.

I am confident that many Irish people would support a campaign to postpone this referendum until such time as they were in a better position to make an informed decision. And I am also confident that, were the Government to press ahead and seek to hold this referendum before people were in a proper position to make an informed decision, many people would support a campaign to abstain from voting.

Anonymous said...

Stewart is to be commended for his intellectual integrity and the clarity of his thinking.

Stewart’s intellectual integrity stands in contrast to his colleagues who grovel in acquiescence to those loony ideologues responsible for the so called fiscal compact.

Stewart has expertly exposed the fiscal compact as a complete nonsense that goes beyond insanity.

To incorporate such a nonsense into Ireland’s constitution would not only be dumb in the extreme it would also as Stewart highlights place Ireland under the control of an unelected gang of loonies unhinged by the intensity of their indoctrination in obsolete ideologies.

The rational approach as so well articulated by Stewart is to delay the holding of a referendum to the last possible moment and then only if that last moment were to actually arise.

The fiscal compact represents a destructive Neanderthalism whose implementation would be a catastrophe for Ireland, Europe and the rest of the world.

Martin O'Dea said...

Finger's crossed as outlined in Jim Stewarts excellent piece - elections in Europe will empower current opposition groups with policies of investment, clemency and future increased control of markets - the correct reaction to a crisis stemming from unfettered market extravagance
Ireland's government over the coming years will most likely start to run with the fox during this time and will lay claim that their negotiations and steadfastness to erroneous policy were central to Ireland emerging from the treasonous originated quagmire.

If this comes to pass - and hopefully it does and that which is good about Europe rises up, what of the political landscape in Ireland. Will people take the well meaning irrelevant current efforts from this government as the route to continue supporting yet again with either FF or FG led future governments who with the best will in the world emerged without ideology from a conflict and stumbled along after social change into Irish versions of the American Republican Party (we have two of them) - -of course offence might be taken here and FG and their current assistants the politics putting first labour party will point to the good work they have done within the confines of their legacy they inherited etc; the problem is they should never have accepted that legacy; they are busily treating the (and with some good ideas) plaque on the teeth of a man who has just been shot

Seamus Coffey said...


This is a useful post and there is much I agree it. However, you say:

"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. "

There isn't much in this I can agree with. There is no twenty year requirement. There is no "reduce this amount by 2% per annum" requirement. There is no need to run a budget surplus of 1.5% per annum. There is no need for debt writedowns.

Take a country with a debt equal to 100% of GDP. Under the debt brake rule that country would have to reduce its debt ratio by one-twentieth of the gap between the current level of debt and the 60% threshold. That means reducing the debt to 98% of GDP in year 2 as .05[100-60] = 2.

[If a country has a debt of 80% of GDP it would have to reduce it to 79% of GDP the following year as 0.05[80 - 60] = 1.]

Anyway back to the country with a debt of 100% of GDP. Consider then, that it is forecast that there will be 2% inflation and 2% real growth. This means GDP will rise to 104. It can be seen that 98% of 104 is 101.9.

All the country has to do is make sure its debt doesn't RISE by more than 1.9 to satisfy the debt brake rule. There is no need for a surplus of anything. The country can run deficits of 1.8% of GDP. There is no need for write-downs. The country can keep borrowing.

The effect of the debt brake rule with debt equal 100% of GDP under 2% and 4% nominal growth scenarios can be seen in this table.

After 20 years the debt can still be around 75% of GDP and even under the pessimistic 2% nominal growth scenario there is never a requirement to run surpluses and after two years of balanced budgets the country can run (small) deficits.

It is the structural deficit rule rather than the debt brake rule that will be the greater restriction of fiscal policy.

Martin O'Dea said...

I think there is an interesting point regarding Leo Varadkar's odd comment on populations not voting on the issue at hand for referenda - I am sure he must have thought that the referendum would not go ahead to say it, but be that as it may, there may well be an unintended truth to what he said.

As much as politicians and commentators, will try to hammer home the message that the referendum is about its own particular content; it is, ironically, impossible to see this referendum as not being seen in Ireland, and especially in Europe, as an endorsement of Ireland's current agreements with Europe. It is very difficult to see it being interpreted any other way within the corridors of power in Europe. A bailout country's people voting for the fiscal compact would give major clout against any future popular resistances

Now that is all alright unless what we are doing is completely wrong, unless we have stumbled punch drunk into an agreement and continued to trudge along with a commitment to an incorrect course with structures in place across the media and political systems capable of mass delusion that seems a simple extension of what was occurring prior to the crash of 2008.

I watched Michael Noonan on the week on politics on Sunday 11/03 and was knocked for six by his reply to one question. The RTE question was a gentle representation of David McWilliams' point for the last 3 years; i.e. that markets would appreciate a default on unpayable debts, or would at least not really cue Armageddon
I think it is extremely important for us not to get caught up in the emotion that clearly permeates RTE at the moment, i.e. isn't it great that someone said that we are somehow doing a little better and that this financial problem may actually begin to go away; as the Minister's unbelievable answer went completely unchallenged.
Mr Noonan (adamant that we should regress 800 years with his unique adherence to 213 and 214)addressed this issue by explaining that we must remember that this (the Greek default) was very well signalled, that markets were informed that it was coming and so it didn't come as a surprise
This is simply astounding. Historians will see that a huge part of the motivations, which to be fair have flipped a lot, framing our commitment and re-commitment to repayment of banking debt was in fear of the repercussions of a default, largely speaking regardless of the morality, arithmetic or many other arguments made throughout the last four years, many of which were accepted in principle but then rebuked as the 'nuclear option'.
So, with the absolute magnitude of the issue here, Mr Noonan explains that in this case it was different because the Markets were informed that this was coming; which, of course, we couldn't do!

Martin O'Dea said...

Sorry,minister, 800 should read 1800!!

Tom Healy said...

@Jim Thanks for a timely and very thoughtful post. Four things are certain (in addition to death and taxation!):
1 There is a solemn, binding and permanent inter-governmental Treaty for those countries ratifying;
2 The Treaty will not be changed in any fundamental respect
3 There will be a referendum in this State - it is almost certain to happen within 2012
4 There will be two options on the ballot paper (not counting abstentions). its Tá or Níl.
A very positive aspect is that each of us European citizens are being asked to cast our verdict on the Treaty as it is and not as we would like it to be.