According to the Sunday Times/Behaviour and Attitudes Survey published on 22 April, 55% of the electorate do not fully understand the Fiscal Compact. This is worrying - if you are going to vote on something that will have profound implications for your fellow citizens, you owe it to yourself and the rest of the country to fully inform yourself as to its implications. After all, would you sign a contract without knowing its terms?

With the results of the survey in mind I thought it timely to set out some simple to understand comments about the treaty.

What are the primary purposes of the treaty and how might it affect the economy?

The government deficit

Governments will be required to ensure that the annual budget deficit (tax revenues minus current expenditure) does not exceed 3% of gross domestic product (GDP) at “market prices”.

Taking this in isolation from any other objectives of the treaty, we need to ask ourselves what the 2011 budget deficit was. According to publicly available data from the Department of Finance the current account budget deficit for the year 2011 was €11.223bn.

According to data published by the Central Statistics Office the 2011 GDP figure was €161.034bn. Therefore, on the face of it, the current account deficit of €11.223bn represents around 7% of the 2011 GDP figure. However, on 23 April 2012 Eurostat issued a briefing document stating that the Irish budgetary deficit for 2011 (including bank recapitalisations) was 13.1%.

However, and this is a question that you, the reader, should consider when assessing if the focus on the current account deficit as a percentage of GDP is excessive or not:

With emigration at record levels (some of whom were unemployed at the time of emigrating and some who were not) together with unemployment at around 14.6%, what is likely to happen if further ‘austerity’ is pursued in the absence of employment growth?

‘We’ all know that things are difficult in Ireland but not all are ‘feeling’ it. Forcing the budget deficit down further through regressive tax increases will probably worsen unemployment and exacerbate the economy’s downward spiral. So society needs to switch its focus from the deficit to employment growth.

The ratio of government debt to gross domestic product

The treaty requires governments to reduce “government debt”1 to 60% of GDP (at “market prices”) over a period of 20 years “at an average rate of 1/20th per year” where the public debt (general government debt) is above 60% of GDP. Note the use of the phrase “average rate”. This suggests to me that there is scope for the government of the day to reduce the “debt” by more than the 5% (1/20th) envisaged by the treaty. Indeed it could be less depending on the prior years.

Ireland’s general government debt, according to a document published by the NTMA, stood at 107% of GDP, or approximately €172.36bn, at the end of 2011. This correlates with an information note on Ireland’s debt published by the NTMA in May 2011 where they estimated the final government debt figure for 2011 would be €173bn.

The NTMA further estimates in this note that general government debt (the figure which must equate to 60% of GDP) in 2015 is expected to be €203.6bn. GDP itself in 2015 is estimated to be €182.7bn. This means an expected GDP growth rate between 1 January 2012 to 31 December 2015 of just under 13.4% (in total when compared to the GDP figure for 2011).

While the Fiscal Compact itself does not explicitly state what year the 5% per annum reduction process is to commence, it does say that legislation, reflecting the terms of the treaty, is to be implemented no later than the beginning of 2018. This means it could happen at any time after the treaty comes into force (1 January 2013) provided it has been passed at referendum. Given the NTMA has published its expected figures up to 2015 it’s helpful to use that year (2015) as a reference point for illustration purposes. For Ireland to even attempt to avoid the need for a prolonged excessive deficit procedure (or long-term austerity – explained below) a GDP growth rate of 110.7% would be needed in order to reach a GDP figure in 2015 of €339.33bn, such that the expected debt figure in 2015 would be equal to 60% of the expected general government debt for that year. Note that for 2011 GDP stood at €161.034bn - what is the likelihood of a doubling of GDP in four years?

For the debt to GDP ratio to be satisfied one of two things will be necessary. Either GDP grows massively (this might be achieved by attracting more FDI into the country, meaning their profits are counted in the GDP statistics) or the debt is savagely paid down. This latter option can be achieved in one of three ways, namely severe expenditure cuts, severe tax increases, or a combination of both.

What are the implications of this requirement?

The past and current administrations have so far favoured cuts in expenditure and regressive tax increases. These affect those not in employment more than those in employment, insofar as those relying on social welfare will be affected more adversely by cuts in expenditure and increases in consumption taxes (namely VAT and other such taxes, e.g. property taxes and water taxes) rather than increases in either income tax or corporation tax.

Are there any downside risks to this requirement other than those highlighted above?

The answer to that question is yes. Currently, there is Irish State debt that is considered off-balance sheet (NAMA & its Special Purpose Vehicle for example), meaning that it’s not counted in the figure of €203.6bn mentioned above. If Eurostat were to change the debt measurement rules of the Irish State such that this off-balance sheet debt were to be counted in the debt – thus, obviously increasing it – this would necessitate even greater “budgetary adjustments” following the passing of the referendum (in the event that GDP doesn’t massively increase) if the 60% ratio is to be satisfied. It’s difficult to know if many people in Ireland consider this.

The excessive deficit procedure

The fiscal compact incorporates the revised Stability and Growth Pact in the context of the “debt brake” rule - i.e. the 60% debt to GDP rule. (A consolidated version of the revised stability and growth pact can be found here.) What is an excessive deficit programme, you may ask? According to a document issued by the EU in December 2011 Ireland and 22 other member states in the EU are undergoing excessive deficit procedures. In summary, the type of austerity we are ‘all’ experiencing at present is the “excessive deficit procedure”.

According to a document issued to members of the Oireachtas in March 2012 by the Oireachtas Library & Research Service, the excessive deficit procedure is automatic where the general Government debt is in excess of 60% of GDP. This appears to be the case regardless of whether the current budget balance is in deficit or surplus. In order words, it would seem that Ireland will continue in an excessive deficit procedure (i.e. the type of austerity being experienced now together with future predicted cuts) until such time that the general government debt to GDP ratio hits 60% - regardless of whether the annual budget is in surplus or in deficit. It is conceivable that a fiscal year would see the Government in budgetary surplus, but with the Fiscal Compact passed there would still be an excessive deficit procedure in place. In other words the objective of the Fiscal Compact appears to be to ensure that any future budgetary surpluses are used to pay down the government debt to the 60% ratio. In theory, of course, this might make perfect sense, but does it make sense in light of some of the components of our government debt? It's up to you to conclude whether that is a good or bad thing for the Irish economy. I personally feel it’s a bad thing, because unlike Michael Noonan I don’t believe that the exchequer is the economy; it’s only a component of it.

The excessive deficit procedure can only be avoided in the event of a qualified majority vote of the EU Council/Commission not to implement such a procedure. In other words, a state is locked into an excessive deficit procedure where the 60% ratio is broken. This seems to be the basis on which some campaigning groups call this treaty the ‘austerity’ treaty.

The structural budget balance

A separate element to the Fiscal Compact is the concept of “the structural budget balance”. Basically, the compact sets a deficit limit of half of one per cent (0.5%), and states that the requirement to have the “budgetary position of the general government balanced or in surplus” will be treated as satisfied if the deficit is not in excess of the half of one per cent. If you consider that the current account budget deficit for 2011 ranged between 7% and 9% but was revised upward by Eurostat recently - as mentioned above - it is difficult to envisage how this requirement can reasonably be met.

Generally speaking economic commentators seem to differ on what is meant by the structural budget balance of the exchequer – with many saying that it cannot be definitively defined - but it should be noted that, in 2007, the structural budget balance of the Irish State was deemed to be in surplus by the EU Commission (though they have since revised their assessment to a negative structural budget balance, i.e. a deficit – see here). In other words, what this effectively demonstrates is ‘uncertainty’ in the minds of those tasked with measuring the structural budget balance. This means that it’s something of a moving target, with the consequent effect of budgetary fiscal uncertainty on an ongoing basis. This, in my view, could have the effect of freezing the economy even more. Signing up to such a policy is not wise in my estimation.

In February Tom McDonell wrote that between 2015 and 2018 there would need to be further ‘austerity’ of circa €5bn in order to meet the 0.5% structural budget balance requirement. Even with such an ‘adjustment’ there would be no guarantee that this budgetary requirement will be met. After all, if GDP falls, tax revenues can fall, and so the overall budgetary position at a given point in time is altered.

Summary

Despite what our Government says about this treaty not being an ‘austerity’ treaty, it is just that. Despite what our Government says about this treaty being a referendum on membership of the European Union it is not that. I think it is fair to say that austerity, while ‘helping’ to reduce the deficit in the short term, is undermining the entire domestic economy and leading to increasing levels of unemployment - which will lead to further austerity which in turn will lead to a further deterioration in the economy. The only way that deterioration will be reversed is for employment growth on a grand scale – rather than of 100 jobs here, and 100 jobs there - to recommence.

If I am honest enough to offer my view of the treaty I would say that it is not something which should be passed by referendum. It deserves a No vote as it is too restrictive for the Irish economy. It does not offer any form of budgetary flexibility now, or at any time in the future. Such flexibility is required now and into the future and should not be surrendered. It might help to think of the Irish economy as like a business that is looking to grow. Ordinarily a business looking to expand and grow might re-invest a portion of any profit made from its activities in order to facilitate that expansion. Under the Fiscal Compact that is not going to be possible. Budgetary surpluses (in their entirety) are going to be required for financing debt repayment until such time as the 60% debt to GDP ratio is satisfied.

It’s now over to you.

The following text was taken from a blogpost by Brian Lucey, which gives a very useful summary of the treaty.

What is the treaty?

Budget must be in structural balance or surplus, defined, as structural deficit cannot be higher than 0.5 percent of GDP

Countries, which have debt/GDP below 60%, can have a structural deficit of 1% or less

A country with debt/GDP above 60% has to reduce the excess by one-twentieth a year

If the budget is not in balance, automatic correction rules must be enforced

If a euro zone country does not write the balanced budget rules into its national law, it can be sued in the European Court of Justice and can be fined 0.1 percent of its GDP.

The agreement will enter into force once 12-euro zone countries ratify, or on January 1, 2013. – Euro zone countries will coordinate national debt issuance plans in advance.

Only countries that have ratified the fiscal compact and written balanced budget rule into national law will be eligible for bailouts from the European Stability Mechanism.

all EU countries, whether in Euro or not, apart from Czech Republic and UK, are signatories to the compact. {jathumbnailoff}

1. General Government Debt is a gross measure and does not allow for the offsetting of Exchequer cash balances. As well as the National Debt it includes the promissory notes issued to certain financial institutions, local government debt and debt of non-commercial State bodies. GGD ratios are as published by the Department of Finance in Budget 2012.

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