John FitzGerald: Where did the €30bn in cuts go?

After seven years of tough cuts in public expenditure and increases in taxation we are, hopefully, at the end of the process of adjustment. This does not mean next year’s budget will return to the ways of the bubble years – it will still need to keep a very tight rein on the public finances. However, it will probably involve a small easing in the fiscal pressures that nearly everyone in the State has experienced since 2007.

With the bulk of the adjustment completed, it is a good vantage point to review the €30 billion taken out of the budget since 2008.

These cuts in expenditure or increases in taxation amounted to over 21 per cent of national income – GNP.

A little over a third of these measures involved raising revenue and the rest involved cuts in public expenditure. Although this has resulted in a huge turnaround in the public finances, the government deficit will still be over 2 per cent of GDP this year.

Nobody was untouched by the adjustment. There was a reduction in disposable income per person of up to 10 per cent. Many public services were cut back, and service levels fell. The one exception to the drastic cuts in expenditure was welfare payments, which actually saw a significant increase in expenditure over the period 2007 to 2011.

Because unemployment trebled over that period, the cost of unemployment payments also mushroomed.

While there were some limited cuts in welfare rates (especially for the younger unemployed), the dramatic increase in numbers relying on welfare meant a substantial increase in expenditure.

With real GNP down 14 per cent at the trough of the recession, the share of the greatly reduced national income going on welfare increased by six percentage points between 2007 and 2011, around €9.5 billion.

One-third to welfare

So, of the €30 billion budget adjustment over recent years, one-third went to fund increased spending on social welfare.

If welfare spending had not gone up so significantly, the standard of living of those dependent on the welfare system would have been dramatically lower.

The counterpart to the cost of the extra spending to support those worst affected by the crisis was that the rest of the community had to shoulder a substantially greater burden.

The table (above) shows the share of transfers (welfare payments) in GDP for a range of countries that suffered major problems over the last seven years, and also for some of the countries that experienced fewer difficulties.

For the “crisis” countries – Ireland, Spain, Portugal and Greece – between 2007 and 2011 there was a major increase in expenditure on transfers expressed as a share of GDP (GNP in the Irish case), but in Ireland the increase in available resources devoted to welfare was significantly greater than in any other country. This was in spite of the fact that Ireland had a less drastic rise in unemployment than in Greece or Spain. Obviously, in countries like Germany, where unemployment remained fairly stable, the share of resources going to welfare did not change much.

Over the course of the adjustment period the combined effects of the cuts in welfare rates and increases in taxes meant that most people experienced a fall in income of around 10 per cent.

The fall was slightly larger for those in the lowest income category, as shown in an article in the ESRI Quarterly Economic Commentary.

However, the welfare system had to support a much higher share of the population than previously. The EU SILC data show that, if social welfare transfers were excluded, 50 per cent of the population would have been at risk of poverty in 2013 compared to 40 per cent in 2004.

While approximately a third of the €30 billion in cuts and tax increases went to fund the increased expenditure on welfare, the bulk of the other two-thirds went to reduce the massive deficit.

Part of the gap between expenditure and revenue arose from increased debt interest as a result of the borrowing to fund the banks.

Promissory notes

However, because of the very favourable deal on the promissory notes, Ireland is currently paying little or no interest on much of the money needed to pay off the debts of Anglo-Irish Bank.

With the borrowing to fund the rest of the bank bailout costing around 3 per cent a year, the interest payments resulting from the collapse in the banks probably amounts to around €1 billion a year – while still a deplorable figure it is a small fraction of the total fiscal adjustment of €30 billion.

The true damage done to the public finances and the wider economy by the banking crisis was much larger than the ongoing cost of the interest arising from bailing out the banks.

The bursting of the credit bubble and the resulting collapse in economic activity, especially in investment, produced a trebling in the rate of unemployment, a huge fall in output and an 18 per cent fall in government revenue. It plunged a generation of young homeowners into negative equity and it led to sharply accelerated emigration.

This was the real cost to the economy of the banking crisis.