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Fiscal Consolidation in Ireland (Larch et al.)

Fiscal Consolidation in Ireland: Recent Successes and Remaining Challenges by Martin Larch, Janis Malzubris and Stefano Santacroce published by European Commission (5/2016).

Ireland very successfully shouldered an impressive amount of fiscal consolidation under its 2011-2013 EU-IMF financial assistance programme. After peaking at around 12% of GDP in 2009 (excluding deficit-increasing financial sector measures), the general government deficit is expected to have fallen below 2% of GDP in 2015. As a result, Ireland is now rightly considered to be a good example of how a well-designed adjustment programme can work when it is coupled with strong domestic ownership. This economic brief zooms in on Ireland’s budgetary adjustment and compares it with developments in the euro area as a whole. Our analysis also looks at expenditure by government function, a dimension that is often overlooked but which is crucial to understanding fiscal policy making. We conclude that in designing its future fiscal strategy Ireland faces important challenges, the origins of which precede the crisis. Government expenditure as a percentage of GDP rose rapidly in the early 2000s from a relatively low level, as successive Irish governments used soaring revenues from the country’s over-heated real estate sector to increase expenditure on social protection. With the bursting of the real estate bubble in 2008, Ireland launched a largely expenditure-based consolidation strategy that focused mainly on cutting the public sector wage bill and investment expenditure. While representing the largest expenditure item, social protection contributed less to the overall consolidation effort. This was a deliberate political choice and in line with the EU-IMF financial assistance programme. The Irish authorities agreed with international lenders to achieve sustainable public finances in a way that was socially fair and protected the most vulnerable. This strategy paid off. Protecting the welfare system helped to safeguard social cohesion during the sharp economic adjustment and thereby contributed to the strong sense of programme ownership. Today, government spending as a percentage of GDP in Ireland is still below the euro area average, while the share of social protection in total primary expenditure is close to the average. Thus, other expenditure items, especially government investment expenditure, are still very much compressed. Ireland now faces a number of important fiscal policy issues and trade-offs, such as how to meet growing public infrastructure needs and how to deal with the growing budgetary pressures associated with an ageing society. Will it find new stable forms of revenue, or adjust the composition of expenditure? These challenges, which recently surfaced in the context of the country’s National Economic Dialogue, a new domestic policy forum, are likely to receive increasing attention in the coming years. Acknowledgements:

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