Impending Brexit doom offers up tough choices

By Jim Power

The Summer Economic Statement released by the Department of Finance this week attracted considerable media and political attention, but in reality, it did not contain anything that was remotely surprising or controversial.

When the Minister for Finance stands up on October 8, he will have to present a budget that on the one hand may have to deal with an economy showing some signs of overheating, but certainly would not require any fiscal stimulus.

However, on the other hand he may be presenting a budget to an economy that will shortly afterwards have to face up to a disorderly Brexit and its very uncertain consequences.

Clearly, a very different fiscal approach will be required in either eventuality, but we still have no idea what that eventuality might be.

Unfortunately, at this stage we have no idea what Brexit might look like, but Boris Johnson looks likely to be the next leader of the Tory party and British Prime Minister. If he wins the leadership contest, it will most likely be due to the support of the European Research Group (ERG), which is led by Jacob Rees-Mogg. This suggests that he will be under pressure to go for a no-deal Brexit at the end of October.

There can be no certainty about this, but the risk of a disorderly Brexit has certainly heightened, although a further delay cannot be ruled out come October.

The summer statement sought to lay out the macro considerations under both scenarios. Under an orderly Brexit the economy, as measured by GDP, is projected to grow by 3.9% in 2019 and by 3.3% in 2020. A surplus on the General Government Balance equivalent to 0.2% of GDP is projected for 2019 and a surplus equivalent to 0.4% is projected for 2020.

In this scenario, the Government will be in a position to allocate €2.8bn in Budget 2020.

However, of this €2.8bn, €1.2bn is already pre-committed on the current spending side, as is €700m on capital spending. In addition, €200m is being set aside in a reserve fund for the National Broadband Plan and the National Children’s Hospital.

This means that the Minister will have around €700m at his disposal to give away in discretionary tax reductions and expenditure increases. This figure could, of course, be added to through tax increases such as carbon taxes and alcohol or tobacco and, indeed, the economic climate might also have changed for better or for worse come October 8.

The overriding issue is that the fiscal parameters are still tight and the ability to satisfy all demands is not strong, to put it mildly. Tough choices will have to be made, and from a political perspective, this is never easy. While Ireland’s government debt - measured as a percentage of GDP - fell to 64.8% at the end of 2018, the level when measured in terms of the more realistic modified measure - GNI* - stood at 105%.

The bottom line is that Ireland still has a dangerously high level of debt and this will limit the scope for fiscal expansion.

Under a disorderly Brexit scenario, economic growth is projected to be 3% lower in 2020 and this would cause a deterioration of €6.5bn in the General Government Balance.

This would represent a disastrous scenario that would have very negative implications for future government expenditure and taxation plans. This scenario would necessitate a significant fiscal injection of around €5bn in an effort to stabilise the economy and provide targeted support to the sectors most adversely affected.

This money would have to be borrowed, but that is how sensible counter-cyclical policy should operate.

However, in the event of such borrowing, the money would have to be spent in a very productive way and not used to shore up public sector pay or the inefficient delivery of public services.

All of this, of course, would have to be subject to the approval of the EU Commission. For a region hit by an asymmetric shock such as Brexit, that support would have to be forthcoming.

The impending doom posed by Brexit should be a clear reminder of how important it is to have solid public finances and build up a buffer during times of plenty.