John Maynard Keynes once wrote, “If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.” My ambition for Ireland’s government finances is similar: if Ireland could get its government finances humble and competent, on a level with the standard OECD economy, that would be splendid. Two weeks ago, when looking at public sector income, I examined how across two key aspects of Ireland tax system in particular – excessive income tax credits and the lack of a property tax – Ireland is an oddity compared with the typical OECD economy.
This week, as Budget 2011 draws ever closer, it’s time to look at public sector expenditure. As with the post two weeks ago, this post looks for areas where Ireland sticks out like a sore thumb in international comparisons, as the focus for reform, rather than where Ireland is already a “humble, competent” OECD country. First, though, it’s important to review the big picture, to see how much needs to be cut in the years to come. Gross expenditure by the Irish government this year, excluding any bank-related payments, will be about €69bn, while gross income is estimated at €50bn. The government – and the main opposition parties – have committed to reducing that €19bn deficit to about €5bn by 2014.
Personally, I think such remarkable savings are not possible in such a short time-frame and that a target deficit of €7bn by 2015 is more realistic. (For once, this puts me quite close to Sinn Fein’s economic policy!) Either way, increasing taxation revenue to €57bn is about as much as the government can aim for in that time period (see the last Budget 2011 post). Coupled with this, higher national debt means higher debt servicing, so if no other government expenditure item changed, total spending in 2015 would grow to about €73bn, not €69bn.
This means that over the coming 4-5 years, the Irish government has to deliver public expenditure cuts of €10bn (give or take €1bn). This is a huge task for any government, particularly given that all €10bn of the cuts will come from the €65bn of expenditure that is not interest payments on the national debt. This is an average cut of 15%. But should it be an even 15% cut on all non-debt expenditure?
Where is Ireland spending above the odds?
The first point to make is that, relative to total income in the country, Ireland’s government spends more than most others in the EU. Excluding defence, Ireland’s government spends 52.4% of national income, putting Ireland’s government fifth in the EU league behind Denmark, Sweden, France and Finland (all around 54%) and well ahead of the UK, Germany and Spain (less than 50%).
To see where this money is being spent, it is important to look at the breakdown of government expenditure. Eurostat breaks government expenditure down into 10 main parts, the latest figures being for 2008. The first is “General Public Services”, which includes money spent on the executive and legislative, on foreign economic aid and on public debt transactions. The second is Defence, the third Public Order and Safety (police, courts and prisons), while the fourth is “Economic affairs”, which includes money spent on agriculture, energy, transport and communication.
The fifth is Environment Protection, including waste and waste water, while the sixth is “Housing & community amenities”, which covers housing developments, as well as water and street lights. A relatively small category is what is termed “Recreation, culture and religion”. The final three categories are three of the largest, on average, Health, Education and “Social Protection”, which includes old age pensions and unemployment.
The graph below shows total spending in each of these ten areas for 14 European countries. The colours represent different types of spending, with larger areas such as social protection and health at the bottom. The scale is percentage points of gross national income in 2010, so you can see governments in most countries spending either just above or just below half of national income.
Of 14 countries analysed (the EU-15 plus Norway, minus Greece and Luxembourg), Ireland is almost always an outlier when looking at spending by sector. Ireland’s government is one of the top two spenders in five of Eurostat’s ten areas but in the bottom three in four other areas. Only in education is Ireland’s 6.7% of national income spent close to the typical EU figure of 6.2%. The areas where Ireland spends less than any other country are Defence (predictably) and “General Public Services”, while Ireland comes 12th out of 14 in expenditure on both Social Protection (17% of national income) and Recreation & Culture (1%).
In two relatively small areas of expenditure, Ireland’s government spends a multiple of the EU average: in housing and community amenities (principally housing developments) and in environment protection (principally management of waste and waste water). The figure for housing – 3% of national income – is actually over four times the typical country’s figure of 0.7%. Halving total expenditure in these areas would still leave Ireland spending more than most but would save about €2bn, assuming since 2008 about €500m has already been saved.
Other expenditure areas that are predominantly capital projects also look unsustainable, particularly “Economic Affairs” which includes money spent on energy, transport and communication. Ireland’s 6.7% of national income spent in these areas is just over one quarter higher than our peers. Cutting spending in this area by one quarter would save in the region of €3bn, again assuming that since 2008 about €500m has already been saved in this area. Aware as I am that capital investment is important, Ireland cannot afford to invest twice as much as our peers – at least not from central revenue. For projects that have a verifiable rate of return, the National Pensions Reserve Fund may be an option.
The other two outliers are not capital-intensive, though: they are labour-intensive. The smaller of the two is “Public Order & Safety”, where Ireland spends 2.3% of its national income, behind the UK but more than twice Belgium or Norway. Bringing Ireland’s spending in this area into line with the EU average would save somewhere in the region of €700m.
Unhealthy Irish Public Spending?
Last, but unfortunately by no means least, is Irish public spending in health care. Ireland’s government spends 10% of national income on healthcare, more than a quarter above the typical EU-15 country. What makes this truly puzzling is that Ireland should be an outlier in the other direction: Ireland has a significantly younger population than its EU-15 peers. The graph below shows a scatter of public spending on health and the average age in a country, for a sample of thirty countries. A trend-line in light green shows the mild upward relationship between a country’s age and its spending on health. Ireland is the anomaly: by far the youngest population apart from Cyprus but spending by far the most.
The figures are if not astounding then by any definition significant. If Ireland’s government spent – as its median age might suggest – just 7% of national income on health, rather than the 10% currently spent, the government could expect to save anywhere up to €3.5bn on its healthcare bill, taking into account some of the savings that have been made in the last two years.
In review, bringing expenditure in these five areas outlined above – health, economic affairs, public order, housing and environment – back into line with our EU peers would save about €9.2bn. General efficiency savings and ensuring social welfare reaches only those intended could achieve the remainder, giving the total of €10bn needed to bring Ireland’s deficit back to manageable levels.
At that point, Ireland would have “bare bones” public expenditure. I don’t think this is a wise end-point. Rather, I think this represents the ideal opportunity to put the country’s public finances on a sustainable track once and for all. This will involve devolving responsibility for money and for people to individual public sector organisations. As they strive to match their budgets to the outcomes they deliver for the country, this will mean finally switching how the government spends its money from an accounting mentality (costs) to an economic approach (benefits to society, relative to costs).
On previous occasions, I’ve talked directly about the sustainability or not of the Croke Park Deal, which binds this government and the next one on redundancies and further cuts in public sector pay to 2014. I’ve deliberately avoided any discussion here about the number of people at work and how much they get paid. I’ll leave it up to the reader to judge whether – in an environment where €10bn needs to be cut from €65bn and where two thirds of costs in health are pay costs – the government can afford to ring-fence €20bn in public sector pay. I think the point to make today is that identifying where we’re off track is the first step to getting back on track.