Ireland is in the grip of one of the biggest economic and social challenges any country has faced in modern history. In its latest economic commentary, the International Monetary Fund described what we are going through as the deepest slump in economic activity any country has experienced since at least the Second World War. More recently, the Economic and Social Research Institute estimated that GNP per capita here will have declined by 16.5% by 2010.

In the first six months of this year more than 127,000 people were added to our dole queues. That is an average of 1,000 people every working day so far this year. We now have almost 420,000 people signing on for unemployment related payments and social welfare credits every month. Against this, we only have 1.9 million people still at work. The social and fiscal burden on those people is growing by the day. The Quarterly National Household Survey revealed that net employment is being wiped out at a rate of 30,000 jobs every month.

Our public finances are in tatters too. Never before has any country experienced such a rapid slump in tax revenues as economic activity collapsed.

At the start of 2007, just before the last General Election, the Department of Finance estimated that by this year, 2009, the Exchequer would collect just over €56 billion in taxes on economic activity of all sorts. That is a very big sum and it was on the basis of that €56 billion sum, and the official forecast that there would be even more money available in 2010 and 2011, that all political parties drew up their election manifestos and packed them with lavish promises for the electorate in 2007.

What a disaster all that has turned out to be. Were it not for massive tax hikes in the two budgets since last October the actual amount of tax collected in 2009 would be less than €31 billion. That is 45% short of the €56 billion we were led to believe would be available just two years ago.

The result of course is a requirement for the Government to borrow over €20 billion to run the economy this year.

The root cause of the fiscal collapse has been the unbalanced nature of the Irish economy and the structure of the taxation system. The Government got carried away on fair-weather taxes such as those generated from the unsustainable housing boom. These tax revenues were, by definition, short-term because no housing boom can last indefinitely. Despite that obvious fact, the Government made very long-term spending commitments and assumed the tax bonanza would last forever. They engaged in a massive and expensive expansion in public sector employment and services and slashed every other tax rate know to man. Taxes on the average worker were cut to the lowest combined rates in the developed world outside of Mexico and Korea. Despite the fact that global interest rates were historically low and that access to credit both at home and abroad had never been easier, massive tax breaks were given to property developers and investors. This was an irresponsible approach to the structure of the taxation system and of our economy that has now blown up in our faces.

Official figures demonstrate just how badly our taxation system is structured. The Government budgeted in April this year for economic activity to contract by 7.75% in 2009. To deal with the effect of that, they raised taxes by €3.75 billion between the October and April budgets. If they had not done so, the overall tax revenue forecast for 2009 would be as low as €30.6 billion, down from €42 billion in 2008. That’s a fall of 27% in taxes paid as a direct result of a 7.75% slump in economic activity.

The fact that the underlying percentage fall in Exchequer revenue would be three and a half times larger than the fall in economic activity is testament to a monumental structural problem in our public finances that had gone checked for several years.

Savage cuts in public expenditure and further tax hikes are now inevitable. The Government has already promised our European partners that it will take €4 billion out of the economy in December’s Budget and another €4 billion again next year. More of the same is also promised for 2012 and 2013 in an effort to bring the budget deficit back into line with the European stability and growth pact.

The menu of likely cutbacks was clearly set out in last week’s report from the McCarthy Group on Public Service Numbers and Expenditure Programmes which detailed over €5 billion in potential cutbacks and 17,500 job losses throughout the public sector.
The fact that Government has to consider taking such drastic action in the depths of recession is surely an indictment on the way the country was run and how our economic success was handled throughout the past 12 years.

What we are going through now is not a normal recession. Our banking system has collapsed, our prosperity has been decimated, our unemployment rate has soared and living standards are plummeting. There is nothing but fear and retrenchment among business and workers alike and precious little hope is being offered by those in charge. The fact that the Government feels it has no choice but to cut public spending so drastically and raises taxes so spectacularly at this, the worst possible moment, is evidence of its massive failure. Fiscal retrenchment on the scale being considered will make matters far worse not better at this point in time.

Consider for a moment the IMF staff note position about appropriate fiscal policy in the face of the global financial crisis published on December 29th 2008. It said the optimal fiscal package in the current environment “should be timely, large, lasting, diversified, contingent, collective, and sustainable: timely, because the need for action is immediate; large, because the current and expected decrease in private demand is exceptionally large; lasting because the downturn will last for some time; diversified because of the unusual degree of uncertainty associated with any single measure; contingent, because the need to reduce the perceived probability of another “Great Depression” requires a commitment to do more, if needed; collective, since each country that has fiscal space should contribute; and sustainable, so as not to lead to a debt explosion and adverse reactions of financial markets. Looking at the content of the fiscal package, in the current circumstances, spending increases, and targeted tax cuts and transfers, are likely to have the highest multipliers.”

On every front mentioned by these eminent IMF economists the Irish Government has failed. Rather than being in a position to introduce a fiscal package to shore up domestic demand in the face of the financial crisis, it had been boxed into a situation where it must do the opposite. This is the disastrous result of fiscal irresponsibility for which we must all now pay.

It is a mistake, however, to proceed to correct the sudden and catastrophic imbalances that have opened up in our public finances at the pace that is now being planned. The Government’s objective is bringing our general Government deficit back down to 3% of GDP by 2013. This has been forced upon us by the rules of Europe’s Stability and Growth pact, the rules of fiscal management that came as part and parcel of membership of the euro. Under normal circumstances these are good rules, designed to underpin the integrity of the single currency. However these are not normal circumstances.

The blow to the Irish economy has been far too severe. In the late 1980s and throughout the 1990s Ireland made great efforts to qualify for full membership of Europe’s fledgling economic and monetary union. There were fears that, in such a union, economic activity and wealth would migrate to the centre and that peripheral countries like Ireland might do poorly. Regional transfer policies including structural and cohesion funds were central to addressing those fears and to ensuring a more level playing field. It was never Europe’s intention to allow Ireland to wither in a monetary union or to turn into what, in 1988, former Central Bank Governor Maurice Doyle labelled “the Appalachia of Europe”.

Now, 21 years on, that very fear - that Ireland could become an economic black-spot, a backward region of a far larger single European economy - can no longer be ruled out. Our banks are broken, our public finances are ruined, our taxes are soaring, unemployment is going through the roof and the competitiveness of our economy is sorely compromised. There appears to be little prospect of economic growth before 2011 and, even then, any growth will be very modest according to international forecasts such as those of the IMF and the OECD. We cannot afford any further policy mistakes. If we get things wrong then a vicious circle of economic malaise could easily materialise. It is quite possible that if we continue on the path that we are on, and try curing our public finances at the pace currently envisaged by the Government, it could all backfire.

The best cure for the fiscal nightmare that we are in is the resumption of robust economic growth. Such economic growth means more activity; more activity means more revenue for the Government and some light at the end of the tunnel. The problem is, of course, that we cannot tell when global economic growth will resume, or how strong it might be, or how the type of international economy that emerges might suit Ireland. The international environment is outside of our control. In the mean time the Government’s strategy is to do all in its power to prepare for it by slimming down the public sector, raising taxes on all and sundry, and ploughing billions of euro into our broken banking system. There are a lot of risks in all of that. Surely it is expecting too much of heavily indebted, heavily taxed, insecure, fearful domestic taxpayers to fund all of this out of declining wages and fewer jobs. Unless the global economy experiences the fastest revival since Lazarus got up out his bed and walked then the burden of fiscal adjustment the government is planning to place on the Irish public may be too great. Surely a stronger case could be made at European level for greater recognition of the real difficulties we are in and of the fact that the cure as proposed by conventional economics runs a very significant risk of making our problems substantially worse. What’s so sacred anyway about having a General Government Deficit of 3% of GDP by 2013, especially if achieving that target runs the risk of turning an economic recession into a depression?

It is true that one of the lessons of the 1980s was that running large fiscal deficits and losing control of our public finances ruined the economy. It is also true that a cheaper public sector will reduce the burden on the productive sector of our economy; that it can contribute to lower taxes than we otherwise might have and that all these things can help improve competitiveness. But timing is important. If we try to do it all too aggressively and the global economy takes longer to recover than we expect, then the social and political cost could be extremely high. In that regard, trying to adjust our public finances too aggressively without finding new ways to promote economic growth at the same time, could prove to be disastrous.

However, the need for a correction in our public finance is not the only area in which we risk paying an extremely high price for irresponsibility. Our rush to bail out banks and save each and every one of them at great expense to ordinary taxpayers is extremely risky. Ireland is now a regional economy in a much larger economic and monetary union. We no longer have our own money, or our own exchange rate or our own interest rate. In addition, our own Central Bank has no real independent control over banking regulation or monetary policy. That is all coming from Frankfurt. We have entered a new monetary world. We have been there for all of the past decade. Yet the Government’s mindset in relation to our banks appears to be stuck in the last century.

Why would any region in a big economic and monetary union feel it is imperative to save every single bank in its region and to pile the cost of those bailouts onto the backs of ordinary taxpayers? It defies logic. Banks go bust elsewhere quite regularly, even in the United States. Why does our Government think all Irish banks must be saved irrespective of the cost? The Taoiseach has been recently quoted saying he would be there with a chequebook to save any Irish bank. That’s barmy. Why? At the height of their mad lending spree the Irish banks were borrowing the equivalent of 45% of GDP on international money markets, and lending it onto property developers and investors and others here. Any banks could have done that. They would not have had to be Irish owned.

Last September the Government gave the most generous guarantee that any government has ever given to a banking sector in the face of a crisis. It promised that Irish taxpayers would refund all deposits in Irish banks if those deposits were lost due to a bank failure. It also promised that ordinary taxpayers would pick up the bill for any defaults on any money loaned to an Irish bank by any other banks or investors including bond holders. The Guarantee was to last for two years until 2010. At the time this Guarantee was portrayed by the Government as essential in order to ensure a supply of liquidity to the Irish banking system. It was all done behind closed doors and the advice given, as well as the debates that took place, were secret.

The Guarantee that was given is too generous. No other country anywhere gave as much. Irish taxpayers are now far too exposed to the losses in relation to the banking system. In the meantime €7 billion of public money has been invested into the banking system with precious little in terms of new lending into the economy to show for it. There is a widespread view among the public that when it comes to banking we are paying too much for too little. And this is before we learn how much the proposed National Asset Management Agency will pay our damaged banks for their distressed loans.

There is no sane reason why Irish taxpayers should continue protecting investors who bought bonds issued by Irish banks. Those investors are private risk takers and they should be made live with the consequence of the risks they have taken. The protection given by the Guarantee to bond investors in Irish banks should be removed September next year when the first two-year term for that Guarantee is up. This shouldn’t preclude the Government from renewing the Guarantee for normal wholesale borrowing by Irish banks. It would, however, help send a message to the international financial markets that the Irish Government is reducing its debt exposure in a rational way and is not lumbering ordinary taxpayers with debts obligations they should have no liability for.

Ireland has lived though an era of enormous irresponsibility. We had irresponsibility in the way the Government managed the economy; irresponsibility in banking; irresponsibility by developers and associated professions; we had irresponsibility in the personal sector as evidenced by the enormous debts people took on; irresponsibility in so many others sectors too. The result of all that irresponsibility now is that trust has been shattered. The restoration of trust is essential to the restoration of our prosperity. There can be no greater demonstration of the massive economic cost of the breakdown of trust than what happened to all those who invested in the stock market. When the banks no longer trusted each other, they stopped lending, stock markets and economies collapsed, and prosperity has been destroyed.

It seems unlikely that any economy can be restored to full health without a restoration of trust. This represents an enormous challenge because trust, once it has been broken, is extremely difficult to restore.

What Ireland needs is a new era of responsibility; an era where Government’s take responsibility and stand up for ordinary people in the face of powerful vested interests; an era where banks are held to account for the massive public rescue effort they have been gifted with and are forced to play a far more active part in the restoration of credit flows throughout the economy; an era where the fiscal burden of adjustment placed on ordinary people takes into account the responsibility to ensure that those very people are not broken by the weight and of that burden and an unacceptable pace of adjustment. We need a new era where political leaders take responsibility for the mistakes they have made. They need to recognise that when they fail to live up to their responsibilities then the trust of the people is lost. Without that trust the Government cannot lead.