Are the fiscal rules impeding Ireland’s ability to meet its capital investment needs?

Tim Costello20th April 20174min
The benefits of increased public investment, when efficient, effective and productivity enhancing, are clear. Public investment can serve to increase a country’s long-term potential growth and can provide a short-term boost to aggregate demand.

The benefits of increased public investment, when efficient, effective and productivity enhancing, are clear. Public investment can serve to increase a country’s long-term potential growth and can provide a short-term boost to aggregate demand.

In an environment of low interest rates, the case for governments to pursue large public investment projects is even more compelling. Yet, the global financial crisis resulted in many countries prioritising cuts in capital spending over current spending. Many countries then failed to capitalise on the fiscal space created by accommodative monetary policy.

A combination of strong economic growth and a fast-growing population has placed added pressure on Ireland’s capital infrastructure and services, which suffered from significant spending cuts in the wake of the crisis. In order to safeguard Ireland’s competitive position and futureproof the Irish economy for a post-Brexit world, capital investment in growth-enhancing projects is essential.

In February 2017, the Government launched a consultation process for the ‘Ireland 2040’ National Planning Framework. The plan will aim to provide a strategic planning and development framework for Ireland to the year 2040 and seek to address questions around how Ireland can prepare for a future where its population will be both larger in number and older in age.

The need to invest in the foundations of the future has to be balanced with the need for Ireland to meet its obligations under the EU fiscal rules. The fiscal rules play a crucial role in governing Member States’ fiscal sustainability and serve to discourage the sort of pro-cyclical policies that caused countries in Europe so much difficulty during the crisis. However, there are those who question whether the design of the fiscal rules results in a bias towards current spending over capital investment.

A new IIEA policy brief Capital Constraints: Balancing the EU Fiscal Rules with Ireland’s Capital Investment Needs examines the main arguments in the debate on whether or not fiscal rules contain an anti-investment bias that deters governments from pursuing large public investment projects. It also outlines and analyses some of the proposals made by academics and others to adjust the fiscal rules framework.

The brief concludes that, in an environment of low interest rates, with jobs, growth and investment at the top of the EU agenda, and in light of the unique circumstances facing the Irish economy, finding a way to better incentivise capital expenditure within a rules-based fiscal framework would be a worthwhile undertaking – albeit not an easy one.

The fiscal rules are already derided by many as being too complicated – adding a new element, whether it be a ‘golden rule’ to allow debt financing of capital expenditure or a minimum target for capital expenditure, would risk further complexities.  Yet, as Olivier Blanchard and Francesco Giavazzi have argued, the challenges of implementing some form of capital expenditure exception to the fiscal rules should not be used as an argument to justify inaction on such an important issue.

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