Esmond Birnie: a clean sheet for public spending

PwC’s Chief Economist, Dr Esmond Birnie, met with Owen McQuade to discuss the prospects for the local economy and what the Executive should do now. Hard questions must be asked about the purpose of government and any new jobs must create wealth.

Looking at the short-term prospects for the local economy, Esmond Birnie sees the province’s economic plight as “the classic glass; half-full or half-empty”.

The recovery is looking mixed but he does not see this as indicating a double-dip recession. “This year as a whole will see positive growth but it will be lacklustre,” Birnie comments. “We expect a weak recovery with Northern Ireland growth likely to hit 0.8 per cent in 2010 and around 1.8 per cent in 2011; that’s well behind likely UK-wide growth of 1.6 per cent and 2.2 per cent, respectively.”

On reflection, he thinks the austere June emergency Budget was unavoidable. “It was essential to sustain good confidence in the debt market,” he surmises, “and that made it a necessary Budget.”

With £6 billion Whitehall cuts already inherited from the last government and Osborne adding a further £17 billion, he foresees the £23 billion reduction in current and capital spending as a major challenge (and once inflation is allowed for the reduction will be even sharper).

As regards the local impact, he says it is not possible to “do a precise readacross, a sort of negative Barnett calculation.” However, based on the £128 million local impact of the coalition’s £6 billion of initial UK-wide cuts, taking a further £17 billion out of public spending could mean the Executive facing an additional £500 million reduction.

“And when you add in other factors like the impact of Civil Service equal pay and the absence of income from water charging, you get up towards £1 billion in cash terms and well over that in ’real’ terms.”

Progressive austerity, in the Treasury’s words, is his predicted result from the effects of the income tax allowance, increase in VAT and tax credit changes.

“However, Northern Ireland’s income distribution is already skewed, with proportionally more on benefits, and a bigger public sector than in the other eleven UK regions. That means that any significant review of public sector spending is likely to hit Northern Ireland more,” he remarks.

“The £64 million question is: ‘Will the private sector compensate for this pain?’”

Birnie explains that some forecasts suggest that up to 10 per cent of UK public sector jobs – 600,000 – will be lost over the next four to five years: “Reading across to Northern Ireland that equates to 22,500 jobs, or 4,000 to 5,000 jobs a year. Countering that equates to 1 per cent growth in private sector employment each year, not unreachable but with the world economy still depressed, this would be a major challenge.”

In the anxiety over jobs, it is also “crucially important” that the Executive does not forget the Programme for Government’s (PfG) targets on GVA (gross value added), which has not grown alongside increases in employment.

The PfG aimed to attract 6,500 new jobs from inward investment, with those jobs increasing the value-added in their particular sector. Commercial exploitation of R&D was also pledged, to promote higher value-added economic activity and Invest NI was tasked with promoting value-added growth projects from locally-owned companies.

“Over the last 10 to 12 years the Northern Ireland economy has had a credible growth in employment of 1.5 per cent, or 12,000 people, per annum, but we didn’t combine this growth [with] wealth creation”.

Growth in employment, he says, was mostly through the expansion of retail and call centres. “While we created employment, we weren’t increasing the average GVA,” he states. “For every job we lost, we created a new job that was actually worth less.”

This need to balance job creation with wealth creation is therefore a “real dilemma” for policy-makers and politicians.

Reshaping the economy

A key objective of June’s emergency Budget was to reshape the UK economy, with growth coming from increased exports and investment, rather than consumer and government spending. Birnie sees this as being in the “right direction”.

The Office for Budget Responsibility’s medium-term forecast indicates a slow modest recovery up to 2 per cent underpinned by investment and exportled growth. However, the devaluation in exchange rate, by a quarter, has not so far translated into much growth of exports from either the UK or Northern Ireland.

“There is a view that there is a lag of several years,” he comments. “Another, more pessimistic, view is that the UK has lost its core manufacturing capacity and can’t expand. Manufacturing is now based in niche markets and not on volume.”

Investment by industry has been dependent on bank lending “and we know the problems there,” he adds.

Anticipating the autumn spending review, Birnie observes: “Obviously this is a challenge, but it is also an opportunity.”

Government, in his view, should start with a blank sheet of paper, asking the difficult questions such as: “What is government for? Are there things better delivered by the private sector? Are there things that could be shifted from central to local government? Is there a bigger role for NGOs?” He mentions that the Scottish Government’s review of spending took such an approach and asked such fundamental questions.

Corporation tax

Birnie has a mixed view of the prospect of a lower corporation tax regime for Northern Ireland. He explains that if Northern Ireland had lower corporation tax, the Executive would have to pay a similar amount, i.e. £150-200 million, from the spending block to be compliant with the Azores ruling regarding European law.

He notes that complying with the Azores ruling would offer the Executive a wider range of tax-raising powers than just control of corporation tax. “The experience from RoI is that it is better to use tax-varying powers in certain areas,” he remarks.

“There is fixation on headline tax rate. Even if we got it down to 12.5 per cent, many countries have lower rates, and then it becomes a race to the bottom and a futile battle.”

As an alternative, he proposes: “Why not create a tailored package of tax incentives for R&D and IP [intellectual property]?” Tax breaks could be used to encourage and incentivise R&D and its commercialisation, which in turn would raise GVA in a way that low corporation tax wouldn’t.

The economic indicators, meanwhile, show the world economy in recovery mode, with 3.0 per cent annual growth, but the drivers of growth have shifted, with a higher proportion coming from the socalled BRIC countries of Brazil, Russia, India and China, particularly China. “The Chinese economy has as high a proportion of GDP growth as the US. The US is still the biggest economy by far but China is growing at 10 per cent each year,” he points out. “This has implications for exporters to look beyond the Eurozone. India was the second largest source of inward investment after the US during 2002-07.”

Birnie also notes the strong emphasis placed by the Coalition Government on a new, multi-polar view of the world economy, with ministers seeking to forge special relationships with India and China, and looking beyond the Eurozone and US.

PwC has already made a comprehensive submission to the Chancellor in respect of options for the Comprehensive Spending Review and has copied its proposals to Finance Minister, Sammy Wilson. Birnie says that by taking the ‘clean sheet of paper’ approach to spending, it could be possible to make a substantial dent in the likely level of cuts the Executive might expect over the next CSR period.

“That would deliver fundamental change, a new change from the ground upwards whereby we would try and justify all programmes,” he says in conclusion.

Two further sets of questions, though, must be answered. “Government should ask how effectively they are delivering services and if the private or voluntary sectors could deliver them more efficiently. Another aspect is that they would ask citizens: How much do you value those programmes?”