Budget 2018 – Issues for Consideration

Dr. Tom McDonnell

NERI (Nevin Economic Research Institute)

Dublin

Tom.mcdonnell@nerinstitute.net

Select Committee on Budgetary Oversight,

20th September 2017

Economic Context

Where we are?

Dashboard of Macroeconomic Indicators

(2017 are IMF/OECD projections)

2012 2013 2014 2015 2016 2017

Real GDP Percentage volume change over previous year

Euro area -0.9 -0.3 1.2 2.0 1.7 1.8

United Kingdom 1.3 1.9 3.1 2.2 1.8 1.6

United States 2.2 1.7 2.4 2.6 1.6 2.1

Unemployment** Percentage of labour force

Euro area 11.3 12.0 11.6 10.9 10.0 9.3

United Kingdom 8.0 7.6 6.2 5.4 4.9 4.8

United States 8.1 7.4 6.2 5.3 4.9 4.6

Inflation*** Percentage annual average rate of change

Euro area 2.5 1.3 0.4 0.0 0.2 1.7

United Kingdom 2.8 2.6 1.5 0.1 0.6 2.5

United States 2.1 1.5 1.6 0.1 1.3 2.7

Compensation per Employee Percentage change from previous period

Euro area 1.1 1.4 1.4 1.4 1.4 1.8

United Kingdom 1.7 2.1 0.7 1.2 2.8 2.5

United States 2.4 1.1 2.6 2.6 2.1 2.5

Current Account Balance Percentage of Gross Domestic Product

Euro area 1.3 2.2 2.4 3.0 3.4 3.0

United Kingdom -3.7 -4.4 -4.7 -4.3 -4.4 -3.3

United States -2.8 -2.2 -2.3 -2.6 -2.6 -2.7

Fiscal Balance Percentage of Gross Domestic Product

Euro area -3.6 -3.0 -2.6 -2.1 -1.7 -1.5

United Kingdom -7.7 -5.6 -5.7 -4.4 -3.1 -2.8

United States -7.9 -4.4 -4.0 -3.5 -4.4 -4.0

Dashboard of Macroeconomic Indicators (ROI)

(Annual changes – data as of 8 September)

2012 2013 2014 2015 2016 Latest

Percentage volume change over previous year

Gross Domestic Product 0.0 1.6 8.3 25.6 5.1 6.1 (Q1’17)

Domestic Demand 2.4 -1.6 8.3 9.3 21.3 6.5 (Q1’17)

Personal Consumption -0.9 -0.7 2.0 4.2 3.3 1.8 (Q1’17)

Retail Sales (SA) -0.9 1.3 8.2 9.5 6.7 3.2 (Q2’17)

Industrial Production -1.5 -2.2 22.9 34.8 0.7 -0.9 (Q2’17)

Percentage annual average rate of change

Employment -0.6 2.4 1.7 2.6 2.9 3.5 (Q1’17)

Average Hourly Earnings 0.2 -0.3 -0.1 0.2 0.6 1.6 (Q2’17)

Average Weekly Earnings 0.6 -0.5 0.3 1.2 1.1 2.2 (Q2’17)

Inflation (HICP) 1.9 0.5 0.3 0.0 -0.2 -0.2 (M7’17)

Percentage of annual GDP or quarterly GDP

Investment 19.6 18.7 20.8 20.3 31.8 22.2 (Q1’17)

Current Account Balance -2.6 2.1 1.6 10.9 3.3 12.4 (Q1’17)

Government Balance -8.0 -6.1 -3.6 -1.9 -0.7 -2.0 (Q1’17)

Government Gross Debt 119.5 119.4 104.5 76.9 72.8 74.3 (Q1’17)

Percentage of labour force

Unemployment 14.7 13.0 11.3 9.4 7.9 6.3 (M8’17)

Long-term Unemployment 9.0 7.8 6.6 5.3 4.2 3.6 (Q1’17)

Percentage of households

Deprivation 26.9 30.5 29.0 25.5 - 25.5 (2015)

At Risk of Poverty 17.3 16.5 17.2 16.9 - 16.9 (2015)

Percentage

Gini Coefficient 31.8 32.0 32.0 30.8 - 30.8 (2015)

Is the Irish economy overheating?Cannot directly observe the cyclical position.

• A range of indicators inform our view as to whether an economy is overheating.

• Important indicators in the direction of potential overheating include:

o A falling and below the long-term average unemployment rate;

• (Mixed – the rate is falling but is higher than in the UK/US)

o A rising and above long-term average employment rate;

• (Mixed – the employment rate is improving but is still below that of the EU and over 10 percentage points below best performers like Sweden)

o A faster than average rate of growth in consumer prices,

• (No – Consumer prices up 0.4% in August – Sterling weakness is a factor)

o A faster than average rate of growth in asset prices;

• (Mixed - Residential property prices are up 12.3% in July - but just 72% of peak)

o A faster than average rate of growth in wage inflation;

• (No – hourly earnings were up 1.6% in the second quarter and this follows a long period of nominal wage stagnation)

Is the Irish economy

overheating? (cont.)o A faster than average rate of growth in underlying investment,

• (Yes and strong PMIs)

o A rising and above long-term underlying investment rate as a per cent of output;

• (Mixed – growing quickly but from a very low base)

o A faster than average rate of growth in private consumption

• (Mixed – strong growth in 2016 but consumption grew just 0.3% in real terms between 2008 and 2015)

o A faster than average rate of growth in private sector credit

• (Mixed – lending to households up just 0.4% although property related loans and loans to construction and real estate SMEs are increasingly quickly)

o A deterioration in the current account balance particularly if it is already negative,

• (Difficult to say – headline balance is positive but significant pollution of the national accounts - CA* is negative but may be misleading – overall the ‘real’ CA is likely to be in positive territory)

o A sustained deterioration in the savings rate

• (No – savings rate of households increased from 10.7% of GDI in 2015 to 11.5% in 2016)

o A sustained deterioration in the net international investment position.

• (No – economy is a net lender to ROW)

Economic Outlook for ROI • In our Autumn QEO projected real GDP will grow by a strong, and above trend, rate of 4.5%

in 2017 on the back of strong employment growth and the working through of pent-up demand.

o H1 growth was 5.5% so our forecast may have been too pessimistic

• Growth should start to slow to its trend rate thereafter (i.e. post-2017). We project real growth of 3.4% in 2018 and 3.1% in 2019

• Labour market conditions should continue to improve in 2017. We project robust growth of 3.4% in employment and for average hourly earnings to increase by 2.1%. A tightening labour market will drive wage growth as unemployment falls below 6% in early 2018.

• Wage and employment growth will vary from sector to sector. We foresee particularly strong gains in the construction sector as housing output and supply starts to slowly narrow the gap with housing demand. Demand-led sectors like retail should also experience growth.

• Inflation should remain subdued in the short-term. However, wage pressure and strengthening domestic demand should start to push up prices gradually over the next 6-18 months

Macro projections (ROI)2016 2016 2017 2018 2019

Real Output Percentage real change over previous year

Gross Domestic Product €265.4bn 5.1 4.5 3.4 3.1

Personal Consumption €96.6bn 3.3 3.3 2.8 2.6

Government Consumption €28.4bn 5.3 2.6 2.1 2.0

Investment €87.7bn 61.2 0.9 5.8 3.7

Exports €335.0bn 4.6 5.1 4.4 3.7

Imports €274.4bn 16.4 3.5 5.0 3.7

Earnings Percentage nominal change over previous year

Average Hourly Earnings €22.04 0.6 2.1 2.6 2.7

Government Finances Percentage of GDP

General Government

Balance -€1.8bn -0.7 -0.4 -0.1 0.1

Gross Debt €200.6bn 72.8 70.0 68.6 66.8

Labour Force Percentage change over previous year

Employment 2,020,000 2.9 3.4 1.7 1.6

Percentage of labour force

Unemployment 173,100 7.9 6.3 5.8 5.5

Downside risks to growth There is a wide range of other downside risks to our baseline projection including:

• Rising energy prices (geopolitical instability)

• International moves towards protectionism

• Rising interest rates (low but rising probability)

• Brexit:o Lower growth and potential growth in the UK

o Weaker Sterling and currency volatility

o Impact on trade and investment

• US tax policy; EU level CCCTB

• Declining competitiveness – e.g. rents and childcare costs

• Downward trend in productivity growth becoming structuralo Productivity will drive the long-run growth path of the Irish economy

Public Finances, Fiscal Rules

and Fiscal Policy in ROI• This time last year we said:

o The Budget will take place with a small deficit in the public finances and a medium-to-high, albeit

declining, debt to GDP ratio. The public finances, while improving, remain fragile and vulnerable to

external policy decisions and external and internal growth shocks.

o On a no policy change basis, Ireland will have one of the lowest public spending-to-GDP ratios in the

entire EU by 2021, and a historically low spending ratio by modern Irish standards.

o Such a low level of spending has significant negative implications for the future provision and quality

of public services and infrastructure, and has implications for the future sufficiency of welfare

payments.

• This remains the case. Though GDP is not an appropriate denominator….

• Per capita comparisons with other high income EU countries are more useful.

• We forecast a deficit of 0.1% of GDP in 2018

• Net fiscal space for new commitments appears to be around €0.35 billion in 2018.

o Legitimate concerns around EU Commission methodology

Labour Market Participation

Q4 14 Q4 15 Q4 16 Q4 14 Q4 15 Q4 16

65.2 66.0 66.9 57.7 57.7 57.8

65.8 66.5 67.4 58.1 58.0 58.2

64.1 64.8 65.8 57.0 56.9 57.1

74.1 74.4 75.3 60.5 60.6 61.3

62.6 63.9 65.6 59.8 60.0 60.1

63.7 63.8 64.1 56.4 56.1 55.9

74.5 75.6 75.9 64.1 64.2 64.4

72.4 73.3 73.8 62.6 62.9 63.0

France

Sw eden

United Kingdom

Employment rate % (15-64 years) Participation rate % (15 years and over)

EU28

EU15

Eurozone

Germany

Ireland

OECD data for 2015: Labour force participation rate (15-64)

Ireland 70.1%, OECD 71.3%, US 72.6%, EU 72.7%, UK 77.6%, Sweden 81.7%, Iceland 87.9%

Demographics – Working Age Population

in 2014 (% of total population)

Working Age

• Ireland 65.2% (65.7% in 2013, 68% in 2004)

• EU na (66.0% in 2013, 67.2% in 2004

• UK 64.9% (65.3% in 2013, 66.1% in 2004)

• US 66.3% (66.6% in 2013, 67% in 2004)

Fertility rates in 2015

• Ireland 1.9

• EU 1.5

• UK 1.8

• US 1.8

Young population (2014)

• Ireland 22.0% (21.9% in 2013, 20.9% in 2004)

• EU na (15.6% in 2013, 16.4% in 2004)

• UK 17.8% (19.3% in 2013, 18.5% in 2004

• US 19.2% (19.3% in 2013, 20.7% in 2004)

Elderly population (2014)

• Ireland 12.7%% (12.4% in 2013, 11.1% in 2004)

• EU na (18.4% in 2013, 16.5% in 2004)

• UK 17.3% (17.0% in 2013, 15.5% in 2004

• US 14.5% (14.1% in 2013, 12.4% in 2004)

Public spending and taxation

How does Ireland compare?

Per capita public spending excluding interest payments in 2016, €bn

Population

(thousands)

Public

spending

Per capita spending

€

1 Luxembourg 583.6 22.1 37,868

2 Denmark 5,729.0 144.7 25,257

3 Sweden 9,923.1 229.4 23,118

4 Finland 5,494.6 117.9 21,457

5 Austria 8,739.1 171.2 19,590

6 Belgium 11,271.0 213.0 18,898

7 France 66,671.0 1,215.2 18,227

8 Netherlands 17,030.0 296.5 17,410

9 Germany 82,484.8 1,344.3 16,298

10 Rep. Ireland 4,716.5 68.4 14,502

11 United Kingdom 65,572.0 938.1 14,306

Peer countries

(weighted

average)

17,112

Gap to peer

countries (€)

2,610

Gap scaled to Irish

population

(€ billions)

12.3

Total and per capita public spending in 2015, €bnCountry Total A B C D E F G H I J

Belgium 221.02 33.30 3.46 7.23 26.50 3.67 1.63 31.45 4.90 26.35 82.91

Denmark 149.01 20.16 3.06 2.67 9.95 1.21 0.67 23.26 4.79 19.14 64.10

Germany 1,333.86 180.39 30.49 47.47 95.19 18.47 11.61 217.24 30.83 127.39 574.77

France 1,242.79 137.22 38.32 35.61 124.48 21.93 23.34 178.24 29.00 119.17 535.48

Luxembourg 21.57 2.26 0.14 0.51 2.56 0.56 0.27 2.34 0.61 2.67 9.66

Netherlands 305.36 33.96 7.72 12.26 26.87 9.68 2.17 54.08 9.50 36.79 112.32

Austria 175.42 23.28 1.95 4.70 20.93 1.53 1.19 27.18 4.20 16.86 73.60

Finland 119.38 17.84 2.81 2.62 9.96 0.50 0.86 15.01 3.10 13.09 53.62

Sweden 224.45 31.60 5.07 5.83 18.76 1.30 3.33 31.06 4.89 29.17 93.43

UK 1,104.29 117.02 54.91 51.55 78.82 20.29 12.46 196.62 16.77 131.98 423.86

Ireland 75.32 10.43 0.90 2.78 8.66 1.02 1.48 14.57 1.48 9.37 24.63

Per capita

(€000)

Ireland 16,225 2,247 193 598 1,865 219 318 3,138 319 2,019 5,306

Peers 18,000 2,199 539 627 1,530 290 213 2,864 398 1,926 7,415

Gap 1,775 -48 346 29 -335 71 -105 -274 79 -93 2,109

Gap scaled

to

population 8.2 -0.2 1.6 0.1 -1.6 0.3 -0.5 -1.3 0.4 -0.4 9.8

A = General public services; B = Defence; C = Public Order and Safety; D = Economic Affairs; E = Environmental Protection; F = Housing and Community Amenities; G = Health; H = Recreation, culture and religion; I = Education; J = Social ProtectionPeer country is the population weighted average.A negative gap means that the Republic of Ireland out-spends the peer country weighted average.

Annual expenditure on educational institutions per pupil/student based on FTE,

by education level and programme orientation, 2013, Euros

Primary & lower

secondary

(Levels 1 and 2)

Upper secondary

& post-secondary

non-tertiary

(Levels 3 and 4)

Tertiary

(Levels 5-8)

Belgium 8,723.70 10,617.9 13,055.4

Germany 7,189.30 9,704.3 13,132.1

Rep. Ireland 7,220.70 9,763.6 11,611.5

France 6,893.70 11,084.3 13,259.9

Netherlands 8,027.70 9,852.3 15,302.9

Austria 10,280.50 11,697.5 13,407.1

Finland 9,266.80 8,020.5 16,312.3

Sweden 10,938.80 11,111.0 23,540.5

UK 9,368.00 9,470.0 20,968.6

Norway 15,680.60 18,722.5

Switzerland 18,566.10 19,847.8 26,986.8

USA 8,515.20 10,261.5 20,765.7

Japan 7,394.70 8,446.0 14,170.3

Average 10,070.43 11,569.63 17,354.69

Average (EU) 8,836.06 10,194.73 16,122.35

Median 8,995.25 10,439.70 15,302.9

Rep. Ireland gap to

median 1,774.55 676.10 3,691.4

Rep. Ireland

(% median) 80.27% 93.52% 75.88%

Estimating the scale of the Republic’s public

spending gap on education

No. of students No. of students No. of students Total

First level Second level Third level Total

2012/13 526,442 362,847 164,863 1,045,162

2015/16 553,380 345,550 179,850 1,078,780

Levels 1 and 2 Levels 3 and 4 Levels 5-8

2012/13 707,866 181,423 164,863

Gap to median

2012/13 (€)

1,774.55 676.10 3,691.40

Implied spending

gap 2012/13 (€bn)

1.3 0.1 0.6 2.0

2015/16 726,155 172,775 179,850

Implied

spending gap

2015/16 (€bn)

1.3 0.1 0.7 2.1

Per capita Gross Fixed Capital Formation

(GFCF) and R&D at current prices, €

Country 2015 (GFCF) 2016 (GFCF) Four Year Average

2014 (R&D) 2015 (R&D)

Belgium 863 863 851 250.6 247.9

Denmark 1,729 1,792 1756 528.2 538.3

Germany 788 810 778 340.0 346.4

France 1,146 1,142 1192 243.5 244.2

Luxembourg 3,436 3,519 3287 532.2 583.8

Netherlands 1,439 1,396 1408 346.7 358.4

Austria 1,180 1,203 1175 341.4 350.3

Finland 1,491 1,515 1533 376.5 361.3

Sweden 1,903 2,055 1986 461.8 453.2

UK 1,070 946 958 194.9 219.2

Rep. Ireland 936 1,038 911 176.9 182.2

Peer countries 1,077 1,060 1059 289.9 296.4

Gap 141 22 148 113 114.2

Gap scaled to population

(€ bn) 0.7 0.1 0.7 0.5 0.5

Per Capita Receipts from Taxes and

Social Contributions 2015

Per Capita Receipts from Taxes on Labour and

ITR on Labour 2015

Taxation on income paid by employees is actually above average, but this surplus is more than offset by a €9.5 billion cumulative shortfall in employer and non-employed payments largely comprised of social contributions.

Per Capita Receipts from Taxes on

Labour by Payer 2015

CountryLabour Tax Paid by

Employees €Labour Tax Paid by

Employers €Labour Tax Paid by Non-

employed €Total Tax

Luxembourg 10118 4215 1355 15689

Denmark 8285 323 2883 11491

Sweden 4736 5333 1364 11433

Austria 4830 3829 1159 9818

Belgium 4808 3215 745 8769

Finland 4280 3332 1083 8695

Netherlands 4355 2073 1830 8259

Germany 4747 2453 951 8151

France 2922 4365 553 7840

Ireland 4168 1418 91 5678

United Kingdom 3499 1406 90 4996

Peer Weighted Average 4056 2804 759 7618

Gap per Capita-113 1386 667 1940

Implied gap (population) Billions € -0.5 6.4 3.1 9.0

Income tax plus employee social security contributions in 2016, % of

gross wage earnings (single person at average earnings), EU15 and OECD35

EU15 Country Total Payment 2016 Income Tax Employee SSC Gross wage earnings (US

ppp)

1 Belgium 40.7 26.8 14.0 58,214

2 Germany 39.7 19.0 20.7 61,750

3 Denmark 36.2 36.2 0.0 57,310

4 Austria 31.9 13.9 18.0 55,680

5 Italy 31.1 21.6 9.5 42,166

6 Luxembourg 31.0 18.1 12.8 65,522

7 Finland 30.8 22.0 8.8 48,479

8 Netherlands 30.4 16.9 13.5 63,549

9 France 29.1 14.8 14.3 47,817

10 Portugal 27.6 16.6 11.0 29,946

11 Greece 25.4 9.6 15.8 32,974

12 Sweden 24.9 17.9 7.0 47,450

13 United Kingdom 23.3 14.0 9.4 53,020

14 Spain 21.4 15.0 6.4 40,276

15 Ireland (ROI) 19.2 15.2 4.0 44,737

Non-EU Western

European

Norway 27.9 19.7 8.2 60,020

Iceland 29.2 28.9 0.3 59,044

Switzerland 16.9 10.7 6.2 70,077

Unweighted averages

EU15 (ex. ROI) 30.3 18.7 11.5 50,297

OECD 25.5 15.7 9.8 43,015

Other

OECD median 25.4 15.2 9.4 44,737

United States 26.0 18.3 7.7 52,543

Range (OECD) (7.0) - (40.7) (0.0) – (36.2) (0.0) – (22.1) (13,112) – (70,077)

Comparison of total tax wedge in 2016 as % of total

labour costs (single person at average earnings), EU15 and OECD35

EU15 Country Total Tax Wedge 2016 Income Tax Employee SSC Employer SSC Labour Costs

1 Belgium 54.0 20.8 10.9 22.3 74,913

2 Germany 49.4 15.9 17.3 16.2 73,683

3 France 48.1 10.8 10.5 26.8 65,294

4 Italy 47.8 16.4 7.2 24.2 55,609

5 Austria 47.1 10.8 13.9 22.4 71,776

6 Finland 43.8 17.9 7.1 18.7 59,663

7 Sweden 42.8 13.6 5.3 23.9 62,359

8 Portugal 41.5 13.4 8.9 19.2 37,058

9 Greece 40.2 7.7 12.6 19.9 41,169

10 Spain 39.5 11.6 4.9 23.0 52,319

11 Luxembourg 38.4 16.2 11.4 10.8 73,489

12 Netherlands 37.5 15.2 12.2 10.1 70,665

13 Denmark 36.5 35.9 0.0 0.8 57,759

14 United Kingdom 30.8 12.6 8.4 9.7 58,714

15 Ireland (ROI) 27.1 13.8 3.6 9.7 49,547

Non-EU Western

European

Norway 36.2 17.5 7.3 11.5 67,823

Iceland 34.0 26.9 0.3 6.8 63,384

Switzerland 21.8 10.0 5.9 5.9 74,439

Unweighted

averages

EU15 (ex. ROI) 42.7 15.6 9.3 17.7 61,034

OECD 36.0 13.4 8.2 14.4 50,214

Other

OECD median 38.1 12.6 7.6 13.9 54,053

United States 31.7 16.9 7.1 7.7 56,956

Range (OECD) (7.0) – (54.0) (0.0) – (35.9) (0.0) – (19.0) (0.0) – (26.8) (14,638) – (74,913)

Comparison of Personal Average Tax Rates on Labour Income for Gross

Wage Earnings between 50% & 250% of the Average Wage – Single Earners No Children

Comparison of Tax Wedge on Labour Costs for Gross Wage Earnings between

50% and 250% of the Average Wage– Single Earners No Children

Comparison of Personal Average Tax Rates on Labour Income for Gross Wage

Earnings between 50% and 250% of the Average Wage – One Earner Married Couple No Children

Comparison of Tax Wedge on Labour Costs for Gross Wage Earnings between

50% and 250% of the Average Wage– – One Earner Married Couple 2 Children

Average Tax Rate (Income Tax and USC) for Tax Unit Categories by

Gross Income 2015

Income Cases refers to tax units. A married couple or civil partnership are considered a single unit. “Gross Income” refers to income before adjustments for capital allowances, interest payments, losses, allowed expenses or retirement annuities but after superannuation contribution deductions by employees.

Comparison of Average Income Tax and USC paid by Gross Income 2015

Consumption Taxes• Ireland is a high tax country when it comes to taxes on

consumption.o This is true on a per capita basis and on an ITR basis

• On a per capita basis we estimate that taxes are €207

higher than the high income peer country average.

• This amounts to €1 billion when scaled over the

population.

• Ireland is actually slightly below average when it comes

to VAT. However, other taxes on consumption (mainly

excises) are very high compared to other countries.

• Environmental taxes are lower than in the peer country

average on a per capita basis

Per Capita Receipts from Taxes on Capital 2015Capital and

Business

Income Taxes

€

Taxes on Stocks

(wealth) €

Total Taxes on Capital € Total Taxes Less Corporate

Tax Receips €

Luxembourg 6665 3107 9772 5695

Denmark 2420 1638 4057 2800

Belgium 2317 1569 3886 2656

United Kingdom2061 1734 3795 2810

France 2146 1397 3544 2676

Ireland 2311 818 3129 1630

Austria 2440 476 2916 1991

Sweden 2262 621 2883 1522

Finland 2102 585 2688 1857

Germany 1893 467 2360 1477

Netherlands 1649 678 2327 1236

Peer Weighted

Average

2054 1096 3150 2187

Rep. Ireland gap

to average (per

Capita) €

-258 278 21 557

Re. Ireland gap

to average

(total) € Billions

-1.2 1.3 0.1 2.6

Inclusive economic growth

Using fiscal policy wisely

Growth parameters• The key parameters underlying future prospects for the Irish economy are:

o The investment rate

o Demographic changes

o Participation and unemployment rates

o Total Factor Productivity

• Ireland’s long-run growth potential depends on the economy’s ability to

generate productivity gains year-on-year.

o Productivity growth in Ireland has been on a downward trend for over

20 years.

o Productivity is almost everything…. and policy can influence

productivity.

33

Policies for Productivity Growth

(A) Labour quality/Education and Skills

Suggestions

• Increase teacher autonomy and accountability and reduce classroom sizes

• Increase education budget for early years learning

• Use fiscal policy to reduce economic inequality (income and wealth) and promote social and economic inclusion

• Protect childcare, family and housing supports and healthcare services at sufficient levels to avert child poverty

• Mismatch - Annually review the efficacy of activation programmes and training schemes and reallocate resources to

well-performing programmes and schemes

Labour productivity increases as learning and experience increase.

Human capital not only enhances labour productivity but is also a necessary input for innovation and

technology adoption.

Strong education systems are empirically associated with increases in the long-run rate of per capita

economic growth (OECD contends half of the growth achieved by OECD countries since WWII has been

driven by progress in education).

Public spending on education institutions

per pupil (FTE) in 2013, selected countries (PPS)

35

Human Capital• Human capital represents the knowledge, skills, competences and other

attributes embodied in individuals that are relevant to economic activityo a critical input for growth because it enhances labour productivity and is a necessary

input for innovation, technical progress and technology adoption

o not just about schooling. The child’s home environment determines much of the early development in cognitive and non-cognitive skills.

o The early years are the most important for development, and external factors, like poverty, can have extremely damaging and lasting effects on human capital. It is for this reason that family supports and in-kind public health services are positively associated with long-run growth.

o human capital development is a life-long process and training programmes providing market-relevant skills may generate economy-wide employment gains under conditions

of skill shortages or mismatches

• Children possess powerful learning abilities in their early years and Heckman (2000) argues that investing in learning in early childhood brings greater returns than at any other stage in life.

Budget 2018:

Education priorities for inclusive growthIn order of long-term impact:1. Pre primary

2. Primary3. Secondary4. Tertiary

Within each category the best ‘bang for buck’ is increased resources for groups in danger of falling behind (e.g. economically disadvantaged communities)

Ireland under-spends on ancillary supports at primary level – suggest reversing cuts to the capitation grants and provide additional resources for support staff

What about 3rd level?Target individuals at risk of falling away from the labour force – mature students and/or those with weak literacy and numeracy skills

4th Level (Postgraduate) is important because of relationship with R&D and innovative capacity

Policies for Productivity Growth

(B) Innovative capacity

Suggestions• Increase spending on basic and applied research as % of GDP as well as on seed funding for high potential start-ups

• Incentivise (subsidise) take-up of science, technology, engineering and mathematics courses at undergraduate and

postgraduate levels

• Reform the patent system to promote innovation and the use of new technologies (shorten, weaken, use-it-or-lose-it)

• Establish a state investment bank to raise affordable funding for innovating enterprise

• Provide grants to SMEs for adoption of new technology

• Increase support for horizontal linkages between the state, higher level institutes and enterprise

• Reform bankruptcy law to not overly penalise failure

• Address market failures in the provision of high speed broadband access

R&D and innovation are key determinants of competitiveness, productivity and economic growth.

Innovative capacity is itself a function of education levels, government policies that support R&D, and

the quality of capital markets, among other things.

Public R&D Expenditures, (% of GDP and GNP)

39

Enterprise development agencies provided €149 million to support in-company R&D in 2013.An R&D tax credit was introduced in 2004 the cost of which appear to have been circa €500 million in 2014.A Knowledge Development Box (KDI) was introduced in Budget 2016 to encourage R&D in Ireland.

Public spending on R&D was €843 million in 2015

2015 ratios will be revised down to reflect impact of Ireland’s 2015 output surge

Per capita spend on public sector R&D, 2015

selected high income economies, (€)

40

Figures shown are the combined totals for government and higher education R&D expenditure. Definition differs for Germany, Netherland and the United States. Data is 2014 for Japan, South Korea and Switzerland and 2013 for the United States.

Fixed Broadband Penetration Rates,

Subscriptions per 100 persons

41

Ireland’s household penetration rate was 65% in 2015 and 54% in rural areas compared to 72% in the EU and 63% in rural areas

Next generation access (June 2015):• ROI (79.7% overall, 24.9% rural)• EU (70.9% overall, 27.8% rural)

ROI ranks 26th in the EU for access to high-speed fibre broadband

Innovative capacity• An economy’s ‘Innovative capacity’ is its ability to generate original ideas and communicate

and assimilate existing innovations.

o Innovative capacity is itself a function of education levels, the quality of capital markets

and government policies that support R&D.

• Policymakers can incentivise the production and diffusion of innovations through

measures to increase the productivity of R&D and other knowledge production activities. This

can be achieved by reducing the cost of innovation inputs (subsidies/tax breaks) or by

improving the quality and efficiency of those inputs.

o One way to increase the productivity of knowledge production is to invest in human

capital. This is because human capital is a complement to the production and

exploitation of ideas

o A second way to increase the productivity of knowledge production is for governments to

support and invest in those technologies which themselves reduce the cost of

knowledge search and the diffusion of useful ideas (e.g. broadband)

• Mazzucato (2013) argues that Germany’s competitiveness strategy has been driven by its

ability to build a strong innovation system, with patient long-term finance (e.g. KfW),

strong science industry links (Fraunhofer institutes) and above average R&D/GDP

spending.

Budget 2018: Direction of Reforms

(Innovation/R&D)1. Increase spending on basic and applied research as % of GDP and on seed funding for high

potential start-ups. Increase per pupil spending on education.

2. Incentivise (subsidise) take-up of science, technology, engineering and mathematics (STEM) courses at undergraduate and postgraduate levels and support attractive career paths for STEM workers.

3. Establish a state investment bank to raise affordable and patient funding for innovating enterprise (equity stakes) – the ‘entrepreneurial state’.

4. Explore potential for grants to SMEs for adoption of new technology.

5. Increase support for horizontal linkages between the state, higher level institutes and enterprise – coordinate networks of firms through. government schemes - is a ‘one-stop-shop for enterprises’ a good idea?

6. Address market failures in the provision of high speed broadband to rural areas.

7. Have independent and regular evaluation of innovation policy tools (OECD).

8. Provide for multi-year funding envelopes and consolidate funding and actions into a small number of agencies (OECD).

Mazzucato (2013): “Germany’s competitiveness strategy has been driven by its ability to build a strong innovation system, with patient long-term finance (e.g. KfW), strong science industry links (Fraunhofer institutes) and above average R&D/GDP spending”

43

Policies for Productivity Growth

(C) Infrastructure

Suggestions• Spend more on independently evaluated public infrastructure projects (circa 3% to 4% of GDP – for a normal country)

• but what about Ireland? – is there an appropriate denominator

• Establish an infrastructure bank to facilitate the provision of stable, long-term finance for infrastructure and to engage in

counter cyclical investment

• Establish an expert group to independently evaluate infrastructure needs and co-ordinate ex ante and ex post evaluation of

specific projects

A) Efficient investment in infrastructure is strongly related to long-run increases in the economy’s

productive capacity.

B) Increased investment in public infrastructure raises output in the short-term because of demand

effects and in the long term as a result of supply effects.

C) Not all investments are equally productive. Certain types of investment contribute to knowledge

based growth (schools, broadband) and are therefore particularly beneficial in the long-run.

Budget 2018 and beyond: Capital Spending• What is the goal?

o Increase employment, productive capacity and long-run growth?

o Support the regions?

o Quality of life and equity considerations?

o Help meet environmental targets?

• Often overlooked is maintenance of existing infrastructure o If it was worth doing in the first place it is presumably also worth maintaining

• Infrastructure deficits:

o Public transport in the Greater Dublin Area (GDA)

o Water infrastructure

o Rural broadband (the tyranny of geography)

o Housing supply (particularly GDA)

o School buildings

• Looking ahead – the cities (jncluding Dublin) offer the best growth potential – Western counterweight to Dublin - the need for scale – environmental considerations

o Prioritise infrastructure supports for Cork, Limerick and Galway

o Public transport and housing (internal); external connections (Cork port &Cork/Limerick motorway)

o Support regional universities as potential growth engines

• What else?

o Brexit proofing – the need for direct connections with the EU – Rosslare and Cork ports and transport linkages to those ports

o Climate change and energy sufficiency – renewable energy infrastructure – connecting small players (e.g. wind and solar) to the grid

Budget 2018 – Selected Issues for Consideration

Dr. Tom McDonnell

NERI (Nevin Economic Research Institute)

Dublin

Tom.mcdonnell@nerinstitute.net

Select Committee on Budgetary Oversight,

20th September 2017