Economic and Budgetary Response July 2019

Economic and Budgetary Response

Ireland is facing the challenge of Brexit in a strong economic position, with record employment levels and unemployment down to 4.5 per cent – the lowest since 2005. The IMD’s latest report ranked Ireland as the world’s seventh most competitive economy (out of 63 economies assessed) and second most competitive economy in the euro area. This represents an improvement of 17 places from the 2011 low of 24th place.

Notwithstanding this impressive performance and regardless of Brexit, there are a number of serious risks to future economic performance, including global trade tensions, international tax developments, potential overheating due to capacity constraints, and continued high levels of public debt.

Since the referendum result in 2016, we have been taking steps to build up the resilience of the economy in the face of Brexit, including:
 Building up our fiscal buffers by balancing the books and establishing the Rainy Day Fund, which, by year-end, is budgeted to have accumulated €2 billion of assets;

 Investing in sustainable long-term development of the economy through Project Ireland 2040 (encompassing the National Planning Framework and €116 billion of investment through the National Development Plan) and Future Jobs Ireland;

 Actions across the whole of Government, including through the new trade strategy, Ireland Connected, to diversify trade beyond the UK market while working to consolidate the exports we currently send to the UK;

 The Global Ireland strategy, which provides a new framework for expanding and deepening Ireland’s global reach and influence, supporting our economic resilience.

The Government has also already taken specific actions to help get Irish business prepared for Brexit. Since the UK referendum, all of our national Budgets have been framed to prepare for the challenge of Brexit, with dedicated measures announced in Budgets 2017, 2018 and 2019 and this will continue in planning for Budget 2020. Specific initiatives have been introduced, such as loan supports for agri-businesses and SMEs, aimed at supporting those businesses most affected by Brexit.

A key pillar of the Government’s response to Brexit is making the case for backing at EU level, and ensuring a clear understanding of the unique and disproportionate impact Brexit will have on Ireland. In its November 2018 Contingency Communication, the Commission clearly stated that it stands ready to engage with the Member States that will be most affected by a no deal withdrawal and, in particular, to support Ireland in addressing the specific challenges of Irish businesses.

Economic Impact of Brexit

Despite the measures taken to date, it is clear that due to our close economic and trading relationship with the UK, Ireland will be impacted more than any other EU country. Brexit will have a significant impact on our economy, including the all-island economy, the labour market and the public finances, with the most negative impacts likely to be in agri-food and indigenous manufacturing sectors.
The UK’s departure from the EU is an event without precedent in modern economic history, and quantifying the impact of this is challenging. Nonetheless, estimating the impact is important to help Government to understand the possible macroeconomic implications and to design the appropriate policy response.

In March 2019, the ESRI and the Department of Finance produced updated estimates of the potential macroeconomic impacts of Brexit on the Irish economy. This work takes account of substantial new microeconomic research on the impact of tariff and non-tariff measures, along with revised assessments of the impact on the UK that have been produced since the initial impact assessment of Brexit by the ESRI and Department of Finance in 2016. The various Brexit scenario results show that the impacts on the Irish economy are large and that Brexit will ultimately negatively impact firms, households, the labour market and the public finances.

This study finds that, compared to a no Brexit baseline, the level of GDP in Ireland ten years after Brexit would be around 2.6 per cent lower in a deal scenario and 5.0 per cent lower in a ‘Disorderly No Deal’ scenario, respectively. A no deal Brexit would result in a sharp reduction in growth with negative consequences throughout the economy. The reduced growth would feed through the fiscal channel as the automatic stabilisers would be activated. Specifically, tax revenue would be lower and there would be upward pressure on expenditure areas, in particular, social protection transfers. Ireland’s EU budget contribution, funded from the Exchequer, might also increase in a no deal scenario, given that the EU’s contingency measure in relation to the EU budget is for 2019 only.

The study also emphasises the negative impact Brexit will have on the Irish labour market. The results from the study show that employment, in the long run, would be 1.8 per cent lower in a deal scenario and 3.4 per cent lower in a “Disorderly No Deal” scenario, compared to a scenario where the UK stays in the EU.

The deterioration in Ireland’s fiscal balance would be structural, not cyclical, in nature. This would reflect a permanent reduction in the size of the economy and, consequently in the amount of tax revenue it generates. Under the disorderly Brexit scenario, this could involve a headline deficit in the region of ½ to –1½ per cent of GDP for next year, depending on the magnitude of the economic shock. The wide range reflects the uncertainty surrounding the budgetary impact of such an unprecedented shock.

It is important to recognise that such estimates may not capture the full impact, and the figures may be conservative. In the event of a no deal Brexit, there would be significant disruption with further negative material impacts on Ireland and the all-island economy, particularly in the early years, arising from issues such as significant market volatility, further sterling depreciation, and disruption to trade with the UK including Northern Ireland. The full impact will also depend on decisions taken by the UK in relation to tariffs imposed on goods from the EU, including Ireland.

There are also significant sectoral and regional dimensions to this economic impact and some sectors and regions will be more affected than others. Indeed, the negative impacts will be most keenly felt in those sectors with strong export ties to the UK market – such as the agri-food, manufacturing and tourism sectors and also SMEs generally – along with their suppliers. The impact will be particularly noticeable in the regions where there is a reliance on these sectors and businesses as firms adjust to potentially higher tariff and non-tariff barriers, as well as currency fluctuations. Further, given Ireland’s unique macroeconomic and sectoral exposures to the UK, these impacts would be disproportionate relative to the rest of the EU.

The unprecedented nature of the event means forecasts are subject to greater uncertainty and variance than during normal times. An alternative study by the Central Bank of Ireland suggests the short-run and long-run impacts of a disorderly Brexit could be more negative than the Department of Finance/ESRI study suggests. This study puts greater weight on the effects of uncertainty on consumer and business decisions. The Central Bank’s estimate, as published in January 2019, is that a disorderly Brexit could reduce the growth rate of the Irish economy by up to four percentage points in the first year. Over ten years, the Central Bank estimates that a disorderly Brexit could reduce the overall level of Irish output by 6.1 per cent, as compared to 1.7 per cent in the case of a transition to a

Free Trade Area-like arrangement.

Next Steps  The Government will continue to work to strengthen the resilience of the economy, to maximise opportunities, manage risk on the domestic and external fronts and to prepare our economy for the challenges of Brexit.

 In this context, Government will take a prudent and sensible approach to Budget 2020. The Government is currently planning based on two budgetary scenarios, as set out in the recently published Summer Economic Statement. Scenario A sets out the environment relating to an orderly Brexit, with Scenario B outlining an alternative situation in the case of a disorderly Brexit (see below). Over the summer, the Government will monitor developments in the UK closely and will decide which scenario is the most likely and base Budget 2020 on that.

 

Goods Services

o Scenario A: Orderly Brexit: the economy continues to grow at a robust pace of 3.3 per cent in 2020 and overheating risks must be managed. Decisions in relation to the allocation between tax and expenditure of the total unallocated amount of €0.7 billion will be made during the budgetary process, with the Government targeting a headline surplus of 0.4 per cent of GDP next year.

o Scenario B: Disorderly Brexit: While overheating risks dissipate, automatic stabilisers kick in (i.e., automatic counter-cyclical support that the public finances provide to the economy through, for instance, welfare payments due to higher unemployment numbers and lower tax collections on the revenue side, which helps cushion aggregate demand). In addition to the automatic stabilisers, there will be a requirement for a number of targeted temporary supports for sectors most affected, particularly in the areas of agriculture and enterprise. The general government balance would be expected to deteriorate by more than €6 billion in 2020 to a deficit of ½ to –1½ per cent of GDP.

 In the event of a no deal Brexit, the Government will implement a range of economic responses that will seek to mitigate the impact on vulnerable sectors and groups, within this macroeconomic framework. This approach will include:

o Targeted supports for vulnerable but viable sectors and enterprises;

o Labour market and activation interventions to support employees affected;

o Continued increased capital investment in accordance with Project Ireland 2040 which will act as a stimulus to the economy;

o Continued engagement with the European Commission and other Member States in respect of financial supports and flexibilities under State Aid rules and the Common Agricultural Policy