Professor John McHale:

I thank the Deputy for those questions. This is one place where we have to be careful to respect our mandate, in that it does not really allow us to get into giving advice or making suggestions for the composition of spending increases or tax cuts. My remarks, therefore, will have to be a bit more general rather than making specific recommendations on capital spending.

One thing we have observed and on which we have produced an analytical note is that currently public investment or public capital spending is low by our own historic standards as well as by international standards. Even though recent increases in planned capital spending have improved the situation somewhat, public capital spending is still just about keeping up with the depreciation of existing capital stock. There is some positive net investment but it is not very large. That is the background.

One of the issues that has come up a lot and which is implicit in the Deputy's question is whether the existing fiscal rules overly constrain capital spending. I wish to say a few words about the fiscal rules themselves first because they have come under a lot of attack. One of the reasons countries have these fiscal rules is that often the democratic process can create a tendency towards a deficit bias, which is not surprising in the sense that politicians have to get re-elected and their time horizons are thus that bit shorter than those of a body like the IFAC. Fiscal rules serve the function of pulling countries back, when the deficit is getting too large or the debt levels too high, to something more appropriate to the economy for the long term.

In the Irish case, the deficit bias problem is not too serious. There is a real understanding of the damage that excessive deficits and debts can do and so there is a natural tendency anyway, within the political process, to pull that back. However, a key problem in Ireland in the past has been that in good times when we had revenue surges, often when we were running budget surpluses rather than deficits, we introduced tax cuts and increases in spending which were very difficult to reverse once the revenue surges reversed.

We saw that during the property bubble and there is a danger that it might occur again with the recent surge in corporation tax. One aspect of the fiscal rules that is very beneficial in stopping it from happening is the expenditure benchmark because it constrains overall expenditure growth, net of discretionary tax changes, to be in line with the underlying growth in the economy. That is a positive aspect of the rules. On the other hand, if the rules are at odds with what we might consider optimal fiscal policy then we should be concerned about the rules.

I know that many are concerned that the rules might be taking us away from optimal fiscal policy. It is true that if we were following optimal fiscal policy, we would want to undertake investments which have a positive net financial return. One could argue that the ideal rules would actually exclude net investment from the overall calculation of the deficit target and there have been developments at a European level to look into possible modifications of the rules to exclude at least certain categories of net investment. That is a positive development. That said, there is one other question that we need to ask. Even if we were concerned that the rules were not most effectively designed and that they should be making more of a distinction between current and capital spending, we still have to ask if the overall deficit target that we are aiming at is correct. In this, we must take into account that we still have a very high debt and need to bring it down. The only way we can really bring that debt down is by bringing the deficit down towards a balanced budget position. We also have to recognise that there are strong, underlying demographic pressures that will be going on for a number of years to come. Professor John Fitzgerald in an article published last week pointed out that there is annual growth of 3.5% in the number of pensioners, just to take one example of those underlying demographic pressures. Therefore, even though we might be concerned that the rules should be making more of a distinction between current and capital spending, given the need to bring the debt down and given the demographic pressures, we probably should be running a reasonably sizeable current budget surplus and an overall budget that is reasonably close to balanced is probably not inappropriate in the current circumstances. This means that we have difficult decisions to make. We certainly do not want to squeeze capital spending but we must take into account the demographic pressures and the need to bring the debt down, while still aiming for something close to a balanced budget, which the current fiscal rules do. It is a somewhat long-winded answer but I am saying that while people have raised issues about the fiscal rules, where we end up in terms of the overall deficit target seems to be broadly appropriate.