City AM: Ireland's bailout won't halt contagion

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Written by Allister Heath

29 November 2011

ONLY the naïve will believe that Ireland’s bailout will halt the Eurozone crisis. It is too late for that; the best that the EU/IMF/UK plan will achieve is to slightly delay contagion.

The 6 per cent interest rate on the EU portion of the loans is far too high, especially given that Eire’s inflation rate is so low. There will be no haircuts for senior bondholders, though holders of subordinated debt will rightly be hit – a system will be introduced under which private bondholders could be made to share the burden of any future Eurozone sovereign debt restructuring, subject to a case-by-case evaluation “without any automaticity.” A clear system whereby losses are shared is desperately needed. It’s a scandal the bailout culture has still not come to an end. One of the surprises was that Ireland will have to tap into its National Pension Reserve Fund, which has €24.5bn under management. That is a good move.

It is galling the UK is being forced to put its hand in its pocket, even though it isn’t part of the euro. But at least nobody believes we are about to be contaminated by the crisis. The coalition’s relatively tough budget has seen to that. But the respite may be only temporary. The UK faces unsustainable commitments and an ageing population. The Adam Smith Institute identifies three fiscal scenarios. The worst, where present spending plans are followed to 2015-16 and all subsequent “proceeds of growth” used to fund higher spending, would result in another crisis by 2019. The second, where the proceeds of growth are split 50:50 between spending hikes and debt cuts from 2015-16, would delay calamity till 2031. The third, where spending is held constant, would eliminate the national debt by 2041.

The Institute argues that the best way to achieve spending restraint is for the state to move away from being the insurer of first resort and become instead a safety net. The majority of people would provide for themselves, while the state’s focus will only be on the most needy. Miles Saltiel, author of the report, says the government should mandate a minimum healthcare package that everyone would be forced to buy, and would fund premiums for those unable to afford them. Service providers – such as hospitals – would be privatised, raising £236bn after recapitalising PFI obligations of £28.9bn. The report proposes a tax and regulatory regime to foster private provision of incapacity, income and mortgage insurance. State support would focus on the poor. Education and pensions would also be reformed.

While fiscal consolidation has saved us from the Eurozone’s fate, we cannot be complacent. Public spending will explode again as soon as the austerity phase ends – and we are already taxed more than is sensible. The coalition has focused on belt-tightening, decimation and efficiency gains. What we really need is radical structural change in the way services are funded and operated. This will eventually be forced upon us – so we might as well get thinking now.

Published in City AM here