ECONOMICS:In the event of a bailout Ireland would have to change its budgetary approach, but the process would not be as bad as feared, writes DAN O'BRIEN

WHAT ARE the views of the European Commission and the International Monetary Fund on how to deal with budgetary crises? By chance, the latter yesterday provided quite a few answers to how it views the matter.

The IMF’s opinions are important for Ireland, as the probability that it will have a role in setting Irish budgetary policy in the years ahead is rising.

In the World Economic Outlook, one of its flagship publications, some of which was published yesterday, a chapter is devoted to how best to deal with budgetary crises. It reviews the work of economists who have studied past attempts at fixing deficits across the world. It adds to the body of research with new work of its own.

The report notes that the average budget deficit among advanced economies this year will reach a historically high 9 per cent of GDP. By the end of the year public debt will reach an average of 100 per cent of GDP, the highest in half a century.

As the IMF never tires of warning, the enormous costs of ageing populations in the rich world are beginning to kick in. The financial crisis, which has caused fiscal crises in many developed countries, could hardly have come at a worse time.

Given all this, much needs to be done in most countries to place public budgets on a firmer footing for the long term.

Two aspects of yesterday’s report are particularly relevant for Ireland.

First, the IMF says that the evidence points to spending cuts being a more effective way of balancing budgets than tax increases.

Second, it finds that there is no doubt but that deficit-squeezing measures have a negative effect on economic growth, thereby rejecting the argument made by some who say that households and corporates increase their spending when they see governments cutting theirs (this is called “Ricardian equivalence” in the jargon).

Both of these findings give an indication of the sort of budgetary strategy the IMF might seek if Ireland sought recourse to the bailout fund established with the EU last May.

Conceptually, there are two big issues – one is the magnitude of the budgetary adjustment (ie, how much more than the much talked about €3 billion in cuts and extra taxes would be imposed) and the other is its composition (ie, where to cut, which taxes would rise and the mix of the two).

Both the IMF and the European Commission have praised the magnitude of the Government’s adjustment programme set out last year, even if the former made plain in July that it would prefer to see the adjustment accelerated in 2011.

Given that Brian Lenihan confirmed yesterday that he intends to follow this advice and given that adjustments of this magnitude are already dampening growth by the IMF’s own estimates, it is unlikely a bailout would involve a significantly larger or more rapid pace of adjustment than the Government would introduce on its own.

If it comes to a rescue, the change in the budgetary consolidation process would almost certainly be in composition rather than magnitude. In the 2010 budget, the burden of adjustment was firmly on cuts rather than taxes. So here, too, policy is in line with how the IMF believes it should be done.

But there would likely be change in the types of cuts. Hitherto, most of the expenditure efforts have focused on across-the-board public sector pay cuts and reductions in most welfare benefits.

Politics would appear to be the most important factor in the formulation of this approach – taking something from most people generates less resistance than taking a great deal from a smaller number.

This across-the-board compression approach is very unlikely to be maintained if a bailout is required. The IMF typically seeks structural change in rescued countries and that has been the approach of the commission in Greece since the bailout began earlier this year.

All areas of expenditure would be looked at again by the commission-IMF teams. The capital budget, welfare benefits and public sector pay – as the largest expenditure items – would face particular scrutiny.

The Croke Park deal would go straight into the shredder.

Reforms, however, would not be nearly as painful as those in Greece. As past country studies by the IMF and European Commission show, Greece needs to change the way it does most things. Similar reports on Ireland advocate far fewer changes (in part, however, this is because these organisations did not scrutinise Ireland as closely while the economy boomed).

This was illustrated when Ashoka Mody, one of the IMF officials who would be centrally involved in the setting of policy in the event of a bailout, took the unusual step of writing an article in this newspaper in July. He prioritised two measures – the need for wider-ranging legal instruments to deal with failed banks and the establishment of an independent fiscal council. Neither measure is politically painful.

As discussed in this column previously, there is no reason to believe that a bailout would result in any imposed change to Ireland’s corporation tax rate. No report by either the IMF or the European Commission (or indeed the OECD, whose work would also be closely scrutinised by those setting the terms of the bailout) has ever suggested a hiking of the corporation tax rate.

A bailout must be avoided if at all possible. But it would not mean the end of the world if it happened.