Don and Sue both make the obvious leftist response to Osborne’s proposal to lend to Ireland: how can a government which claims that spending cuts are necessary suddenly find £7bn?
It’s a good, glib debating point, but maybe not much more. In truth, it could be that lending to Ireland will reduce UK government borrowing.
The reason for this is simple. The UK can raise £7bn very cheaply, and earn a high return by lending to Ireland. The terms of the loan are not yet known, but let’s assume for illustration that the interest rate is 7.7%, the current yield on five year Irish gilts. UK yields are now at 2%, so this implies that, over the course of the loan, the UK would earn just over £2.2bn.
We could add to this the taxes the Exchequer would receive from UK exporters, who find their ability to sell to Ireland enhanced. But this is a second-order gain. In 2009, Ireland spent 17% of its GDP (pdf) on UK goods and services. So, if our £7bn loan raises Irish GDP by £7bn, and assuming a tax rate of 40% on exporters‘ income, the Treasury will get another £640m: 0.4 x 0.23 x 7.
The Treasury’s £7bn loan could therefore earn it a total return of just under £3bn. This is almost certainly better than it would get from orthodox loose fiscal policy. To recoup £3bn from £7bn of borrowing to finance domestic spending at a 40% tax rate requires a multiplier of well over three. This is larger than most plausible estimates.
All of which raises the question. If bailing out Ireland is such a good idea, why not do more of it? Why not lend to Portugal and Greece as well, and to all comers?
Simple - default risk. Lending to Ireland brings with it the risk that Ireland won’t repay - a risk which Duncan thinks very high.
This changes the maths. If the Treasury gets back only half of its loan, then it’s touch and go whether lending to Ireland is better than ordinary Keynesian borrowing. (The politics, of course, is much worse, as Osborne would get much more flak for a bad overseas loan than he would for lacklustre domestic fiscal policy).
But let’s be clear. The question here is not: how can Osborne find £7bn? He’ll find it from the same place as the other £155bn he’ll borrow this year - from the gilt market. Instead, the issue is: what is the default risk and the interest rate on this loan? It is this, and this alone, that determines whether the loan is a good idea or not.