FRIDAY, FEB. 24: Government debt will exceed 30 per cent of gross domestic product (GDP) as the ability to collect tax revenues declines faster than the ability to cut spending.  

Payroll tax and customs duties are the main drivers of Government revenue and these move in direct proportion to GDP, which will shrink again in 2012 and 2013.  

The Budget’s debt estimate of 24 per cent is optimistic at best.

Consider that the budget deficit for 2011-2012 was 80 per cent higher than estimated. Against this backdrop, the economy is starting to make the necessary wage, price and structural adjustments that are prerequisite to entering the recovery phase of the business cycle.  

The process of market self-correction began in 2009 — one year into the recession. Leading the way was the financial services sector where business costs fell by a whopping 17 per cent, through redundancies and pay cuts.  

Both cost cutting strategies put downward pressure on wages and salaries in a sector that employs around 2,700 people or 7 per cent of the total employment.

The hospitality and construction sectors, with similar numbers of workers as financial services, are following suit.  

The downward correction in inflation-adjusted wages in the hospitality sector will improve the competitive position and attractiveness of our tourism product lines. As a rule, the speed with which the private sector makes the necessary changes to its pre-recession business model will factor in how soon recovery gets underway.

Public sector employees have signalled their willingness to push Government costs in the downward direction. This is significant because of its size — 5,700 employees. Unfortunately, for 2012-2013, this will not translate into lower spending on wages and salaries, which make up 40 per cent of total spending.

The Budget’s anticipated boost in consumer spending and business investment from suspended pension contributions is unlikely to materialise. A doubling in non-performing loans in 2011 suggests that household and business debt burdens remain unsustainably high at 90 per cent of GDP.  

Debt repayment will suppress consumer and business spending over the next three to five years as deleveraging takes effect.

The removal of stamp duty on mortgages is a step in the right direction in respect of stemming the rising tide of non-performing loans.

Spending by residents, tourists and international business will increase as inflation-adjusted prices fall.

Purchases of building materials are making a comeback. Between September and December, retail sales increased by 14 per cent, 25 per cent, 10 per cent and 27 per cent.  

Declines in the local price-level make imported goods and services more expensive. Perhaps this is driving resident purchases abroad down by approximately 25 per cent in November and December.  

Together, these provide a much-needed stimulus.

The Government has all but committed itself to austerity over the medium-term. Austerity brings into question the nature of one’s national sovereignty. In times of crisis, foreign bondholders have greater say in a country’s spending and taxation plans than voters. Greece and Italy are cases in point: technocrats, whose primary purpose is to balance the government’s budget normally at great cost to the taxpaying public, replace democratically elected governments.

Our Government is between a rock and a hard place.

Trying to wrestle the economy from the jaws of recession, by maintaining the status quo in respect of public sector jobs can place the island beyond its debt threshold, which is perhaps around 40 per cent of GDP.  

Once the word is out, prospective lenders will charge more for additional loans, which in turn elevates the risk of a sovereign debt crisis. Alternatively, focusing on debt reduction will surely prolong the recession and may move us to the same debt threshold. Possibly the best advice is to hold the slack tight.

Craig Simmons is an economist who teaches at Bermuda College.