Monday, November 24, 2014

Ireland and the Austerity Debate

DUBLIN – Both sides of the austerity debate that is now gripping economists and policymakers cite Ireland’s experience as evidence for their case. And, however much they try to position the country as a poster-child, neither side is able to convince the other. Yet this tug-of-war is important, because it illustrates the complex range of arguments that are in play. It also demonstrates why more conclusive economic policy making is proving so elusive.

Here is a quick reminder of Ireland’s sad recent economic history. Lulled into complacency and excess by ample supplies of artificially cheap financing, Irish banks went on a lending binge. Irresponsible risk-taking and excessive greed outpaced prudential regulation and supervision. The banking system ended up fueling massive speculation, including a huge run-up in real-estate prices, only to be brought to its knees when the bubbles popped.

Unlike the many Irish households that lost jobs and part of their wealth, the banks were deemed to be “too big to fail,” so Ireland’s political elites intervened with state funding. But, by under-estimating both the domestic and international aspects of the problem, the authorities transformed a banking problem into a national tragedy.

Rather than restoring the banks to financial health and ensuring responsible behavior, the Irish economy as a whole was dragged down. Growth collapsed; unemployment spiked. Lacking opportunities, emigration increased – a vivid reminder of how economic crises have wreaked havoc on the country’s demographics throughout its history.

Investors withdrew in droves from what was once deemed the “Celtic Tiger.” The government had no choice but to request a bailout from the “troika” – the International Monetary Fund, the European Central Bank, and the European Commission – thereby transferring an important component of national economic governance to an ad hoc, fragile, and sometimes feuding group of institutions.

While other struggling eurozone members also turned to the troika, Ireland stands out in at least two notable ways. First, two democratically-elected governments have steadfastly implemented the agreed austerity programs with little need for waivers and modifications – and thus without the associated political drama. Second, despite enduring considerable pain, Irish society has stuck with the program, staging few of the street protests that have been common in other austerity-hit countries.

All of this puts Ireland in the middle of three important issues raised in the austerity debates: whether orthodox policy, with its heavy emphasis on immediate budget cuts, can restore conditions for growth, employment gains, and financial stability; whether the benefits of eurozone membership still outweigh the costs for countries that must restructure their economies; and how a small, open economy should strategically position itself in today’s world.

Austerity’s supporters point to the fact that Ireland is on the verge of “graduating” from the troika’s program. Growth has resumed, financial-risk premia have fallen sharply, foreign investment is picking up, and exports are booming. All of this, they argue, provides the basis for sustainable growth and declining unemployment. Ireland, they conclude, was right to stay in the eurozone, especially because small, open economies that are unanchored can be easily buffeted by a fluid global economy.

“Not so fast,” says the other side. The critics of austerity point to the fact that Irish GDP has still not returned to its 2007 level. Unemployment remains far too high, with alarming levels of long-term and youth joblessness. Public debt remains too high as well, and, making matters worse, much more of it is now owed to official rather than private creditors (which would complicate debt restructuring should it become necessary).

The critics reject the argument that small, open economies are necessarily better off in a monetary union, pointing to how well Switzerland is coping. And they lament that eurozone membership means that Ireland’s “internal devaluations,” which involve significant cuts in real wages, have not yet run their course.

The data on the “Irish experiment” – including the lack of solid counterfactuals – are not conclusive enough for one side to declare a decisive victory. Yet there is some good analytical news. Ireland provides insights that are helpful in understanding how sociopolitical systems, including economically devastated countries like Cyprus and Greece, have coped so far with shocks that were essentially unthinkable just a few years ago.

On my current visit, most of the Irish citizens with whom I have spoken say that the country had no alternative but to follow the path of austerity. While they appreciate the urgent need for growth and jobs, they believe that this can be achieved only after Ireland’s finances are put back on a sound footing. They also argue that, given the banks’ irresponsibility, there is no quick way to promote sustained expansion. They are still angry at bankers, but have yet to gain proper retribution.

Ireland’s accumulation of wealth during its Celtic Tiger period, when the country surged toward the top of Europe’s economic league table, has also been an effective shock absorber. This, together with fears about being left out in the geopolitical cold (despite the country’s historical links with Britain and America), dampens Irish enthusiasm for economic experiments outside the eurozone.

Indeed, Irish society seems remarkably hesitant to change course. Right or wrong, Ireland will stick with austerity. Efforts to regain national control of the country’s destiny, the Irish seem to believe, must take time. In some of Europe’s other struggling countries, however, citizens may well prove less patient.

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    1. CommentedJim Neuhaus

      I have a test for discussions about Ireland : if there is no mention of the specifics of the Irish economy wrt corporate tax evasion or the outsize share of foreign company (virtual) activity, it is safe to assume the article has only a distant relationship with observable reality.
      I think this article fails the test.

      The real test for the Irish economy will come if/when other European nations move to close the tax loopholes that Ireland benefited from during the last 20 years (which appears more likely today than ever before). Only then will we be able to assess the Irish economy on its own merits.
      I think it is safe to say that without these fiscal crutches, the Irish economy may find it difficult to return to its recent glorious shape (btw this feat is shared with Luxembourg and a few other statelets currently topping the EU gdp/capita charts).

    2. CommentedDaniel Rosenthal

      A lack of counterfactuals? What about Iceland? Or Sweden in the late '90s? Or Argentina in the last decade?

      Mr El-Erian, you've got a fine line to walk: too salty and you're a limpid lefty; too fresh and you're a banker's boy. I sympathize.

    3. CommentedJose araujo

      Msinummoc the new European regime, the nationalization of liabilities and privatization of assets, the end of free markets and all mighty planning bureaus and committees.

      The Euro killed the Celtic Tiger, and only the Euro's death and free markets can revive it. Free Capital and Financial Markets where bankruptcy is a possibility and interest rates reflect the default and risk rate of the businesses, and a free currency market where the value of the currency is defined by the balance of payments

    4. CommentedPaul Hunt

      @Adam Harper,

      To an extent you are correct in that a structural fiscal deficit cannot be sustained and fiscal adjustment is required. Dr. El-Erian notes a weary and resigned acceptance of this. But there is also considerable anger and resentment that private bank debts have been imposed on taxpayers thereby increasing the fiscal deficit - and the extent of adjustment required.

      There is a strand of economic commentary in Ireland - and it strikes a chord with a significant tranche of public opinion - that Ireland was prevented by the ECB from resolving the most egregious failed banks (Anglo Irish and Irish Nationwide). Irresponsible borrowers had their counterparts in irresponsible lenders who failed to price the risk to which they were exposed and were subsequently bailed out by taxpayers.

      This simmering anger and resentment has prevented the Government introducing structural reforms that would advance economic recovery. It could not risk the ferocious response of the affected narrow sectional rent-capturing economic interests undermining the broad, if sullen, acceptance of fiscal adjustment. It has succeeded in whittling doing the programme of structural reforms initially agreed with the Troika to almost nothing.

      Of course, there has to be a considerable doubt that the Government would have introduced these structural reforms even if the circumstances had been propitious. The profound failures of democratic governance that occasioned the Irish boom and bust remain. The Government is advancing cosmetic remedies. But, in the absence of serious reforms of democratic governance and of meaningful structural reforms, the path to economic recovery will be much longer and harder than it need be.

    5. CommentedShane Beck

      As long as the Irish government has low taxation revenue due to such financial corporate arrangements as the Double Irish arrangement or Dutch Sandwich, the citizens of Ireland will have to endure austerity, EU subsidies notwithstanding. I would suggest that Ireland is an economic anomaly due to its taxation structures

    6. CommentedMichael Hennigan - Finfacts

      Whether the choice is radical policies or the status quo, the challenge for Ireland is that it has no viable jobs engine.

      With a broad rate of unemployment of 24% according to the IMF last month; a 25% bad loans ratio, in line with Greece, despite the transfer of toxic property loans to a public agency; second to Greece in the rankings of the burden of sovereign debt but when household debt is included, Ireland is the biggest debtor of the western world as a ratio of economic output excluding business debt.

      Ireland's gross public debt burden is at 159% of GNP; Irish household debt as a ratio of GNP is 155% compared with Greece's ratio of 55% of GDP. Gross national product is used as a better but still imperfect metric of Irish economic output as it excludes the profits of the dominant foreign-owned sector.

      Maybe Ireland will be able to piggyback on an economic miracle in the developed world in a decade, to grow it's way out of debt (!), in the meantime, the prospect is low growth. Even if a radical route was taken to ditch the euro and aspire to force some debt accommodation on Europe, not even the farmers would be able to feed themselves without imported basic food.

      Jobs in the internationally tradeable foreign-owned sector peaked 13 years ago and there has been limited transfer of technology to the indigenous sector, as many of the jobs in foreign firms are in administration and software localisation.

      Even if the value of exports was discounted for multinational transfer pricing and revenue diversions by firms such as Google, indigenous exports would only account for 20% of the resultant total.

      Two-thirds of private sector workers are in traditional non-exporting firms; only 7% of SMEs export and the poor performance of the indigenous sector coincides with low social security costs and corporate taxes.

      Ireland with 20 firms per 1,000 inhabitants, is at half the European average.

      The apparent acceptance of austerity in Ireland relates to its concentration on a minority in the private sector who have no job security and are not unionised. Social welfare rates also are higher than levels in the UK.

      This year, tax revenues (excluding social security receipts) will be at a similar level to 2005 while gross current government expenditure will be 44% above the 2005 level.

      It should also be noted that despite a failed governance system, apart from changes at the Central Bank, it's business as usual in Ireland.

    7. CommentedG. A. Pakela

      The more interesting aspect of this article is not the auterity or not question, but whether the Irish government could have taken an alternative course with respect to its banks. Banks are private sector entities - they could have been forced into bankruptcy, with shareholders wiped out and bondholders given an extreme haircut. At the end of the chain, depositors could have been given their own haircut.

      In the U.S., at the turn of the century, the public was caught up in the dot-com, NASDAQ and general stock market frenzy. After the bubble burst, the dot-comers were wiped out, the NASDAQ folks took a big haircut and shareholders in the general market also took a hit. This undoubtably contributed to the recession in 2001, but it did not result in a depression, even after the affect of 9/11.

    8. CommentedAdam Harper

      This is correct, they didn't have a choice, not really. They could try to postpone it, but as I've said many times, Austerity is not a solution, nor is it the problem. It is the result; the result of unsustainable expansions of fiscal defecits. The result of international investors recoiling from irresponsible borrowers. The result of putting your hand out to the IMF, begging for help. We can go ahead and postpone this result if we wanted to; keep borrowing, keep spending, keep wasting, but eventually, we'd find ourselves right back where we are, staring austerity in the face once again.

    9. CommentedPaul Hunt

      Dr. El-Erian is obviously aware that Ireland does economic stagnation, but, perhaps, isn't aware of how well it does it. It has had decades of experience of self-inflicted stagnation - the '30s,, '50s, '80s and now the 2010s - interspersed with exernally infuenced stagnation, with the 'Emergency' in the '40s and OPEC I in the early to mid '70s. Despite being forced to trim their sails, there remains a majority of citizens who are quite comfortable - and certainly very comfortable compared to previous generations (and generally more comfortable than those in many other distressed EU Member States). Those who are struggling will have to make do and mend; those who can't or choose not to will have to up sticks and leave.

      In addition, there will always be some short term fixes and fiddles to help keep the show on the road, plug a few gaps, keep large numbers of well-positioned 'insiders' in clover and be hyped out of all proportion to convey an optical illusion of progress and economic recovery. For example, there's €6+ billion available for 'investment' from the raid on the remnants of the National Pension Reserve Fund. The EU has some limited funds for 'labour activation'. Some more soft loans can be squeezed out of the EIB. The ESM might cough up something for 'retroactive' recap of the banks. The members of the Irish 'diaspora' who are well connected might drum up some more FDI. Who knows?

      The official line is: "Whatever you do, don't even think about changes in democratic governance, in sectoral economic policy, in institutional arrangements and procedures, in competition policy and enforcement or in economic regulation that might provide the basis for a sustainable economic recovery. What's in place now has been hard-won. The majority of citizens are not complaining unduly. You have no idea what upset you'd cause if you tried to change these things. Keep things nice and steady and we'll be grand."

      Without these changes stagnation will continue until reasonably healthy demographics will pull Ireland out of the mire. Still it should prove a good bet for PIMCO and other investors. They won't lose - unlike a significant proportion of the Irish population.