Duncan’s Economic Blog

Ireland: A Warning

Posted in Uncategorized by duncanseconomicblog on September 21, 2010

A year ago I wrote a post for Left Foot Forward on the Irish economy. I noted how, unlike Britain, the Irish Government had reacted to the global recession by cutting spending and attempting to drive down costs to remain globally competitive. I also noted this was broadly the policy pushed by the Conservatives at the time.

I assessed what had happened in the year between September 2008 and September 2009.

Nearly one year on, what has been the effect of these polices? Irish GDP is expected to fall by 12%, a staggering decline. Unemployment has reached 12.4% and is still rising. The economy is now in the grip of a severe deflation (minus 5.9%). Finance Minister Brian Lenihan openly talks of the need to “get our cost base down” in order to regain competitiveness. A policy of aiming to balance the budget and drive down wage costs is a throwback to the so-called Treasury View of the 1930s, a policy rejected then by progressives and rightly rejected now. The final irony is that, despite all of this needless suffering, the Irish Government will still be running a budget deficit of 12% of GDP this year while the ratings agencies have already cut Ireland’s sovereign bonds from AAA to AA.

In December last year, as Ireland delivered yet another emergency budget that was again praised by British Tories, I wrote an update.

Iain Dale writes that:

“The PBR the British Chancellor should have delivered, was delivered yesterday in Dublin. Hopefully George Osborne is studying it in great detail.

The results of Ireland’s policy are plain to see:

• Irish unemployment is 12.5 per cent;

• The country is experiencing deflation at –6.6 per cent;

GDP has fallen 7.4 per cent over the past year and 10.5% from its peak;

• And despite the cuts they have still had their credit rating downgraded.

But what exactly are the measures that the Tories are so keen to praise?

Child benefit is being cut by 10%.

Unemployment benefit is being cut by 4.1%, with larger cuts for those under 25.

Public Sector workers are facing pay cuts of 5-8%.

Prescription charges are being increased by 50%.

Other increased health charges including A&E, inpatient and outpatient charges and a higher monthly threshold above which people cannot get free drugs under the Drug Payment Scheme.

The Health budget is being cut by €400mn on top of previously announced cuts

Further departmental cuts will be announced in coming days.

€960mn is cut from the investment budget

So, a year after the first post and two years after Ireland embarked on its programme of cutting, where are we now?

Not in a good place. As the FT reports:

Ireland’s central bank governor has indicated that Brian Cowen’s government needs to go even further in cutting the forthcoming budget if it wants to restore international confidence in its management of the economy.

A year ago the populist Fianna Fáil-led coalition won international plaudits as one of the first EU countries to tackle the crisis head on, administering cuts in public sector pay averaging 15 per cent, and reductions in child and other benefits in the most savage budget in decades.

Yet today Ireland, together with Greece and Portugal, is seen as the most vulnerable of the EU’s peripheral economies, as it struggles with a property and banking crash that has blown a hole in the public finances and threatens the economic recovery.

As Ireland prepares to engage in (another) round of cuts, Bloomberg reports how unconvinced “the markets” are by Irish policy.

Thirty-seven percent of those surveyed say Ireland is likely to default, more than double the rate three months ago, according to a quarterly poll of 1,408 investors, traders and analysts.

Ireland is providing a vivid example that the “cuts don’t work”. As the head of asset allocation at Credit Suisse Private Bank warned a year ago

Spending cuts to be announced today by Finance Minister Brian Lenihan may end up sacrificing long-term economic growth for reducing the budget deficit, an Irish author and head of asset allocation at Credit Suisse Private Banking has warned.

Michael O’Sullivan, whose book, ‘Ireland and the Global Question’, was published in 2006, warned this week that Mr Lenihan’s expected swingeing cuts could do long-term damage. “Arguably the Irish bond market is being saved at the expense of Irish society”, said Mr O’Sullivan.

“By cutting spending you lower the trend line of growth and store up bigger fiscal problems down the line,” he added.

Cutting now reduces growth and  tax revenue and increases unemployment and welfare spending. It does not close the deficit in a sustainable manner.

Ireland, a euro member, may have little choice but to pursue this policy. The UK though does face a choice, and we are making the wrong one.

25 Responses

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  1. Daniel Furr said, on September 21, 2010 at 9:58 am

    Ireland is in the single currency – it cannot devalue. Britain can. The left seems to be ignoring that.

    The problem with the European debt crisis is the Euro itself. Nations cannot devalue the currency as a means to ease the burden.

    • duncanseconomicblog said, on September 21, 2010 at 10:01 am

      Daniel – and yet Osborne is opting for cuts. And when Sterling devalued he called it a crisis.

      Plus – We were constantly told to “look at Greece”, also a Eurozone member.

    • Dafydd said, on September 24, 2010 at 10:20 am

      Errrr, devaluing is just a mealy mouthed partial default (restructuring).

      Nothing wrong with that, but spending cuts are not the replacement for devaluation. Rescheduling is.

  2. pablopatito said, on September 21, 2010 at 10:08 am

    But surely the Tories aren’t planning cuts anywhere near the levels the Irish did? The Irish experience tells us you mustn’t cut too much, not that you mustn’t cut at all.

    • duncanseconomicblog said, on September 21, 2010 at 10:16 am

      Ireland has been attempting to reduce the deficit from around 11% of GDP in 2008 to 3% by 2014. Two years on it is still in double figures.

      Osborne aims to go from 10.1% in 2010/11 to 2.1% in 2014/15.

      • pablopatito said, on September 21, 2010 at 2:05 pm

        OK then. The Irish experience tells us you mustn’t cut too much *too soon*, not that you mustn’t cut at all. Aren’t most of Osborne’s cuts coming much later in the downturn than Ireland, and he is initially cutting far less deep?

        I have no idea whether “Cutting now reduces growth and tax revenue and increases unemployment and welfare spending”, though I like the arguments the likes of you have been making.

        But I don’t see how Ireland proves anything regarding Osborne’s plan. Its like explaining how someone died of hypothermia on Snowdon proves my mother was right about wearing my coat to school.

        • duncanseconomicblog said, on September 21, 2010 at 2:13 pm

          Pablopatito,

          Obviously it can’t “prove” that Osborne is wrong. But it provides pointers – and Osborne (plus many Tories) praised Ireland throughout this period.

          On your first point – this depends on a judgement of where we are in the private sector recovery. Osborne clearly thinks we are pretty far advanced and the private sector can take the strain.

          • Mike S said, on September 22, 2010 at 3:26 pm

            ‘…judgement of where we are in the private sector recovery. Osborne clearly thinks we are pretty far advanced…’

            Duncan,

            This is a good point but maybe too generous? Increasingly, supporters of the ‘Osborne strategy’ are claiming that the Government’s approach is being shaped by a sophisticated – and evolving – reading of the economic cycle. I’ve seen it claimed on one prominent Lib Dem blogging site that the coalition’s cuts are now urgently needed to contain inflation!

            If only it were true that coalition policy is being informed by the UK’s macroeconomic context. The reality is that this prescription for economic management is totally unchanged from the Tory view circa late 08 / early 09. All Osborne is doing is what – at every point in this long crisis – he said he would do. Whatever else is driving coalition policy on the deficit – it isn’t the economic context!

  3. Liam Murray said, on September 21, 2010 at 11:34 am

    As ever I come at this a lay man, trying to learn as much as to make a point.

    Isn’t there a case that the Ireland experience only demonstrates the folly of that ‘anti-stimulus’ position as adopted at that point in time? That the mess Ireland is clearly in is a function of the innadequacy of their initial reaction a couple of years ago (yes, championed by Tories) and the absence of the positive steps Brown took (again, opposed by the Tories)? It amounts to argument – albeit a very convinciing one – that the Tories WERE wrong, not that they ARE wrong NOW.

    I know we’re straying into the politics rather than the economics again but consider this – I’m 39 and have voted Labour all my life until May, making the judgement then that those best placed to address the problems we faced at that point were the Tories. There’s no contradiction in adoptiing that position and acknowledging it would’ve been a disaster had they been in office two years previously. In short that’s the argument being made here – it doesn’t amount to a reasoned argument that cuts are wrong now.

    • duncanseconomicblog said, on September 21, 2010 at 11:41 am

      Liam,

      I think you’re right on the first point. This goes a long way towards showing that Brown was right and the Tories wrong on stimulus.

      Now it’s a judgement call. I think that the Irish example shows the danger of cutting too quickly. It depends on how strong the private sector recovery is, is it strong enough to withstand the drag from fiscal tightening?

      I don’t think it is. Osborne appears to disagree.

      There is also the question of how you close a large deficit. Osborne thinks you do it by cutting spending and raising taxes. I think this can be self defeating.

      Taking the political point – is it possible tha Osborne’s actions are driven by a small state ideology rather than economic commonsense? Possibly so.

      • Liam Murray said, on September 21, 2010 at 12:06 pm

        I’m in little doubt that Osborne’s instincts are typical ‘small-state’ Tory instincts. My constraint refrain online (particularly at Hopi’s place) is that no single set of instincts is universally applicable or welcome – indeed that constant application of one particular set of values leads to 1979, 2010 etc. – take your pick. I switched because I think the ying-yang of centre left & centre right politics is, in the long run, good for the country and arguably the last 50/60 years demonstrate just that.

        When I voted Labour in 1997 I was pretty confident that I’d do likewise for a few terms and did just that. I have no such confidence this time but still think the coalition is doing the right thing for the moment. If it turns out I’m wrong I’ll happily admit it…

  4. vimothy said, on September 21, 2010 at 7:36 pm

    Is the bond market even being saved? I mean, if the economy is much smaller, what has happened to the real value of those savings? It’s like quack medicine–the patient isn’t recovering; increase the dose!

    Meanwhile, in the UK unemployment is up: http://www.guardian.co.uk/business/2010/sep/15/unemployment-claimant-count-rises-unexpectedly

  5. Tyler said, on September 23, 2010 at 9:32 am

    Duncan, you have totally missed one major theme of the Irish situation.

    What is really blowing up Irish bond markets, CDS and the deficit is the bailouts needed for AIB and Anglo. The combined balance sheets are much bigger than Irish GDP.

    The initial reaction to Irish prudence was actually quite positive from the markets….especially given they are stuck in the Euro and have had growth built upon massive extension of cheap credit. An internal devaluation (lower wages, higher unemployement) is to be expected surely.

    Markets only really reacted when the bad news about the Irish banks, essentially telling us how leveraged and how much bad debt there was floating around in the Irish financial system. The whole thing was a massive bubble.

    Now, what you are essentially saying, is that the Irish government should take on MORE debt to reinflate the bubble, kicking te can down the road a few years. Slightly less pain now for lower future growth.

    You might have the view that there will be no day of reckoning in debt terms, but history tme and time again shows otherwise. In my view it is better to deal with the underlying issue now, take the pain and rebuild an economy from a lower, more competative cost base. Your typically left-wing view is to substitute one bubble for another. All i thikn you will achieve by doing that is to make the next recession significantly worse than this one, and probably decrease the time between recessions.

    • duncanseconomicblog said, on September 23, 2010 at 9:47 am

      Tyler,

      On the Irish Banks/Property bubble (one I must say whihc was praised by many British Tories who seemed impressed by the Celtic tiger’s model), I’ve got a long-ish essay in Soundings this month. (Mainly on Greece, Ireland also covered).

      • Tyler said, on September 23, 2010 at 1:00 pm

        Link to it if you will, or better still, repaste it on your blog…

        My point is still valid though. Prudence isn’t causing this round of Ireland woes – a horribly shafted banking industry is. The effect being that banks can’t lend, and the government can’t borrow easily (or rather it can, but in real terms it faces the choice of borrowing to stop the banks failing, or letting them go and supporting the economy, but not knowing how much fallout from a banking collapse there will be).

        Devil and the deep blue sea. Either way, they are totally trapped.

  6. Tyler said, on September 23, 2010 at 9:42 am

    Just to reiterate;

    “As Ireland prepares to engage in (another) round of cuts, Bloomberg reports how unconvinced “the markets” are by Irish policy.

    Thirty-seven percent of those surveyed say Ireland is likely to default, more than double the rate three months ago, according to a quarterly poll of 1,408 investors, traders and analysts.”

    This is because of the likely bailouts that AIB and Anglo will need, given their combined balance sheets are larger than Irish GDP. This is NOTHING to do with the Irish cutting/prudence agenda. Irish CDS had been gently dropping from the early 2009 crisis peak (from 400 to a respectable 125, UK currently @70 for comparison) on the back of the prudence agenda. This is until the news about the banks came out, sending Irish CDS up to an all time high around 465.

    What this is really telling us is that the Irish economy had fantastic growth over the previous decade built on massive leverage and hge debts. Bubble economics at its best.

  7. […] Iain Martin thinks the Irish experience will prove a blessing for Labour. I think he’s right (and indeed have been pointing this out for the past year). […]

  8. John Green said, on September 28, 2010 at 1:07 pm

    Sorry Duncan, your analogy stinks. The deficit will be abolished and there will not be a double-dip recession. Your prayers will not be answered.

    You should read the latest IMF assessment; in line with almost every other independent assessment of the prospects for the British economy it offers a ringing endorsement of government policy. Of course, you will not find this assessment on leftfootforward pages as it completely removes the only plank in Labour’s strategy.

    Sorry Duncan, go back to Ireland and try again.

  9. John Green said, on September 28, 2010 at 11:19 pm

    OK Duncan, how about buying me a pint if we avoid a double-dip recession.

    • duncanseconomicblog said, on September 29, 2010 at 1:18 pm

      Done.

  10. […] is despite the economic disaster that has been unfolding in Ireland over the past two years. In 2008 Lenihan decided against a […]

  11. […] mostly due to the good work done by Duncan Weldon, (who neatly exposes certain former Irish cheerleaders here) on the combination of Austerity economic policies, large private sector banking debts and […]

  12. […] The same of course occurred in Ireland – two years of ‘emergency budgets’, cuts and ‘tough m…. […]


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