Ireland: The Bill Arrives
One week on from the Irish “bailout” and with days to go before the budget (for the latest shenanigans and arm twisting of independent TDs see this excellent Bloomberg story), some excellent analysis is appearing. Much of the best commentary is appearing at the superb Social Europe website and I’d especially recommend the articles by John Weeks, George Irvin and Andrew Watts.
Barry Eichgreen’s article (from a long term supporter of the Euro) is an important contribution.
I’m currently fleshing out my own thoughts on how to move from a short term fix (see here) to a longer term resolution (hopefully finished in the next day or so).
But in the meantime it is worth pausing for a moment and taking stock of what is happening. Because really it’s very simple: Europe has been presented with a bill and is bickering over whom will pay it.
I’m sure we’ve all been there – a long and rather good meal with a large group of people, some of them close friends and some of them vague acquaintances. The bill arrives and suddenly people are disputing exactly how much wine they drank, asking who had a starter and who ordered coffee.
The situation in Ireland is simply this writ large. During a decade long boom, induced by negative real interest rates, too light regulation and a too-close-for-comfort relationship between Irish politicians, bankers and property developers Ireland has run up a huge amount of debt (government, household and banking sector). The debate now is about how that is settled.
As Michael Pettis has clearly set out, the different strategies open to Ireland and Europe will land different countries and social classes with the adjustment costs:
- Abandoning the euro and devaluing imposes much of the burden on creditors whose assets are redenominated, especially those with newly mismatched books (i.e. their redenominated assets were funded with non-redenominated euro liabilities). These may include the wealthy, but because they know this, we will probably see significant flight capital as they liquidate assets and take them out of the country. Foreign banks who have lent to the redenominating country will also take big losses. This may sound invidious, but although an approach in which foreigners bear a disproportionate share of the pain may not be fair, it certainly is convenient.
- Forcing down labor costs through unemployment puts the bulk of the burden on workers and the lower middle classes, especially non-unionized workers. Other forms of deflation hurt borrowers, including small businesses and mortgage borrowers.
- Trade barriers may be impractical within Europe (at least before abandoning the euro), but to the extent that they are imposed they force domestic consumers and foreign producers to bear the cost of the adjustment. Remember however that local households comprise both domestic consumers and domestic workers, so the real impact on household income may be positive if trade barriers are expansionary for employment (which they usually are in diversified deficit economies). The question is which households. The unemployed working class may benefit while the struggling middle class may get hurt.
- Inflation hurts everyone on a fixed income. Middle class people with savings, pensioners, and non-unionized workers are usually the ones hurt the most.
- Default and debt forgiveness places the adjustment cost on lenders, in this context especially on lenders to the sovereign borrower. Again, it is worth remembering that if a disproportionate share of lending comes from foreigners, they absorb a disproportionate share of the cost.
- Raising consumption and value-added taxes hurts consumers, mainly the middle and working classes since the poorer you are the higher consumption is as a share of your income, while raising income taxes on businesses puts the pain of adjustment on businesses, especially small businesses who often aren’t able to protect themselves. Finally cutting fiscal expenditures mainly affects the middle classes (medical and education) and the working classes and poor.
As Michael argues, this is essentially a political question – there isn’t a simple, technocratic economic solution. A point worth remembering when economists offer their own solutions. The question is ideological not technical and what matters is no just “what works” but what is right.