Hibernian Woe

As Iain Martin notes, it didn’t take Labour long to welcome the news that the Irish economy shrank by 1.2% last quarter*. Welcome isn’t quite how they put it but since Irish economic pain is a weapon with which the opposition can attack the coalition, Irish misery is a price worth paying so Ed Balls can feel vindicated.

At least those who think fiscal restraint is needed at times such as these and who were perhaps too quick to welcome last quarter’s healthy growth in Ireland can say they want to see Ireland do well.

In truth, both sides of the British (and for that matter American) debate are too fond of treating the Irish as though they were nothing more than tiny lab rats subjected to a series of interesting economic experiments. How useful those experiments are, however, is a moot point since a) Ireland was particularly vulnerable to the kind of perfect economic hurricane that hit it and b) even though times are bleak now it’s not at all obvious that they’d be better if only the government had decided to keep spending (money it doesn’t have) to “promote growth”.

This is a terrible crisis for Ireland and one with abundant parallels with the misery of the 1980s. Then too national debt soared to 118% of national income, 33% of tax receipts were spent on debt interest, unemployment touched 18% and one of Ireland’s chief exports was, yet again, its people. In 1987 the spread between Irish and German three-month money rates was 10% while the spread on 10 year bonds was 700 points. (At the moment, by contrast, it is 417 points.)

So in that sense Ireland has been here before. Perhaps this is the reality and the boom was just a blip? One hopes not. It’s true that global conditions were friendlier to Irish recovery in the late 1980s and early 1990s than they are now. True too devaluation is no longer an option. And it’s also true that there probably won’t be a fresh influx of international (especially American) investment to help this time around. Consequently, the (real) success of past austerity packages is no guarantee that this one will work now.

It’s also the case that Ireland’s efforts to restore confidence may not work. As Economics21 argue:

While the Swiss and UK guarantees seem to have succeeded thanks to their banking system’s international activity and broad diversification, the Irish guarantee has not been as successful, largely because of its banks concentrated exposure to a bursting domestic real estate bubble. The result has been a deeply insolvent banking system that some believe will ultimately push the Irish government itself bankruptcy. Barclays was the latest to warn that the government will likely have to renege on its guarantee and seek concessions from bank creditors if it is to avoid sovereign bankruptcy. As of August, the Irish banking system owed €95 billion to the European Central Bank (ECB), which means about 12% of all Irish bank assets are now financed through official liquidity facilities. This is only slightly below the 17% of Greek assets funded through official channels and a sign that the private sector is no longer willing to fund Irish banks.

[…] Analysts on the political left are using the implosion of the Irish economy to advance their mistaken narrative about the supposed dangers of reductions in public expenditures. This overlooks that any savings generated by spending cuts were more than offset by outlays associated with the €90 billion NAMA to acquire bad loans in the banking system. While Ireland has made additional pledges to reduce the deficit to 3% of GDP in the medium term, its “consolidation plan would benefit from greater specificity,” as the IMF diplomatically puts it. In other words, Ireland has no credible plan to bring spending and revenues in line and has not done what is necessary to “reduce the uncertainties associated with the consolidation process.”

Large spending cuts can only succeed when they remove uncertainty and change private sector expectations about future disposable income growth and the cost of government. Ireland’s cuts failed to do that because they were dwarfed by the growth in the expected cost of the bank bailout. This means that the government’s implied cost to households and businesses has continued to grow despite the fiscal tightening. Implied government spending continues to grow.

Now the severity of Ireland’s problems – in banking and property especially – may be such that it is, in some senses, a uniquely unfortunate country right now. Certainly it’s in a weaker position than Britain (or the US) and so a less useful model for austerity-fans than they sometimes think.

However the reverse is also true: even if you believe that “austerity” has failed in Ireland that doesn’t mean that a more Keynesian approach (which had been tried for much of the 1980s without success) would have fared any better. Indeed it might well have exacerbated the problem and bankrupted poor Hibernia already.

So what next? Free Exchange suggests either a German-led bail-out or leaving the Eurozone. The former seems unlikely which leaves the latter…

*The tiny sliver of hope is that GNP – that is the indigenous economy and not counting profits by multinationals – is not getting worse: it contracted by 0.3% this quarters compared to 0.5% last quarter and declines of 2% in the final quarter of 2009 and 5.2% before that. Not good, obviously, but not as bad as it has been.