It isn’t spending cuts
Those arguing against spending cuts have recently adopted a one-word argument: Ireland. The case it stands for is as simple as it is bogus. Ireland had a deficit, now even worse than Britain’s. It adopted an agenda of sharp public spending cuts, on the same logic used by the British government. The result? A double-dip recession and a fresh round of misery. The lesson from Ireland is that cuts don’t work — and that George Osborne is leading Britain into the swamp.
The argument is seductive, but only if one is ignorant about what has just happened in Ireland. It is true that after bouncing back in the first quarter, the economy shrunk again in the second quarter, but such variability is to be expected in any country exiting a slump as severe as Ireland’s. But the real meteor that has just crashed into the government has nothing to do with the cuts, without which the Republic would almost certainly now be bust. It stems from Ireland’s hasty promise to guarantee 100 per cent of all bank deposits, and a subsequent failure to fix many of its most important banks. The decision to bail out Allied Irish Banks added some €50 billion to the national debt. Rather than disguise this by fiddling the accounts (as Gordon Brown did in Britain) the Irish have taken it on the chin. They have published a worst-case scenario: a one-off increase in its deficit to 32 per cent of economic output, assuming (unlike Britain) that the bank money has gone for ever. The markets were impressed, slightly lowering the interest charged on Irish government debt.
There is a crucial aspect of the Irish crisis that everybody appears to have forgotten, which goes a long way towards explaining Ireland’s problems: its membership of the dysfunctional single currency, an institution it should never have joined. Ireland, like Britain, had its economy deformed by debt — the result of year after year of dangerously cheap credit, aided and abetted by central banks. Ireland’s cheap money came from the European Central Bank, which kept interest rates even lower than the Bank of England, thus guaranteeing an even greater boom and subsequent bust. Even in January 2006, when many of the stupider lending decisions taken by Irish banks were being planned, eurozone interest rates were only 2.25 per cent. This arguably made sense for Germany, but was absurdly low for Ireland; it could have done with 9 per cent.
Politicians always like to take credit for prosperity, real or illusory. For some time in Ireland, inflation was running higher than interest rates. That meant ‘real’ interest rates were negative: companies and consumers were being paid to borrow. Projects that would never have been worthwhile had the authorities priced money properly were signed off with abandon.
Of course, Ireland’s microeconomic reforms — including cutting corporation tax to 12.5 per cent — played a key role in transforming its economy from backwater to global hub. But much of the reported ‘growth’ was froth caused by excessively low interest rates. When the bubble popped, thanks to the US subprime debacle, the consequences were devastating. As property prices slumped and firms went bust, so, predictably, did most of Ireland’s banks.
Ireland’s membership of the euro was thus the single most important reason for last week’s cripplingly large bailout of its financial institutions. It is hard to argue that Ireland should be spending (or rather borrowing) more. The authorities in Dublin understand this; last week’s bailout was an attempt to draw a line under bad debts. Its commitment to real austerity — including public sector pay cuts of up to 20 per cent in some cases — means that the markets are much happier with Ireland than they are with the likes of Greece and Portugal. It is in times of economic peril that the advantages of a country controlling its own currency become most obvious. Sterling has plunged far further against international currencies than the euro, giving our exporters the advantage over their French, German and (yes) Irish rivals. Stoking the boom, compounding the bust: the single currency has been a curse for Ireland’s economy. The idea that one interest rate would fit so many countries was always a nonsense. The tragedy is that so many in Ireland have had to suffer so much to prove it.
Allister Heath is editor of City A.M. and an associate editor of The Spectator.