Ireland, as a peripheral economy of the eurozone, experienced a 14 percent contraction in national income between September 2008 and September 2010. The recession in Ireland, statistically, began one year earlier than the eurozone . In mid 2009, the eurozone statistically exited the recession and returned to growth. By 2010 Ireland had not. During these two years Ireland’s budget deficit deteriorated, and is currently the largest in the EMU, at 14.7 percent of GDP. The general government debt is 32 percent. This is the result of the bank bailout. Our public debt is just over 80 percent of GDP and unemployment 13.6 percent. The increase in all of these indicators (including a contraction in national income) occurred after the introduction of two fiscal austerity budgets in 2008 and 2009. To understand this chaotic mess we need to examine the interdependence between Ireland and the Eurozone.
The strategy adopted by the Irish government (after its decision on Sept 30th 2008, to guarantee the deposits and bonds of Irelands banking system to the tune of €440bn) was to target public spending and unit labour costs as a means of adjustment because it cannot devalue its currency. In terms of wage policy, the FF government introduced emergency legislation to override the Non-Payment of Wages Act for the public sector in the 2009 budget. This enabled government to implement a pay cut that averaged between 5 and 15 percent. It also sent a signal to the entire economy that the Non-Payment of Wages Act was not an obstacle to downward wage flexibility in labour costs. This began a competitive devaluation of wages (although the evidence for pay cuts in the private sector is negligible).
In labour market policy government have introduced some measures to offset unemployment but there has been no statutory support for wage subsidies or short time working. In fiscal policy most of the adjustment has occurred via spending cuts rather than increased revenue. €4.6bn has been taken out of expenditure but net government spending has actually increased due to the surge in unemployment and expenditure on social protection.
Despite this massive cutback in government spending, the premium on government bonds progressively increased. In 2008 the yield was 4.3 percent. In May 2010 the yield had increased to 5.9 percent. In November 2010, after the government announced a 4 year €15bn austerity package bond yields subsequently rose to over 7 percent. Fiscal austerity has completely failed to achieve its objective yet we are about to be exposed to another 4 years of it; amounting to a subtraction of €15bn from an already depressed economy. The decision by the Fianna Fail-Green government to guarantee the entire liabilities of Irelands banking system on September 30th made the state insolvent.
The European Context and EMU
The EMU is designed for a symmetric pan-European economy but operates in an asymmetric way (Hancké & Johnston, 2009). The narrow focus on cost competitiveness and fiscal consolidation ignores the institutional diversity, differing problem loads and structural imbalances both across and within eurozone economies. It assumes that all eurozone economies will converge in both price and wage costs. Countries share a monetary currency but not the corresponding institutional governance required to coordinate economic policy. Market processes alone have proved to be an ineffective means of economic integration since the establishment of the Euro.
From 1999-2008, large export countries at the centre of the eurozone (Germany) continued to run current account surpluses. This surplus capital and savings was channelled into peripheral economies of the Eurozone (Ireland and Spain, in particular) creating an unnecessary oversupply of credit (facilitated by low ECB interest rates) that was ultimately channelled into unproductive activity; housing, particularly in Ireland and Spain.
This structural divergence cannot be accommodated by monetary policy alone. In the absence of a central government or a functional equivalent each national economy will continue to operate as though they are institutionally independent. The crisis in the sovereign bond markets, however, has provided a reality check for eurozone economies to recognise the extent of their financial interdependence. Yet the policy prescriptions since 2008 have been oriented toward nationalistic austerity packages not coordinated strategies of collective action to tackle structural imbalances.
Secondly, the implicit assumption and narrow guidelines of the EMU is that economic problems only emerge from budgetary indiscipline not risky and unsustainable economic behaviour in the private market (Pissani-Ferry, Bruegel, 2010). The growth and stability pact was designed on the basis that public spending is the primary problem facing national governments. The crisis in Spain and Ireland, however, is the direct result of a collapse in private investment and the associated tax revenues government had come to depend upon.
The European Central Bank
Both Ireland and Spain experienced an asset price (housing) boom upon entry to the EMU. Non-fiscal asset price bubbles facilitated by cheap credit and low ECB interest rates created the problem in Spain and Ireland not government spending. Or, more precisely, the problem is not labour costs and government spending but the mismanagement of private capital by private actors coupled with an unsustainable tax base.
The ECB, however, operates according to average (mean) indicators of labour costs and inflation across sixteen eurozone economies. Thus, whilst the Irish and Spanish economies were overheating internally, the ECB continued to cut interest rates to encourage higher levels of economic growth in what was perceived to be the underperforming economies of Germany and France.
Furthermore, during the period 1999-2009 it was Greece, Germany, Italy and France that regularly exceeded the 3 percent deficit requirement of the growth and stability pact. Ireland, on the other hand, went from a stable budget balance to a fiscal deficit of 14.7 percent in less than two years. Spain went from a stable budget surplus to a deficit of 10.1 percent in less than 18 months. Spain actually ran a fiscal surplus in 2005, 2006 and 2007.
This begs a fundamental question as to whether it is genuinely feasible to use the statistical mean of the growth and stability pact (GSP) as a basis for how national economies should manage their budget deficits in both an economic crisis and a period of growth. The arbitrary deadline of 2014 to reduce the general government deficit from 32 percent to 3 percent is nonsense.
Irelands low tax regime and EMU
Ireland did not run a significant deficit prior to 2008 but it institutionalised an unsustainable low tax regime that could not afford the bank bailout. The Irish economy became reliant upon consumption and pro-cyclical taxes (i.e. stamp duty on property) that evaporated when its liquidity rich and credit fuelled housing bubble burst. Furthermore, most political parties and media outlets across the country legitimised and supported this process. The EMU is not designed to tackle unsustainable growth strategies of national economies or the structural composition of tax revenues. It simply assumes that government spending in-itself is the problem.
Ireland has adopted and internalised the constraints of the EMU in how it has responded to the crisis. The neo-classical design of the EMU is central to our problems.Becasue of this constraint the Irish government and the EU Commission have pursued an orthodox liberal strategy that attempts to shift the entire burden of adjustment on to labour market actors and government spending without providing the corresponding investment strategy to boost economic growth.
By 2007 tax breaks accounted for more lost revenue than was taken in via income tax. The property related tax breaks were used to incentivise multi-story car parks, hotels, holiday homes and private hospitals. Most of the schemes evolved into a major source of tax avoidance for the wealthy, constituting a major transfer of wealth from Irish citizens to a small group of wealthy individuals (Curran – Sunday Business Post, 2010). Collectively, these incentives had a combined gross tax cost of €3.28 billion. The net loss to the state was around €2.2 bn. These publicly provided state aids to the private sector were approved by the EU commission.
The collapse in private and public investment
The mismanagement of private wealth can be observed in the CSO ‘estimate of capital stock’. This quantifies where capital is located and invested in the Irish economy. According to Davy Stockbrokers capital stock soared by 157 percent between 2000-2008 but real estate accounted for two thirds of this investment. In 2008 net capital stock was €477bn (Davy, 2010). €302.5bn went into unproductive assets whilst only €174.4bn was invested in productive activity.
It is this collapse in capital investment that accounts for the contraction in the Irish economy. The vast majority of the ‘core productive capital’ was not driven by private sector enterprise but state and semi-state activity: roads, schools, hospitals, gas, waterworks and waste management. Davy stockbrokers concluded productive private sector investment accounted for only €14.5bn from 2000-2008.
The collapse in government finances during 2008 and 2009 amounted to €17.5bn (Burke, 2010). This collapse in tax revenue coupled with the bank guarantee scheme (amounting to 234.1 percent of GDP (EU Commission, 2010), has resulted in a projected general government deficit of 32 percent. These figures clearly indicate that Irelands deficit is a tax not a spend problem. Government institutionalised a low tax regime and became overly dependent on pro-cyclical taxes associated with its asset price bubble.
Ireland is a low tax, low spend economy. Total tax revenue to the Irish exchequer is on a par with Latvia, Romania and Lithuania (O’Donough & Dundon, 2010). This is the outcome of market liberalism and the cause of our domestic problems which led the state to socialise the losses of the private finance-sector. To pay for this we have experienced 2 years of massive austerity that have failed. The new policy response being encouraged by the EU-IMF and FF government is a 4 year adjustment plan that will inevitably lead to a deeper reccession, more job losses and distributive conflict. We are in unchartered waters. No economy has made the type of adjustment being asked of Ireland in the absence of a currency devaluation. To say that this is a critical juncture that will determine our future for the next 20 years is no understatement.
The main problem facing peripheral economies of the Eurozone is the policy constraint of the EMU which shifts the entire burden of adjustment on to labour costs and fiscal deficits. Ireland has adopted a neo-liberal strategy because there is no organised counter-power or class coalition in either the economic or political domain. Trade unions lack sufficient deterrent power in the labour market and we have no coherent left opposition in parliament. Given this weakness Ireland is in real danger of becoming a failed laboratory experiment on how small eurozone countries adjust to macro-economic shocks in the EMU. We need a transnational coordinated strategy across the European Union to act as a counter-force to self defeating beggar thy neighbour policies espoused by the EU Commission and ECB.