Irelands credit fuelled construction boom has resulted in a collapsed domestic economy, growing unemployment and an insolvent state. This essay will argue that the causal mechanisms behind the Irish crisis can be traced to the perverse macro-financial incentives created by the European Monetary Union (EMU) and the micro-composition of Ireland’s low tax liberal market political economy.
The origin of the European and Irish economic crisis can be found in the reckless behaviour of private banks in global finance markets. The aggressive deregulation of global finance markets and domestic credit-mortgage markets led to unprecedented levels of interbank lending within member states of the European Union (Lane, 2011).
In 2003 Irish banks borrowed the equivalent of 60 percent of gross national product (GNP) on European money markets. By 2007 this had risen to almost 280 percent when securitized mortgages are included (see Figure 5 Graphs).
This cheap money was channelled into real estate and property speculation. The outcome was colossal growth in house prices in the Irish domestic market (see figure 4) Direct and indirect employment associated with residential construction grew from 7.2 percent in 1998 to almost 17 percent in 2007.
When the financial crisis hit in 2008 the Irish state guaranteed the private liabilities of the three main domestic banks – Anglo-Irish, Allied Irish Banks and the Bank of Ireland. The bad debt owed by property developers to these banks, in addition to the collapsed tax revenue associated with construction, resulted in the insolvency of the state.
The Irish general government deficit went from 1.2 percent in 2007 to 32 percent in 2010. In the same period the debt to GDP ratio went from less than 50 to 110 percent and unemployment soared from 4 to 14.7 percent. To bring down the deficit, the government introduced three austerity packages that amounted to 14 percent of GDP, the largest recorded by any developed economy in the western world (IMF, 2010).
In 2010 the Irish state was priced out of international bond markets and had to resort to an European Central Bank-International Monetary Fund (ECB-IMF) financial loan. The condition of this loan is the introduction of an additional €15bn austerity package. Irish taxpayers are paying for the reckless behaviour of private market actors in private finance markets.
The transmission effect of finance into the real economy has produced what Colin Crouch (2009) calls ‘privatized Keynesianism’. Privatized Keynesianism can be considered as a response by policymakers to the decline in real wages. Demand managed Keynesianism associated with the Fordist era of production enabled the expansion of mass production with mass consumers through real wage growth. Confident, secure working class consumers were not a threat to capitalist democracy but a conduit to it.
As prosperity stagnated, with the demise of ‘les trente glorieuses’, capitalist democracies had to find new ways to combine the need for accumulation, mass consumer demand and social stability. Policymakers across the western world responded by opening up product, finance and labour markets to increased trade and competition. This increased flexibility in the labour market created the conundrum of how to sustain domestic demand and high levels of consumption.
Countries with a strong manufacturing base such asGermany exported the problem by securing confident consumers in countries such as Ireland, UK and the USA (and emerging markets).
These countries increasingly relied upon personally delivered domestic services to generate employment. The problem of how to sustain a consumption economy in an insecure flexible labour market was resolved by increasing the availability of cheap credit. The credit card replaced real wages.
The growth of credit markets in Ireland, the UK and USA meant that these economies became premised on debt financed consumer spending. Thus, unlike the post-war European welfare state, individuals rather than the state took on debt to stimulate the economy. This debt in Ireland was mostly accounted for by mortgages.
Hence the shift from state to privatised Keynesianism. Government policies began to encourage house-price inflation as a means to enable households to leverage credit for consumer spending. The rapid increase in the price of land and housing were considered ‘good inflation’. Rather than focus on increasing competitiveness through productive investment or the buying and selling of goods and services, the neoliberal oriented Anglo-Irish-American economies began to sell houses to one another as means to increase wealth.
Ireland is the only liberal market economy (LME) in the Eurozone. It was the fastest growing economy to enter the European Monetary Union (EMU) and has a business model that is closer to the USA than Germany. In the pre-EMU period Ireland constructed an export economy premised on internationally traded goods and services in the Information and Communication Technology (ICT) and pharmaceutical sectors.
When the economy began to slow down after the dotcom bubble a new growth model premised on cheap money emerged. Irish banks took advantage of the absence of exchange rate controls and low European Central Bank (ECB) interest rates. The government de-regulated finance and mortgage markets and introduced a whole series of tax breaks for property construction.
The outcome was a colossal house price bubble (see figure 4). The same occurred in Spain and the USA.
There is increasing evidence to suggest that the ECB maintained historically low interest rates in the Eurozone as a response to stagnant domestic demand in the German political economy. The sluggish German economy was a result of a decade of wage restraint (ILO, 2010).
Wage growth in the highly productive export sectors, particularly those in chemicals, engineering steel and metal fabrication have been lower than almost every other OECD country. In some sectors, they have declined. But, industrial output from these sectors has been growing steadily from the mid 1990s. Thus, their rate of profit has increased whilst wages have declined. Most of this profit has been recycled into the finance industry.
The growth in derivatives and other complex financial products has created what Wolfgang Streeck (2011) calls ‘money factories’. These money factories recycle and repackage financial products and make their profit not from increasing productivity or investing in the real economy but through interest rates, much like state financed bond markets.
German banks, particularly Deutsche Bank, lent significant amounts of capital to Irish and Spanish banks in the post-EMU era to fund their real estate boom. This was made possible by a liberal financial regulatory regime implicit in the design of the EMU.
The ECB-Frankfurt interest rates were aimed at mean or average inflation levels in the Eurozone. In theory they are not targeted at specific countries. But, in practice, interest rates were kept low because of stagnant domestic demand in the German economy which was the direct outcome of holding down real wage growth.
The impact in Ireland and Spain of this low wage strategy in Germany was negative interest rates and an influx of cheap money into the economy (see Figure 6). Domestic policymakers could not use monetary tools to contain inflationary pressures associated with rapidly rising house prices (which fuelled residential construction). In the context of 7 and 8 percent economic growth rates per annum, it would have been inconceivable for the Irish central bank to adopt negative interest rates.
But, as Colin Hay (2009) has argued, the ECB was targeting the Harmonised Index of Consumer Prices (HICP) and this index does not include house prices or mortgage repayments. The Irish Central Bank would have been targeting the domestic Consumer Price Inflation (CPI) as this is the measure used by trade unions to determine nominal wage demand.
The general point is that the single European market in finance-credit was an exogenous factor that facilitated an unsustainable boom in Ireland and Spain’s property markets. Negative interest rates were the consequence of German wage restraint. This is the first factor that must be considered when examining the Irish case.
In an ideal rational-efficient world Ireland would have mirrored the German political economy after its entry into the EMU. But, given extensive historic-empirical research on the diversity of institutional configurations that make up national labour, fiscal and wage policy in Europe, this was unlikely to happen.
The seventeen economies that make up the Eurozone have very different welfare and industrial relations regimes. Irish policymakers entered the Euro with a political economy that was gradually converging on European standards of living. But, its expenditure on social protection and education as a percentage of GNP was significantly below the EU15 average.
In addition,Ireland’s physical infrastructure, a core factor in long term economic competitiveness, significantly lagged behind European standards. The largesse that was made available from the pre-EMU Celtic Tiger and European Structural Adjustment funds facilitated a massive capital expenditure programme from 2000.
Capital expenditure in 2004 was double the EU15 average. The National Development Plan was the strategic mechanism through which productive investment in roads, buildings, electricity and waste sewerage took place. This investment contributed to the inflationary pressures in the Irish economy but it also generated significant employment in construction.
Whereas the rest of Europe was engaged in ‘permanent austerity’, Irelandwas engaged in ‘developmental expansion’ to overcome infrastructural bottlenecks.
The unproductive investment inIreland’s political economy occurred in the private real estate market. According to White (2010), real estate accounted for two thirds of the €477bn available for capital investment from 2000-2008. During this period bank lending tripled, rising from 60 percent of GNP in 1998 to 270 percent at the peak of the construction boom in 2007. Real estate increased from 37 percent to 72 percent of total bank lending. It was this increase in bank lending on wholesale money markets that created the house price bubble in the Irish economy.
House prices and construction employment soared (Figures 3 & 4)Between 1991 and 2007 house prices inDublinincreased by 490 percent. By 2006, land prices in Ireland were the highest inEurope. By 2007 almost 20 percent of GNP was accounted for by construction. This created an employment boom in craft related trades, general labourers and professions such as architecture.
Ireland experienced a jobs miracle from 1993-2000 with 650,000 jobs created in the private service market. This slowed down after 2000. Unemployment remained at approx 6-7 percent. But, between 2002 and 2007, Ireland experienced a second employment boom with an additional 400,000 jobs created. Less than two percent of these were accounted for by Irelands export economy.
Almost all of these jobs were created in construction, domestic retail and public services. By 2006 one in four males under the age of 25 were employed in the construction sector. Most of these were low skilled labourers. By 2004, labour shortages were overcome by a huge influx of inward migration from central and Eastern Europe.
The expansion of credit made possible by low ECB interest rates fuelled house prices which shifted the Irish economic growth model from one premised on exports (pre-EMU) to one premised on construction (post-EMU). As detailed by Norris and Coates (2010), the commercial mortgage sector was de-regulated as part of a wider process of domestic financial liberalisation.
Policymakers were aware that house price inflation would lead to increased wage demands. But, to tackle house price inflation the government adopted policies to increase the supply of housing (i.e. build more) rather than ‘interfere’ in the property market by managing lending criteria or controlling prices.
The National Institute for Regional and Spatial Analysis (NIRSA) have described the Irish governments approach to economic policy as a ‘patchwork system of neoliberal governance’. At a Euro-macro level it involved the abolition of quantitative restrictions on credit growth, lowering bank reserve requirements, dismantling capital controls and the removal of restrictions on interest rates.
At the domestic level Irish policymakers adopted pro-cyclical fiscal policies, developer rather than government led planning, light touch regulation, poor corporate governance and minimal taxation. The patchwork quilt of neoliberal governance, however, was complicated by the existence of national social partnership, centralised pay bargaining and a relatively generous welfare safety net.
Trade unions were not excluded from the national governance framework but central to it.
Kelly (2010) argues that the Irish government and central bank were captured by the interests of the financial industry, a classic case of crony capitalism. This is only part of the story.
Economic growth rates of 6-7 percent per annum from 2000-2007 increased government revenue and employment growth (See figure 2). The 2002 budget, in particular, was designed to win electoral support after the economy begun to slow down. The government introduced a series of tax reliefs on the purchase of rented residential property and expanded tax reliefs for private hospitals, car parks, urban and rural renewal.
The 2003 and 2004 budgets extended and widened these property related schemes with the result that Irish fiscal policy was aggressively pro-cyclical and directly linked to construction related capital investment (Gurdgiev et al, 2010).
The increased revenue enabled government expenditure to increase by approximately 11 percent during this period. Most of this expenditure went on increasing social welfare payments and public sector pay. This satisfied and kept intact the underlying distributional coalition of Irish social partnership.
Irish corporatism was premised on centralised wage restraint in return for decreasing income taxes. Hardiman and Dellepiane (2010) argue that the net effect of a government committed to income tax reduction was a path dependent route of sharing out growth through rising personal incomes rather than an improvement and collective investment in public services.
Regan (2010) describes this as a ‘liberal market’ rather than a ‘social democratic’ political exchange.
The general point is thatIreland’s fiscal policy regime was totally inappropriate to the conditions of a monetary union. The tax to GNP ratio remained steady throughout the construction boom. But, this masked a significant change in the underlying composition of the tax base.
Income tax as a percentage of the total tax take declined from 37 percent in 1994 to 27 percent in 2006. In addition, the tax base was increasingly narrowed with the net effect that 50 percent of employees were taken out of the income tax net altogether.
By 2007 Irish revenue was hugely dependent on domestic consumer spending (VAT and indirect taxes) and property related taxes (stamp duty, VAT on new homes, capital acquisition taxes). Property related taxes went from 8 percent of total tax revenue in 2002 to over 15 percent in 2006.
Thus, when the property market collapsed, tax revenues plummeted (see figure 7). From 2008-2009 government revenues fell by almost €18bn or almost 20 percent of GNP. Yet, given the rapid rise in unemployment and the associated social protection payments, government expenditure increased from 37 to 47 percent of GNP.
Ireland’s liberal and low tax political economy was the consequence of domestic political choices. This is the second factor in explaining the rise and fall of Ireland’s property boom.
Thus, low ECB interest rates, de-regulated finance markets and domestic tax policies led to the boom-bust cycle in Ireland’s property market. None of the actors, including Irish trade unions, called stop because it generated full employment, strong economic growth and increased revenue for social expenditure. All three of these variables were central to maintaining the underlying political coalition of Irish social partnership.
This institutional framework was one of the first casualties of the crisis. The ECB-IMF adjustment policies are now focused on improving ‘national competitiveness’ through removing the few remaining institutional regulations in what is otherwise a ‘flexible liberal labour market’.
The policy response has been to impose wage devaluation in the hope that this will improve investment, economic growth and jobs. However, there is little or no evidence to suggest this will happen. Most jobs in the Irish economy since 1998 have been reliant on high levels of domestic consumption and real estate construction. 60 percent of the 380,000 job losses since 2008 are the direct result of a collapse in real estate (NESC, 2011).
The construction boom was based on cheap credit and increasing real wages through low marginal tax rates. This seriously calls into question the strategy of a ‘growth’ led rather than ‘employment’ led labour market strategy.
The absence of strategic coordination to ensure investment in skills, productivity and employment between the export and domestic sectors is the source of Ireland’s problem.
This strategic coordination, however, would require an institutional framework of embedded social dialogue, encompassing employer associations and a developmental industrial plan that is lacking in Irelandsliberal market laissez faire economy.
Crouch, C. (2009) ‘Privatised Keynesianism: An unacknowledged policy regime’, British Journal of Politics & International Relations, 11:3, 382–399.
Gurdgiev C, Lucey B, Mac and Bhaird C and Lorcan Roche-Kelly (2011) “The Irish Economy: Three Strikes and You’re Out? “ Panoeconomicus, 58(1): 19-41.
Hay, C. (2009) ‘Good inflation, bad inflation: The housing boom, economic growth and the disaggregation of inflationary preferences in the UKand Ireland’, British Journal of Politics & International Relations, 11:3, 461–478.
International Monetary Fund (2010), Will it Hurt? Macroeconomic Effects of Fiscal Consolidation, Chapter three (World Economic Outlook).
Hardiman N & Dellepiane, S (2010) European Economic Crisis:Irelandin Comparative Perspective. APSA Annual Meeting Paper.Washington. Available at SSRN: http://ssrn.com/abstract=1642791
Kelly, M. (2010). Whatever Happened toIreland? CEPR Discussion PaperLondon, Centre for Economic Policy Research. http://ssrn.com/paper=1611507
Lane, P. (2011). The Irish Crisis. IIIS Working Papers.DublinNational Economic and Social Council -NESCReport 123 (2011): Supports and Services for Unemployed Jobseekers: Challenges and Opportunities in a Time of Recession.
Norris M & Coates D (2010) How Housing Killed the Celtic Tiger: Anatomy, Consequences and Lessons of Ireland’s Housing Boom and Bust, 2000-2009. UCD Working Paper.Dublin
Regan, Aidan (2010) The Political Economy of Wage Bargaining in the EMU: Irish Liberal Corporatism in Crisis (2010). APSA 2010 Annual Meeting Paper. Available at SSRN: http://ssrn.com/abstract=1657571
 The same occurred inSpain and theUSA.
 The genealogy of the term ‘mortgage’ can be traced to the French ‘dead peasant’.