Second thoughts on Ireland

Irish political economy seems to be falling apart in front of our eyes and the bond market isn't so happy, even after Ireland accepted the EU/IMF bailout.  That would appear to be political risk.  Maybe there won't be a happy ending even in the short run.

Here is Thomas Friedman, a number of years back, touting the wonders of the Irish model.  Cato and Heritage made similar claims.  What are we to make of this broader span of Irish history?  I see a few candidate views, not necessarily mutually exclusive:

1. The Irish had some excellent economic policies, but they needed to regulate their banks more.  They were simply too optimistic and too sloppy.

2. Irish troubles could have been contained, at some point over the last two years, had Ireland not been on the euro.  They would have devalued, defaulted, and had a rapid bounce back up, within the next three years.

3. Ireland never should have guaranteed the liabilities of its banking sector.  Indeed, Ireland (as New Zealand did long ago) should have encouraged larger, more diversified foreign banks to dominate its financial sector.

4. Irish troubles are intimately connected with low corporate tax rates.  Revenue starvation induced the Irish government to court and tolerate a real estate bubble.  One claim is that Ireland relied too much on property taxes.

5. The good and bad policies are a bundle of sorts, and Ireland needed the mix to rise from squalor and the dominance of anti-commercial interest groups, no matter how painful the present day may seem.  I recall vividly, growing up, that Ireland was thought of as not much more than a Third World country.

6. We are overreacting to the Irish failure.  It is one of the first European dominoes to fall, but over time many different policy models will look like mistakes.

What other candidate views are there?

Comments

Definitely agree with #3. There seems to be an implicit assumption in the world today that all banks are guaranteed by their home governments. I don't see how a small country can possibly be home to a large bank under such a system.

Support for my view: Iceland and Ireland. Examples arguing against my view: Luxembourg and Switzerland. What have they done differently? (Or are they just next?)

The "memory lane" trip from slim2120 is from Alex Tabarrok, which is one reason why his recent posts on the Fed should be completely ignored.

The real question is this: "What is the counterfactual scenario of Ireland having retained the Punt instead of joining the Euro?"

It's hard to say. It didn't make much difference for Iceland, but my hunch is that foreign lending and corporate tax-shelter movement to Ireland would have been much less overall, and that Ireland would have grown slower, but steadier, and would be about in the same position as it is now (or will-be come 2012), but without having gone through the trauma of a crisis.

Definitely disagree with #2. (Is anyone really making this claim?) Ireland's banks can't cover the deposits of its citizens. The only way that devaluing and Irish currency could remedy that is if those banks had a lot more non-Irish assets than they do Irish liabilities, and that isn't the case. And defaulting on your on those citizen's bank deposits won't export the pain like you could if the debt was owed to foreigners. You could try to covert those bank deposit liabilities to foreign debt by having the government covert them using debt sold to foreigners, and then default on that debt, but the bond markets are likely to see that coming and not let you get away with it.

#3 looks good to me. Without a government guarantee the Irish banks might have behaved more prudently, and surely wouldn't have grown so big.

The periphery nations almost led a self-fulfilled prophecy. The drumbeat and predictions have been occurring for a couple of years now yet things stayed on course. Funny thing is that the euro is still trading high at 1.36-37. Germany will be pleased eventually.

Not to knock on the periphery too much, Austria and Switzerland (maybe CH is less since they are pretty diversified) are good at hiding their exposure to Eastern Europe and the CEE. The E. Europeans liked currency arbitrage as much as Icelandic people for loans, we'll see how long books can be cooked - which is apparently a problem for all developed nations these days.

In terms of policies, I would say #3 through #6.

However, there is a political portion of the equation missing. Fianna Fail, the political party that implemented these policies, has a history of cheap populism and corruption.

There are three democracies in the world where electoral politics is dominated by a somewhat sleazy, populist party that implements all sorts of economic policies based on fantasy, then the more sober, less popular party comes in to govern for a short period and cleans up the mess. One is Ireland, with the Fianna Fail/ Fine Gael dynamic, another is Argentia with the Peronists/ Radicals. This doesn't make for sensible handling of the national finances.

Hopefully the government has lost its majority in the legislature. The attitude of the Irish Greens is unprecedented in the history of coalition politics.

I'd nominate 1, 3 and factors related to 2 and 4.

Being in the Euro limited pre-crisis interest rate flexibility, and rates were set at levels appropriate for Germany and France, not Ireland or Spain. Against this backdrop, and following a long period when both the economy and property prices grew at an extraordinary rate, the Irish government should have raised taxes (possibly on assessed property holdings) and moderated public spending to yield a large fiscal surplus rather than merely a balanced budget.

To quote Chief Brody when Capt. Quint smashes the boat's radio with a baseball bat in Jaws:

"THAT'S GREAT! THAT'S JUST GREAT!"

@2
Can anyone imagine the Irish credit bubble to develop without euro?!

In 2007 it was clear to the Irish Central Bank that there was a property bubble:

"[The ICB] warned that despite the interest rate rises the demand for credit in Ireland remains strong and that Ireland's private sector credit to GDP ratio was now the highest in the euro zone area.

"This is clearly linked to the high volume of housing output in the past few years. Property-related lending has accounted for about four-fifths of the increase in credit over the past year," it said.

The Central Bank said that residential mortgage borrowing had pushed personal sector credit to almost one-and-a-half times personal disposable income at end 2006."

Here's more: http://www.finfacts.ie/irelandbusinessnews/publis...

Another thing is that the ICB could not have done anything about it.

A nod to #5. Living in Northern Ireland, there were whispers amung the catholic/nationalists along the lines of "do we REALLY want to unite Ireland? seems we've more up here than they've down there...."

And this wasn't nearly all that long ago

Ireland certainly has a "crisis" right now, but let's not forget that Ireland's 2009 real GDP per capita is TWICE that in 1996, and FOUR TIMES that of 1988.

During the second half of the 1990's, Ireland had a 10% GDP growth rate, slowing down to "just" 5-6% from 2000 to 2007.

Brazil has high taxes, high real interest rates, its own currency, and a flexible exchange rate, and yet it's at the top of a big bubble right now. So you can throw away a good part of the items above just based on what's happening in Brazil.

The common feature of the Mexican, then Irish, and now Brazilian phenomenon is that, at some point, they were cover matter of too many newspapers and weekly magazines that could only see good things about what wasn't good at all. The King has no clothes, that's the only pattern.

Ireland is lucky on the other hand to be in the Eurozone. At least it has no alternative besides doing its fiscal homework -- unlike Brazil and the US who chose the path of costly procrastination.

@craig:

The state is a violence a is a never ending hunger, it is never satiated, nor filled.

Second thoughts on Ireland? Isn't it the difference between the n+1st thought on Ireland and the nth thought on Ireland that matters (for big n)?

Allowing massive immigration, as in Ireland in recent years, helps make housing bubbles worse in at least two ways:

- Bringing in lots of immigrants to do the jobs Irishmen just won't do building houses causes a temporary housing shortage (construction workers have to live somewhere) which makes delusional thinking about the future housing needs easier to rationalize.

- Without massive immigration, a housing bubble would drive up construction wages so much that costs of construction would eventually squelch the bubble.

2 & 3 did them in. The Euro has been a disastrous experiment and will continue to be. China and the U.S. are devaluing so it would make sense for Greece and Ireland to do the same... except they can't due to the Euro.

2. Irish troubles could have been contained, at some point over the last two years, had Ireland not been on the euro.

3. Ireland never should have guaranteed the liabilities of its banking sector.

Frank, Re number 4:

Today's FT claims that Ireland dramatically cut income tax rates and substituted in their place property taxes. So, that is the support for 4.

You may have to be registered to view it. It lists three follies, with this being one of them.

I can't agree with #4 either - the logic can apply to any other tax too. Whatever source of revenue, if the government allows expendatures to match pace with a bubble run-up in the economy, then it'll be bad news when the bubble bursts. Doesn't matter if the bubble is Real Estate or corporate profits or personal incomes.

The real problem is a bubble in government spending, and beyond that, a bubble in structural spending. If the excess tax dollars just got spent on roads, upgrading power grids, ports, etc., it wouldn't be much of a problem since those things don't obligate future revenues so much.

But these days it seems new spending goes mostly for transfer payments (e.g. entitlement programs) and larger government workforces (often of dubious work output), so when the bubble pops and revenues go down, it's massively painful and destabliizing.

there is a bad assumption that many have that the banks could be regulated better. the problem was that money was too easy because they had German monetary policy with low interest rates for an extremely overheated economy, which is a function of them being on the euro. in spite of their rapid growth, it was a blip to the eurozone as a whole, so monetary policy could not be tightened appropriately, allowing excessive fuel for the bubble to keep growing.

we had a similar problem in the US, that due to the Greenspan/Bernanke Fed's excessive fear of deflation, they kept rates too low for too long in the post-internet bubble recession. that kept the recession shallow by inflating a huge real estate bubble. that it didn't go on as long as ireland's overheated/easy money growth did is probably the main reason they had a bigger bubble than we did. the idea that it could have been out-regulated is fantasy. there were plenty of regulations on the books for the Fed/OCC/FHFA/et al to step in, but outside of a few contrarians very few people were saying there was a bubble. there will never be an enlightened regulator that can come in and take away the punchbowl just when the majority of the populace is having the most fun. no one gets credit for preventing crises that never actually happen.

UK vs Ireland comparison proves conclusively it's all about euro.

Tyler, I'm not sure that Crooked Timber post shows what you think it shows:

"The result was that even with booming economic growth, the government faced a fiscal hole. This hole was filled by taxes on property transactions which, as the property market got ever more bubbly, became an ever more important source of government revenue."

This shows that the government overspent, not that there's a problem with low corporate income tax rates.

There's a post on Cato that debunks this fairly easily:
http://www.cato-at-liberty.org/dont-blame-ireland...

Irish policymakers made three mistakes:
(1) They did not control government spending. They trebled spending in a decade with the last five years of increases, effectively permanent increases in spending given the nature of Ireland's public service, on the back of temporary taxation revenues, directly and indirectly stemming from the construction boom.
(2) They did not control bank lending. As Kindleberger would note, you can't have a bubble without some source of new credit. And a failure to control Ireland's banks after entry into EMU was the source of new credit.
(3) They did not control construction output. As Kindleberger would also note, it's rare you have a bubble with a boom in transaction volumes, as well as a boom in prices. Ireland's boom in property output - some parts of the country have enough property till at least 2015 and more than likely 2020 now, http://bit.ly/7d1MmF - facilitate a boom in transactions.
These three mistakes have led to four problems: the government deficit and banking system collapse that are the focus of the international press, negative equity comparable to the worst affected US state, and unemployment.

Two further comments:
(a) It is interesting to compare Ireland's three "lack of controls" - government spending, banks and construction - with, say, the UK or Spain. Spain had (1) and (3) but not (2), while the UK had (1) and (2), but not (3). Neither had any of the three as badly as Ireland had its, though. (I'll let someone else do the comparison with the US.)
(b) Irish policy made three significant mistakes. But it also did a number of things right, including ease of doing business, corporate tax and labour supply. In 2008 and 2009, it created more FDI jobs per capita than any other country in the world and the indications are that 2010 will be better again.

As ever, people like being apocalyptic, but that doesn't always help.

The Irish economy was picking up nicely in June (when I wrote that overly upbeat comparison with Greece), and Irish banks passed the European stress tests in July. Then the government opted to give Irish banks a blank check on the national Treasury. That was dumb and dumber, instantly tripling the apparent budget deficit as a share of GDP.

Ireland doesn't need Irish banks any more than it needs an Irish airline or Irish steel mill. The world has plenty of banks -- probably too many -- and money and credit can flow around national borders quite easily.

Comments for this post are closed