Dr. Nat O’Connor is a Policy Analyst for TASC (Think-Tank for Action on Social Change), an independent think-tank that seeks to combat Ireland’s high level of economic inequality (they have a multi-person blog at www.progressive-economy.ie). James Arnold interviewed him about the economic crisis in Ireland, including the causes of crisis, the impact of the government’s austerity measures, and the recent EU / IMF ‘bailout’.

Prior to 2008, Ireland was regarded as the ‘Celtic Tiger’, a rapidly growing economy. How did such a deep economic crisis come about so fast?

A classic problem for economists – especially academic economists – is that it is politicians who are in charge of many aspects of the economy.

Ireland’s international image as a ‘Celtic Tiger’ actually had two distinct phases. Phase 1 (1990s to early 2000s) was genuine modernisation, as part of a ‘catching up’ with other Western economies. Phase 2 was a ‘prolonged boom’ period (from 2003, after a mild recession in 2002), where the driving forces behind GDP growth changed.

From the early 2000s, housing and construction generally became increasingly important for the economy, as well as banking and other international finance, facilitated by Ireland’s loose regulation and tax avoidance laws (e.g. the ‘double Irish’[1]). House prices continued to rise well above inflation, wage increases, GDP growth, etc. Cheap credit from the European Central Bank fuelled the boom, as people took out increasingly large loans – either as investors, or as individuals taking mortgages. Crucially, lack of bank regulation and a series of property- and land-based tax breaks fuelled the boom also. For political reasons, the Government did not want the ‘good times’ to end, however continued ‘prosperity’ was due to borrowed money, and therefore borrowed time before the whole economy became too leveraged and collapsed, as it did so spectacularly in 2008.

Even without a global financial crisis, Ireland’s housing bubble would have burst eventually. But both events happened close together in time, which helps explain why Ireland’s economy collapsed to such an extent, so quickly. Tax revenue fell by a third in two years, due in no small part from the collapse in receipts from cyclical transaction taxes[2] from construction (e.g. stamp duty, VAT, etc.), as well as the increase in unemployment (leading to less income tax and social insurance payments).

Simultaneously, the increase in unemployment led to higher social welfare costs, thus expanding the gap between Government revenue and spending. Unemployment has increased enormously, to nearly 14 per cent (from effectively full employment, around 4 per cent unemployed, only years previously). Youth unemployment, low skills and regional disparities are major features of unemployment that make the real picture worse in some places. Out-migration has started again in earnest, initially with a mix of EU migrant workers and Irish, but increasingly including young, well-educated Irish people.

Another dimension of the crisis is the banking system. Ireland’s weakly-regulated banks lent excessively, including mortgage and development lending. When the value of property fell dramatically, many loans were found to be secured on land or property assets now worth much less than the loan. In some cases, developments have been left incomplete. The extent of bad loans on the banks’ book has impaired them greatly. Anglo Irish Bank (‘Anglo’) was the worst case, with massive exposure to the downturn in the construction industry.

Are there any lessons to be drawn from the rapidity of Ireland’s economic decline?

Strong regulation is absolutely required to protect the public interest.

Much more transparency of information, especially surrounding Government budgets and other decisions, would have facilitated analysis that might have warned sooner of the growing unsustainability of the economy.

A more critical media would have helped too; for example, many newspapers simply lapped up the extra revenue from bulging property sections, rather than question the fundamentals of the housing market.

What was the government’s response to the crisis, and what effect did it have?

The Government’s immediate response to the banking crisis was to have catastrophic effects. In September 2008, the Government gave a blanket guarantee of all bank debt. They were misinformed of the extent of the bank’s problems (they thought it was a liquidity problem, rather than a solvency issue, at the time), but the all-encompassing nature of the guarantee, potentially €400 billion plus, was far more than Ireland could credibly afford to pay. As it happens, the major banks were insolvent, and the Government has taken increasing amount of their debt (€50 billion to date) and made it part of the national debt. This includes recapitalising the banks, which has brought Anglo and another major bank AIB (Allied Irish Bank) into state-ownership. Bank of Ireland is likely to become majority state-owned also, if it requires any further capital.

This was and is unsustainable. It is also unjust to expect ordinary Irish people to pay for the banks private debt, incurred through reckless lending by other private institutions. There is ‘moral hazard’ here, where banks are not paying the price for their mistakes. Ireland must reconfigure the bank debt and separate it from the national debt, if there is to be any realistic possibility of paying it. Beforehand, there is a need to reconfigure much private debt (householders and businesses) owed to the banks. Otherwise, this represents a risk of a further banking crisis in future, as many people and businesses cannot afford to pay their debts to the banks.

The Government’s fiscal response was to immediately turn to austerity. Whereas most other countries around Europe had some degree of stimulus – including raising the minimum wage and increasing capital spending to bolster aggregate demand – Ireland quickly moved towards cutting spending, including welfare.

Crucially, the Government has not made any serious investment in jobs or economic activity, despite the existence of a sovereign wealth fund (the National Pension Reserve Fund/NPRF).

What do you make of the EU/IMF bailout?

The EU/IMF ‘bailout’ is not a bailout. It is a loan facility at a moderately-high rate of interest, albeit less than current excessive market rates. The extent of Ireland’s deficit requires us to borrow money for a few years, while gradually building up the tax base and reducing spending; alongside fostering economic activity and job creation. Therefore, we do need to borrow money, and the IMF/EU loan is the best of bad options in that regard.

However, the terms of the loan are largely the product of the current Government; albeit constrained by political reality at a European level. They have agreed a series of cuts and tax increases, without any real plan to boost jobs and economic growth. The lack of a credible growth strategy may have been a major reason why the markets refused to lend to Ireland at reasonable rates. Lenders simply do not see a path to growth that would see their money repaid. The terms of the IMF/EU loan deal have ‘copper-fastened’ the lack of state-led investment, by requiring Ireland to use much of the NPRF for current expenditure before the loan becomes available. This is counter-productive because it will close off any prospect for economic growth.

What about the austerity measures in the budget: what groups will be most affected, and what impact will they have on the economy?

Austerity measures in the budgets, including the latest €6 billion in tax and cuts (equivalent in scale to 4 per cent of GDP), have disproportionately affected low and middle income earners. High earners have seen some tax reliefs removed, which represents the loss of a ‘bonus’, but the tax system has not been used to tap wealth reserves, which are disproportionately held by a small number in society.

The austerity measures reduce aggregate demand and employment – as any fiscal contraction must do. However, the particular taxes and cuts chosen were neither equality-proofed to do the least social harm, nor were they economy-proofed to do the least harm to growth and jobs.

Given the policies they’ve pursued, would you say that the government is promoting the interests of the banks, the lenders and the investors, rather than those of the general population?

Yes. Whereas the EU/IMF loan is not a bailout, but merely an (expensive) loan, the real bailout was the transfer of private banking debt (incurred by private institutions investing in Ireland’s private banks) to the Irish people. The Government (rightly) believed that Ireland needs a working banking system, but they (wrongly) tried to save the current one, rather than allowing failed institutions to collapse and establishing new ones, which would include foreign-owned banks having a major role.

Some investors took a major hit (e.g. bank shareholders, subordinated bondholders), whereas others (‘senior’ bondholders) have been preserved, despite the improbability that the Irish state can actually repay the bank debt – never mind the immorality of seeking to make ordinary people do so.

What alternatives do you see to the government’s current proposals?

Options for Ireland are narrowing. Most worryingly, the two major opposition parties (who are likely to form the next coalition government) have similar economic thinking to the current Government parties.

Ireland still has some money in the NPRF (around €4.2 billion). This could be used to drive highly-targeted stimulus measures, such as home insulation, expanding broadband and a loan guarantee scheme for small and medium enterprises.

There is a need for wide-ranging reform of the public service. The ‘Croke Park’ deal[3] between the Government and the public service protects public pay (after a series of cuts) in exchange for reform. This reform agenda needs to be made more explicit, with political decisions taken to reshape the state’s approach to major areas of public policy, like housing, health and education. Merely cutting, without serious reform, only shrinks budgets without addressing fundamental reasons why some programmes are inefficient or unsuccessful.

Ireland will almost certainly need to restructure its debt – at least the part taken on from the banking system. This could be done now, in co-operation with our EU partners, otherwise it is likely to be forced by economic circumstances later, after much hardship for many people.

The European dimension to Ireland’s situation cannot be understated. The European Central Bank (ECB) allowed reckless lending into Ireland, yet now seeks to protect bondholders in Irish banks which lent recklessly. There is a genuine fear of contagion to other EU states and risk to the euro itself, yet most monetary policy solutions (e.g. quantitative easing, devaluation) are now pooled at eurozone level, and therefore out of Ireland’s direct control. Ideas, such as Eurobonds[4] do need to be given serious consideration. Direct aid to Ireland from our EU partners would also be reasonable, given that their banks and financial institutions lent recklessly too, and were part of the problem.

Following on from that, what effect would you say Euro membership has had on Ireland?

In the immediate aftermath of the crisis, membership of the euro currency was probably of benefit to Ireland. For example, speculation on our currency is minimised and its exchange rate was not greatly affected. Ireland imports a lot, including for the purpose of re-exporting (our only major growth potential at present). So being in the euro was important.

Would it be feasible for Ireland to drop out of the Euro and default on its debt (as, e.g., Dean Baker has argued here)?

It would be exceedingly painful for Ireland to leave the euro currency now, and probably impossible to do so without massive default on the national debt. One obvious reason is that the debt is denominated in euro, so any attempt to convert that debt into New Irish Punts or whatever would be a de facto debt restructuring/default.

Without going as far as leaving the euro, Ireland always has the option of restructuring the national debt. We should certainly separate the nationalised banking debt from the rest of the national debt, and seek major write downs of the banking debt. The ECB’s lack of regulation was a partial cause of our problems, as they did not stop European financial institutions pouring money into Ireland’s already massively overheated construction/property market. They should bear some of the debt burden.

I disagree with Dean Baker’s analysis. For example, he writes, “Ireland’s problem was certainly not out of control government spending”. He’s missing the point here. We had moderate levels of Government spending (in EU comparative perspective) matched by moderate-high tax take due to temporary, cyclical taxes. When the boom ended, so did a third of tax revenue. We had been living under the illusion that moderate levels of spending could be maintained by low levels of non-cyclical tax take. Ireland’s political dilemma as the economy moves towards a new ‘normal’ is to decide whether to significantly increase tax on everyone to maintain (and even grow) public expenditure to typical European levels, or else return to being a ‘low tax’ economy, which means wholesale abandonment of many programmes of public spending.

I agree with Baker that the ECB should be politically accountable, and that Ireland has options. Not least, our Finance Minister has a voice at the table of European Finance Ministers and Ireland has a veto in EU policy-making – that’s real leverage.

However, Baker doesn’t analyse the conditions under which Argentina grew, versus the recessionary world that Ireland would be seeking to export to. Plus, membership of the eurozone is a major part of the reason why export firms base themselves in Ireland.

Realistically, if the ECB is unwilling to let a European bank fail, it is far less likely to allow a sovereign euro member state to do so. What Ireland needs is a strong Government to present the economic case to our European partners that we cannot pay the banks debts, and we need a European-level co-ordinated action to save not only Ireland, but Greece, Portugal, maybe Spain directly too, and certainly the whole euro project. If this means reversing engines at the ECB and engaging in quantitative easing, so be it. The question of the best policy to pursue should not be answered with an ideological response, but requires an empirical analysis of how the euro debt crisis can be best handled.

Lastly, I wanted to ask you about the response to the austerity measures from political organisations (trade unions, civil society groups, etc.)

There have been a number of public protests, notably a recent 50,000+ person rally organised by the Irish Congress of Trade Unions (www.ictu.ie). An umbrella organisation called Claiming Our Future (www.claimingourfuture.ie) organised a day-long meeting of 1,000+ people, mirrored on similar events in Iceland, designed to elicit policy preferences and alternative strategies from the ‘grassroots’ of society. There have been recent protests against Budget 2011’s twelve per cent cut to the minimum wage, and Opposition parties have pledged to restore the old rate (€8.65 per hour). Prior to the Budget, 10,000+ students rapidly mobilised to protest against increases in third level fees. And there have been more localised events and protests.

A small number of activist protestors ‘camped’ outside Government Buildings for a number of evenings, which provided material for the various foreign and domestic news media who were also camped there during the days where the announcement of Ireland’s approach to the IMF for a loan came out in a piecemeal fashion. The presence of these protestors allowed foreign media in particular to claim ‘tension’ in the atmosphere. But the presence of a few dozen hardcore activists was more than outweighed by the absence of the rest of the 4 million plus population.

Despite acknowledging the various civil society responses, the reaction from the broader population has been muted, if not stunned, by the reversal of Ireland’s fortunes. There is widespread mention in the news of people’s ‘anger’ and ‘frustration’, but it seems that this is somewhat bottled up. It is perhaps symptomatic of growing individualisation (atomisation?) that people have not come together for more collective action. The continuing weight of long-standing cultural forces cannot be underestimated in this regard. There is a lot of shame felt by people who have lost their jobs and/or homes. And those who retain their incomes or housing are under pressure to keep them; hence, there is perhaps a lack of solidarity with those who succumbed to this pressure.

The indication of whether the majority of people are really angry will come with the General Election early next year. A major realignment of Irish party politics to a more economic (left-right) divide is certainly possible, which will require generations of people to change their voting habits – which is difficult for individuals to do.

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Editor’s Notes

[1] The ‘Double Irish’ Arrangement is a form of tax avoidance: see http://en.wikipedia.org/wiki/Double_Irish_Arrangement

[2] Revenues from “cyclical” taxes fluctuate with the cycle of boom and bust, and so decrease in times of recession.

[3] “Under the terms of the Croke Park agreement, the Government has given a commitment not to cut public service pay and not to introduce compulsory redundancies until 2014 in return for co-operation with a widespread series of reform and efficiency measures.” (Irish Times, 2 Dec 2010)

[4] Eurobonds are bonds – i.e. debt – issued by the eurozone in common, rather than individual member countries. This would be favourable to weaker economies, such as Ireland, as they would be able to link with stronger economies to borrow money. However, stronger countries, like France and Germany, are opposed, as it would increase their borrowing rates.

James Arnold is an MPhil/PhD student in Philosophy at King’s College London