How Ireland became a giant Ponzi scheme
The fall of the Irish economy throws some much-needed light on what lies behind the current economic recession.
‘I don’t expect that hospitals will have to close or schools will have to close… but I do expect a fundamental reappraisal of the public sector will have to take place in which we secure absolute value for money in the delivery of services.’
That was the cheery upshot of the announcement by Ireland’s finance minister, Brian Lenihan, that the eye-watering cost of Ireland’s bank bailout was still rising. Lenihan’s latest declaration, made on 30 September, is that Allied Irish Bank, one of four big Irish institutions that have received enormous government support, will need another €3 billion of recapitalisation. While the bank will try to get that money from the markets, the government is essentially nationalising it. The Irish government has now coughed up over €32 billion to cover banking losses at Allied Irish, Bank of Ireland, Irish Nationwide Building Society and Anglo Irish Bank.
As a result of all these bailouts, Ireland has to pay roughly double the interest on its bonds compared with a country like Germany. The Economist now predicts that Irish debt will eventually rise to well over 100 per cent of GDP, despite the fact that Ireland has been more willing than any other country in Europe to do the markets’ bidding, slashing public spending in an effort to bring the deficit under control. In 2009, the Irish government introduced a seven per cent pension levy – effectively a pay cut – for most public-sector workers, and then enforced further pay cuts. The result has been a very sharp rise in unemployment, which has rocketed from 4.6 per cent in 2008 to 13.7 per cent last month.
This is all a far cry from the ‘Celtic Tiger’. During the 1990s, Irish GDP rose at a remarkable average annual rate of 6.9 per cent, turning Ireland into one of the wealthiest countries in Europe by head of population. European Union subsidies are often lazily put forward as an explanation for the Celtic Tiger phenomenon, but actually they had a relatively small impact. More relevantly, the fact that Ireland was a member of an open EU market was a major attraction for foreign direct investment, particularly from the US, alongside the fact that Ireland had an educated, English-speaking workforce and government policies that were very friendly to outside investors.
Ireland didn’t just take off in the 1990s – it did so in sexy, hi-tech, modern industries, making other nations green with envy. As an Economist article from 2004 noted, Ireland was taking roughly one quarter of all US foreign direct investment (FDI) into Europe and a third of all FDI in pharmaceuticals and healthcare (producing most of Europe’s supplies of Viagra and Botox in the process). Intel built its biggest semiconductor plant outside of America in Leixlip in the west of Dublin, while Dell’s PC plant at Limerick was one of its most productive plants in the world. No wonder officials from the EU’s newest members in Eastern Europe were forming an orderly queue in Dublin to find out how it was done.
However, by the Noughties, that economic boom had started to falter. Many of the conditions that made the boom possible – like Ireland’s low-cost, low-tax economy – had been undermined by rising wages and property prices and changing EU rules on taxation. The interest rates that prevailed as Ireland joined the Euro in 1999, determined by bigger but less dynamic economies elsewhere in Europe, were relatively cheap given the state of the Irish economy, and this helped to encourage a credit boom. Ireland got used to rapid GDP growth – with GDP rising from 1.9 per cent in 1991 to China-like rates of 11.5 per cent in 1997 and 10.7 per cent in 1999 – but then rates fell back to 4.5 per cent in 2003 and 4.7 per cent in 2004.
Challenging the idea that the recession is entirely the fault of risk-taking bankers, the actions of the Irish government were key in building up these economic woes. Having justified its existence on the back of such startling rises in GDP, the Irish government was unwilling to choke off growth in order to hold back this credit binge. A massive property bubble was being created, greatly assisted by the mania of institutions like the Anglo Irish Bank (though, unlike in the UK, this bubble did at least lead to some actual houses being built).
But the opportunity to build a substantial indigenous industry off the back of all that FDI was largely missed. Foreign companies were repatriating the profits back home, leading to some weird economic quirks. In most countries, there is relatively little difference between gross domestic product (the amount of wealth produced within the economy) and gross national product (which is GDP plus inflows and outflows of money). In Ireland, however, GDP was 25 per cent bigger than GNP, revealing just how much of the country’s wealth was being exported.
The policy choices that were made in Ireland in the early to mid-Noughties were pretty important. Given that membership of the Euro meant Ireland had no control over interest or exchange rates, which a country like Britain can use to regulate the economy, firm action needed to be taken to make sure that capital didn’t simply go into stoking the property bubble. But instead, Ireland effectively became a gigantic Ponzi scheme, with property prices pushed ever higher, followed by the inevitable traumatic fall at the first loss of confidence. Of course a small country like Ireland could never remain immune to global recession, but its fall was all the harder because nothing was done to rein in the likes of Anglo Irish, despite clear warnings that disaster beckoned. The people of Ireland are now footing the bill.
The recent reaction of the Irish government has only made things worse. Other countries have tried to negotiate their way through the current mess by using stimulus measures to keep economic activity ticking along until the private sector is in a fit state to take up the slack. In Ireland, austerity was imposed immediately and aggressively. Yet while government spending has been slashed, the devastated economy has delivered smaller tax revenues. The result? Public-sector debt as a percentage of GDP is exactly where it was before austerity was introduced. While Keynesian ‘pump priming’ is a much overrated solution to recession, the emphasis on austerity over economic growth has backfired.
One thing that the Irish authorities have been able to rely on, however, is the uselessness of the trade union movement in defending pay and jobs. After more than a decade of ‘social partnership’ between government and the labour movement, there is little capacity for opposition to the current spending cuts being made by Dublin. Other European leaders have looked on with envy at the lack of political response to Ireland’s draconian cuts.
Ireland’s travails should be an object lesson in the dangers of sustaining growth on the basis of cheap credit rather than productive investment. They should also be noted by those in Britain’s coalition government who want to slash-and-burn public spending. We do, it is true, need to find a way of creating a more productive and dynamic economy, and there are undoubtedly examples where state spending is wasteful and does not meet society’s needs. But simply cutting back without investing in the education, infrastructure, research and innovation required to remake the economy is short-termist in the extreme.
Rob Lyons is deputy editor of spiked.