Austerity Advances?

The Irish do not do well with good news. The next time you’re near an Irish person, as an experiment, say something positive. Anything. Watch the eyes narrow slightly as he or she looks about nervously. The person might even laugh, because somewhere there’s a sneaking suspicion that something tricky is going on. All our best poetry -- and Irish poetry is the best -- arises out of periods of economic misery. 

The problem is particularly acute at the moment: Ireland is on the verge of exiting the bailout from the European Union and the International Monetary Fund (IMF) after five years of economic despair. Despair is something of an understatement. Since 2007 alone, Ireland has seen a cumulative fall in the value of national output (as measured by GDP) of more than 20 percent. Economic demand has also plummeted since 2007 -- by 22 percent in volume and almost 30 percent in value. And national debt is severe: Today, the Irish government owes almost 118 percent of the value of its national output to national and international creditors.

Individually, Irish people, too, are suffering: Unemployment rose from four percent in 2006 to over 15 percent at its peak in 2012. The ratio of the number of unemployed to the number of job vacancies is higher only in Latvia, Portugal, and Cyprus. Perhaps that is why Ireland has returned to the days of emigration. During 2012, more than 50,000 citizens left Ireland (200,600 total since 2008). That is comparable to the last large-scale wave of Irish emigration, in the 1980s; in 1989, the height of the exodus, 70,000 left.

It is all a bit grim. You can bet that the next Irish Nobel Prize laureate is churning out poems right now. But she probably is doing it in Australia.

When Ireland exits its bailout this year, it will be the first EU country to do so. And some might think this is good news -- proof that IMF- and EU-mandated austerity worked and that Ireland is well on its way to recovery. Given how tough the last five years have been for the Irish people, though, it is hard to believe that the light at the end of the tunnel isn't just a train.

To be sure, there is evidence that things are getting better in Ireland relative to the way they were in 2010. As new data show, investment is up, unemployment is falling, new businesses are being created, and foreign direct investment is returning to the country, creating new jobs and new opportunities. The value of Ireland’s national output has been (roughly) constant over the last two years.

To understand how positive that is, one needs to keep in mind where Ireland might have been without external assistance, and without its ability to follow austerity policies for years without serious social unrest. Policymakers have had to manage reducing the deficit -- but at a speed that keeps the economy somewhat buoyant. And they have, at least partially.

For example, although Ireland’s budget deficit in 2012 was 7.4 percent of national output, which sounds terrible, it was actually within the EU-IMF target. Ireland’s deeply indebted households have also been paying down their debts as best they can, and so household debt has been falling since 2008. Ireland has issued sovereign debt again, in quite some volume, and has a sizeable cash buffer as well. Ireland’s bond yields -- the cost of the state’s borrowing -- have fallen since June 2012, and there are negotiations at the European level to take over some of the state’s banking-related debt.

Ireland’s banks, whose lax lending policies caused the construction boom that eventually bankrupted the country, are returning to a regular size and have more sustainable-looking balance sheets each day. The guarantee of their assets and liabilities was rescinded in March 2013, which means that the state is no longer bound to honor the debts incurred by the banking system. You might say it is a case of closing the door after the horse has bolted -- after all, the bank rescue has already cost more than 64 billion euros (roughly $87 billion) -- but the lack of the guarantee is symbolically important for the Irish people and for investor relations.

Once the backlog of potentially dodgy personal and business-related mortgages is cleared away, some of the core banks should become profitable once more. Several of these have been all but nationalized. So a return to some form of profitability will help in the eventual sale of some of these quasi-state assets.

During the darkest days of the economic crisis, Dublin created a National Asset Management Agency to house many of the worst loans created during the boom. The objective of NAMA is to manage the sale of these loans over the next ten years.  It also eventually removed the banking license of Anglo Irish Bank, which by then was a pile of toxic loans called the Irish Bank Resolution Corporation, a classic bad bank. By winding up IBRC (and its 25 billion euros, or $34 billion, of promissory notes) and granting loan extensions on some banking debt, Ireland has pushed the average maturity of its government debt to about 13 years. We have kicked the can quite far down the road. 

Europe needs austerity to have worked in Ireland; it needs a success story to point to. And among Ireland, Cyprus, Greece, Italy, Portugal, and Spain, Ireland was always the best bet. It has a small and open economy with a highly skilled workforce and low unionization in the private sector. That helped Ireland reduce its labor costs substantially and easily. (There is some dispute over just how much, but the general trend is downward.) And combined with the euro’s depreciation against other major currencies, including the U.S. dollar, Ireland is once more an attractive investment destination.

But Ireland is no poster child. It is on track to restore its public finances. But it has not yet. It has restored its competitiveness through wage cuts, but only partially. Thanks to the euro’s fluctuations, Ireland is getting more investment. But that might not last long: Ireland’s future tax burden is alarmingly high. The economy will need to expand rapidly for the country to service interest costs on its debt. In 2012, for example, just servicing Ireland’s national debt cost over 15 percent of all tax revenue. The next generation will have to bear up under high taxes unless productivity magically explodes. The real reason for increased investment is that international investors believe the Irish will put up with almost anything, and hence that they will get their money in some form. (There is no consensus on why the Irish have borne austerity with so little protest, but the fact is that they have.)

As Ireland exits the EU-IMF bailout, the state’s chances of actual recovery are perhaps 70/30 over the next three to five years. There is more positive than negative in Ireland’s story these days. Or at least the markets and official funders believe Ireland’s story as officials tell it.

The real threat to Ireland’s recovery is demographic. A recent survey found that young Irish people have no savings whatsoever. Their consumption levels are far below those of their European counterparts. With more babies born this year than in any other since 1891, Ireland’s only boom in the next few years will be in people. There are real and present threats to Ireland’s recovery, but one of the biggest is a large movement of young families out of, or into, the Irish economy. A large erosion of the tax base through emigration could kill off the recovery quite quickly. However, should the government invest in Irish children through childcare, education, and school building, young families could be convinced to stay. And they could provide the platform for an Irish renewal in the next generation.

Now wouldn’t that be good news?