Wednesday, February 9, 2011

Ireland’s Austerity Woes


Ireland’s Austerity Woes
07/02/2011 By Nat OConnor
From the very beginning of the crisis, the Irish Government’s response has failed to protect vulnerable people and has damaged the long-term prospects of the economy.

To put the scale of Ireland’s austerity measures into context, about €30 billion worth of austerity measures (cuts to public spending and tax increases) have occurred since the crisis began at the end of 2008. In scale, these total just under a fifth of the current size of Ireland’s economy (GDP €160 billion). To apply the same level of austerity across the EU, with its GDP of €12.5 trillion, there would have to be €2.4 trillion worth of tax increases and spending cuts.

What is even worse is that Ireland is only half-way through the process. The last budget was the first of four agreed with the EU and IMF in order to secure loans to Ireland. What follows is a brief overview of events, and austerity measures adopted in response, for those who might not be familiar with the details of the Irish case.

Lehman Brothers filed for bankruptcy on 15 September 2008. The Irish Government held a ‘midnight meeting’ on 29 September 2008, centred on Ireland’s banking crisis. Hence, Ireland’s financial and economic crisis dates from then, although other aspects of the crisis only emerged into broad public discourse in later months.

The discourse around the crisis centred on ‘external’ events from the outset. The problems in Ireland were blamed on the global financial crisis. However, it soon became apparent that Ireland would probably have suffered a recession sooner or later, even in the absence of international events; although some people denied this for quite some time. Ireland’s speculative property/construction bubble peaked just as Lehman Brothers fell. As a result, the coincidence of both national and international factors has led Ireland to experience a particularly severe and prolonged economic collapse.

The fiscal policies of the Government in the years leading up to 2008 were increasingly unsustainable. The construction bubble brought in much increased revenue from transaction taxes (e.g. stamp duty on property purchases, plus VAT from construction-related activities). Much of this tax revenue was from private debt invested in the construction market. In addition, income tax receipts were high and low unemployment reduced demand for welfare spending.

During the boom, the Government cut personal taxation and continued to permit high levels of tax relief to individuals and corporations, fatally undermining the stability of tax revenue. When the bubble burst, tax receipts fell by a third in two years. Up until this point, Ireland had been living a fantasy, where unsustainable tax receipts masking otherwise low taxation miraculously allowed the state to raise public spending and provide more services. When tax revenues collapsed, suddenly a massive current deficit appeared. One direct result is that the future size and role of the state is now at stake in Ireland. The balance of austerity measures between taxes and cuts will determine whether Ireland takes a route of low taxation (and therefore eviscerated public spending) or more public services (and therefore more European-average levels of taxation to pay for them).

On 30 September 2008, the day after their emergency midnight meeting, the Government announced a bank guarantee scheme, with the state guaranteeing €440 billion to six Irish banks, with the objective of safeguarding the Irish banking system. To put the scale of the guarantee into perspective, Ireland’s GDP in 2008 was €180 billion. Some prominent figures had called for a bank guarantee scheme, but the devil is in the detail. The guarantee was a blanket guarantee, which did not discriminate between banks of genuine systemic importance to the economy and others, which were not (notably Anglo Irish Bank, which was heavily involved in lending to the construction sector). It also covered more bondholders than should have been protected. Ultimately, it was a costly gamble that assumed liquidity was the only problem. However, it quickly came to light that the problem was not one of liquidity, but of solvency across the entire banking sector.

The Irish Government established NAMA (the National Assets Management Agency) in late 2009 to remove ‘bad loans’ from the balance sheets of Irish banks. However, NAMA was slow to start and has faced legal challenges to its powers. It was quickly overtaken by events. The lack of solvency in the Irish banks has forced the state to recapitalise them. This has led to the complete nationalisation of Anglo Irish Bank (known as ‘Anglo’) and more recently, the near-total state ownership of Allied Irish Bank (known as AIB). Perversely, NAMA continues to transfer loans from these state-owned banks to itself, a state-owned institution, costing unnecessary millions in legal and accountancy fees.

As a euro area member, Ireland has had no direct recourse to monetary policy. A range of monetary policy measures were taken by the European Central Bank in response to the crisis; however, these were insufficient compared to the scale of the problems Ireland was facing.

To date, the government has had four national budgets during the crisis period. (Details available on The first budget, at the end of 2008, was two months early in order to respond to the emerging global financial crisis. Taxation was raised and public spending lowered. This budget did raise the level of unemployment payments, but subsequent budgets cut the rates and qualifying criteria for benefits to a greater degree than this budget raised them.

In the 2009 budget, the Government announced a policy of encouraging workers back in to employment by cutting their social welfare payments. Payments for young people (20-24) were set at special low rates. For all other cases, the rate was to be reduced where job offers or activation measures were refused. Further cuts and tax increases followed in the 2010 budget.

The fourth austerity budget, for 2011, again reduced social welfare payments. The national minimum wage was also reduced by nearly 12 per cent. Increases in personal tax in this budget have also disproportionately impacted on the low paid. Changes to rates and bands meant that an employee on €20,000 per year paid as much extra tax as an employee on €200,000. In addition, changes to social insurance created a new Universal Social Charge, which introduced much higher rates onto low- and middle-income employees than had previously been the case. And, of course, people on lower incomes are more reliant on the state services that are suffering cutbacks.

Unsurprisingly, consumer spending in the economy has collapsed and Ireland continues to experience negative growth in the domestic economy; GNP continues to fall. Unemployment is at 13.4 per cent and renewed high emigration masks a higher rate of job losses. The situation is better for GDP, which is growing again (albeit at low levels) due to strong performance by exporting firms.

The last budget was merely the first instalment in a four-year plan, which envisages further cuts and tax increases. Polling day in Ireland’s General Election is 25 February. The result will determine the extent and timing of further austerity measures, but one thing is sure: much more pain is yet to be inflicted on the Irish people. At the same time, the election provides an opportunity for the next government to change direction on economics: more can be done to increase investment and foster job creation, especially by indigenous companies; private bank debt can be separated from the sovereign national debt; and the conditions of the EU-IMF loans can be changed. Indeed, all of these things must happen if Ireland is to be realistically able to afford to repay the loans.

The resistance within some quarters in Ireland to such measures is perhaps more surprising to an outside observer than it is from within. Part of the solution to Ireland’s current insolvency is that many economic commentators and practitioners have to admit that our previous economic model was – and remains – seriously deficient. There is no going back to ‘business as usual’, but to accept this implies a great deal of cognitive dissonance for those who were the strongest supporters of the economic consensus that brought Ireland to ruin.

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