A Strategy for Resuscitating Ireland
What measures need to be taken to ensure Ireland recovers from the economic crisis?
- Ireland has a political system capable of making relatively speedy decisions, a trait that some bigger countries lack.
- The ability to cut pay in nominal terms is crucial to survival in a currency union, where one does not have the option to devalue the currency to regain lost competitiveness. Ireland has passed that test.
- There is a risk that Europe's economic recovery will be confined to the bigger countries — and that countries like Ireland will not share the benefits.
- By 2007, bank lending in Ireland had risen to 200% of national income — twice the European average.
- People see the financial crisis of 2008 as not much more than a temporary interruption of the earlier growth trajectory.
The physical appearances are positive. A new terminal is moving rapidly toward completion at Dublin Airport. The road system around my own town of Dunboyne is undergoing a transformation greater than anything that happened in the last two centuries.
And a rail service that closed when I was a small child is on the way toward being reopened. Real wealth has been built up by many families whose homes have been reequipped with modern conveniences of all kinds. And, fortunately, most of those gains have been preserved despite the 40% fall in house prices.
Meanwhile, the shops are full — and, most importantly, a tough budget cutting welfare and workers’ pay apparently has been accepted with remarkable maturity by the electorate. The ability to cut pay in nominal terms is crucial to survival in a currency union, where one does not have the option to devalue the currency to regain lost competitiveness. Ireland, to the surprise of some, has passed that test.
Given that Ireland enjoyed almost miraculously high growth rates from 1994 to 2007, it is easy for people who became so used to success to see the financial crisis of 2008 as not much more than a temporary interruption of the earlier growth trajectory. Indeed, there is strong statistical evidence that consumers are gaining confidence. For example, car sales are up.
It is only when one analyzes the figures in more depth that one sees that the problem facing Ireland is different from that facing some other countries — and that the path to recovery may have to be much longer.
The deeper problems are well-analyzed by Morgan Kelly, an economics professor from my old university, University College Dublin, in a recent paper entitled "The Irish Credit Bubble."
He identifies two features that distinguish the Irish problem from that of most other countries. One is the disproportionate reliance Ireland placed on the building industry to generate jobs, spending and tax revenues. The other is the disproportionate increase in bank lending in Ireland since 2000.
House building provided just 4-6% of national income in the 1990s, but it provided 15% of Irish national income in 2007 — far too much to be healthy.
Bank lending amounted to only 60% of GNP in Ireland in 1997 (slightly below the European average), but by 2007 bank lending had risen to 200% of national income (twice the European average).
And to make matters worse, that lending was no longer based, as it was in 1997, on Irish deposits. Rather, it was based predominantly on money borrowed on a short-term basis on foreign money markets, and some of it was in bonds that will mature for repayment in 2010. That was visibly imprudent.
Professor Kelly foresees a substantial further fall in Irish house prices. He argues that this will lead to some people, who find that their mortgage exceeds the reduced value of their home, walking away from their liabilities by emigrating as soon as they can find work abroad.
He also foresees write-downs in the value of the mortgage book of some of the banks having to be so great as to eliminate even the extra capital the banks recently obtained from the Irish taxpayer.
And he argues that, in 2008, the Irish government should not have guaranteed all the debts of the banks, just the deposits. He believes that the taxpayers should not take this on the next time there is a problem.
Professor Kelly is one of the few Irish economists who foresaw the problem, so his views deserve special attention. As we have learned from the 1930s, it was not so much the stock market collapse of 1929 that did the damage, as the bank failures of 1931.
Cleaning up the banking system, finally determining what the banks’ assets are really worth, then restructuring the banks quickly — these are the key tasks to be undertaken if the problems are not to stay around for a long time. The National Assets Management Agency is the body charged with this daunting task.
Many of the houses built during Ireland's credit boom were needed and will still be needed. Before the boom started, the Irish housing stock was insufficient for a population that was growing and which contained an increasing number of people living on their own. But some of the houses were built in the wrong places, in low-density schemes far away from public transport and other amenities.
I argued in 1999 in a policy document of my party, Fine Gael, entitled "Plan for the Nation" that the new home building that was going to be needed by Ireland’s growing population should be concentrated in growth centers close to rail links. If that policy had been followed, the houses would now be more marketable — and the write-downs facing the mortgage holders and the banks today would be less.
Looking to the future, it appears that Ireland is saddled with a banking problem that will hold it back for years to come, after other countries with less indebted banks have resumed growth. The Irish banks may not be able to give credit even to good Irish businesses with good prospects.
But Ireland still has many of the ingredients for a dynamic economy — a relatively young, educated and internationally minded population and good natural resources.
It also has a political system which, as we have seen, is capable of making relatively speedy decisions (a trait that some bigger countries lack). It will need to build on these strengths.
The European Union also needs to build a common European banking system to complement its European currency, so that smaller member states of the euro share in the economic recovery of the bigger ones.
For example, banks in other European countries are in a better state than the Irish banks. It should be possible to encourage them to lend directly to viable Irish businesses and households, without having to go through Irish banks that have other things on their minds.
This would require arrangements to be made for easier cross-border debt collection and for standard terms for bankruptcy and for priority between creditors.
In normal times, it might be difficult to get that agreed upon, but it should be easier now that solidarity within the EU is needed for lending to start flowing again. This should be a test for the European Union, to find a way to encourage cross-border banking as part of a program for economic recovery.
Otherwise, there is a risk that the economic recovery will be confined to the bigger countries, and that smaller peripheral countries, like Ireland, will not share the benefits.
Finally, it is not enough to help banks to get out of unsustainable situations. People need to be able to draw a line under their financial problems, too.
Ireland itself desperately needs to update its personal bankruptcy laws so that people get a chance to start again — rather than remaining in bondage for up to 12 years, as is now the case.