Rebuilding the economy
ONLY THE most pessimistic of forecasters would have predicted that 2010 would see Ireland overwhelmed by the cost of its banking crisis and forced to turn to the European Union (EU) and the International Monetary Fund (IMF) for aid. If anything the early part of the year was characterised by what turned out to be unfounded optimism about the prospects for the economy and the level of fiscal adjustment that would be needed to return the national finances to a sustainable path.
It is hard to pinpoint the moment when it became clear that rather than turning a corner, the economy was still heading for the rocks. In truth it was the cumulative impact of a series of events, the most significant being the realisation that the true cost of bailing out Anglo Irish Bank would be several orders of magnitude larger than predicted. This combined with slower economic growth at home and abroad meant that by the middle of the year it was clear a plan B would be needed.
Arguably the greatest criticism that can be levelled against the Government is not that its original plan to resolve the banking crisis and restore growth – with the National Asset Management Agency (Nama) as its centre piece – did not work. It is that it failed to realise early enough that its approach was not working.
The complacency and inertia that characterised the initial response to the banking crisis in 2008 was once again manifest. The result was that when Ministers returned from their summer break, they were totally unprepared for the swift change in international sentiment towards Ireland that followed. It is debatable whether it would have made any difference if the Government had seen what was coming. But at the same time, it would have been preferable for the Coalition to try to take greater control over events rather than be bounced from pillar to post by the bond market before collapsing into the arms of the EU and the IMF.
The situation in which Ireland now finds itself remains incredibly grave. We have signed up to a three-year fiscal programme which will involve unprecedented levels of austerity. The measures agreed with the EU and the IMF will in themselves significantly dampen the economic growth that is supposed, ultimately, to lead to recovery.
Having adopted a text book solution to the banking crisis by setting up Nama, we are now adopting a textbook approach to fiscal adjustment. However, the IMF’s position has some provenance even if the organisation itself admits to being in relatively uncharted territory when it comes to applying its methods to a developed economy and on the scale currently being contemplated.
For its part, the European Central Bank (ECB) may have strayed out of its depth in trying to deal with the Irish banking crisis and the wider euro problem. The sea change in its attitude to Ireland may have precipitated Ireland’s denouement in the bond markets but, more worryingly, it indicated the Frankfurt authorities had overplayed their hand and started to panic. The ECB has now succeeded in extracting itself from the role of Ireland’s financier of last resort and passed the baton to Europe proper and the IMF. However, the episode will leave a lasting and not terribly positive legacy.
That said, the events of the last three months are likely to amount to little more than a footnote in the drama that is expected to unfold. The fundamental contradictions at the heart of the single currency project have been exposed and will be probed over the coming year by an increasingly sceptical market. The next pressure point will be Portugal and the consensus is that a more far-reaching solution than any of those cobbled together so far will be needed. Of the various options being considered, some form of joint debt issuance by member states, with associated tighter fiscal co-ordination, would appear to carry the most support.
As a small member state with most of its credibility already squandered, Ireland will not be in a terribly strong position to influence the outcome of this process. But by the same token it has the most to gain from such an outcome. In the absence of some sort of eurobond, Ireland’s path back to the sovereign debt markets and greater control over our own affairs will be longer and less certain.
The magnitude of events to be played out over the coming year effectively renders all talk of renegotiating the deal done with the EU and the IMF as almost pointless. Ireland’s cost of borrowing in the longer term will depend far more on what happens in the wider arena than any negotiations with the EU and the IMF over the rates they will charge us. Likewise our ability to force greater burden-sharing on bank bondholders. As populist as both these policies may be, the incoming government would be best advised not to expend too much energy on them. The deal negotiated by the outgoing Coalition is by its very nature one that reflected a huge disparity of power between the two sides. But what it does hold out for the incoming government is the space and stability to actually set about economic reforms and other policies that will foster growth and jobs. In fairness to the current administration, they had little of either. Whether they had any worthwhile ideas or ambition in this regard is a moot point.
There has never been a climate more conducive to economic reform. Indeed a number of overdue reforms have been mandated by the EU and the IMF. The next government should consider these as a starting point and should not be afraid to look to business for other ideas. In the coming year, the focus should be on rebuilding the domestic economy while European events unfold as they will, hopefully in our favour.