Kelly's route out of economic crisis is itself a road to ruin
OPINION:If Ireland did what Morgan Kelly advocates, the European Central Bank itself might go bust and the euro could collapse
MORGAN KELLY has sparked a lively debate about Irish economic policy with his Irish Timesarticle of last Saturday – much like his previous interventions. He has a lot of credibility because he foresaw the bursting of the Irish housing bubble. To his credit, he does not confine himself to a critique with his latest contribution, but offers his own suggestions.
He is advocating a two-pronged strategy:
(1)That Ireland walk away from the EU-IMF deal (a notion that is, of course, attracting a lot of favourable media comment) and;
(2)that, in order to be able to pay its way in the absence of funds from the EU-IMF, Ireland should immediately eliminate its budget deficit (a drastic notion that, equally predictably, is being ignored in the same media comment).
While I favour speeding up the adjustment, doing it all in one year would be impossibly disruptive.
He claims that a strategy along these lines is needed because otherwise, he thinks, our debts are unsustainable. He bases this on pessimistic growth assumptions, which may or may not transpire. And he argues that a slow, messy bankruptcy would destroy an Irish economy that depends so much on international trust. Better, he argues, to do the whole job immediately.
There are a number of elements missing in Professor Kelly’s analysis.
First, he does not consider the impact of what he is suggesting on other countries, and how they might react.
The effect of a comparatively well-off country like Ireland (a founder member of the euro which had benefited more than most from EU agricultural, regional and cohesion funds) failing to pay money it owed to an EU institution would undermine the mutual confidence on which the EU is based.
If Ireland were to walk away from the EU-IMF deal, that would leave the European Central Bank itself with a huge shortfall. In fact the ECB might be insolvent. It might have to go to the member states to look for more capital. Emulating Ireland’s example, they might refuse, and then the euro would collapse. If they even hesitated about recapitalising the ECB, the resultant uncertainty could have a devastating effect on the world economy; an economy on which Ireland is more dependent for sales than most.
If the euro collapsed because of a failure of other EU states to recapitalise the ECB, or because of a breakdown in trust between its members, Ireland would have to launch a currency of its own in the same year that it would also have to cut wages by perhaps 40 per cent and increase tax revenues to meet Prof Kelly’s other requirement of balancing its budget in one year.
In walking away from the EU-IMF deal, Ireland would be reneging on freely contracted debts to an EU institution and to other EU members, so we would also presumably be excluded from the benefits of EU membership. For Ireland, the Common Agricultural Policy would disappear overnight, as might its access to EU markets for other products, at least until the debts it owed had been collected by other means.
Prof Kelly, who is an economic historian, should look up what happened when we last walked away from international financial obligations. We refused to pay land annuities to the UK in the 1930s, and found some of our critical exports excluded from the UK market, with devastating effects in what came to be remembered as the Economic War.
That is not to say that the EU should not be challenged. The EU-IMF programme may indeed be too optimistic. There is a lack of joined-up thinking on economic policy in the EU. The EU institutions may be too nervous about burden-sharing by private bondholders. There is a selfish nationalism in some of the stands being taken by our EU partners. But then there is a selfish nationalism in some of our own attitudes too. We all have domestic political constituencies and media to appease.
Ireland may not be as influential as it would like to be in the EU. But at least we are still in the EU, and we have some influence there still. We can use that influence to move the EU towards a more credible long-term strategy, one that allows countries such as Ireland time to restore their finances, and allows surplus countries such as Germany time to rebalance their economies towards consumption.
The coming into effect of the European Stability Mechanism in 2013 offers the prospect of all countries still in difficulty having more time and space to resolve their problems in a way that balances public and private interests better than was possible in the emergency conditions of 2008.
In calmer economic times, things are possible that are impossible in the midst of crisis and potential panic.
But trying to achieve all that overnight, by holding a gun to everyone else’s head as well as to our own, as the professor urges, seems to me to be needlessly reckless. Prof Kelly argues that we need to do something like this to keep our international credibility. But, like the advocates of default, I am afraid that the course he favours would destroy our international credibility instantly. It would involve immediate shock therapy for our economy, which could do much more harm than good. It would undermine trust.
All banking, all money, is based on mutual trust and confidence. Why else do we accept a scrap of paper, with no inherent value itself, as worth €100 or €500 or whatever other number is written on it?
Why else do we hand over our saving to banks on the promise that the money will be there when we need it?
It is all about trust. Without trust, the entire modern economy, built up over three centuries, would disappear overnight.
Breaking trust with our European and international neighbours would undermine the future of our own economy, and the economies of those to whom we sell. That is why I do not think Prof Kelly’s article, for all its erudition, offers good advice at all.
John Bruton is a former taoiseach and former EU ambassador to Washington. He is chairman of IFSC Ireland, a private sector body that seeks to promote Ireland’s international financial services sector