Tuesday, 23 November 2010

With Friends Like These- the Dismemberment of the Irish Economy

By Michael Burke

The mainstream discussion in Britain about the economic and financial crisis that has engulfed Ireland has become dominated by the question of whether British taxpayers should participate in a bailout of ‘the Irish’. Chancellor George Osborne says £8bn will be made available as part of the rescue package as it is Britain’s national interest and is ‘helping a friend in need’, while the hard Right of the Tory Party objects that cuts are being made in Britain while ‘the country pays’ to help out a member of the Eurozone.

The inability of the British establishment to discuss anything to do with Ireland without parading a series of prejudices is well-known - the inability to distinguish between an interest-bearing loan and a gift a little more surprising. The real position is that the £8bn loan will certainly be at higher interest rate (5% or more) than Britain is currently paying (3% or less), consequently making a profitable return on the ‘gift’.

But neither has the British Exchequer gone into the development finance business. Not a penny of the £8bn will be used to keep a single Irish worker in employment, or a school or a hospital from closing. In fact it is widely reported that the forthcoming Irish Budget, which will be a condition of the multilateral lending in which Britain is a junior participant, will include a further €8bn welfare and jobs cuts, as well as new cuts to jobs, investment and spending on essential services. The minimum wage is also likely to be cut, further compressing incomes and the total cuts over 4 years at least €15bn.

International Loan-Sharking

Like Greece before it , the population of Ireland within the southern state will experience the true nature of the bailout; a form of international loan-sharking. The economy and government finances have spiralled downwards because huge transfers of wealth and incomes have been made to the rich, led by the banks, to soften for them the effects of the recession. These transfers were from the poor.

The downward economic spiral naturally ran out of control, as incomes plummeted and new debts mounted. These were reflected in the soaring costs of government borrowing in the bond markets as investors viewed eventual default as an increasing likelihood. Now Irish taxpayers are being forced to take on even greater debts and to accept the extremes of further ‘austerity’ measures in a doomed attempt to pay for them. The Dublin government is the borrower - but the funds will be offered to existing creditors. As the Financial Times’s Martin Wolf remarked of the earlier Greek crisis, this is worse than Argentina’s debt crisis, as the creditors are being paid to escape, and there is no-one to replace them.

Who Benefits?

The holders of Irish government debt are mainly Europe’s financial institutions, fund managers, banks, pension and insurance funds. As the chart below shows, about 84% of the Irish government debt is foreign-owned.

Chart 1

10 11 23 Ireland Chart 1

In terms of recent bond issuance, this dominance of European financial institutions is if anything increased, with just 9% held in Ireland. European and British financial institutions are playing the leading role in this.

Chart 2

10 11 23 Ireland Chart 2

In fact, the British state-owned RBS bank is the biggest single holder of Irish government bonds, owning €4.9bn of these at the end of 2009 and €53bn in total debt assets in Ireland. It is the risk of default on this asset, along with the other holdings of the British finance sector in Irish government and bank debt, which reveals what is the actual so called ‘national interest’ that moved George Osborne to use British taxpayers’ money. This is another bailout for British banks, with the government in Dublin saddling Irish taxpayers with new debts to pay for it. This process is being replicated in all the major economies across the EU.

How Did We Get Here?

Britain and Ireland are very different countries, not least because the former occupied all or part of the latter for centuries. But one thing the London and Dublin governments share is a neo-liberal ideology learnt at the feet of Margaret Thatcher. One of the features of that ideology is a commitment to low taxes and low government spending. In reality, this is a policy which is designed to benefit capital at the expense of labour. Both Irish and British government policy is ‘reverse Robin Hood’ – take from the poor to give to the rich.

Since 1992, average government revenues in the EU have been 44.8% of GDP, compared to 39.8% for Britain and 35.6% for Ireland. Consequently, Britain is also a low-spend country, where government outlays are approximately one-eight below the EU average as a proportion of GDP. 1 But the Dublin government took such a ‘low tax-low spend’ policy to an extreme. Average Irish government spending over that period was just 33.8% of GDP compared 47.5% for the Euro Area as a whole, that is nearly one-third below average.

For Britain, there was also an over-reliance on tax revenues from banking and financial speculation, whereas Dublin’s tax revenues were overly reliant on property speculation. In both cases the narrowness of the tax base left the economy and government finances especially vulnerable to the Great Recession. Britain had the most severe recession of any of the large European economies, while Ireland had the most severe loss of output of any economy in the Euro Area economy. Ireland’s recession seems set to enter its fourth consecutive year in January 2011.

Uniquely, the Dublin government responded to the crisis by exacerbating the recession through a series of spending cuts and tax increases, mainly the former. It is here that the most important lesson arises for policy in Britain and elsewhere. Ireland’s policy was based on the Orwellian-sounding 1984 speak phrase ‘Expansionary Fiscal Contraction’ (EFC), implying that the economy can grow while government spending is reduced, or in fact because it is reduced. This notion is based on the assumption that lower government spending will reduce interest rates and thereby encourage businesses to invest and consumers to spend. Even The Economist magazine has described recent support for such a policy from academics and, less rigorously, from Goldman Sachs as ‘seriously flawed’ . In fact SEB has already highlighted separate IMF research which argues that every cut in government spending, under current circumstances, will lead to a fall in output of twice that in the first year, and a cumulative fall of six times the initial cut over five years. 2

The Dublin government has introduced five separate Budget or emergency packages, totalling €14.6bn, since the end of 2008 and now intends to repeat the onslaught over another four years. At the outset of the process that would have been equivalent to 7.7% of GDP but is now equal to 9.3% - because of the subsequent economic slump. Irish GDP numbers are themselves inflated, in part, by US multinational corporations who park sales and profits in Ireland accrued elsewhere to avail themselves of the ultra-low corporate tax rates, which at 12.5% are the lowest in the OECD. In relation to the domestic sector, which accounts for the overwhelming bulk of tax revenues, the government measures are now equivalent to 11.5% of GNP.

The impact of the measures taken by the Irish government are clear, businesses reduced their investment further so that the collapse in gross fixed capital formation is equivalent to the entire decline in GDP. Consumers, frightened by job losses and suffering falling incomes, cut back on spending. As a result, taxation revenues slumped, from €48bn in 2007 to a government projection of €31bn in 2010. It is this €17bn disappearance of taxation revenues that is almost entirely responsible for a budget deficit, which is projected to be €18.7bn this year.3 Meanwhile, despite repeated and deep cuts in social welfare entitlements, as well as in all areas of government spending, the welfare bill has soared from €20.6bn in 2007 to €35.9bn under the impact of a surge in unemployment and growing poverty.

In Britain, the Tory-led Coalition has set out plans that will remove £111bn annually from the economy by 2014/15 4. According to the forecasts from the Office of Budge Responsibility that would then be equivalent to 6.2% of GDP. Of course, if the British Thatcherites were to emulate their co-thinkers in Dublin, each new Budget would be greeted with expressions of disappointment that cuts had not led to savings, and the dose of cuts would be increased. Given that the budget deficit in Britain is actually falling currently, courtesy of modest Labour increased spending in the 2009 Budget, that will be difficult to justify in the immediate future.

But a crucial point remains that all such ‘fiscal consolidations’ are premised on the illogical and disproven notion ‘EFC’. EFC is a mirage, the result is actually ‘Contractionary Fiscal Contraction’. That applies equally to the Tories’ savage cuts as well as all somewhat milder, slower more anguished versions of the same emanating from the Labour frontbench.

Bailout Is Not the End

Reports suggest that the Irish bailout package will be just under €100bn, so immediately doubling Ireland’s stock of outstanding national government debt. Contrary to widespread assertions, including from the Irish Finance Minister Brian Lenihan, this is not solely or even primarily a result of the extraordinary bank bailout which informed observers believe may total €76bn in losses for Irish taxpayers, as these have mostly been met already. Instead both Barclays Capital and Goldman Sachs estimate that more than two-thirds of the bailout is required to cover the public sector deficit over the next three years. It is the combination of fiscal and banking policy that has led to the bailout, and the drain from the banks could be blocked by the removal of the bank guarantee and burning the bondholders.

A similar bailout has not worked for Greece. Even though no Greek government borrowing will be required from the market for three years, Greek long-term bond yields are still 12%, reflecting a growing perception that default will eventually occur. From the mildest recession in the Euro Area in 2009 (except Cyprus), the Greek economy is now in an accelerating decline with Greece's statistics agency Elstat saying the "significant reduction" in public spending had contributed to the deepening of the country's recession.

The Irish bailout is widely associated with the IMF but only one-third or so of the funds is likely to come from that source. The bulk will come from the European Finance and Stability Fund (EFSF). This differs mainly in that the usual IMF package often includes some limited default or “restructuring” and losses for the bondholders in recognition of some of the losses in the market already incurred. The role of EFSF and the European Central Bank is precisely to ensure payment in full to European banks . The specific role of the IMF, representing the US, is to oppose any hike in the ultra-low corporate tax rate .

The bailout of Ireland’s economy will fail. Increasing debts and reducing incomes via ‘austerity’ measures will not resolve Ireland’s debt crisis. Moody’s, one of the leading credit ratings’ agencies has already indicated that transferring more bank to the State and the lower growth outlook will lead to a downgrade of Irish government debt , implying an increased likelihood of default. This is not the end of the crisis, either for Ireland or more widely in Europe.


Sources

1. EU, Euro Area Report, Winter 2010, Statistical Annex.

2. Will It Hurt?, IMF, World Economic Outlook, October 2010, Chapter 3.

3. Dept. Of Finance, Information Note on the Economic and Budgetary Outlook, 2011-2014, November 2010.

4. UK Treasury, Comprehensive Spending Review, October 2010.


SEB readers might like to read the piece here by Michael Burke, which appears on the TASC website in Ireland and argues that the Dublin government's 'National Recovery Plan' is an asset recovery plan for bondholders.


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