As the euro zone crisis rages on, Ireland has become a powerful symbol of exhortation — a kind of inverted cautionary tale — used by the currency union’s fiscal hawks. “Cut public spending, reform your economy, and you, like Ireland, can survive financial crisis and come out the other side,” runs their exhortation.
Ireland’s public finances are currently being propped up by the troika of the EU, European Central Bank and International Monetary Fund under a bailout program scheduled to end by the close of next year, but it is certainly far from a hopeless cause.
Mario Draghi, president of the European Central Bank, recently affirmed that Ireland has achieved “remarkable, very significant, substantial progress” in fiscal consolidation and other areas and that the point at which the country could once again finance its debt in the free market was “not a far distant perspective.” Anxious to test the waters ahead of full fiscal independence from the troika, on Thursday Ireland made a tentative but successful foray into the bond market, selling a chunky €4.2 billion ($5.1 billion) in long-term debt for the first time since it was forced out of the market in 2010. However, the rate for the 5-year tranche of the sale, at 5.9 percent, suggests that Ireland’s future financing would be expensive.
Is it too soon to declare Ireland’s fiscal crisis over?
The country has certainly come a long way. In 2009 its economy shrank by 7 percent, causing its fiscal deficit to swell to 14.2 percent of gross domestic product. In 2010 the deficit ballooned to 31.3 percent, almost three times as much as any leading economy. But this year it will ease to under 9 percent, according to the IMF, after severe cuts to public services. As a result, although GDP fell quarter-on-quarter in the first quarter, it was still 1.2 percent up on the year.
But there is still a fair-sized mountain to climb to get the deficit down to a sustainable level at which bond payments can be met and investors will not panic at the prospect that they might not be. Credibility would be established by a deficit of no more than around 3 percent. A deficit of this size is the maximum allowed for each member state by the EU’s Stability and Growth Pact in the (relatively) halcyon days of 1997. It is also Ireland’s target for 2015.
To achieve this, Ireland will need to grow its economy despite the tail winds generated by the euro zone’s economic crisis, and to make further cuts in spending. How achievable is this?
One of Ireland’s greatest advantages is its high level of exports. Political leaders across Europe have urged their compatriots to help their country export its way out of economic morass; in Ireland this proposition is at least more tenable than elsewhere. Gross exports are roughly equal to the overall size of the economy — whereas they account for only one-fifth of Greece’s GDP. Moreover, many of these exports are outside the troubled euro zone, reducing the power of the commonly-repeated accusation that for euro zone countries to rely for their economic growth on exporting to other member states is akin to 17 drowning sailors clinging on to each other for safety on their way to the bottom of the sea. In 2011, 24 percent of Irish exports were to the U.S., and 16 percent were to the United Kingdom. They are enjoying the tailwinds of a 14 percent year-on-year fall in the euro to $1.24, and a 12 percent rise in sterling to €1.27.
Ireland is also exporting its people in large numbers once more, as it has done periodically throughout its history when the outlook at home has darkened. More than 250,000 Irish people have emigrated since its economic crisis began — a high number for a country of 4.6 million inhabitants. This should ease Ireland’s deficit by cutting the value of out-of-work benefit payments, though the departure of often highly skilled young people at the beginning of their working lives could hit economic growth in the very long term.
Moreover, those Irish in work have a high reputation which should boost foreign direct investment, particularly since 2011 figures for Ireland’s hourly labor costs — at €27.4 — show a fall back down to below the euro zone average according to Eurostat, the EU’s statistical arm.
In the 2012 World Competitiveness Yearbook published by IMD, the Swiss business school, Ireland comes top in the availability of skilled labor and in the flexibility and adaptability of the workforce.
Ireland has a very flexible labor market in two senses, says John Greenwood, chief economist at Invesco in London: “Wages and prices have been very adjustable, and we also see quite a bit of emigration.”
However, some of the strengths are more limited than first appears; others are the flipside of weaknesses.
Ireland’s reliance on the U.S. and U.K. for such a high proportion of its exports still leaves it exposed to the euro zone crisis, because the U.S. and U.K. are themselves vulnerable to it. Troubles in the currency union have pushed the U.K. into recession.
High emigration has not been enough to prevent a rise in unemployment from 5 percent to 15 percent. This number explains why Ireland scored top for availability of skilled labor in the IMD survey and why its labor costs have fallen relative to other countries. However, it is one big reason why Ireland will find it hard to push its deficit down by another 5 percentage points to around 3 percent.
In a July report on Ireland, the IMF frets over “the growing problem of long-term unemployment,” and calls for benefit reforms to increase incentives to work. It also warns that when it comes to cutting public spending, “after five years of consolidation, few low-hanging fruit remain.” Many members of the Irish public have for many years vigorously opposed the cuts, which include reductions in welfare and civil servants’ salaries. The need to cut even more deeply could make future protests still more vehement, to the point where, as in Greece, they start seriously to disrupt the economy.
The alternative — to rely increasingly on raising revenue instead — could be even harder. Almost half of Irish households failed (or refused) to meet an April deadline to pay a new €100 property tax: The public is weary of new levies after years of austerity. Political critics have noted that a very similar tax was largely behind the 1990 fall from power of Margaret Thatcher, the prime of minister of Ireland’s larger neighbor. Ireland’s civil disobedience over the levy may mark a new and more directly militant phase in the Irish people’s resistance against austerity.
Ireland faces, therefore, the same dangerous problem as Spain and Greece: Its people and economy have already suffered greatly from severe cuts, but will need to make even more sacrifices if they want to establish the fiscal credibility that will allow them to stay in the euro zone. Ireland’s task will be to achieve a balancing act that allows cuts deep enough to reduce the deficit, but not so deep that they destroy the economy. It is not yet clear — for Ireland and for any other of the troubled peripheral euro zone states — that this tightrope walk is mathematically possible, no matter how skilled the financial gymnast.
However, Ireland’s saving grace may be its small size. This makes it, in mathematical terms, relatively easy for the euro zone as a whole to find the money to save the country — for example, by using emergency bond buying to guarantee a floor for Irish bond prices as the country exits the protective recuperation ward of the bailout. Having insisted that Ireland needed to swallow harsh medicine, the euro zone cannot afford to let other member states see it killing the patient — this would destroy the credibility of the austerity message which has been the linchpin of the transnational response to the euro zone debt crisis. The euro zone may be tempted, therefore, to use its beefed-up funding mechanisms to give Ireland some crucial leeway.
