Bill Emmott - International Author & Adviser

Article

Be brave and Britain won´t be another Ireland
The Times - October 4th 2010

When you have got yourself into a mess, it can be comforting to find that your neighbour is even worse trouble than you are. That unfortunate role is being played by Ireland. There is a danger, however: that the neighbour’s struggles might make you less inclined to deal properly with your own. That would be a mistake: the case for fiscal austerity in Britain should rest on British conditions, not on events across the Irish Sea.

            The Irish government’s announcement that the cost of its bank bailout would raise its budget deficit to an amazing 32% of GDP did make Britain’s fiscal problems—a deficit “only” one-third that size—look trivial by comparison. This has come about even after Ireland has already made deep, painful cuts in public spending during the past two years. What is even more amazing is that the same government that got Ireland into this mess is still in office.

            Not for much longer, surely.  The betting is that Brian Cowen’s Fianna Fail-Green Party coalition will collapse once its budget has passed through parliament at the end of this year, that early elections will then be held, and that they will bring a more centre-left government to power, formed by Fine Gael and Labour. If so, that would bring Ireland’s first change of government for 12 years, but also end a 23-year spell during which the centre-right Fianna Fail party has run the country for all but 30 months.

            The length of that period of dominance is a clue to why Ireland is in its current mess and to why the blame can and should fall squarely on Fianna Fail. In a way, the story of the Irish financial crisis is beautifully simple, with no need to cite incomprehensible derivative securities nor to blame recklessness on the other side of the Atlantic. It is a classic story of how long economic booms breed complacency, and how the most dangerous words in finance are “this time is different”.

            The long Irish boom, which really began when the country sorted out a previous fiscal mess in the mid-1980s, had genuinely solid foundations. The title of “the Celtic tiger” was thoroughly deserved, was fuelled by the arrival of  international companies in search of flexible, cheap, well-educated workers, and led to a wave of immigration, both of Irish exiles and of foreigners, which in turn increased the demand for property. Thus began an extraordinary speculative bubble in houses and offices, a bubble made bigger when entry into the euro in 1999 brought the costs of borrowing tumbling down.

            Every financial historian knows that property booms have a devastating effect on banks. Lending for property produces the archetypal maturity mismatch, as bankers call it: short-term funds, from deposits and money-market borrowing, are turned into long-term loans tied to an illiquid asset, namely a house or commercial development. When house prices rise, such lending is immensely profitable. When they fall, in Ireland’s case by 40% or more, the banks go bust. That is what has happened. And the trouble is that property prices are still falling, so the true extent of the dud loans cannot yet be known.

            The story may be beautifully simple, but it was tragically avoidable. It was obvious that Irish property prices would one day collapse. The only questions were when and by how much. The belief that inward immigration and a continued global economic boom would either avert this outcome or soften any fall were a delusion, as a glance at Japan’s property crash of the 1990s should have shown. The collapse was predictable and was widely predicted.

            Bankers were delusional and sometimes malign, and deserve all the brickbats they are getting. But ultimately the blame rests squarely on the Fianna Fail government. At such times, only the government can step in to regulate the banking system, in order to prevent delusion turning into disaster. That is what happened in Spain, which enjoyed a similar property boom and bust, fbut rom which its big banks have emerged relatively unscathed thanks to tight and far-sighted financial regulation. Ireland just let the party go on. And the finance minister for much of that time was the man who is now prime minister, Brian Cowen.

            So much for the morality play. What might happen now, and what are the implications for Britain and for the eurozone? The likely immediate outcome is that Ireland will have a new recession, as borrowing costs have risen thanks to the cost of the bank bailout and as the government feels forced to introduce a new round of spending cuts and tax rises. Such measures are both necessary and damaging, for the risk is that fiscal austerity and a new recession will cause property prices to fall further, bringing more losses for the banks.

            But there is no real choice.  Fortunately, the Irish government does not need to borrow more for roughly another nine months, and so can—or rather its likely successor can—hope that the markets will be friendlier by the time it has to do so again. However, they certainly won’t be friendly if the deficit looks out of control. Like Greece, Ireland is trapped by its own past mistakes.

            As with Greece, the consequences for the eurozone are, first, that Ireland may well need to tap the special rescue fund assembled earlier this year by the International Monetary Fund and European governments. But also as with Greece, if the Irish economy continues to decline the country may need to negotiate a restructuring of its foreign debts in order to reduce that burden. Some may say that it should also leave the euro, but that would make things even worse. Moreover Ireland’s flexible economy means that unlike Greece it has good grounds to hope that its export competitiveness will be restored through lower wages and higher productivity rather than needing a currency devaluation.

            And the consequences for Britain? As always, Britain is condemned to be resented in Ireland, for sterling’s devaluation over the past three years has made life a lot tougher for the Irish. That devaluation is one reason why the British situation is not as bad as Ireland’s, but another is that our property market has not dominated our financial crisis in the way Ireland’s has. Our fiscal austerity plan, which will come into sharp focus with the spending review on October 20th, could, like the Irish one, make things worse. But if it does, and only then, Britain, unlike Ireland, will be able to—and should—use its reverse gear, both by relaxing fiscal policy and by using an expansionary monetary policy.

             


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