National Review / Digital
PIIGS to the Slaughter
The Irish debt crisis portends worse to come


Checking into a roach motel often seems like a straightforward decision.        

 Signing up for the euro, the shiny new currency supposedly saturated in German fiscal rectitude, not only pleased Ireland’s paymasters in Brussels (the country has benefited hugely from lavish dollops of EU “structural” assistance) but offered Dublin the prospect of riches far closer to hand than the end of the traditional rainbow. The combination of EU aid (amounting in some years to as much as 3 percent of GDP), domestic frugality, shrewd supply-side reforms, and (those were the days) a timely currency devaluation had already given birth to a Celtic Tiger nourished on export-led success. But that beast was now set to burn very bright indeed.

And so it did. Money poured in, bringing the traditional speculative excess in its wake. So far, so normal: Usually such festivities are brought to a more or less timely close by both external and internal pressure. Inflation heats up, the currency buckles, interest rates rise, fiscal policy is tightened, bank lending is reined in, and everyone is soon back on their best behavior — until the next time.

Joining the euro meant that much of this script was jettisoned. Market signals were muffled by membership in a unified monetary system in which one size truly did not fit all. In particular, Irish interest rates, determined primarily by the needs of the eurozone’s sluggish Franco-German core, were kept far too low (on average, they were negative in real terms between 1998 and 2007) for a roaring economy growing at an annual average rate of 6 percent between 1988 and 2007. Throw in a poorly regulated banking system, endemic cronyism, vast infusions of foreign cash (euro membership had dramatically reduced currency risk), a lending war led by the remarkably reckless Anglo Irish Bank, the genuine housing needs of a large new immigrant population (a striking phenomenon in this land once known for its emigrants), and briskly increasing wage rates, and the stage was set for a gigantic property boom. What could go wrong?

Just about everything; and it went so badly that (finally) doing the right thing may have made matters even worse. When the global financial crisis erupted and the Irish economy slumped (GDP fell by 7.1 percent in 2009 after a 2 percent decline the previous year), real-estate prices fell (they are now some 35 percent below their peak, and weaker still in Dublin), and the banks came down with them. The government’s response bore some resemblance to the approach taken so successfully by Sweden during a not-entirely-dissimilar banking crisis in the early 1990s. This included guaranteeing most of the liabilities of the country’s troubled banks (and troubled they were — by 2007, property-related lending accounted for some 60 percent of their loan books) and transferring toxic assets to NAMA, the National Asset Management Agency, a state-run “bad bank.”

But Ireland’s banking sector was far larger relative to its GDP than Sweden’s had been, and so was its real-estate bubble. The Irish government has also had to contend with a far less favorable economic climate, a difference made even more damaging by the fact that the Irish tax system is unusually sensitive to changes in economic activity. Tax revenues fell by almost 14 percent in 2008 and by 19 percent in 2009, bringing yet more misery to the republic’s previously respectable but swiftly deteriorating public finances.  

Recovery from a mess like this is never plain sailing, but one way to lessen the pain is to arrange a currency devaluation (Sweden let the krona fall by 20 percent in late 1992) to give exporters a break. Unfortunately, membership in the eurozone had closed off that option. Ireland was thus stuck with an overpriced currency, an overpriced workforce, and a rapidly growing hard-money debt burden that could not be inflated away. All that was left was “internal devaluation.” That’s an ugly name for an ugly cure generally revolving around extraordinarily brutal public-sector austerity. The aim is to restore both the state’s finances and the nation’s international competitiveness, and it’s just what Ireland had been attempting since 2008 with a series of increasingly bleak budgets intended to reduce the deficit by over $19 billion.

December 20, 2010    |     Volume LXII, No. 23

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