Wednesday, November 18, 2009

Ireland's Investment Strike

A very interesting article here by Michael Burke on the current shambles that is the Irish economy and the government's rescue plans (although the term "shambles" obscures the fact that the government knows exactly what it's doing):

The crisis of the economy and of the banking sector, as well as a potentially looming crisis in the balance of payments all have the same primary source. Bank lending to private sector developers and other speculators has brought about a ruinous situation for the Irish economy, its banks and the level of its foreign debt. These issues need to be confronted head-on, and any policy prescriptions which do not are sure to end in failure.

Irish Government's Response to the Crisis

The coalition government of the Irish Republic, comprised of Fianna Fail and the Green Party, has set out its policy response to the economic and banking crisis. Perhaps it is the catastrophic scope of recent of events which has led policy in a Biblical direction. Whatever the cause, the government's stance is summarised in Matthew 4:25, "For whoever has, to him more shall be given; and whoever does not have, even what he has shall be taken away from him."

The thrust of policy is to bail out bank shareholders and large-scale property developers by using taxpayer funds. This represents a transfer of wealth from the poor to the rich, on a very large scale. The two planks of the policy have been an austerity Budget and the proposed establishment of the National Asset Management Agency (NAMA). This Agency will purchase banks' bad debts owed by property developers and speculators, paid for by issuing bonds, ultimately covered by Irish taxpayers.

The two aspects of the government's stance are clearly linked. Their main aim is to rescue the greatest possible amount of private capital from the economic and financial wreckage, with Irish taxpayers picking up the bill. At the same time, the enormous levels of debt associated with NAMA (at least Euros 54bn in bond issues have been suggested) are offered as justification for large-scale cuts in government spending, including on social welfare and other provisions.

Austerity Budget

The Emergency Budget unveiled in April focused on reducing social spending in a series of measures that included a raid on state employees' pensions, pay cuts, job losses and reductions in welfare spending. At the same time, taxes were also increased. As outlined above, the automatic increase in government spending was one of the few bright spots on the economic horizon.

Now, to replace that with an austerity budget in the depth of recession is, at least, a high risk strategy. According to Finance Minister Lenihan, the combined total of spending cuts in the Emergency Budget and previous public sector pay cuts amounts to Euros 3.3bn. In addition, tax increases announced in April amount to an estimated Euros 1.8bn [10]. This represents a fiscal tightening of 3% of GDP. Given that the economy is already contracting at double digit rates, this represents a gross overreaction, effectively ensuring that the 'cure' is as bad as the disease. Worse, the tax increases are not progressive ones, aimed at higher income groups or the wealthy, but aimed at the poorest in society (along with a halving of the jobseekers' allowance, which is explicitly aimed at young workers).

While these policies could easily be criticised in terms of morality or justice, they also make no economic sense. If it is accepted that taxes have to rise at some point to stabilise government finances, it is imperative now that these do not fall on the poor, as they have a far greater propensity to consume their income, which is precisely what is needed during recession. By contrast, sheltering the rich from tax rises merely increases their ability to save, or to purchase luxury goods.


The leadership of the FF/Green coalition government has argued that the austerity budget is a necessary measure to stabilise government finances. But the proposed NAMA legislation threatens to overwhelm government finances entirely.

The outline of the plan is reasonably straightforward. At the time of writing the proposed legislation is being debated in the Dail. The government intention is that NAMA will be established in order to purchase up to Euros 77bn in bad debts from the banks, relieving them of this burden on their balance sheets. For reference, Euros this is over 42% of Ireland's 2008 GDP, and, given the contraction in the economy, will be a greater proportion of 2009 GDP. The government will issue at least 54bn in bonds to pay the banks for these bad debts, that is, the debt will owed by Irish taxpayers. The government claims that this discount or 'haircut' represents a potential bargain for taxpayers, while admitting that it is overpaying for the assets by at least Euros 7bn. Of this Euros 54bn total, the government admits that Euros 9bn will be eaten up by loans where the borrowers have already defaulted. The plan is highly controversial because many commentators expect the eventual losses to be much greater, leaving the bill with taxpayers. It has also been suggested that the resources of the National Pension Reserve Fund be used in part to fun NAMA.

Yet, as we have previously shown, it would be possible to restore a function banking system and to alleviate the worst effects of the downturn by taking control of the leading elements of the property and construction industries. In this way it would be wholly unnecessary to compensate either bankrupt property developers or bank shareholders in order to revive economic activity and restore the provision of credit to viable businesses. As even the big home builders have pointed out, NAMA does nothing even to ensure that builders have any working capital over the next 6 to 9 months. NAMA is a gargantuan error, completely missing the main transmission processes which could restore economic and financial stability.

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