Alan Wheatley: Ireland shows eurozone strugglers fiscal discipline eventually rewarded
Published 12/02/2013 | 15:47
TO the relief of its creditors, Ireland is showing the rest of the struggling euro zone periphery that fiscal and wage discipline will eventually be rewarded by the bond markets, if not appreciated by the man in the street.
A less heartening lesson is that throwing away the crutch of IMF and EU support, as Dublin is likely to be able to do later this year, is no ticket back to pre-crisis prosperity: nations on the euro zone's rim have dug a debt hole so deep that they face years more of morale-sapping austerity and sub-par growth.
"In all of these countries, it's going to take the rest of the decade to bring debt down to more comfortable levels," said Douglas Renwick with Fitch Ratings in London.
Take Ireland itself. The country is held up as a model pupil for the way it has complied with a loans-for-reforms rescue programme agreed with the 'troika' of the International Monetary Fund, the European Union and the European Central Bank after a banking crisis toppled its economy in 2008.
The country has recorded a current account surplus in the past three years. Imports have suffered but Ireland has also ramped up exports by cutting wages. Its real effective exchange rate, measured by comparing Ireland's unit labour costs against those of its trading partners, tumbled 28.5pc between 2008 and 2011, according to the IMF.
That restoration in competitiveness is testament to a labour market that is much more flexible than those of Spain, Italy, Portugal or Greece.
Ireland is also benefiting from long-standing policies that have lured multinational manufacturers. It has a very low corporation tax, its investment in education has produced a skilled work force, and it has used EU structural funds well to build infrastructure.
As a result, its exports of goods and services reached 107pc of gross domestic product in 2011, compared with 36pc in Portugal and 30pc in Spain, according to the World Bank.
On the fiscal front, too, Ireland has set an example by picking judicious deficit reduction targets.
Despite a string of early setbacks in judging the extent of the banking crisis, it has largely hit its goals, earning it credibility in the markets and goodwill from its creditors.
Other countries with more ambitious, front-loaded targets have suffered significant slippage in some cases - not helped by the fact that they embarked on deficit-cutting later than Ireland when economic and market conditions were much harsher, Renwick said.
"One of the lessons to be learned is to set credible deficit targets that are realistically achievable. And when you achieve those targets, you're anchoring expectations and giving the strong impression that the adjustment is on track," he said.
So far so good. What's more, a deal last week to ease the burden of debts the state incurred to save its banking system in 2008 should pave the way for Ireland to be the first bailed-out euro zone country to wave goodbye to the troika.
Despite that agreement, though, the government's debt will remain around 120pc of GDP and total debt to the non-financial sector of the economy is around 400pc of GDP.
"Excessive levels of debt act as a major constraint on economic growth and negatively impact on all economic sectors," according to Ireland's National Competitiveness Council.
PAIN IN SPAIN
Every country is different, making comparisons treacherous, but the council's conclusions apply just as much to Portugal and Spain, which had non-financial debt of around 360pc and 290pc, respectively, in 2011.
What's more, all three countries have a net international investment position (NIIP) that was negative to the tune of around 100pc of GDP in 2011, according to the European Commission's scorecard of macroeconomic imbalances.
The NIIP measures the difference between a country's assets and liabilities. As such, it is a key gauge of whether a country can service its debts and other financial obligations in the long term.
Like Ireland, Spain has witnessed impressive growth in exports. But the impact of austerity and a plunge in house prices - still sliding in Spain though now stabilising in Ireland after a 50pc fall - mean that home-grown demand is depressed in both countries.
"Spain is in a self-perpetuating crisis," said Edward Hugh, an economist in Barcelona. "However much better exports get, it's just not enough to compensate because domestic demand has gone down further. It's a labour of Sisyphus that they're performing."
Spanish bond yields have fallen and banks can refinance themselves more easily. But the improvement in the financial economy is not filtering through to the man in the street, Hugh said.
With the best and the brightest emigrating and an ageing population adding to strains on the public finances, Hugh said unemployment, now near 26pc and rising, was unlikely to fall back below 20pc by 2020.
"They're stuck in a netherworld at the moment," he said.
A PRECEDENT OR NOT?
Ireland's cheers are very much muffled, too. Unemployment has trebled since the crisis to more than 14pc and would be higher but for emigration. Net exports have been the only positive contributor to growth since 2008.
"Too many people, particularly in Brussels, want to look at the figures for labour costs and say everything is great in Ireland because they've regained competitiveness," said Peter Dixon, an economist with Commerzbank in London. "That's true to a point, but it's not getting people back into work."
Jacob Kirkegaard, a researcher with the Peterson Institute for International Economics in Washington, agreed. After such a deep financial crisis - the banking sector's assets were eight times Ireland's annual output at the peak of the bubble - domestic demand would remain subdued for a long time, he said.
"Ireland is not in any sense in good shape," Kirkegaard said. "There are lessons to be learned for the rest of the euro area from Ireland. But the idea that you can get through a crisis of the magnitude that Ireland has had in just a few years is not one of them."
One pertinent lesson, he suggested, could be drawn from last week's bank-debt restructuring.
The complex deal has stirred controversy, with some economists saying the European Central Bank, in acquiescing to it, had turned a blind eye to an operation that is tantamount to government financing by a central bank.
That is because the Central Bank of Ireland, by swapping high-yielding promissory notes for longer-term government bonds, will substantially ease the cashflow call on the government.
CBI Governor Patrick Honohan has rejected the argument that the deal is akin to monetary financing and says it does not set a precedent.
Still, Kirkegaard said the moral of the story is that if a country swallows its medicine, as Ireland has, the rest of the euro zone will find a way to give it the push needed to regain bond market access. Why? Because fears of moral hazard - rewarding bad behaviour - will have been allayed.
Lisbon, which is dipping its toes in the bond market in the hope of exiting its troika programme late in 2013, will be looking at Ireland's example with particular interest, he said.
"If you're Portugal, you'd be very wise to draw the conclusion that you're going to do everything you can to meet your IMF targets," Kirkegaard said.
"And then, if you're unable to restore market access by the end of your programme, you'll turn around to the euro area and say you've got to give us something as you did with Ireland. And I think they'd succeed."