Business Irish

Saturday 24 June 2017

Plan B: how leaving euro can save Ireland

Our current economic problems didn't begin with the debt crisis but have their roots in decision to join eurozone, says Cormac Lucey

Is a eurozone exit the answer to Ireland's economic woes?
Is a eurozone exit the answer to Ireland's economic woes?
Lucey's IMF graph

Cormac Lucey

IT may seem odd, with the Troika having departed Ireland in December 2013, to call for a default on our debts and for exit from the eurozone.

Instinctively, people don't want to do either of these things. The first would involve reneging on debts freely entered into. The second would involve reneging on the European Union's current big project.

And the problems of the eurozone have been fixed, right? Listen carefully to the words of someone who should know – Mario Draghi, the head of the European Central Bank.

In January he dismissed as "premature" upbeat comments from European Commission president Jose Manuel Barroso, who had earlier predicted that the eurozone would put the crisis behind it in 2014.

Or consider the words the former head of the German Central Bank, Axel Weber. He told the World Economic Forum in Davos in January that the underlying disorder continues to fester and the region is likely to face a fresh market attack this year. "Europe is under threat. I am still really concerned. Markets have improved but the economic situation for most countries has not improved," he said.

Since 2008, Ireland (and the rest of the eurozone) has been caught in a debt crisis. You might have thought that, having made enormous sacrifices, we are now slowly but surely paying down those debts. But look at the graph we have reproduced. It comes from an IMF publication last summer.

It shows total economy-wide indebtedness (that is, the sum of government, corporate and household debt) for selected eurozone countries compared to national income (GDP) for the years 2003, 2008 and 2012. Across the eurozone, aggregate debt levels have increased markedly (rather than decreased) since 2008. The increase has been greatest for the country on the left-hand side of the graph – Ireland.

We have the greatest aggregate debt level of those countries surveyed.

Why are we making so little economic progress despite enduring so much personal pain?

In my view, the authorities have misdiagnosed the problem.

Their policy prescription, Plan A, is not working. The authorities do not see that it was Ireland's decision to join the euro which sowed the seeds of our financial crisis. Instead, senior policy-makers – such as Central Bank governor Patrick Honohan – would have us believe that the crisis was "three-quarters home-grown".

The hard reality is that the eurozone should never have been formed with its original membership.

The diversity in economic cycles and patterns of national behaviour, coupled with the lack of real integration between the eurozone's national economies, means that the eurozone falls a long way short of the conditions necessary for a functioning common currency area.

It also means that an interest rate that is broadly appropriate for the eurozone as a whole can be acutely inappropriate for substantial regions within its borders.

Between 1997 and 2007 this meant that Ireland (and the rest of the eurozone periphery) got interest rates which were far too low for its conditions.

The result of under-priced credit was a credit boom, a property boom, an employment boom, a public sector boom and a cost boom.

Eventually they all turned to bust. It was not feckless Paddies looking for a party who were substantially to blame for Ireland's economic crisis but pie-in-the-sky Europeans of questionable competence playing Lego with currency systems – the workings of which they didn't understand then and still don't understand today.

Today, there are three central reasons why we should seek to leave the eurozone:

Reason 1

The eurozone will nearly always give us interest rates inappropriate to our circumstances. Between 1997 and 2007 those rates were too low. Since 2008 they have been too high.

The result has been an Irish domestic economy that has swung from a decade of binge-eating to crash-dieting. To get appropriate interest rates for Ireland we must restore monetary independence or align ourselves with an appropriate (rather than an inappropriate) currency, eg sterling.

Reason 3

By ceding control of monetary policy to Frankfurt, we forego it in Ireland. That means that the monetary policy which has been successfully followed in the US and in the UK (quantitative easing, abbreviated by everyone to QE) is denied Ireland. Although like us those countries have very large debt problems, they have suffered far less economic stress than Ireland as a result of applying QE.

To follow the US and the UK in this regard, we must seize back our monetary independence from the sado-monetarists of Frankfurt.

Reason 3

By exiting the euro we can allow our currency to find a new and lower level that will be much more likely to stimulate economic growth and employment.

Normally if a country suffers a severe economic downturn its currency will drop and act a bit like an economic airbag to absorb some of the recession's deflationary effects. The results of such a currency drop are to make the country's exports and tourism product more competitive. But, since 2007, our currency, the euro, has risen – not fallen – by 25 per cent against sterling.

If you do the sums on current exchange rates, you can compute that an old Punt is now worth £1.05 sterling. This is an alarmingly high exchange rate for an Irish economy that remains so weak. The alternative to correcting these cost and exchange rate imbalances by exiting the euro (external devaluation) is to correct the imbalances by more of Plan A – or, in other words, the internal devaluation of cost cuts, wage cuts and more economic sacrifice.

The implications of Plan A were spelt out recently in Dublin by Dr Pippa Malmgren, economic adviser to former US President George W Bush.

She said: "But you have to accept 20 years of no growth. That's the only other option. It's what European policymakers expect Ireland to do. The question is, do the Irish people have the tolerance to take that much pain?"

Advocates of Plan A will argue that we have no choice. But we do.

Plan B – a eurozone exit and managed debt restructuring (something successfully managed by Independent News and Media plc in the last 12 months) – is Ireland's alternative. It has substantial costs but offers considerably better prospects than 20 more years of Plan A.

Cormac Lucey is programme director of the Diploma in Business Finance at the IMI. His new book – 'Plan B: How Leaving the Euro Can Save Ireland' – is published by Gill & Macmilan on Wednesday

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