Friday 9 December 2016

Amid all the chaos, can 'best boy in class' status save Ireland?

Published 10/11/2011 | 05:00

Euroland appears to be upside down: reforming countries have to repay debt while miscreants can default; an unelected ECB can override the democratic process in problem countries; and larger states can bully the small. Many object to these recent developments -- but all is not what it seems.

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There is a natural bias toward excessive government spending in democracies. Spending is usually targeted at some relatively small group that can easily mobilise itself to exert pressure for increased payouts. Meanwhile, the costs are spread among a large and disparate number of taxpayers who find it more difficult to organise.

To the recipients, benefits are very important and they have a big incentive to agitate for more; for taxpayers, the costs are spread more thinly and there is less incentive for each individual to protest. Public-sector workers have unions; VAT payers generally do not.

Taxpayers often complain, of course, and especially at election time. But even then, voters often plump for lower taxes without full regard to spending levels. And this elevates the bias in favour of spending to one in favour of budget deficits. Deficits accumulate as larger debts -- to be repaid by future generations that cannot vote.

These democratic tendencies apply equally -- if not more forcefully -- in reverse. When governments try to cut expenditure, interest groups rally in defence of their benefits and we have riots in Italy and Greece. Taxpayers will be grateful but more silent.

But the reality of the eurozone has recently become clearer in four important respects.

First, there are limits to the assistance that can be given to problem countries and they may even be thrown out of the euro. This seems harsh -- especially when ambiguity on these matters contributed to their problems -- but it is the new reality.

Second, the threatened suspension of assistance to problem countries is less an attempt to dictate behaviour than a return to old democratic procedure. It is the markets that are reluctant to finance these countries in the first instance -- and taxpayers in Germany have a democratic right to refuse to step in.

Third, profligate countries can no longer hide in eurozone ambiguity and will henceforth be assessed individually by markets. Membership in the euro has become far less important -- even if it survives.

Fourth, countries with lower spending and less government intrusion -- like Ireland -- are more likely to survive any future crisis and will therefore find it easier to attract financing at reasonable rates.

The eurozone should probably have put limits on spending -- instead of on debts -- and the European model of the all-protective state will increasingly be called into question.

For Ireland, the lessons are clear.

Whenever possible -- and there are limits to spending cuts on the vulnerable -- budgetary strategy should aim at reducing expenditure, rather than raising taxes.

Also, national reputation must be preserved at all costs, even if speculators in defunct banks that are of no concern to the financial system have to be repaid at the behest of a flailing ECB. Financial markets know this is an unreasonable demand but will ultimately admire Ireland's tenacity.

Our public and private sectors will need to borrow about €125bn per year after 2013 in medium-term funds.

If interest rates are one percentage point lower due to an enhanced reputation, this will save €3.5bn in annual interest charges after just three years. At that stage, Greece will still be in intensive care.

So it is no longer a question for Ireland of being the best boy in the class. The cosy eurozone school years are over and it is important to be a credible graduate in a harsh new world.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies

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