Friday 28 October 2016

Failure to opt for real stability risks disaster for our economy

We only have to look at Greece or Portugal to learn some harsh lessons, writes Dan O'Brien

Published 21/02/2016 | 02:30

Micheál Martin and Enda Kenny
Micheál Martin and Enda Kenny

Another election or a coalition between the two Civil War parties. These increasingly appear to be the only two likely outcomes of the election in five days' time.

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Today's Sunday Independent/Millward Brown opinion poll shows no sign of the current Coalition gaining any re-election momentum. More generally, it shows as little sign of a defragmentation of the vote.

Among the most fascinating questions posed in today's poll is respondents' opinions on the best option in the event of a hung Dail. Providing yet more evidence that the Irish electorate is not nearly as stability-orientated as pundits had believed, by far the most favoured outcome is a second election. A full one-third of those polled preferred this rerun option. The next most chosen option, a Fine Gael-Fianna Fail coalition, is preferred by 24pc of respondents.

Barring a huge turnaround over the next few days, the widely held belief among political analysts - that Irish voters would do as British voters did last year and back continuity - is looking to be very wrong. Instead, the electorate here seems to be preparing to do what electorates in other crisis-hit eurozone countries did last year and desert the incumbents.

In all three eurozone bailout countries which had elections last year, voters didn't buy the mainstream parties' argument that their respective recoveries would be put at risk if they voted for change and untested groupings. They have all suffered varying degrees of political instability as a result. But the effects of that instability on their economies has differed.

What lessons are there for Irish voters as they weigh up Fine Gael and Labour warnings which link political instability with economic instability? In Greece, voters elected a government which promised painless solutions to that country's woes. They ignored the warnings of the mainstream parties that these promises were false.

And so they turned out to be. The victory for the hard left Syriza party, and the subsequent choices it made, killed Greece's recovery stone dead. It is hard to conclude that a government of a similar hue here would produce a different outcome.

In Portugal's election in October there was much less change in the composition of the Lisbon parliament than there was in Greece's, or than there is likely to be here after Friday's vote. But the parliamentary arithmetic in Portugal meant it was difficult to make up the numbers to form a majority.

The coalition that was eventually formed is weak and fragile. While that has not halted the country's embryonic recovery in its tracks, the effects have been negative. Business confidence fell sharply. So did consumer confidence, dragging down retail spending in the final months of the year. And in recent weeks, Portuguese government bond yields have soared, rising as high as four times those of the Irish government.

Spain is different again. Today that country enters its third month of care-taker government. In the campaign running up to its December election, the two mainstream parties had expected the vote to defragment, just as the Coalition parties here hoped.

Spain's governing party - which is, as it happens, a sister party of Fine Gael in the European centre-right political grouping - played the same stability card during December's campaign. Its strategists believed that voters would not take a chance on a change of government. They were as wrong as Fine Gael and Labour strategists appear to be at this juncture.

Given that Spain's election took place just over two months ago there is less evidence to go on regarding the effects on the economy, but the inconclusive outcome and the growing likelihood of a fresh election within months appear to have had only a limited economic impact thus far.

While both consumer and business confidence indicators are down, a closely watched survey of Spain's manufacturing sector actually picked up strongly in the new year. The bond market has not (yet) got the jitters over the failure to form a new government.

Spain is more similar to Ireland than to Greece and Portugal in that its economic recovery is rather well established. This points to the possibility - and only the possibility - that because Ireland's recovery has plenty of momentum it could survive a period of political uncertainty, such as a failure to agree a coalition arrangement in the days, weeks and possibly even months after next Friday's poll.

But then again, it may not. The reason Ireland recovered more rapidly than the Mediterranean crisis countries was its extreme openness to trade and investment. That allowed its export engine to provide plenty of forward thrust while the domestic economy was out cold.

But openness can also leave a country vulnerable, and that is particularly true of small, open economies. Spain's economy, for instance, is eight times bigger than Ireland's and much more self-contained, which can help insulate it against bad times elsewhere.

As such, if no government is formed after the election, the fate of the economy will depend to a large extent on what happens internationally. If financial markets tank, the European banking system weakens further and there emerge fresh signs of slump in the economies of Britain, the eurozone and the US, the political and economic risks in Ireland could start feeding off each other. Add in recession risk in China, along with the migration crisis closer to home, and there is a great deal of fragility in the international economy.

Another danger for Ireland is Brexit. After cutting a deal in Brussels on Friday night, Britain's prime minister David Cameron yesterday called the long-awaited referendum on the country's EU membership.

The Dubliner who leads the Confederation of British Industry, Paul Drechsler, was back in his hometown on Friday. He noted that "when the UK sneezes, Ireland catches a cold".

The most obvious immediate risk in this regard is Sterling. The British currency has been weakening against the euro over the past two months. With a huge UK balance of payments deficit - something that is among the best indicators of a currency being vulnerable to a plummeting - a big adverse movement in our exchange position vis a vis Britain is all too possible.

If it looked as if the Brexit referendum was to be lost by the pro-EU camp, sterling could collapse. That would be detrimental to Irish exporters as it would make their goods and services much more expansive in the British market (my column in the business section looks at trade issues in greater detail).

Over the longer term, the impact of a Brexit would be much greater. In a recent study, the German Bertelsmann Institute estimated that average incomes in Ireland could fall by one-fifth in a worst case scenario. That, it is worth noting, is a bigger decline than took place after the property market crash.

And even if Britain and the world does not take a turn for the worse, international perceptions of small economies can move rapidly from one extreme to another. Recall how quickly international confidence in Ireland evaporated after Lehman Brothers collapsed in September 2008 - Ireland went from being a tiger economy to 'Reykjavik on the Liffey'.

International opinion swung back in 2009, but again evaporated in the autumn of 2010.

Then, money flooded out of Ireland leaving huge funding gaps for the banks which ultimately led to a bailout within months.

There is only one thing that can be said with a high degree of certainty at this juncture: the 32nd Dail will be the most diverse and fragmented in the State's history. This fragmentation is likely to have consequences for political stability.

There is much less certainty over the impact such instability could have on the economy, but dismissing the dangers would be foolish indeed.

Twitter: @danobrien20

Sunday Independent

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