Thursday 14 December 2017

Foreign help and native skill all part of the recovery story

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Brendan Keenan

Brendan Keenan

GOOD luck or good judgment? Or did we get by with a little help from our friends? As the Irish economy continues to amaze, the question of how and why it recovered seems as elusive as ever.

Two recent papers come at the question from very different angles, and still leave the readers with plenty to wonder about. In the end, they get quite a long list of elements which contributed to the turnaround, which has made Ireland an object of both wonder and study.

The most recent is from Diarmaid Smyth, an economist at the Central Bank. He concentrates on the role of interest rates, which, as he rightly says, has been somewhat ignored in analyses of Ireland's response to the crash.

Interest rates make for "bad copy", as we say in the newspaper business. They can be difficult to explain when it comes to government borrowing, which is what we are talking about. Even those who do understand them may be inclined to look at more exciting things, such as tax rises and spending cuts.

It comes to the same thing in the end. After health and social welfare, interest payments of almost €7bn on the national debt are the biggest item in Government spending.

Now that the deficit has been eliminated, we are paying it with our taxes. The debt is so large that any change in the interest cost makes a significant difference to the citizen's wallet, up or down.

The track of interest rates under the troika is complicated, but the trend was unambiguously downwards. The original bailout terms were indeed as harsh as popular legend has it, with €70bn of emergency loans being charged at almost 6pc and the lenders enjoying a nice little profit above what it cost them to provide the loans.

The story of how that was reduced to less than 3.5pc after 2011 never quite made it into popular legend, and no wonder. It involved the mind-numbingly complicated "promissory notes", while politics dictated that voters in the lending countries did not hear too much about easier terms for those profligate borrowing countries.

Mr Smyth calculates that, on average, interest payments ended up €2.7bn per year less than had been pencilled into the original rescue programme. That is a remarkable sum; equivalent, at 3pc interest, to debt relief of €90bn.

Perhaps writing off debt, as was demanded so vociferously, is more transparent and more secure, but this comes close to the Deng Xiaoping aphorism about the colour of the cat not mattering. Of just as much interest, though, is what the cat did with this particular mouse.

Coincidence or not, Government spending during the period exceeded its targets by the same substantial amount that interest costs fell. Rather than the savings going into the austerity bucket, they were used to reduce the austerity.

This was possible only because of another piece of luck, if you want to call it that. Revenues also exceeded target, as economic growth began to beat expectations as well. They were also boosted in a curious feedback loop by Central Bank profits from those mind-numbing loan arrangements.

Between one thing and another, the Government was able to spend more than planned, but still beat the troika terms by €1bn a year, to the applause of the markets, EU governments and international pundits; although not the unhappy domestic audience.

Like the Fiscal Advisory Council before it, the paper assesses what might have happened had interest rates not fallen as they did. It makes for a striking example of their importance. Had rates been 1.4 percentage points higher, the deficit would have been two percentage points higher and would have breached the EU rules.

Correcting that would have required another €800m in taxes and cutbacks to meet the rules in 2015. Things would have been even worse had the economy not begun to improve from 2011. If growth were half a per cent less, the deficit would have been almost one percentage point higher.

Then came the bizarre accounting changes in 2015, which added a quarter to GDP and made Irish statistics in this area virtually meaningless, but very attractive-looking. Everyone knows that the national debt is greater than the official figure of 80pc of national output, although a more realistic measure is unlikely ever to become common parlance, even after the CSO manages to produce one.

Smyth's paper illustrates that it is quite difficult to assess what happened from 2010-15. The nature of the economy and the irrelevance of the data make it just as difficult to know what is happening now. He argues for periodic reviews to try to decipher key trends and changes and avoid future miscalculations.

Behind all this is the still simmering question of whether "austerity" works - or can work. The austerity element of those years amounted to around €30bn. Without that painful adjustment, even the favourable interest rate changes and unexpected rules would not have returned the public finances to stability.

That still leaves the question as to whether, without cheaper money and good growth, more austerity could have done the job, or would prove self-defeating. Other over-borrowed countries benefited from ECB action to reduce the cost of loans, but have not achieved Ireland's apparent success.

The other paper, published some time ago by UCD economists Samuel Brazys and Aidan Regan, zeroes in on foreign direct investment (FDI) as the key difference between Ireland and the others.

The foreign sector continued to grow significantly after the crash of 2008. This was partly due to the pipeline of planned investments and partly because the Facebooks, Googles and their ilk were not much affected by the global collapse.

That growth gave Ireland an advantage over Greece or Portugal - even Italy - with their greater dependence on domestic economies hobbled by austerity. The analysts note that three-quarters of the IDA's total budget was spent on marketing after 2008; trying to offset the drama of the failure with the story of the country's success as a location for investment. Their point is that it is a story of state intervention, through taxation, marketing and tailored legislation to make a land fit for US corporates to invest in, rather than free play of global market forces.

It worked, too. The paper was written before last week's new CSO figures suggesting the bulk of growth since 2013 has been from native firms, not foreign. That, too, could be a pipeline effect from the crash, but the domestic recovery might not have been as strong without foreign firms having picked up the slack immediately after 2008, reducing the level of austerity required.

The 50-year span of this political project is the main reason Ireland cannot be held up as a model for other over-borrowed countries - although it also gives Ireland even less excuse for being a serial over-borrower in the first place.

What strikes the authors - and they are not alone - is the refusal of the Commission and many EU governments to recognise it as a success rather than some kind of fraud, and their apparent determination to kill this little golden goose in the rather patchy-looking pasture of the eurozone.

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