Business World

Tuesday 28 January 2020

Ireland must wrest control back from the 'Merkozy' duo

Continuing our series where business leaders suggest ways of kick-starting the economy, former Finance Minister and chair of the IBRC Alan Dukes says that fixing Europe is the key

'Measures to share the costs of debt service across the eurozone are needed. Maybe Eurobonds in some guise'

THE possibilities of kick-starting Ireland's small open economy from internal resources are limited. Growth forecasts for Ireland in 2012 have been revised downwards.

Exports are relatively buoyant, but expectations of a good performance in 2012 must be tempered by the slowdown in growth in the world economy. One way to improve export performance is to try to diversify towards Brazil, Russia, India and China and the faster-growing emerging economies. Even in the current slowdown in global activity, they offer better prospects than many mature economies. Problem is, it takes time and money to develop and expand export penetration.

Reorientation of Government current and capital expenditure can be useful, but the effects are more limited than is usually claimed.

"Shovel-ready" capital projects are not necessarily the most useful or productive ones. Many of them require a multi-year commitment and can be a trap for an unwary government. Current expenditure projects that look attractive in the short term can also be traps, since it can be very difficult to stop even a "temporary" programme once it gets started.

The claimed employment-generating effects of a reorientation of government current and capital expenditure ignore the fact that, in a fiscally tight situation, redirecting expenditure towards allegedly more employment-generating programmes means reducing expenditure somewhere else in the economy, usually with negative effects on employment there.

A reduction in the savings ratio in the short term can help to stimulate economic activity. Perversely, the savings ratio can increase in a recession. A reduction in the savings ratio can require either:

(a) the taxation of savings so that they can be spent by the public authorities (very unpopular with savers), or;

(b) an expectation that prices will increase (encouraging savers to spend while goods are cheap), or;

(c) more fundamental measures that have the effect of increasing confidence in the economy in general.

The restoration of confidence among consumers, producers and export customers is the surest and most enduring way of improving the level of economic activity. The single most important requirement in this connection is a convincing resolution of the eurozone debt problem -- but how?

First, the 17 heads of state and government of the eurozone countries need to make timely, muscular and well thought-out decisions on the measures required to ensure the continuation of the euro (their stated objective). Since they first fumbled over the Greek crisis in the spring of 2010, their prevarication and timidity have both deepened the overall crisis and increased the cost of resolving it. It has been "too little, too late".

Next, they need to wrest control of the issue back from Chancellor Merkel and President Sarkozy. These two leaders have filled the vacuum left by chronic indecision on the part of the others, and have operated a veritable coup d'etat, largely with an eye to electoral considerations and, until recently, in apparent denial of the nature and extent of the crisis.

This was led by Chancellor Merkel's austere German orthodoxy, pandering to the view that "Germany pays for everything" and ignoring the fact that Germany has been the eurozone's biggest beneficiary of the spending and borrowing sprees that have landed us in the current mess.

French President Nicolas Sarkozy unwisely went along with this -- until the prospect of a threat to France's AAA rating loomed. He then belatedly espoused the creed of the monetary firewall.

The "Merkozy" duo has been allowed to divert attention away from the real issues. Interestingly, one of Merkel's "wise men" has now broken ranks and has said that the ECB needs to act as a lender of last resort.

Having decommissioned "Merkozy", the eurozone leaders need to restore the European Commission as the policy leader and executive authority for a co-ordinated fiscal policy. Such a policy approach at Eurozone level needn't concern itself with the fine details of national expenditure and taxation decisions. It should instead concentrate on the overall fiscal balance in each national budget and on the structural robustness and sustainability of both tax and expenditure programmes.

It should, for example, apply the brakes in a given economy if one type of tax becomes disproportionately important or if one sector expands at a disproportionate and unsustainable rate relative to the rest of the economy. It should also look at the sustainability of the overall level of credit provision, both in each member state and in the eurozone as a whole.

In the short term, eurozone leaders must build the "wall of money" needed to halt the contagion. The action must be massive and immediate. The available instruments include the ECB and the European Financial Stability Facility, now joined by the International Monetary Fund.

Up to now, these have not been deployed to the full extent of their respective capacities within the current EU treaty structure. The potential capacity of the European Financial Stability Facility has been weakened by the effects of delay and indecision: it suffers from a decline in market confidence. This makes it even more urgent to make decisive arrangements in the immediate future. The application of punitive interest rates to crisis assistance measures is utterly counterproductive.

Measures to share the costs of debt service across the eurozone are needed. These could, for example, take the form of Eurobonds in some guise. Germany's concern that this would increase its borrowing costs is justified but does not take account of the fact that Germany's borrowing costs would increase anyway if there were a default anywhere in the eurozone.

Such a default would be the inevitable result of further delay in taking effective action. There is no cost-free way out of this problem for any member state.

Future treaty changes in response to this crisis must not be concerned only with fiscal discipline. They must also deal with debt structures and credit flows and give the ECB the proper responsibilities of a central bank.

Alan Dukes is chairman of the Irish Bank Resolution Corporation, formerly known as Anglo Irish Bank

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