Thursday 18 July 2019

Did austerity work, or would the economy have improved anyway?

Did the pain we endured really provide the foundation of our precarious recovery - and was it more severe than it had to be? Donal Lynch asks the experts

Jim Power, Chief Economist, Friends First
Jim Power, Chief Economist, Friends First
Donal Lynch

Donal Lynch

Ireland's recovery continues apace. Last week, the OECD said the economy here will continue its strong expansion over the next two years. The influential Paris-based think tank revised this year's Irish GDP growth figure upwards from the 5pc it predicted in September, to 5.6pc - and said that Irish fiscal policy is expected to exert a smaller 'drag' on activity than in past years.

The European Commission is even more optimistic - it says that our economy will grow by 6pc this year, the fastest rate in the European Union. There is momentum in job creation, consumer confidence has awoken and, crucially, the fiscal outlook of our export partners is good. It appears that we may have weathered the storm and the pain of the last few years may have been worth it.

Economists at the European Central Bank have claimed that austerity measures must take the credit for the position we now find ourselves in, saying policies of the sort imposed by the Troika on weaker Euro-area member states significantly lessens the longer-term pain generally associated with high levels of government debt.

But there are other countries, including Britain, where the relationship between austerity and growth appears to be not very tight - and the case can be made that the British economy has recovered despite austerity, rather than because of it.

There are also some who say that the recovery we now enjoy is more down to benign international factors than the stringency of the Government's belt-tightening and that austerity did not need to be as harsh as it was. I spoke to a number of leading economists and asked them: Did austerity work, or would recovery have gained its current momentum without the pain the country endured?

Jim Power, Chief Economist, Friends First

"At one level, it's clear that austerity did work. At the end of last year, the country regained the level of activity that prevailed prior to the crisis, and this year GDP growth is going to be in or around 6.3pc. The labour market is improving dramatically - there has just been confirmation that unemployment has fallen below 9pc for the first time since December 2008. The Government's borrowing requirements are falling and tax revenue is strong.

"Despite the predictions of some that austerity would destroy the economy forever, we've come out of it in fairly dramatic fashion. My caveat would be that we've benefited from four benign external factors which have moved in our favour: Firstly, the collapse in oil prices over the last couple of years. Secondly, the zero interest rate policy pursued by the European Central Bank. Thirdly, the weakness of the Euro against Sterling and the Dollar. And fourthly, the US and UK economies, which are very important for us, are doing well.

"Taking all that into account, however, I would say overall, yes - austerity has worked. If we had burned the bondholders, as some had suggested, it's true that not as much fiscal correction would have been required. But that was really a moot point. As was clear from the banking inquiry, our European masters wouldn't have allowed that.

"Also, if we had somehow been able to do it, I don't think international confidence in Ireland would be as high as it is today."

Tom McDonnell, Macro-economist at the Nevin Economic Research Institute

"The budget deficit needed to be addressed, so from that point of view austerity was needed, but in terms of whether austerity helped or hindered recovery I think the consensus has been that austerity actually harmed the economy more than the Troika anticipated.

"This was true in Ireland and other countries - Greece especially. Ireland wasn't as badly damaged by austerity as Greece, because we have a more open economy.

"We need to get unemployment down to the levels they are at in Germany and the UK. (The banking crisis) happened seven years ago and, since then, we've recovered less than half the jobs that were lost.

"The crisis was very dramatic when it happened and it created a sudden and sharp shock, and that had a huge impact on public finances. But, underlying this, the economy was still improving year-on-year, and once all the detritus had been cleared away, it was always likely that recovery would take hold."

Seamus Coffey, lecturer in Economics, UCC

"The purpose of austerity was to reduce the deficit, so from that perspective, yes - austerity worked. But there's no doubt that cutting spending and increasing taxes harms the economy.

"That the economy was able to counteract the austerity we can put partly down to external factors which are outside our control. Some of it is the sound economy which was hidden underneath all of the problems. You have to understand the purpose of austerity was not to grow the economy. We had a huge deficit, nobody would lend to us, so we needed austerity to overcome that. Burning the bondholder would have had close to zero impact on that side of the deficit. In the overall scheme of things, it wouldn't have been a significant amount: €8-10bn, at most. Our deficit was €20bn every year and that deficit wasn't a result of a failure to negotiate with our partners, it was because the revenue generated by tax disappeared.

"Simply put: burning the bondholders wasn't going to bring stamp duty back. The process of austerity had a negative impact in the short term and the hope was that once the deficit came down the strong parts of the economy would begin to work properly and growth would result, and that is what happened. Was it too severe? No. You could argue that austerity should have been more austere and that we should have reduced the deficit more quickly."

Philip O'Sullivan, Chief Economist at Investec Ireland

"As a small open economy, Ireland accounts for less than 2pc of Eurozone GDP, whose banking system was on its knees and government out of money, so the country had little choice but to take the harsh economic medicine prescribed for it. Due to severe cutbacks to discretionary expenditure, the public finances are hyper-sensitive to economic developments. The government was able to bring its series of austerity budgets to a close two years ahead of schedule in late 2014, as economic prospects improved and the fiscal jaws began to tighten.

"For the banks, the restoration of confidence around Ireland and favourable external developments, coupled with substantial deleveraging moves, strengthened their funding bases. Domestic demand troughed in 2013 and, as it began to pick up, this had a positive effect on asset quality. Reduced funding costs and impairment charges have boosted profitability metrics.

"The flow of funds from the Exchequer to the banking sector has begun to reverse, with the State starting the process of selling its interests. The Irish economy is robust enough to turn in solid growth in the medium term, aided by a business-friendly climate, much-improved balance sheets - across the government, NFC, banking and household sectors - and very favourable demographics."

Sunday Independent

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