Friday, 17 December 2010

Four Truths about the Irish situation (and one possible solution)

Nat O'Connor: The Government's four-year recovery plan doesn't address the issue of the banks. Without addressing this issue, the credibility of the whole plan is undermined. Richard Douthwaite presented Four Truths about the loan negotiations with the ECB, IMF, etc. These remain valid concerns.

In a context where orthodox monetary policy is no longer available to individual eurozone member states, Douthwaite presents 'deficit easing' as a novel suggestion.

In brief:

Truth 1. If Ireland has to pay interest on the loans being negotiated at a rate which exceeds the rate at which the economy grows over the next few years, it will make the country's situation worse, not better.

Truth 2. Any grant or loan to Ireland will only buy time for the eurozone to come up with a cure for the whole sick system. Ireland should not be asked to bear more than its proportionate share of the cost of gaining this time which is for the benefit of every euro user.

Truth 3. The ECB bears a large share of the responsibility for the regulatory failure which led to the property bubble.

Truth 4. There is a Plan B. Ireland doesn't have to take anything that is offered. It can leave the euro quickly and easily.

In a separate article, Douthwaite proposes a solution in the form of 'deficit easing' (full paper). His proposal is for money to be distributed directly to member states by the ECB (through a form of quantitative easing) and used to pay down national debts and to reduce borrowing requirements for expenditure.

It is increasingly clear that the Irish crisis is a eurozone crisis. And Ireland is caught in a damning position. Either we 'go it alone' and insist on major restructuring of the bank's debts we've taken on - and do huge damage to the (mostly European) banks that lent to our banks - or else we do huge damage to the people in Ireland by taking on huge private debts in order to save - for now - other banks in the eurozone. This is a lose:lose situation, and we need to find another way.

A road to a solution is equally clear. When we pooled our sovereignty into the euro currency and ECB, we took an 'we're all in this together' approach. We need to return to the basic principle of eurozone solidarity; and indeed wider European solidarity. Ireland should push for a eurozone-wide solution that would also aid Portugal, Greece, Spain - but equally Germany and all the rest. Some form of quantitative easing (or equally 'deficit easing') could be a major part of the solution.

The logic of the deficit easing proposal is interesting, although the politics would perhaps be more difficult to manage - what would stop politicians wanting to use this approach more and more? Nevertheless, orthodox monetary policy is not available, and innovative approaches should be given serious consideration.


Mike Hall said...

Well done Nat for bringing Richard Douthwaite's worthy & innovative ideas to wider attention.

It's down to two choices. Either we get a much better deal from the EU/ECB along the various lines suggested or we should leave the euro.

We should accept no compromises, if for no better reason than in the medium & long term (maybe even short term too) leaving the euro would give us many more policy options into the future.

And that future +will+ be characterised by 'peak oil', whether it 'hits' in 2yrs time or 10. (And, yes, that is a reasonable estimation of time frame.)

I think it was a year or two that I read that to meet global demand by 2030 - only 20yrs away - we need to +discover+ & +develop+ SIX new Saudi Arabias. IF there was +any+ chance of that, would we be throwing $billions into getting oil from tar sands, at an energy cost of 1 unit in to get 3 out??

If we think the present global financial situation is 'crisis' (far from over yet!), how does a global year on year energy supply/demand gap of 4 to 6% grab you economists?? Think the world will 'cope' with that, with it's myriad economic & monetary policy dysfunctionalities? I don't.

We would probably be infinitely better off able to choose our own monetary system & also perhaps some along the road of building some self-reliance & resilience into our economy.

Time to start preparing for a reality that will be +nothing+ like any of us have experienced previously.

Slí Eile said...

@Nat the rapid internationalisation of what seemed like an Irish crisis from November onwards points towards the need for a coordinated fiscal and monetary plan across Europe. The failure of austerity to restore fiscal order will propel some of the main players to put together a type of Marshall aid rescue involving re-structing and some element of QE - Eurobonds etc. Breaking up the Euro is a tempting solution but lets see first if Europe can be saved from the deficit hawks who are driving deficits up. The future of the Europe project depends on saving Europe from crazy political economy.

Paul Hunt said...


Well put. But nobody seems to talk about capitalism any more. It's not really 'crazy political economy'; it's the forces of financial capitalism running riot and compelling ordinary citizens everywhere to pay for their mistakes. The galling thing is that they have purloined the language of free markets, competition and liberal democracy; and the progressive-left, by focusing on state-driven, centralised and non-market, collectivist solutions has left the field clear for them.

When capitalists demand free markets they really want free access and exit, opportunities to exercise and abuse market power and to capture unearned profits. When they demand competition and 'light-handed regulation' they really want to suppress competition, to create monopolies and to be allowed to exploit physical and human resources under their control without restraint. And when they demand liberal democracy they want opportunity to subborn and subvert politicians and policy-makers to enact legislation that will protect their activities and impose the costs of their failures on the public.

More state control and participation is not the antidote to capitalism; capitalism is confident it can subvert the state - any state. What capitalists really fear is genuine competition and effective regulation. Markets are the most effective tools we have to assemble and process information and to frame and permit the execution of innumerable choices. It is time for the progressive-left to recognise that markets aren't the enemy; the enemy is capitalism. And, more importantly, to recognise that markets are the most effective means of shackling capitalism to force it to generate economically and socially useful outcomes.

It is time to reclaim markets, competition, regulation and democracy from those who pervert them in their own narrow, sectional interests.

Mike Hall said...

@ Paul Hunt

Nicely put!

Nat O`Connor said...

@Slí Eile,

I agree entirely that the euro currency problems need a European-level solution.

I also agree with Paul Hunt that the current political economy is not 'crazy' for those benefitting from it.

Part of the problem is that Ireland is in a historically unprecedented position. The lack of conventional monetary policy makes it very difficult to make comparisons with past recoveries by Ireland or other countries. Hence, there is a need to break the mould and explore innovative ideas.

Nat O`Connor said...

@Mike Hall,

I agree entirely that 'peak oil' is a massive challenge, in many more ways that people appreciate - e.g. the reliance of food production on petrochemicals.

However, I would note that the eurozone creates perhaps better conditions for deficit easing than would be possible for a single nation state with its own currency, in terms of managing the intense political pressure that would mount in favour of excessively using this type of monetary policy.

Plus, there is always a risk of 'beggar thy neighbour' in monetary policy, which is self-defeating in the long-term, if short-term trade benefits make countries less likely to revisit the fundamentals of their economic models and the resilience of those models.

Paul Hunt said...

@Nat O'C,

I always get a little uneasy when I hear talk about 'breaking the mould' and 'exploring innovative ideas'. The mould-breaking never seems to impact on certain vested interests which are part of the problem. And the innovation invariably seems to involve getting innovative with someone else's money.

There are plenty of things which could be done in terms of reform of governance, process and procedures that would improve economic outcomes and ameliorate the impact of the current fiscal adjustment. But it is unlikely to happen as a number of people in comfortable influential positions might have to extract the digit.

Nat O`Connor said...

@ Paul Hunt

In particular, I was referring to innovative monetary policy. And deficit easing, or just plain quantitative easing by the ECB, is 'innovative' insofar as the economics textbooks don't have too many examples of currencies shared across diverse nation states.

The political framework required to make innovative monetary policy work on a euro level will require "reform of governance, process and procedures".

And in terms of effect, there are major pros and cons to monetary policy (devaluation, QE, etc.) with the main trade-off being between those who benefit from higher inflation (e.g. debtors) and those who benefit from lower inflation (e.g. creditors, savers). But monetary policy it is not about "someone else's money". The euro is our money, the governance of which is pooled.

Paul Hunt said...

Comment, of course, is free, but it does help if it relates to the situation as it is - rather than to how we might wish it to be.

Governance may be pooled, but, with an economy, comprising approx 1.5% of the EZ, that has just been taken into protective custody - for its own safety and the safety of others - I don't think Ireland has much influence on how things will develop.

We could, of course, take the scissors to the bank senior bondholders (which seems to be gaining popular support - particularly among the progressive-left), but I'd be inclined to look for a deep, well-stocked fall-out shelter if that button were pressed. Wouldn't it be better to pull the levers within our grasp that could improve things, rather than seeking either to blame others for our predicament (not accusing you of this) or to pull levers that are totally beyond our grasp.

Nat O`Connor said...

There is a pervasive myth that Ireland is too small to be influential in the EU or the eurozone. I don’t agree.

Ireland is the eight smallest EU country. Does that mean the smaller ones are all powerless too? (Lithuania, Latvia, Slovenia, Estonia, Cyprus, Luxembourg and Malta).

And Denmark, Finland and Slovakia only have one million more people than Ireland. Are 11 out of 27 countries in the EU powerless?

If so, why don’t we form a 'powerless nations club' and wield some clout that way. Our combined GDP is well over a trillion euro, and population over 32 million. That’s some heft.

The only reason Ireland is in "protective custody" as you call it is because the gambling ('investment') in the Irish economy by banks and other institutions across the EU has exposed them to massive potential losses.

The Irish economic situation is a collective action problem for the EU, and the eurozone countries in particular.

You ask: "Wouldn't it be better to pull the levers within our grasp that could improve things, rather than seeking ... to pull levers that are totally beyond our grasp."

Yes and no.

Yes, we should do whatever improves the situation.

No, we should not do things unilaterally that makes collective responses to the problem more difficult, or simply closes doors to better solutions.

Yes, we should present our EU partners with the evidence that the Irish sovereign debt – bloated by bank debt – is unsustainable. It is well within “our grasp” to do so.

The EU has always effectively functioned through unanimity. That’s part of the reason why its decision-making is so slow. Every deal has to get hammered out, with ‘horse-trading’ between member states so that everyone gets something.

The economics of managing major crises has always relied on monetary policy. We have monetary policy. It is not beyond the wit or wisdom of the relevant finance ministers to develop some revised political and bureaucratic mechanisms that allow eurozone states to ‘declare emergencies’ and allow/compel the activation of emergency monetary policy instruments by the ECB for time-limited periods.

There is an institutional problem in the eurozone. It was assumed that the SGP rules (3% deficit, 60% debt) would work all of the time. Far from it! We now need to fix the broken institutions. Not only is it within our grasp, it is absolutely essential that we do it.

Yes, Ireland’s relative leverage in shaping the eurozone institutions and policy will be limited. But if a set of agreed monetary policy actions can benefit all eurozone countries, why would they not adopt them? What Ireland needs is to find win:win solutions, to replace our current lose:lose scenario.

Paul Hunt said...

@Nat O'C,

Many thanks for your considered response. I fully subscribe to your desires; I just think the machanics need more consideration. This paper by Avellenada and Hardiman provides a useful context in which to consider these mechanics:

Indeed, I would go further and contend that what we are seeing in the last decade is a major shift from a European Germany to a German Europe. Having gone through the economic pain of reunification and the further pain of labour and product market reforms during Schroeder's chancelry (and consolidated during the CDU/CSU-SDP coalition), Germany is developing a coherent economic strategy for the EU in the context of the rise of the BRICs. It's not just the Mercs and the Beamers; Germany's mittelstand is powering ahead to produce the high value capital goods (with high knowledge content) to tool up the BRICs. Most of its neighbours (Netherlands, Luxembourg, Scandinavia, the Baltic states, Czech Republic, Slovakia and Slovenia (even the Poles)) are aligned with this strategy. France has no choice but to go along and Italy and Belgium (traditionally indulged by the other founder members) are also on board. Hungary is struggling, but the Balkan states are trying to shape up to join in. Britain, of course, stand aloof. This leaves the peripherals who decided to indulge themselves for the last decade.

And this is also a divide betweeen member-states that are well-governed (or seeking to improve their governance) and the peripheral member-states where governance has varied between inept and disastrous.

And that's why I believe the initial focus should be on the reform of politcial governance by starting on reform of the process and procedures in the Oireachtas. It doen't matter if the flavour of the resulting policy-decisions reflect left, right or centre stances, once the policies are subject to full public scrutiny and the decisions refelct the will of the people as expressed by their elected representatives.

We might then be able to participate more effectively in the EU.

Paul Hunt said...

@Nat O',

Just a brief follow-on. I don't agree that the only reason Ireland was taken into protective custody was stupid investments by EZ financial institutions in Irish banks. (much of this investment was based on assurances of goernance and institutional stability at the EU and national level.) The Irish economy had become seriously imbalanced and had moved off on an unsustainable trajectory at variance to the emerging German Europe strategic model. Much was due to the atavistic Irish fetish for land and property - having being deprived of clear title and the resulting benefits for centuries by a foreign power.

During the '90s ireland operated successfully as an export platform for the US into the EU. By the early 2000s this was probably starting to run its course. Being economically, geographically and culturally located between the US and Britain, it was probably impossibel to avoid getting caught up in the US export of dodgy financial practices to Europe.

What has happened probably could not be avoided, but better governnce would have reduced the severity of the impact.

Nat O`Connor said...

@Paul Hunt,

I think we agree really. I didn't say "stupid investment" was the reason, just "investments"... many of which may have been based on poor information, etc. And I agree lack of regulation and "dodgy" financial dealing was a major factor.

I'm not fully convinced that we have such a "fetish for land and property". Yes, it's now part of our culture. But one cause was the rise of a bigger Irish middle class from the 1920s, who found that protection for tenants was weak. Also the building industry provided an engine for the economy, which dovetailed with social policy goals to clear away some of the appalling 'third class' housing in Dublin and elsewhere.

Home ownership was less than 20 per cent in 1922, and mortgage finance fueled economic activity. The problem from the 2000s was that housing policy facilitated or pushed too many people towards home ownership, and unsustainable debt; whereas we need to reform renting, and provide alternative vehicles for people to put their surplus income into, other than their housing.

Paul Hunt said...

Thank you taking the time to engage so constructively. It's difficult to include all the nuances in a short comment. I suspect we might continue to differ on the roles of the state and markets in managing in the public interest - and I find little willingness to engage on these important issues, but I certainly agree on the need to 'provide alternative vehicles for people to put their surplus income into, other than their housing'.

For me, this is a reflection of the failure/inabaility to build constructively on the 'export platform' model of the 1990s. Some geographical remoteness and Britain, pursuing its own interest badly, cut us off from the heartland of Europe and the German Europe strategic model. This is the way Europe is going and we need to do things that will integrate us more effectively.

But the political and economic forces which will thrive - or at least cope comfortably - during the current crisis don't even recognise the challenge - not to mind do anything to address it.

Paul Hunt said...

Sorry. Should be 'managing capitalism' in the 2nd sentence.

Mike Hall said...

Bill Mitchell's blog:

'The Bankruptcy Machine'

(Eurozone as presently structured - probably not fixable - & the diasaster of 'austerity' politics - it's not 'economics')

Also, reading his other blogs offers convincing arguments that 'deficit' targets are wrong headed & the cause of high unemployment.

Some presentation slides here from his Centre of Full Employment and Equity 'National Conference on Unemployment' 2010

His other blogs go into detail on these issues.

This is who I'd want running the Irish Economy.