This Little PIIG-y hopes to return to the markets

Is Ireland’s apparent recovery a blueprint for the rest of the Eurozone?

In the first month of this year a strange feeling of positivity gripped the Eurozone’s troubled economies. Bond yields were low and the next meeting to postpone the making of key decisions was a while away, while markets around the world were calm. In Europe, however, such a moment could never last long – Spain’s Prime Minister faced calls to resign and Italian bond yields were rocked by the spectre of Silvio Berlusconi. Yet the Eurogroup appears to have stabilised a little since then and it seems increasingly likely that one of the group’s troubled economies will be able to leave its bailout programme. Ireland has had to endure a tough recovery after the implosion of its financial system, yet now has the most positive outlook of the so-called PIIGS.

This seems like good news for the Eurozone. Ireland has been extremely compliant in following the terms set by bailout packages and the public disruption caused was minimal, especially when compared against the anger and protests that periodically swept across the rest of the currency zone. The €80bn bailout it was given was met with the demand for €15bn worth of austerity, which has been largely implemented. The government managed to negotiate with the trade unions without causing unrest, and this wage moderation is allowing Ireland to regain competitiveness. The country experienced a 10% reduction in wages in the professional, technical and scientific sectors in 2011, according to the Central Statistics Office. This marks it apart from the troubled countries around the Mediterranean. Furthermore, with Ireland first in the E.U. for completion of tertiary education and the fact that 48% of 25-34 year olds have a third level qualification, the country is able to specialise in pharmaceuticals, software and financial services; areas which bring considerable dividend and the same areas that are experiencing wage deflation; not a good recipe for fostering domestic demand but one which is helping the Celtic Tiger rediscover its export strength.

Ireland’s position is also helped by its long-established low rate of corporation tax, currently at 12.5%. The influx of FDI that this has brought was one of the main reasons behind Ireland’s rise until 2007 and plenty of large corporations, such as Google, Twitter, Allianz and Facebook, have bases there.

Yet this reliance on foreign firms makes the Irish economy a little unbalanced. The value of its exports is larger than the actual economy, making Ireland very susceptible to problems in foreign markets – and at the moment there are a great deal. It also means that GDP gives a somewhat false representation of the economy. The discrepancy between GDP and GNP (which measures the production of the inhabitants of the nation rather than the production taking place in the nation as GDP does) is as much as 20%, and an Irish watchdog suggested that when this is factored in the ’real’ public debt is likely to reach almost 140% in 2013, higher than Spain or Belgium.

The low GNP also hints at the relatively poor state of the Irish economy outside of the areas dominated by foreign firms. Household debt is more than double disposable income, and GNP was 11% smaller than in 2011. The fact that house building also reached a record low in 2012 is partly a result of this, but is more indicative of the reluctance of banks to lend to first time buyers.

Despite these problems, recently things have been so positive that talk of Ireland leaving its bailout package is becoming more commonplace. Better still would be to allow the Irish government to let go of the stake and therefore risk that it holds in the country’s remaining banks, helping to ease the Irish debt burden, a third of which stems from the blanket guarantees given to the banks in 2008. The government hopes that the European Stability Mechanism can recapitalise AIB and the Bank of Ireland; though finance ministers across Europe had previously stated that the fund was not to be used in this way. However, actions such as this would send a message to policy makers of the other crisis hit countries; if tough choices about public finances are made, the decision makers among the Eurogroup might cut you some slack. Indeed, on the 7th of February the ECB and the Irish government agreed a deal to turn the promissory notes that they issued into long term loans, which should save the government £24bn.

Yet the Irish route is not one that should be followed by the other troubled economies. It is a different type of economy, having followed the so-called Anglo-Saxon path of less regulation, low taxes and liberalist orientation that sprang from the Chicago School of Economics, all of which tend to be an anathema to Continental Europe. The rest of the PIIGS tend to be stuck with more dysfunctional and rigid labour markets; making it hard to lower the unit cost of labour; and less open than Ireland. This is not to start a debate about the merits of free market capitalism, but more to suggest that what appears to be working for the moment in Ireland might not be so successful in the other countries. The IMF’s recent research into the effects of fiscal multipliers was mainly used in Britain as a stick to beat the Chancellor with, yet the report also suggests that the effect of the multiplier may be less in more open economies. Consequently, any austerity in Ireland is more likely to have a positive effect on the public finances than in Greece or Italy, and even the Irish fiscal tightening has struggled to keep the country’s debt pile in check.

Ireland is a bigger exporter of the more complex products than any of the other troubled economies. In an article for Vox which discussed wage competitiveness in the Eurozone, Ustav Kumar and Jesus Felipe made a comparison between the complexity of export products of the Eurozone countries*.

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Notes: 1. Figures are based on the averages of export values for 2001-2007. 2. Products are divided into six groups, 1 is the most complex and 6 is the least. The Top 10 and Top 100 correspond to the most complex products. 4. The definition of product complexity is from Hidalgo and Hausmann (2009).

What this suggests is that Ireland is a separate case to the rest of the troubled economies, as it exports products of greater complexity, and not those where a country may face greater competition from low-wage economies. This is also likely to mean that wage deflation (as Kumar and Felipe refer to it) may not return the same level of relative competitiveness to Portugal, Greece or Italy.

Given that Ireland is in a different situation to the rest of the PIIGS it would seem unwise to suggest that the same medicine would have the same effect. The Irish government also has a bigger mandate to enforce austerity than most of the other governments of crisis hit countries. Ireland should be allowed to ‘graduate’ from the bailout programme as it has by and large met the terms (within reason) set by the Troika; even if some in the Eurogroup are irritated by the nature of its pre-crash success, believing it to be based upon low taxes and reckless banking rather than long-term productivity growth. It is still facing a large debt overhang and struggling domestic demand but for now the Eurogroup is happy to let quiet confidence build around the currency zone’s future and this would certainly help.

*Though they used them for a different purpose than is discussed here.