IRELAND 1995-2015
From Celtic Tiger to Fiscal Crisis to Fastest-Growing EU Economy Ireland 1995-2015
Ireland’s transition from a poor, under-developed country to a highly-developed high-tech economy has been examined by other countries who have sought to emulate Ireland’s phenomenal success, especially in the so-called ‘Celtic Tiger’ years. Its subsequent four dimensional crash – property, banking, fiscal and financial – has also been widely reported and commented on, and the resulting austerity measures are still impacting on Irish households and businesses. Ireland is now reported to be the fastest growing economy in Europe.
Background to the Celtic Tiger years
The 1990s saw unprecedented growth for Ireland – from 1994-2002, Ireland’s real GDP (Gross Domestic Product) averaged 7.8% and unemployment fell from just under 16% to just over 4% [Donovan and Murphy, 2013]. Ireland’s low corporate tax regime, capital grants for MNC’s (Multi National Organisations), tax exemptions for research and development, membership of the EU and Eurozone, English-speaking nationals and a welleducated workforce all worked to attract US multinationals into Ireland. The progressive economic and monetary unification across Europe, along with the revolution of the IT industry in the US meant that Ireland was in a key position to benefit from both of these developments. The Irish government also targeted FDI (Foreign Direct Investment) and there was equilibrium in the public finances.
By the year 2000, home prices has risen by 133% compared to 1994. This rise was linked to the high overall economic growth of the Celtic Tiger years. Real incomes were high, employment had increased and there was net immigration to Ireland for the first time. Home ownership had increased and mortgage lending was financed domestically through deposits of financial institutions at relatively high interest rates, with 80% loan-to-value rates. By 2001, the property boom began to slow down and it was expected that house prices could fall. However, the 2001 downturn did not lead to any tightening of finance.
Irish growth changed from that of an export-led boom to one relying on domestic demand. Lobbyists and builders and developers applied pressure on the government party in power and interest relief on borrowings for residential retail property in Ireland and abroad was offered. Stamp duty was reduced, 100% (and sometimes larger) mortgages were introduced. Tracker mortgages and lengthy loans of thirty years plus became the norm, as banks could now access cheap external whole-scale funding and they engaged in risky lending to builders and developers. Lending to property developers soared, which exacerbated the sum of banks’ losses when the property bubble burst. The normally conservative Irish banks actively sought to emulate the performance of Anglo Irish Bank. There were little internal or external audit controls and no meaningful action taken by the Financial Regulator. With the Irish penchant for owning their own home, property investment continued as many households sought to increase their portfolios with second homes in Ireland and abroad [McGrath, 2014]. The gap between bank lending and deposits rose from €26 billion in 2002 to €129 billion in 2008. By the end of 2007, there was a tightening up of liquidity in international financial markets – Ireland began to rely on short-term subordinated debt and there were under-provisions for possible loan losses.
The Financial Crisis
Ireland’s four dimensional crisis has been widely documented – by 2008, the massively overvalued property market bubble had collapsed, which led to the banking crisis. The Irish banks were over-exposed, due to large international borrowings at low interest rates and zero effective domestic financial regulation. A run on the Irish banks led to the government offering a guarantee for the banking systems liabilities. It then became obvious that State funding was needed to keep Irish banks running. Not only were the banks over-concentrated on lending to the property and construction sector, the government had also continued to rely on funding in the form of taxes related to this sector – stamp duty, capital gains tax, etc. The downturn in tax revenue from this source meant a large loss for the government, which also had to contend with rising unemployment in this area. In 2010, it was recognised that Ireland needed a bailout from the EU, ECB and the IMF [Donovan and Murphy, 2013].
Austerity measures were put in place by the Irish government. Austerity has been defined as policies undertaken by governments to reduce budget deficits during adverse economic conditions [Financial Times Lexicon]. Austerity itself is not a new concept. Its origins are located within the “classical” debates. Fiscal deficits have to be managed and austerity is seen by some as one way of overcoming them. In the 1930s, Keynesian views emerged – amongst other things they stated that government deficits could be beneficial during a slump, especially during periods of very high unemployment. Also austerity would work when the economy was at the top of the business cycle and would prevent the economy from overheating and accelerating inflation [Keynes, 1937]. From the 1970s onwards, austerity was seen as a policy that could be used when the economy was at the bottom of the business cycle. Austerity today is seen by lenders such as the Troika -- the European Commission, European Central Bank and International Monetary Fund -- as the only credible way to show that governments are tackling deficits.
The idea that the public sector is responsible for private sector debt is one that continues to be questioned in Irish society. When there was realisation that Irish banks were insolvent, the government asked the Troika for support. This came in the form of a €64 billion bailout in 2010. In order to convince the Troika that Ireland was a credible borrower, the Irish government agreed to a series of measures designed to reduce the budget deficit. These included increased taxes and public expenditure reductions – commonly known as austerity measures. This effectively moved the burden of debt from the private sector to the State.
There is little argument that reducing public deficit and fiscal debts is beneficial for economies. There is also recognition by policy makers that austerity is slowing domestic recovery and economic growth. At the same time, the international financial markets are looking for austerity as proof that governments can manage budget deficits and do not risk default. Guajordo and Pescatori [2011] found that the short-term effect of fiscal consolidation was contractionary, though it could be reduced by lowering interest rates, devaluing the currency and reducing expenditure. Neither a devaluation of the currency nor altering interest rates is available to countries in the EuroZone. Boyer [2012] argues that austerity works in a context of strong effective demand. Within a context of weak demand, austerity measures will lead to lower output, lower tax revenues and rising government debt-to-GDP ratios. Recent European elections showed strong support for anti-austerity parties, not only in Ireland but also in Greece, Spain and Portugal.
The reality is that fiscal tightening makes economies worse and the countries that have tightened their budgets the most have shrunk the most. When the burden of adjustment falls on those who can least afford it, there are huge social costs and a social backlash against the governments that favour austerity. This can further descend into unfavourable attitudes towards immigrants, who are blamed indirectly for high unemployment levels. There is recognition that austerity has become a self-defeating policy of cutting spending and shrinking economies. The Troika has not embraced counter-cyclical policies in countries under IMF agreements, despite the absence of legal restrictions forbidding any change.
The Aftermath of the Crisis
Ireland technically came out of recession in September 2013, when GDP increased by 0.4% from March to June. Unemployment has fallen from a high of 14.8% in 2011 to 9.5% in August 2015 [Central Statistics Office, 2015]. Property prices have risen, up to 9% in 2015, after years of falling prices and negative equity for many thousands of home-owners. Property price growth is predicted at 5% for 2016 and 3% for 2017 [Standard & Poor’s rating agency]. Exports have grown by 12% [CSO]. Domestic demand has grown by 2.9% – the first rise in over six years.
Overall, the economic indicators are positive; though there continues to be house repossessions, as those who purchased property at the height of the boom struggle to pay high mortgages. Some parts of the population – those with secure public sector employment, those whose mortgages were paid off – were not affected as badly as others who worked in the private sector, where large chunks of the workforce were laid off. Property tax and water charges have being imposed on Irish households and whilst most Irish home-owners have come to terms with the property tax, water charges continue to be an issue, with large-scale protest marches continuing on a regular basis.
Those at the lower end of the socio-economic scale have seen housing rents increasing, especially in urban areas. Homelessness has increased amongst adults and there are 87% more homeless children in Dublin in 2015 compared to 2014 [The Journal]. New entrants into the property market are experiencing more stringent conditions in order to secure a mortgage – secure employment, good credit history, between 10-20% deposit. [www.mortgages.ie] Government revenues have increased and gross government debt as a percentage of GDP has fallen. Domestic demand is determining the level of growth and the construction sector is experiencing an expansion.
The current government – a coalition of Fine Gael, the largest party, and Labour – are in a strong position as they prepare the October Budget. With a General Election looming early next year, it is looking more likely that majority party Fine Gael will continue in power with the current Taoiseach, Enda Kenny, at the helm. He is currently much admired in Europe for “turning around” Ireland’s finances and leading the country out of one of the worst recessions seen in decades. With Ireland predicted to have the highest growth rate in Europe for two years in a row, there is pressure on wages as the unions demand higher salaries and reversal of pay cuts. The government is not in a position for a give-away budget and caution is advised to ensure long-term growth and stability.
Adapted from: McGrath, P. (2014) Austerity and Ireland – Time to Go Back to Basics. Available at: http://ssrn.com/abstract=2456429 or http://dx.doi.org/10.2139/ssrn.2456429
References
- Donovan, D. and Murphy, A.E. (2013) The Fall of the Celtic Tiger: Ireland and the Debt Crisis. Oxford University Press: Oxford.
- http://www.cso.ie/en/index.html
- Keynes, J. M. (1937) “How to avoid a slump: “Dear” Money, 11. The Right Time for Austerity”, The Times, 13 January 1937, p13, Issue 47581, Col. G.
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