Dellepiane and Hardiman on Ireland in the crisis

While there has been a lot of interesting work by economists on Ireland’s crisis over the last year, there hasn’t been much on the _political economy_ of the crisis. This “piece”:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1642791, written this summer by Sebastian Dellepiane Avellaneda and Niamh Hardiman at University College Dublin, is the best that I’ve seen, and is particularly excellent on the interaction between Economic and Monetary Union and domestic decision-making structures. I’ve patched together extracts Brad-De-Long style into a short quasi-narrative below the fold, but if you are interested, you should really download and read the original piece.

bq. From the perspective of the aftermath of the economic crash, it is now clear that some European countries were more vulnerable than others to economic downturn when it did come about. Yet why this should be so became clear only in retrospect. … the deficit problem is most readily explicable in the case of Greece, where as Figure 2 shows, fiscal deficits had persisted throughout the years of Euro membership. … But Ireland and Spain did not run serious deficits during the 1990s … the crash, when it came, placed the peripheral countries of the EU in the most vulnerable position, especially Greece, Ireland, and Spain.

bq. The international dimension … has its origins in the terms on which the Euro itself was created. The relative exchange rates at which Eurozone member states locked into the Euro … reflected the compromises struck by … Germany and France. Germany’s preference for a strong and independent bank, based on the Bundesbank model, prevailed … What was created was a multi-level macroeconomic policy. … the ECB had quite light regulatory and liquidity responsibilities…. the transnational monetary union had no counterpart in fiscal policy – the total EU budget is estimated at some 1% of the GDP of the EU as a whole, … programmatic spending … accounts for most of this.

bq. … The rapid expansion of the financial sector across Europe far outstripped EU institutional capacities to oversee and regulate it. The nature as well as the extent of exposure to risk turned out to vary significantly across countries,… Irish banks were mostly exposed to … a traditional ‘plain vanilla’ kind of over-exposure to the domestic property market, and especially commercial property, but on a scale never before seen.

bq. A rise in interest rates would have been appropriate for the overheated Irish and Spanish economies in the early to mid 2000s. As they could not do this within the Eurozone, relative cost pressures had to be managed through other means, that is, fiscal policy and wage-cost containment. However, the paradoxical effects of the credibility gains these countries achieved through monetary union was to soften their budget constraints, compromising the viability of the original commitment. … The government gained in credibility, which helped keep interest rates low. And the government was freed to increase spending and incur greater deficits without retribution from the markets.

bq. Membership of the Euro threw an unprecedented burden onto the adaptive capacity of the member states in two ways. … fiscal policy acquired new significance as the principal means whereby inflationary pressures could be managed and deficits kept to a minimum …the institutions of wage bargaining thus also became more important as a potential means of managing domestic economic performance in the context of EMU, for unless loss of competitiveness could be managed through relative cost adjustments internally, the cost would be borne otherwise in the form of a rise in unemployment.

bq. National processes through which budgets were approved and policy priorities established gained a new significance … Ireland did succeed in running fiscal surpluses for most of this time, though this generally came about through over-shoot of revenue projections rather than as a planned policy. The real problem …the composition of taxation changed a good deal, as the emphasis shifted away from personal income tax and toward taxes on activities to do with property transactions. … The policy stance responsible for the weak management of the budget derives from several sources: we might identify the role of electoral and party-political considerations, the framework of policy advice, and the wider incentives and constraints embedded in what we might term the Irish growth model.

bq. The suspicion of big government and preference for low personal taxation tilted the Fianna Fáil government toward the right on these issues. Moreover, the traditionally close relationship between Fianna Fáil and the construction industry was intensified by an expansion in the tax breaks and incentive schemes available to the building industry … international commentators frequently noted the unusually weak formal rules governing Irish budgetary procedures. … The dominant ideas … were shaped by an acceptance of the low-tax, export-oriented model (even when not balanced by strong controls over public spending). … free-market preferences extended also to the acceptance of a principles-based rather than a rules-based approach to bank regulation, and the institutional separation of central bank and financial regulator … functions in a ‘light-touch’ regulatory approach. … a woefully misplaced assumption that the banks knew best and could be trusted to look after their own shareholders’ interests … If government fiscal strategy is one side of the cost management strategy required within the Eurozone, wage bargaining is the other.

bq. … Government-led tripartite pay deals had expanded greatly from the agreement that started the series of social partnership agreements under crisis conditions in the mid to late 1980s. The range of issues had expanded by the early 2000s. … it is not clear that the changed policy framework and strategic priorities required by Eurozone membership really altered the bargaining priorities embedded in collective bargaining processes. … the uneven coverage of social partnership and the relative weight of the public sector unions came to be problematic. …the extent of competitiveness losses emanating from inflation-fuelled settlements and rising public sector costs were not subject to any institutionalized monetary disciplines or constraints. … … The trade union movement stressed the desirability of particular kinds of changes to the tax system such as increasing credits to remove the low-paid from the tax net (though this weakened the income tax base overall), and extending bands, rather than cutting rates of tax. But the net effect of the government commitment to tax reduction resulted in a path-dependent route of sharing out growth through rising personal incomes rather than through improvements in public services and other forms of collective consumption, with all the inequalities this entails between households. … The trade union movement had a rather distinctive profile compared with other OECD members states though. Because the foreign-owned high-profit and export-oriented sector tended not to recognize unions at all, union membership was concentrated in less export- dependent enterprises and in the public sector. … risks of a union profile such as this for inflation-generating settlements under conditions of growth … The principal attempt to address this, through an exercise in 2003 in ‘benchmarking’ public sector salaries, was a contentious exercise.

bq. … Thus Ireland, with its extraordinarily high growth rates between the mid-1990s and mid-2000s, should have been running super-high fiscal surpluses (as Finland was). To the contrary though, fiscal policy was consistently pro-cyclical, and this was a recurring phenomenon in Irish public life.

bq. … In summary therefore, Ireland has made many policy mistakes and is paying a high price for correcting them. The corrections are painful yet unavoidable. But the real dynamic for floating the Irish economy off the rocks of recession lies outside its control. The future for Irish growth prospects remains deeply tied into the terms of European debate.