Dellepiane and Hardiman on Ireland in the crisis

by Henry on November 24, 2010

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.

{ 24 comments }

1

James Conran 11.24.10 at 7:41 pm

Martin Wolf’s column today is also (as usual) excellent food for thought:

http://www.ft.com/cms/s/0/9dc7e408-f73e-11df-9b06-00144feab49a.html#axzz16EKQOoWb

2

Martin Bento 11.24.10 at 7:51 pm

The question I have now is: are the Euro-boosters rethinking their position? While I could see the benefits of the Union, I was skeptical of how driven it was by business interests and how tolerant it was of “democracy deficits”. Now, it seems to be heading straight to the demolition of the European welfare state, which is exactly what one would expect from democracy-deficient business interests.

3

Mise 11.24.10 at 11:14 pm

As a self-proclaimed “euro-booster” I’m surprised myself at the turnaround in my feelings towards Europe. I voted for the Lisbon Treaty, in the knowledge that there were some things I agreed with and many things that I disagreed with, beacause of a probably irrational belief that, if Lisbon moved Ireland some way towards German/Scandinavian welfare systems, I was happy to shift some power from Dublin to Brussels. A democratic deficit would be the next battle.

I’m pretty appalled at how abandoned we’ve been by all those wonderful welfare states. The ECB would appear to be calling the shots in terms of the EU’s positions, and any sense that strong social welfare is a key part of the ‘european project’ has been left by the wayside. Can’t help but feel that, as far as the potential merits of any sort of a left-ist welfare state go, our European partners are silently condoning a double standard that will have huge imapcts in Ireland.

4

EWI 11.24.10 at 11:48 pm

I’m pretty appalled at how abandoned we’ve been by all those wonderful welfare states.

Well, neither Frau Merkel nor Monsieur “immediately double my own salary” Sarkozy are noted socialists.

5

Steve N Allen 11.25.10 at 12:19 am

The banks have cost us so much yet they still chain their little pens to the desk when you go in the branch, as if WE would steal from THEM.

6

dsquared 11.25.10 at 7:19 am

One of the very first blog posts I ever did was on the subject of how I was basically in favour of a single European currency, but that the only such currency on offer was the euro, which had deflationary bias and democratic unaccountability built into it (I therefore concluded that the correct economic policy was to support European monetary union on the basis of the pound sterling, but there you go). It was and is a bad currency system, and although the flaws in the euro probably didn’t have much to do with the property bubble because any currency union with Germany and France is going to produce a when-elephants-dance volatility in interest rates for an economy like Ireland, the ECB’s total unwillingness to carry out sensible anti-recessionary monetary policy has made the resolution of that bubble a lot more difficult.

I thought that the Dellepiane and Hardiman paper was good; the one point I’d disagree on it was that the failure of effective bank regulation was a specifically Irish one, not an EU one. The community-level infrastructure for bank regulation actually works very well and is much better designed than American federal/state regulation, but it isn’t good enough to make up for the shortcomings of a fundamentally supine (and if Fintan O’Toole’s book is right, fatally politically compromised) national regulator.

7

dsquared 11.25.10 at 7:20 am

(specifically, Spain did a much better job of regulating its banks, and although it had nearly as big a property bubble as Ireland, it isn’t yet having nearly as big a banking crisis).

8

John Quiggin 11.25.10 at 7:59 am

As dsquared says, the big problem is not the euro but the ECB.

In particular, they are still convinced of the supreme virtues of low inflation, and don’t have much to offer on regulation, even though the combination of low inflation and weak regulation reliably produces asset bubbles and busts.

9

ejh 11.25.10 at 8:30 am

it isn’t yet having nearly as big a banking crisis

Although one is on the way, it seems. As, quite likely, is the final destruction of the Zapatero government by the latest wave of market hysteria as what was good enough for them two weeks ago becames absolutely unsustainable today.

One thing that struck me about the summary above:

The corrections are painful yet unavoidable.

Corrections, or the corrections? Is the claim that the corrections have to be pretty much of the size and nature that Cowen is proposing (or is having proposed to him) or that some sort of change is patently going to have to happen? Because these are, politically, two very different viewpoints.

10

dsquared 11.25.10 at 8:58 am

If Spain does end up having an Irish-style banking blowout, it will be really unfair because the Bank of Spain did absolutely everything it could to try and calm down the bubble, including raising capital requirements and requiring countercyclical “Spanish provisioning” for bad debts (I suppose it will also prove that I was basically right to say that macro-problems have macro-causes and that bank regulation and bankers’ incentives were basically irrelevant, but it will still be monstrously unfair). Ireland, on the other hand, got basically the banking system its political class wanted.

11

otto 11.25.10 at 9:54 am

“the big problem is not the euro but the ECB … they are still convinced of the supreme virtues of low inflation”

The only possible euro on offer was and is one that had the Bundesbank’s approval because it had the Bundesbank’s mentality on inflation. I understand what you are saying here, but it’s a bit like saying, e.g., the problem is not monarchy as such but the Windsors. Maybe so, but the only monarchy on offer in practice is a Windsor-related programme activity.

12

dsquared 11.25.10 at 11:28 am

but it’s a bit like saying, e.g., the problem is not monarchy as such but the Windsors

I am also a Jacobite ;-)

Yeh, I agree. This means that in practice I’m anti-euro, but tend to disassociate myself from most other anti-euro types because they are anti-euro for very different reasons from me. If it came to a referendum on the UK joining the euro (which it hopefully won’t), I’d really have to choke back some gall to join in the campaign.

13

roac 11.25.10 at 5:30 pm

I am also a Jacobite ;-)

One of the things I like about this blog is the way it makes me look up the answers to questions it wouldn’t otherwise have occurred to me to ask. In case anyone else is curious, the current heir of the Stuarts is Max, Duke of Bavaria. He has no issue, nor does his heir, so the title will eventually pass to or through this person:

http://en.wikipedia.org/wiki/Sophie,_Hereditary_Princess_of_Liechtenstein

It says she attended the Girls’ Home Primary School of the English Lady, which certainly predisposes me in her favor.

14

Tim Worstall 11.27.10 at 11:54 am

@13: Not wholly convinced. Her claim comes thorough adoption. Not unusual in German titles but pretty much unheard of in English ones I think.

15

ejh 11.28.10 at 7:01 am

16

Martin Bento 11.28.10 at 12:57 pm

dsquared, so you don’t support the Euro, as offered, but would still, however reluctantly, join the campaign for it because you like the Euro advocates better than the Euro opponents? This is what has worried me: that much of the support for European unification may come down to the tribalism of the cosmopolitansm – we are not like those bad and stupid nationalists. Supporting European unification is a way of proving to yourself and signaling to others that you are a nice person, sophisticated, and not at all xenophobic. Which does not constitute an argument that unification is a good idea.

John Q., perhaps “Euro-boosters” was a misleading word-choice on my part. I’m not just talking about advocates of the Euro; I’m talking about advocates of the whole project of European unification as implemented. This, of course, includes the ECB. Are we yet to the point (and I believe we will be if we are not), where advocates of European unification are having second thoughts?

It always seemed to me that the EU gave entirely too much power to the business and financial sectors, and that the “democracy deficit” was not just a technicality or necessarily transient matter, but a grave problem that would also help business interests undermine the European welfare state. And that was something to lose. European Social Democracy was probably the greatest historical triumph of the Left; it was the great counter-example to the various Communist nightmares. Yet the Left was willing to risk it for the sake of unification. Why? If I look at Western Europe circa 1985 I do not see the grave problem for which the only solution was unification. Rather, I see a situation where there was much more to lose than to gain. Of course, long range plans for unification were already in place, but it is not clear to me what disaster would have struck had those plans remained unfulfilled, or, at least, if the Left had been willing to hold out for a better deal before giving its support.

I don’t understand the confidence in something so unprecedented. The Center-Left did not just support the EU. They were so certain it was the right choice that they were willing to disregard democracy in order to override “popular ignorance”. If “popular ignorance” is vindicated, where does that leave the credibility of the Left and of the intelligentsia? Where should it leave it?

17

Chris Bertram 11.28.10 at 1:36 pm

Martin, I don’t think that attributing a common position to the Centre-Left is historically right. It is just that the Eurosceptic left, of which Bryan Gould was a good British example, lost.

18

dsquared 11.28.10 at 3:34 pm

dsquared, so you don’t support the Euro, as offered, but would still, however reluctantly, join the campaign for it because you like the Euro advocates better than the Euro opponents?

No, I would have reluctantly joined the campaign against it, rueing the forces of history that put me on the same side as such a fearful bunch of xenophobes and nutters. Chris is right – the Eurosceptic left was not once the microscopic minority it now is.

19

John Quiggin 11.28.10 at 5:21 pm

Looking at the UK, I don’t see that the current crisis gives that much support to left Euroscepticism. It seems to me that UK austerity policy under the Coalition has been
(a) essentially unconstrained by the fact that the UK is an EU member
(b) worse in all sorts of respects than that imposed on recipients of EU bailouts
Monetary policy has been more expansionist, but I’m unconvinced that monetary policy is what matters.

20

roac 11.28.10 at 9:00 pm

Tim Worstall @ 14: You may well be right, but frankly the limit of my interest in the issue has been reached. At any rate you and dsquared need to agree on a standard-bearer before the next rising, or it is sure to turn out even worse than the last one.

21

Martin Bento 11.28.10 at 9:20 pm

dsquared and Chris, OK, perhaps there was once more of a Eurosceptic center-left than there is now, but will not the left be judged by what was the prevailing position at the end of the day. The Euro-boosters do seem to have prevailed on the left, such that opposition to unification over, say, the last decade, mostly seemed to come from some of the far left and from the right. Oh, and from the majority of the population, but I’m talking about intellectuals here. In any case, what does and should this do for the credibility of those on Left who do or did advocate unification, which I think you’ll concede was not an inconsiderable number? What does it do for the credibility of the position that we shouldn’t have referenda because we will lose them: the intellectual elite knows best and should impose its will on the unknowing masses for their own good.

John Q., of all the EU countries looking to “enjoy” a bout of austerity, I think Britain is the only one that is not being visibly egged on or coerced by the EU. I also think monetary policy matters, and the consequences of what the libcon government is up to would be much worse without expansion: they should thank Soros for keeping them out of the Euro, though he probably actually thought they should be in.

22

Martin Bento 11.28.10 at 9:27 pm

Oh, and dsquared, apologies for misreading your comment. I assumed “joining the campaign” to mean joining the side seeking a change, rather than joining the side opposing it.

23

ejh 11.28.10 at 9:41 pm

Anybody fancy having a pop at my question in #9?

24

Mise 11.29.10 at 12:23 am

The opposition seem pretty satisified that IMF/ECB are open to ‘corrections’ of many natures outside FF’s specific suggestions, within broad parameters of 15 billion over now five years. Even the unions feel they got a decent hearing on the specifics they would like to see within those corrections. But all that is just irrelevant, really, and will still be when alternative policymakers come to power. I think Cowen and Lenihan are walking a tricky line between claiming their plan was the only one acceptable to the bailout team, while at the same time claiming they came up with it prior to negotiations, and that it wasn’t influenced by them, but is an Irish plan. Its as if the two magically, mystically happened to coincide.

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