Author: Kevin O’Rourke

Beware of journalists bearing history lessons

Today’s Irish Times contains this gem from Stephen Collins:

Another issue that did not get serious traction in the talks was the simplistic call to “burn the bondholders” for which German chancellor Angela Merkel has to take a lot of responsibility.

The European Central Bank was adamantly opposed to the notion as any such move would threaten the financial stability of Europe. It is ironic that the zealots of the US Tea Party movement and many of those on the left in Ireland share a common belief in “burning bondholders” and damn the consequences.

The lesson of the Great Depression of the 1930s was that taking that kind of approach leads to widespread bank failures and national economic collapse which, in turn, threatens the democratic foundations on which our society is built.

Give me a break.

The bank failures of the 1930s were due to bank runs caused by excessively conservative monetary policies, and in particular by the determination of elites to stick with the gold standard well past its sell-by date. Burning bondholders had nothing to do with it.

Insofar as the 1930s involved debt restructuring (in Latin America, for example), this was part of the solution, not part of the problem — cf. the work by Eichengreen and Portes.

The lesson of the 1930s is that slavish adherence to economic orthodoxy can lead to disaster, and that sometimes you need a radical break with past policy mistakes in order to turn around expectations and prepare the way for recovery. FDR’s abandoning the gold standard was one such radical break; there were other radical breaks with the past that were much less benign, and that were directly caused by previous hyper-orthodoxy.

Finally abandoning the socialization of private losses would not just have made the Irish state more solvent, but would have clearly signalled a new beginning in Irish political and economic life. As things stand, it is hard to disagree with Mohamed El-Erian that the present deal is not the game-changer that Ireland needs.

Migration, the limits of internal devaluation, and the bailout

It is time to dust off old ways of thinking about the Irish economy that were useful in the past.

In the long run, migration sets a floor to Irish wages. It has been thus ever since the Famine of the 1840s, and I don’t believe that the Irish have become less mobile in the last 20 years. Now, a lot of Irish wages are still high by international standards, but eventually as ‘internal devaluation’ proceeds, and as peoples’ living standards are lowered as a result of tax hikes and cuts to public services, it seems inevitable that the ‘migration constraint’ will start to bind again.

Once this happens, then very roughly speaking the size of the Irish economy will be largely governed by relationships of the following sort:

w(1-t) + b + P = E

where w is the wage (which determines employment and output, for given levels of the capital stock and technology); t is the tax rate; b is the value to workers of the public services they receive; P is the premium we enjoy as a result of living in Ireland; and E is the living standard which we can enjoy overseas. If the left hand side of this equation falls too far below the right hand side, people will leave until equilibrium is re-established.

Once we hit this constraint, either because w falls, or t increases and b declines, adjustment in the economy will be more quantity-based and less price-based than it has been to date.

And it gets worse, since t and b depend inter alia on the levels of output and employment. There are fixed costs to running a state, and the debts we are now being saddled with are not population-dependent. You don’t have to be Paul Krugman to see the potential for some pretty nasty feedback loops here.

What can politicians do? The most obvious thing to do is to minimize the debt overhang facing this State, so that t is not higher, and b is not lower, than they otherwise would have to be. Less obviously, if politicians — not the existing ones, obviously, but an entirely new political class — can increase P, by providing people with a political project for national renewal that they can buy into, this might also help convince some people at the margin to stay at home. This is not just essential for our democracy, but for the economy as well.

It was all the fault of foreigners

In the past week or so there have been plenty of attempts by the Dublin elite who have sleep-walked this country into catastrophe to blame others. For an example, see the quotations in this article. If Chancellor Merkel had kept her big mouth shut, the implication is, everything would have been alright.

This line of argument seems to imply that Ireland was simply facing a liquidity crisis — in which random events and loose lips can indeed sink ships of state. And, to be fair, there certainly was a liquidity crisis.

However, an awful lot of influential external observers believe that Ireland is also facing a solvency crisis, brought about by the suicidal bank guarantee of September 2008, and compounded by our lousy growth performance (10 successive quarters of falling real GNP, with more potentially to come). The Government could have chosen to listen to Morgan Kelly that evening, but it didn’t — after all, who would take such an irresponsible young person seriously! — and the rest is history. If it is a solvency crisis, then it was always going to come to this, as long as the Government tried to stand by that guarantee. Mrs Merkel may have been the trigger, but if she had stayed quiet there would, inevitably, have been some other trigger.

The really important point to make about what Mrs Merkel said is that she was right. There is indeed a limit to how much taxpayers are going to be willing to bail out bank creditors, and so there should be. If she, or the IMF, or any other external body, forces the sort of restructuring of bank debt that our own leaders have been so reluctant to contemplate, then ordinary Irish people will be very grateful to them. If the restructuring doesn’t happen this weekend or soon thereafter, then presumably it will be a major issue in the forthcoming general election campaign, and we will get an early test of whether Mrs Merkel’s political instincts are right.

Update: today’s FT editorial makes some very similar points.

The sputtering foreign engines of assumed Irish growth

The four-year plan assumes that Irish GDP will grow in real terms by around 2.75% per annum over the next four years. For good measure, it throws in a little bit of assumed inflation as well (0.75%, 1%, 1.25%, 1.5% — a suspiciously smooth progression, would you not say?).

In the context of the proposed austerity package, this seems wildly over-optimistic to me, and it would appear that several market analysts hold the same view. Here’s one quote from the foreign press, but you can easily find more of the same:

Analysts questioned whether the plan was credible. Stephen Lewis, chief economist at Monument Securities, said: “It doesn’t seem all that realistic to me. It seems they’re planning very stringent fiscal measures and yet they expect the economy to grow against that background. That seems highly unlikely.”

Needless to say, I would love to be proved wrong, and the third quarter GDP statistics will be revealing one way or the other.

Optimists point to the growth in Irish exports as the route to our recovery. Since we can’t devalue, we will be relying on foreign income growth more than on relative price shifts to achieve this happy outcome. So it seems worth pointing out that the Dutch CPB’s September data on world trade and industrial production were released yesterday. They confirm a trend which has been there since January: the momentum of the world recovery is steadily decreasing.

Eichengreen suggests some light reading

Barry Eichengreen provides a reading list here.