DUBLIN — Much of Ireland has been riveted this summer by recordings of phone conversations from 2008 that revealed not only shocking levels of greed and bad breeding among some of the country’s top bankers, but a deliberate effort to snooker the government into bailing out the country’s banks by concealing the extent of their insolvency.
As Dan O’Brien, the business editor of the Irish Times, observed, the tapes gave new life to a simple narrative many Irish desperately want to believe: that Ireland was put on the path to financial ruin on a single night five years ago, when a small group of regulators and politicians, pressured by bankers and European leaders, foolishly decided to guarantee all outstanding debts of all Irish banks.
In this telling, it was that one boneheaded decision that wound up bankrupting the government and plunging the economy into a prolonged recession.
In the world beyond its emerald shores, another simple narrative has found a receptive audience, this one about the Draconian spending cuts and tax increases that have been forced on Ireland by its creditors in order to reduce an annual government budget deficit that had reached 32 percent of the country’s annual economic output.
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The Irish themselves have long since accepted the urgent necessity of belt-tightening. But to Keynesian critics who believe in the healing power of fiscal stimulus, the country’s recent slide back into recession is offered as proof of the futility of austerity.
Neither of these fables — the one about the bank bailout, the other about austerity — is adequate to explain the rise and fall of the Celtic Tiger. You don’t have to spend much time here before discovering that the real story turns out to be both more complicated and more interesting.
In fact, you might say that what’s holding back Ireland’s economy is the same thing that is now holding back the once-fast growing economies of Brazil, Russia, India and China. It is the same thing that afflicts Greece, Italy, France and the other struggling economies of Europe. And, to a somewhat lesser degree, it is the same problem bedeviling the U.S. economy.
In each, it is the inability to make fundamental reforms to political and economic institutions that now prevents them from rebalancing their economy, from taking next leap in terms of their productivity and efficiency, from creating a new, more sustainable model for economic growth.
The global credit bubble created the illusion that countries could continue growing their economies without making the fundamental reforms to institutions crafted for an earlier era. The bursting of that bubble has revealed the full extent of that mirage.
“We need to talk not about recovering the economy but recasting it, since in some important ways, what we had before was a disaster,” says Jim Browne, the president of the National University of Ireland at Galway.
The story of the Celtic Tiger begins with a small and once-poor island nation that, after an earlier financial crisis in the 1980s, was masterful in using targeted incentives, a low corporate tax rate and a heavily subsidized entry into the European Union to lure multinational corporations to open factories and back-offices in Ireland.
In the span of 15 years, a country whose chief exports had been beef and butter suddenly turned itself into a modern, industrial economy that boasted the highest output per person in Europe.
Ireland began to lose its way after the tech bubble burst in 2001. Rather than use that opportunity to move on to a different growth model, one more focused on its lagging domestic economy and homegrown companies, Ireland opted to double down on the old formula of foreign investment and government spending that had worked so well before.
To lure banks, insurance companies and accounting firms from New York and London to its Dublin financial-services hub, officials offered special tax breaks and an explicit promise of “light touch” regulation.
Tossing aside the fiscal restraints imposed after the ’80s financial crisis, the government embarked on a spending spree, stepping up investments in infrastructure and education, renewing tax breaks for real estate development and dramatically increasing the pay of government workers.
The Irish economy also got a boost from the European Central Bank, which kept interest rates artificially low to bolster the lagging economies on the continent even as Ireland was beginning to soar again.
At the same time, British, French and German banks began tripping over one another to make loans to households, banks and property developers, as well as the Irish government.
All of these developments combined to create a giant credit bubble in Ireland that, in turn, fueled a real-estate and construction boom. At its peak, this real-estate frenzy probably accounted for 25 percent of the economy’s output and employment and generated a third of the government’s tax revenue.
Households flush with paper wealth and borrowed cash went on a spending spree, as did a government suddenly flush with tax revenue. Wages and prices soared and a country that once boasted it was one of the cheapest places to do business suddenly was one of the most expensive.
Only when the credit bubble burst did Ireland discover how bloated and misshapen its economy had become, how much capital and talent had been misallocated and wasted, how unsustainably inflated its wages and prices and tax revenue had become.
It also revealed that most of its biggest banks were insolvent. The cost of guaranteeing the obligations of Ireland’s privately owned banks brought the government itself to the brink. And the rescue loan from the European Union and the International Monetary Fund came with a demand that the government move quickly to bring its annual budget deficits to within 3 percent of the country’s GDP.
The financial crisis and the ensuing recession dealt a serious blow not only to Ireland’s balance sheet but also to its pride. Many here are quick to blame it all on greedy bankers who caused the bubble and feckless politicians who approved the bank guarantee.
But when collective anger — and there is plenty of it — gives way to more sober individual reflection, most people come around to the conclusion reached by John Allen, an economic-development official, when he says: “We lost the run of ourselves.”
The most obvious thing to say about Ireland today is that it has two economies that maintain a somewhat separate and uneasy coexistence.
One economy is the old Celtic Tiger, the globally competitive, highly productive export machine centered in the large companies and located in the major cities.
While a few are homegrown — CRH Construction and Ryanair — most are European and American.
All benefit from Ireland’s low corporate tax rate, flexible labor laws and English-speaking workforce, supplemented by a steady flow of modest government subsidies for job creation and research and development.
The fall of the euro, the decline in real-estate values and the moderation of starting wages have combined to make Ireland an even more attractive place for new foreign direct investment, which hit record levels in the past two years.
Any doubts about the vibrancy of this economy are easily dispelled on a Friday night when tens of thousands of young workers from companies such as Google, Facebook and Citigroup spill onto the street from the bars and restaurants of Dublin.
Many have emigrated from elsewhere in Europe, lured by the prospect of good jobs at global companies, the opportunity to polish their English and a city full of people just like themselves.
Boost from academia
One important facet of the tech includes Ireland’s top universities, which engage in extensive research collaboration with industry and government. Certainly the best known, and most lavishly funded is the Center for Research on Adaptive Nanostructures and Nanodevices (CRANN) at Trinity College. CRANN boasts 300 researchers from 45 countries, working with companies such as Intel and Merck.
There are clear signs that Ireland’s economy has begun a modest recovery. Some companies report having trouble finding highly skilled workers or experienced managers. And in the Dublin and Galway real estate markets, where values fell as much as 50 percent, shortages for certain types of housing and offices last year led to a 10 percent bounce off the bottom in real estate prices.
Foreign investors are swarming all over Dublin and Galway, looking to buy buildings put on the market by the National Asset Management Agency (NAMA), the government entity set up to take over $90 billion in bad loans to property developers after the banks were nationalized.
The complaint from the real-estate industry is that NAMA is not moving fast enough to dispose of the properties. But NAMA’s boss, Brendan McDonagh, is determined not to repeat the mistake made by the U.S. government after the savings and loan crisis of the early 1990s, when it sold off its inventory too quickly, allowing investors rather than taxpayers to reap the bonanza when the market rebounded.
Danny McCoy is adamant: “The Celtic Tiger was not a mirage.”
McCoy is the president of the Irish Business and Employers Confederation, the Irish chamber of commerce. He is inclined to focus on Ireland’s record exports, the continued flow of foreign direct investment and the bounce in the urban-property markets.
He looks at government pay scales, which have been reduced by as much as 25 percent over three years; the government deficit, which is on target to fall to 3 percent of GDP in 2014; and the government’s ability once again to borrow money from global capital markets. And what McCoy sees are the signs that Ireland is getting its economic mojo back.
If only, he laments, Irish consumers would get past the fear and anger stirred up by their underwater mortgages and start spending again.
If only Irish banks would get on with restructuring the mountain of nonperforming loans on their books so they could begin lending again.
If only the cream of the crop from Irish universities would see the opportunities at home rather than heading abroad in search of better ones.
But to Constantin Gurdgiev, that’s precisely the point. As the Trinity College economist sees it, those “if onlys” are not merely hiccups. Rather, they are symptoms of much deeper structural problems in Ireland’s domestic economy that were at the root of the financial and economic crisis and must be fixed if the country is to return to a path of robust and sustainable growth.
For unlike its export economy, which directly accounts for less than 15 percent of the labor force, Ireland’s domestic economy is relatively inefficient, unproductive and uncompetitive.
Sectors such as retail are highly fragmented, with local stores protected from competition from large chains by zoning and planning rules. Costs of insurance, legal and other professional services are among the highest in Europe, largely because of laws limiting competition.
A big part of the domestic economy is a government that rivals Sweden’s in terms of its size but doesn’t come close in terms of the quality of its services. The health-care system is not cheap or good, leading many people to turn to private insurance and private health providers.
Welfare and pension levels are among the highest in Europe, left largely untouched during the recent cutbacks.
Structural problems — some legal, others cultural — also stand in the way of a full recovery of Ireland’s financial system.
Stringent bankruptcy laws make it extremely difficult for borrowers who cannot repay their debts from ever getting out from under them. Even in the best of circumstances, it takes a decade for insolvent borrowers to have debts written off — and carries a social stigma for far longer.
At the same time, the collective memory of British landowners throwing Irish farmers off their land creates social and political pressure on banks not to foreclose on mortgages that, in all likelihood, never can be repaid.
The result has been a stalemate between lenders and borrowers in a country where a quarter of mortgages are in arrears — and nearly all of them for amounts in excess of the current value of the property.
Nobody knows what property prices will be once all those problem loans are resolved. Nor can anyone know whether the ensuing write-downs will put the banks into insolvency again, requiring yet another government bailout.
Because of this prolonged game of “extend and pretend,” banks have been reluctant to make new loans even to sound businesses, while nervous households hoard their cash and pay down debts.
Unfortunately, the most pernicious long-term effect of the recent financial crisis and recession may be that it stalls that transition by reaffirming the old bias against risk-taking and entrepreneurship.
That same bias is also reflected in Ireland’s tax code, which imposes relatively high taxes on incomes of the self-employed (55 percent) and capital gains (33 percent) but infamously low taxes (12.5 percent) on the profits of domestic and foreign corporations.
The low corporate rate has become such an integral part of the Irish “brand” that even the deputy prime minister, a one-time socialist, dismisses any consideration of raising it even temporarily to deal with the government’s fiscal crisis.
“We have a very insular political system here,” agrees Alan Dukes, a former finance minister and leader of the parliamentary opposition. “The influence of interest groups makes politicians incapable of making hard decisions. We wind up doing a little of everything and not enough of the things that really matter.”