On November 2, Michael Noonan, Ireland's minister for finance, stood before the Irish parliament to explain why the government decided to pay back one billion dollars -- funds that Ireland didn't have -- to unsecured bondholders. It was not that he wanted to pay off the debts run up by the now defunct Anglo Irish Bank, Noonan argued, but he had no choice. His predecessor had made an agreement with the European Central Bank and he was bound to honor it.
Just a year earlier, a member of parliament in the opposition had warned against just such an "indefensible" and "obscene" move. "What legal or moral compulsion is there on Ireland to honor in full debt incurred by Irish banks," he asked, "when there was no state involvement in the arrangements? These loans were entered into freely by willing lenders and borrowers . . . The interest rate charged represented the risk at the time and there never was a state liability."
That man was also Michael Noonan. Despite his party's coming to power in the subsequent year on a platform of change, reform, and jobs, by late 2011 he was repaying bondholders in defunct banks, shelving reform of Ireland's institutions, and doing next to nothing to check unemployment. That November day in Ireland's parliament was telling. Noonan spread his hands as if to say, What can I do?
What indeed? Ireland is broke. The value of the country's output is at a virtual standstill (around 160 billion euros), and the IMF projects it to stay that way for the next few years. Meanwhile, unemployment is at 14.5 percent, and roughly half of the unemployed have been jobless for a year or more. Ireland's households are among the most indebted in the world. Several indexes, such as the EU's Survey on Income and Living Conditions, show that the country's poorest are worst affected. Accordingly, suicides, alcohol consumption, and violent crime have all risen since the construction bubble first burst in 2007. Although there have been protests and muted anger over the dinner table, however, there has been no rioting on the scale of that in Greece. All told, the Irish are bearing a considerable burden fairly well.
Their resilience is especially striking considering that the Irish economy is much worse than that of the eurozone as a whole. Eurozone private consumption is expected to rise by 1.4 percent this year, but Ireland's will grow by only 0.6 percent. The eurozone's governments will be increasing spending on public services by 0.1 percent, but Ireland will be cutting spending by 3.1 percent. Since 2007, investment as measured by gross capital formation in Ireland has fallen by 74 percent, but in the eurozone it has fallen by only 11 percent.
The nation is also indebted; the current budget deficit stands at 16 billion euros. To cover it, in 2010, Ireland borrowed 67.5 billion euros from the European Union, the IMF, and others, in exchange for punitive austerity measures. The recent EU deal to strengthen its fiscal compact will most likely prolong Ireland's period of austerity. Noonan is powerless to go another way, as any finance ministers who follow him will be. Within three years, Ireland is bound to return to budget sustainability, reformulate its banking sector into two highly capitalized "pillar" banks with a mandate to deleverage, and deregulate its protected sectors, such as the legal and medical professions.
Because of these measures, the immediate future presages a slow grind. Ireland's Department of Finance projects revenues to remain flat -- 39.9 billion euros in 2012, compared to 39.2 billion euros in 2011. Current receipts are expected to increase in 2012 by 1.7 percent, but this figure is close to the expected inflation rate. In other words, official forecasts see no real increase in receipts at all. The domestic economy will continue to deflate, in the hope that it will eventually start growing again.
This cut-and-tax, or expansionary fiscal contraction, program looks remarkably similar to the one credited with Ireland's economic turnaround in the 1980s. The idea is simple: get your fiscal house in order by balancing the books and opening up labor markets. The private sector's confidence will grow. Investment will come, buoying tax revenues, reducing unemployment, and making everything okay once again.
But that happy story neglects some important historical artifacts -- namely Ireland's two devaluations in the 1980s and 1990s, the creation of the European Single Market, the ready availability of funds from the EU to help build roads and universities, and a demographic dividend of young, well-educated people willing to work for very little. Moreover, Ireland's business-friendly tax policies and subsidy-driven approach to courting foreign direct investment also helped reinvigorate the nation's economy. In a few short years, it caught up to its European cousins.
Another such Irish miracle is not in the offing. First, Ireland's strength as a foreign direct investment hub will be eroded by the stricter fiscal discipline imposed by the eurozone core. Although efforts to consolidate the eurozone's corporate tax base are stalled at the moment, renewed effort in this area would mean the loss of a staple of the Irish industrial development strategy since the 1950s. The Internal Revenue Service in the United States may also throw a wrench in the works if it decides to close lucrative tax loopholes for U.S. multinationals in an effort to balance the United States' own precarious budget.
Second, the extent of Ireland's household and firm-level indebtedness means that the country will see a long period of "debt minimization," in the phrase of the economist Richard Koo. This will have the effect of driving growth down, as money goes toward repaying debts rather than consumption and investment. Already, evidence shows that the private sector is deleveraging, so any attempt at fiscal consolidation will result in a rising, not falling, fiscal deficit.
Third, Ireland will not likely start borrowing from international bond markets anytime soon. This has nothing to do with Ireland itself. Markets are just unwilling to hold European debt. And, if they decide to, they will likely opt for safer German bonds rather than lend to risky countries.