Friday, April 29, 2011

The Economic Charade of the Irish Bailout

Can Ireland export its way back to solvency? That is the question underlying Ireland’s ostensible recovery budget. The Irish tale is a familiar one: boom, bust, and bailout. Of course, in an era marked by spectacular recklessness, Irish banks distinguished themselves -- perhaps only matched by their government; an ill-considered guarantee of financial sector liabilities in 2008 turned banking insolvency into sovereign insolvency. Austerity followed. Mounting losses -- and some imprudent remarks from Ms. Merkel -- drove up borrowing costs, eventually forcing the joint EU/IMF rescue package, and further austerity. Unfortunately, however, the credibility of the subsequent recovery plan is itself questionable.

Sectoral surpluses and deficits must balance. Consequently, any fiscal consolidation must be accompanied by some combination of a stronger trade position or increased private spending – or the economy will shrink. The Irish budget recognizes this reality, although it is a bit reminiscent of a student working backwards from the correct answer.

Starting from the targeted 2.8 percent of G.D.P. public deficit in 2014, the Irish government strains to make the pieces of the economic puzzle fit. An aggressive export forecast – as much as is credible -- is the second component of the budget. It leaves an implied private sector surplus of roughly 5.5 percent of G.D.P. – improbable, but not implausible. Alas, this misrepresents the economic pressures besieging the Irish government.

The 2.8 percent of G.D.P. government deficit is not in fact a 2.8 percent deficit. Ballooning interest payments (mostly abroad) turn a projected deficit into a primary surplus. Moreover, the balance of trade is not a reliable proxy – which the Irish government assumes is the case -- for the current account for a small, open economy; repatriated export profits from foreign multinationals reduce the headline trade number. Together, these facts conspire to understate the necessary adjustments from the export and private sectors by some 3-4 percent of G.D.P.

Can it be done? With loans outstanding to households still near 111 percent of G.D.P., the burden of this greater adjustment will almost certainly fall on net exports rather than private spending. Monetary union means only “internal devaluation” – deflation – remains as a mechanism to regain competitiveness. Already, Irish unit labor costs have begun to fall after soaring much of the last decade. There is a limit, however, to how far wages can come down in a heavily indebted society; otherwise, Fisher’s debt deflation beckons. Ireland’s best chance is for the labor costs of its main trade partners to adjust upward instead. That is a faint hope in a world beset by nascent trade war.

Critics argue the rescue package amounts to little more than a backdoor bailout of German banks by Irish taxpayers. The truth is even more scandalous. Indeed, Germany has made a profit of several hundred basis points from the bailout. This charade cannot continue. Debts must be restructured to payable levels. Delay only increases the collateral damage to the Irish people – and to the Eurozone’s viability.

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