From Boom to Bust: How the Irish economy became addicted to cheap money
Rumours of this special little island's special ability to perform economic miracles were, as we all know by now, greatly exaggerated. Aidan Regan outlines the peculiar alignment of stars that led to boom, and the choices made that guaranteed spectacular bust.
In 1986 Ireland devalued its currency to try kick-start a failed economy that had its legacy in the economic policy decisions of a 1977-1981 Fianna Fáil government which borrowed too much money and spent it recklessly, adopting unnecessary pro-cyclical fiscal policies. The 1981-1987 Fine Gael-Labour government tried to tax the country out of recession. This also failed. In a period when Ireland should have been saving it spent, when it should have been spending it taxed. The whole process was a mess and conditioned by poor domestic policy decisions and external changes in the European and Global economy.
Contemporary Irish political-economic history started when a minority Fianna Fáil government was elected in 1987 under Charles Haughey. This was a significant year for a variety of reasons. Firstly, in the midst of a work, wage and economic crisis, a new pro-market, conservative liberal political party emerged: the Progressive Democrats, who won 14 seats in the February 1987 election, making them bigger than the Irish Labour party. Secondly, three months after the general election Ireland voted in favour of the Single European Act. This fundamentally changed the rules of the game in the policy capacity of national governments to manage their economic affairs in a transnational European environment. Coupled with the rise of Thatcher and Reagan (who were waging class war via the state in the UK and USA) this created a paradigm shift in international political economy. Thirdly, 1987 was the year the IFSC (International Financial Services Centre) was established. It was the brain child of senior civil servants, banking officials and Charles Haughey, all of whom aimed, with its establishment, to tap into the emergence of the bold new world of finance capitalism.
The last big event to occur in 1987 was the emergence of what later became known as 'social partnership' - a centralised wage bargaining-income policy agreement that gave trade unions access to political power in a context where their economic power was weakening. This seems an unlikely event, for a variety of reasons. Across the English speaking liberal-market world governments were cutting links with trade unions and dismantling the labour market conditions that gave labour collective bargaining power. Also, Fianna Fáil arrived into government with the support of the new pro-market PDs. Once in government they announced a plan of radical cuts in public spending. Fine Gael, meanwhile, (via the Tallaght strategy) declared they would not oppose economic reforms introduced by the government- thus giving Fianna Fáil free reign on economic issues. Fianna Fáil could have acted like the Thatcher government in the UK. They chose not to do this and actively sought the support of Trade Unions for a 'Programme for Recovery'. Why? Because, electorally, they depended on the working class, trade union vote.
So, 1987 set the platform for the subsequent 23 years. Immediately, Ireland got lucky and landed on the crest of an international upturn in the global economy. The significant public money from EU structural adjustment funds aimed at less developed European economies helped, significantly.
The first partnership agreement centralised wage negotiations and created certainty in wage outcomes. This reduced inflation. In return for a reduction in income tax the trade unions agreed to wage restraint (3 per cent over three years). The reduction in income tax resulted in greater take home pay for every worker. In this environment of 'economic growth' fiscal austerity appeared to work. The budget deficit was reduced and debt-GNP ratio improved.
But it would be a mistake to say that cuts in public spending caused the improvement in the economy. It did not. The improvement was caused by the 1986 currency devaluation; EU-Structural investment; global growth and increased FDI (after the Single European Act); and wage restraint by trade unions. Trade unions traded their economic power for political power – to access the levers of public policy and government in an environment where there was no left political opposition in parliament.
So, from 1987, a path was created by all political-economic actors that prioritised giving workers more spending power through reductions in income tax in exchange for wage restraint. Political decisions were aimed at market friendly policies to encourage inward investment for job creation. From 1987-1994 Ireland experienced 'growth without jobs'. Trade unions used the political process of social partnership to prioritise employment with successive Fianna Fáil governments. In 1992 Fianna Fáil entered a government with the Labour party – a coalition which lasted only two years. From 1994-1997 a new coalition emerged that included Fine Gael, Labour and the Democratic Left. Given that Labour were already in government this enabled them to increase their bargaining power when it came to the distribution of ministerial portfolios. To date, this is the only left leaning government Ireland has had in its contemporary history.
It was within these few years that Ireland's 'Celtic Tiger' labour market was established. It was premised on active industrial policies to support export led growth (i.e. making stuff), premised on low corporate taxation and average levels of income tax. It was, in comparative terms, quite sustainable. In 1992 Ireland voted in favour of the Maastricht Treaty. This treaty changed the European project from one premised on political-economic integration to a project of market liberalisation based on capital, service and labour mobility. Maastricht completely changed the rules of the game facing national governments. All economic policy decisions were focused on 'supply' and not 'demand'. Governments were allowed develop policies to supply increased education, R&D and skills to the economy but limited in their capacity to create demand for jobs.
During the years 1994-1997 Ireland managed this constraint relatively well and experienced what can only be described as a jobs miracle: investment in education increased the overall skills profile of the workforce, active state policies encouraged productive investment and balanced fiscal policies avoided the over-heating of the economy. It was a 'soft' social democratic compromise conditioned by the new reality of Maastricht. The main driving force behind this brief period of political-economic change was the workforce; skilled labour and productive enterprise.
Everything changed in 1997 when a new Fianna Fáil-PD government came to power. This election fundamentally altered the political-economic landscape. The main driving force behind the economy was no longer the workforce but cheap credit. It was not production but consumer-domestic demand. Within a few months, the new Finance Minister (Charlie McCreevy) slashed capital gains tax in half - to a hugely positive media reaction. For the next four years income tax was slashed. The National Wage Agreements were based on wage restraint for tax cuts – something the trade unions have to take some responsibility for. That said, each budget gave away three to four times more in tax concessions than was outlined in social partnership agreements. The policy was: give people back their money and encourage them to spend it on stuff they don't need.
By 1999 Ireland was gearing up for entry into the EMU, and the Euro was adopted in 2000. Once we entered the Euro it was party central for those who could access international credit markets. The Euro opened up a huge reserve of low interest rates and cheap credit for the Irish economy; the total opposite of what was required. This was the end of developmental industrial policies aimed at generating a social democratic economy. Ireland evolved into a country addicted to cheap credit and government fiscal policy incentivised business to channel money into unproductive activity - real estate, banking, finance and property. The European Commission barely noticed. In fact, they welcomed Charlie McCreevy with open arms when he was sent packing to Europe; making him the Commissioner for Internal Market and Services portfolio from 2004-2010.
After Ireland's entry into the Euro (post-2000), a colossal credit driven property boom emerged in the domestic economy. Irish banks borrowed billions from European banks awash with surplus capital deposits. This small island on the periphery of Europe (amounting to less than 1.8 per cent of EU GDP) was able to access a sea of money without any exchange rate restrictions. From 2003-2007 the net foreign liabilities of Irish banks went from 10 per cent of GDP to almost 70 per cent of GDP. Irish banks were borrowing and lending cheap money to developers and consumers that amounted to quadruple the public-capital spending programme. Government policies fuelled this ecstasy of consumption by encouraging more money into the economy. The labour market and skill portfolio of Irish workers changed rapidly. Construction and domestic services boomed.
Another big change occured in 2003, when Ireland, Sweden and Britain opened their labour markets to the new EU accession countries (from Central and Eastern Europe). Inward migration soared and produced a net positive cultural impact. Economically it was a disaster. More houses were built to support a growing workforce building the same houses. All of the focus was on the domestic economy and it created significant structural tensions between the service, construction, manufacturing and public sectors.
In this flood of money people didn't know what to do with themselves; flat screen TVs, new cars and properties in Bulgaria were coming out their ears. It was surreal, and no doubt sociologists will come up with interesting theories to explain the irrational exuberance an over-supply of money can induce. It incentivised greed, short-termism and outright stupidity. Groupthink kicked in and anyone who dared critique Ireland's growth model was dumped into the looney-left dustbin.
Everyone knew our public services, particularly our health services, were not fit for purpose. Yet, as long as the money kept flowing, as long as disposable income increased, the electorate continued to support and vote in successive FF-PD governments. The boom years left Ireland addicted to foreign-financed credit. The economy was not growing; it was high on cheap money. The political system never internalised the constraints of the EMU. Even though Ireland had limited capacity to manage its macro-economy in an integrated Euro-global market it still had control over fiscal and labour market policy; both were used to fuel an asset price bubble rather than to generate the seeds of a highly skilled, high wage democratic industrial economy.
In 2008 the Irish nation gradually woke up to the reality of its self-indulgence. It took another 24 months for the hangover to wear off, and with that the realisation that the Nurofen we gave to the banks the night before didn't really work kicked in. A recognition slowly dawned that decisions made were going to have lethal and long term consequences. There was a gradual realisation that the banks flooded the economy with cheap money; that people sucked it up and wasted it on cheap imports and overpriced houses; that our much lauded 'entrepreneurs' were property speculators, not wealth creators; that our media rescinded its responsibility and turned into a forum for self-congratulating wannabe celebrities; that our aesthetic culture evolved into a vicarious reality TV show; that our politicians stoked the fire with classic gombeenism in a political system not fit for purpose. The sociological implications of this period provides a reservoir of material for anyone with a critical mind.
We need a real analysis of Ireland's irrational exuberance and a real debate on the type of political economy we want our institutions to support. There is a real danger that a hungover Irish society will turn to the benevolent technocrats of the EMU-IMF like a patient to a doctor looking for anti-depressants to solve a self induced problem. In 1987 a liberal-market PD party emerged and became incorporated into Fianna Fáil. This subsequently changed the political-economic landscape of Ireland as we know it. Is it realistic to think that a left-social democratic alternative could emerge in 2011 to act as a counter-power to this real and present danger?
(Image top - Linda Kavanagh. See more here.)
This piece was originally published on Aidan's blog, here.