The Fall of the Celtic Tiger: Ireland and the Euro Debt Crisis, by Donal Donovan and Antoin E Murphy, Oxford University Press, 318 pp, ISBN 978-0199663958
The foul-mouthed taped conversations between senior executives of Anglo Irish Bank published in the Irish Independent in July of this year remind us that as Bob Dylan sang “Money doesn’t talk, it swears.” Irish taxpayers will be paying the debts of Anglo Irish and Irish Nationwide for a generation, yet five years after the collapse of those rogue banks no comprehensive inquiry into how they were enabled to behave as they did has been held. The government has promised that an inquiry will soon be established but must first settle a petty squabble over which Oireachtas committee will hold it. It is very unlikely that any inquiry will add much to what we already know. Brian Lenihan, the minister for finance who foisted the debts of the banks onto the shoulders of the taxpayers, is dead. Jean-Claude Trichet, the president of the European Central Bank at the time of the bailout, who is believed to have coerced Lenihan into transforming the debts of the banks into sovereign debt, cannot be compelled to give evidence to an Irish enquiry. Like so many previous inquiries, one on banking is likely to be another futile exercise in barrister enrichment.
If a banking inquiry is held all members should be required to read The Fall of the Celtic Tiger by Anton Murphy and Donal O’Donovan, which is the most comprehensive and penetrating analysis of the catastrophe that befell the Irish economy, beginning with the near collapse of the banking system in September 2009. To understand why the Celtic Tiger collapsed it is necessary to understand whence this strange beast sprang and the book begins by outlining the background to the astonishing levels of economic growth achieved in Ireland in the period 1994 to 2004. While opening to trade from the 1960s onwards and joining the EU had improved economic performance, Ireland lagged behind other small open economies until the 1990s. The first phase of the Celtic Tiger era, from the early 1990s until 2004, was based on our ability to attract high-tech industries, particularly in information technology and pharmaceuticals because we had a relatively well-educated English-speaking labour force, low corporation tax and, perhaps most importantly from the point of view of the US multinationals, were part of the Single European Market. The new knowledge-based industries allowed Ireland to leap from being a predominantly agricultural economy with a number of relatively low-tech manufacturing sector to being a high-tech economy within twenty years.
The first phase of the Celtic Tiger, from 1994 to 2004, was based on exporting goods and services, which is the only path to prosperity available to a small open economy. By 2000 Ireland had high growth, low unemployment, a budgetary surplus and a low and falling debt to GDP ratio. This happy state seemed threatened by the collapse of the dot.com bubble, the shock of 9/11 and their effects on global investment and growth. Property prices, which had been rising steadily from the mid 1990s, stalled in 2001 and would have reached a stable equilibrium had the government not intervened. But in the 2002 Budget the property industry was given major tax concessions and from 2002 to 2008 much of the growth in the Irish economy was based on the building industry, which grew to an incredible 13 per cent of GDP when the average for the rest of the EU was about 5 per cent.
The property bubble was facilitated by the banks which, following Ireland’s adoption of the euro were able to access the vast pool of money from European financial markets. Panicked by the growth of Anglo Irish Bank’s property lending, the formerly staid AIB and to a lesser extent the Bank of Ireland rapidly increased their lending to the property sector. The banks became ever more reliant on short-term wholesale funding and the ratio of loans to deposits soared. By 2006 the total loans of Irish banks to property developers exceeded their total deposits.
O Donovan and Murphy pose the question of why nobody shouted stop and answer it convincingly. From the 1970s onwards, new macroeconomic theories were developed called the New Classical Macroeconomics (NCM). These theories rejected Keynes’s assertion that market economies are inherently unstable, lurching from boom to bust and that government intervention is needed to stabilise them. According to the Efficient Market Hypothesis (EFH), all consumers are rational with perfect foresight and all markets incorporate all information needed to establish equilibrium prices. The absurdity of these theories were apparent to everybody with any experience of markets yet most economists accepted them and some received Nobel prizes for inventing them.
If the EFH is valid, regulation is unnecessary. In the USA the laws regulating banking introduced in the wake of the Great Depression were repealed following lobbying by the banks themselves, who argued that they were unnecessary as they had sophisticated models analysing risk which would ensure stability. The European Central Bank also operated on the basis that the EFH was valid and its only priority was avoiding inflation. Regulation was left to national institutions and in Ireland the regulatory function was removed from the Central Bank and given to a financial regulator. The regulator adopted “light touch regulation”, partly in order to entice global financial institutions to locate in Ireland. Light touch regulation became no regulation. The Nyberg report on the banking collapse argues that only a regulator without “either relevant experience, training or historical knowledge” could have dismantled traditional prudential safeguards. This is what occurred in Ireland after we joined the euro. It is significant that neither the governor of the Central Bank nor the Financial Regulator had qualifications in economics or finance or experience in banking. Both were generalist bureaucrats promoted on the basis of “Buggins’s turn”.
This book argues that the regulator and the Central Bank were not the only institutions that failed to perceive the dangers facing the economy. Most economists and financial journalists were cheerleaders for the boom and those who raised warning voices were shouted down. When Prof Morgan Kelly published an article in The Irish Times in 2006 arguing that a property market and banking collapse was imminent, the banks contacted UCD demanding that another economist refute his arguments. It was Morgan Kelly, George Lee and David McWilliams that Bertie Ahern had in mind when he suggested that economists who were predicting economic collapse should kill themselves.
While most public anger about the collapse has focussed on the irresponsible behaviour of the banks and the placing of the burden of rescuing them on the shoulders of the taxpayer, O Donovan and Murphy point out that even had the banks not collapsed, Ireland would have faced a fiscal crisis when the building boom ended. The huge increases in government spending from the late 1990s onwards were funded by the taxes raised from the property sector, particularly stamp duties and capital gains tax. A downturn in the construction industry would inevitably lead to a sharp drop in revenue from these taxes. The peculiar nature of the Fianna Fáil/PD government led to reductions in income tax accompanied by increases in government spending, particularly on public sector pay. To buy industrial peace from the public sector unions, governments had increased pay in return for very limited and in some cases non-existent increases in productivity under “benchmarking” deals. The attitude of the public sector unions was exemplified by Joe O’Toole, head of the primary teachers’ union, who stepping off his cruiser on the Shannon said that the ATM machine was stacked up and would spew out whatever pay increases teachers demanded. Two-thirds of the increases in educational spending between 2000 and 2010 went on teachers’ pay. This spending did not result in improvements in educational attainment. There has been a sharp drop in reading and mathematical skills in Ireland compared with other developed countries and the international rankings of Irish universities have fallen significantly. Most of the increase in spending on health also went on pay, resulting in Ireland having some of the highest-paid doctors in the world and a ramshackle and inequitable healthcare system.
When the US government allowed Lehmann Bros to collapse, the resultant turmoil led to huge withdrawals of money from the Irish banks. Faced with the possibility of a continuing run on banks, the government, on September 28th, 2008, guaranteed all their liabilities. At the time of the guarantee, the government believed that the banks faced only liquidity problems (not enough cash to meet everyday demands) when in fact the banks were insolvent, in that the value of their assets was less than the value of their liabilities. It soon became apparent that all the banks were insolvent and would need huge capital injections to stay afloat. O Donovan and Murphy conclude that the bank guarantee was the “least worst” option in that allowing any bank to fail would have led to the collapse of the banking system, with catastrophic consequences for the economy. While most economists would agree that it was necessary to guarantee the depositors in Allied Irish Bank and Bank of Ireland, it is questionable whether it was essential to guarantee Anglo Irish, which could have been wound up without fatal consequences for the Irish banking system. Though the collapse of Lehmann’s was the immediate predicating factor in the Irish banking crisis, the collapse was inevitable when the property bubble burst because of the huge exposure of the Irish banks to property loans
Over the next two years tax revenues collapsed and despite sharp reductions in public spending, the budget deficit and government borrowing rose to unsustainable levels while the cost of the bank rescue rose from week to week as the extent of the banks’ losses on property-related loans escalated. By autumn 2010 the ECB was so concerned about the Irish crisis and its implications for the ECB itself, which had become the main provider of liquidity to the Irish banks, that Ireland was forced into accepting a bailout from the ECB, the EU and the IMF. As the authors point out, laments over the loss of sovereignty involved in accepting the bailout are misplaced. The budgetary excesses of the years 2000 to 2008 and the massive foreign borrowings of the banks were what led to the need for the bailout. The argument that senior bondholders in the banks be forced to take losses had some validity in that while Irish banks had borrowed irresponsibly, the bondholders had lent irresponsibly. But the US supported the ECB in insisting on all bondholders being paid because if they were not, a domino cascade of losses would have occurred in the global banks.
As so many people suffer the consequences of the fall of the Celtic Tiger, including many who benefited little from the boom, it is natural to seek to assign blame to individuals and institutions. The book points out that at the political level, the irresponsible budgetary policies pursued by the Fianna Fáil/PD governments were partly to blame for the crisis but the Fine Gael and Labour parties too had promised more spending and lower taxation in the 2007 election and presumably would have delivered them if elected. The authors are rightly critical of the Department of Finance, the Central Bank and the Financial Regulator for failing to monitor the banks more closely and failing to warn government more trenchantly of the possibility of disaster. The authors do not spare their own profession of economics for its uncritical acceptance of the absurd Efficient Market Hypothesis and their neglect of macro/monetary issues after Ireland adopted the euro.
O’Donovan and Murphy in a concluding chapter argue that the Irish economy and Irish society have underlying strengths that will ensure economic recovery. This is a very sanguine conclusion in view of continuing high unemployment (which would be higher were it not for levels of emigration comparable to the 1980s), very low growth and the need for many more years of “austerity”. While inward foreign investment remains strong, all of this is in areas that require small numbers of highly skilled workers, a significant number of whom will not be Irish due to our failure to produce enough graduates in ICT.
The most dispiriting aspect of the crisis is the failure to implement the radical political, economic and administrative reforms that would make Ireland competitive in the way that other small open European economies are competitive. As the date for the departure of the troika draws near, there is a feeling in political circles that the need to take any radical ‑ and consequently unpopular ‑ actions can be indefinitely postponed and that we can return to the debased clientelist policies which have hobbled economic and social development since independence.
Sean Byrne lectures in Economics at the Dublin Institute of Technology. His main areas of interest are International Economics and Globalisation.