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Ireland's pain: Multiply by 10

Stephanie Flanders | 12:20 UK time, Wednesday, 24 November 2010

In these days of financial crisis, we're bombarded by bad news with a lot of zeroes attached. Sometimes it's difficult to keep track of what it means for ordinary people - and the economy of which they are a part.

Ireland's crisis is a case in point. Now we know it's in line for an 85bn euros rescue package - conditioned, in part, on a 15bn euros programme of further budget cuts by the Irish government which we'll be hearing more about this afternoon.

If you live in Britain, you will understandably be wondering what these numbers actually mean. But here's a good place to start: take every number you hear later today from the Irish finance minister and multiply it by 10.

This year Ireland's national output, or GDP, will be around 160bn euros. As it happens, Britain's GDP will be about 1,600bn euros so that 15bn euros in cuts would be more like 150bn euros - or £126bn - if it was happening in the UK.

Put it another way: today's 15bn euros in cuts represents a tightening of just over 9% of Ireland's national output over four years. For reference, the UK government is planning to reduce structural borrowing by around 8% of GDP over five years from 2010.

So, you might say, this is not so different from Britain's own austerity. But remember, Britain is just starting its fiscal tightening. Ireland's "era of austerity" started more than two years ago.

The government here has already cut spending or raised taxes by 15bn euros in the past two years. In the teeth of the steepest recession in Europe (see chart below), it has already done more tightening in the past two years than the British government is planning to do in the next five. And now it is promising to do the same again, by 2014.

Chart showing output loss

In fact, it's even worse than that. In discussing Ireland, most economists - and certainly all international organisations like the IMF - tend to emphasis GNP, not GDP, because the earnings of foreign multinationals account for such a large share of Ireland's national output. So, whereas GDP this year will be around 160bn euros, GNP will be closer to 130bn euros. So that 15bn euros in cuts will feel more like 11% of national income than 9%.

It was a global curiosity when Brian Lenihan unveiled a major austerity budget in the spring of 2008, just as pretty much every other country in the world was lurching toward fiscal stimulus (remember the London G20?) The feeling was that Ireland's enormous banking woes had left it no choice.

But optimistic souls talked about the possibility of an "expansionary fiscal tightening" - the idea that budget cuts would do so improve Ireland's standing in global financial markets and the confidence of the private sector that they might actually support growth, and hasten the end of Ireland's recession. (Incidentally, George Osborne used to talk about it as well.)

You don't hear much of that talk today. The government is forecasting average growth of 2.75% a year between 2011 and 2014, but in their summer staff report, the IMF thought even that could be optimistic - and their forecasts back then did not take into account additional bank bailout costs in 2010 of 20% of GDP.

In that same report, the IMF suggested that of all the 30-odd countries it monitors closely, Ireland was most at risk of suffering from outright deflation (see chart below). That risk, too, must surely have intensified as a result of the events of the past few weeks.

Chart showing deflation vulnerability indicator

People here still believe in the euro. Certainly, being in the single currency area - with a "one-size-doesn't-really-fit-any" monetary policy - helped magnify Ireland's boom. As has been written many times here, it also made it easier for the rest of Europe to lend the Irish private sector an extraordinary amount (see chart at end of this post).

Now the euro is magnifying Ireland's bust, because to make an export-led recovery remotely plausible, prices and wages have to fall instead of the currency. Unemployment in Ireland has risen from 4% to more than 13%. The IMF don't expect it to fall much below 10% between now and 2015.

In today's FT, Martin Wolf argues [registration required] that Ireland's experience shows the "German" approach to monetary union is fundamentally misconceived. That is for others to judge. But it has certainly not been a recipe for "no more boom and bust". The currency has been stable - but very little else.

Having ridden the roller-coaster up, now Ireland has to ride it down. The official IMF assessment is that Ireland is embarked on a prolonged period of "internal devaluation" to rebuild competitiveness within a single currency. The clever economists at the Fund may be able to tell the difference between that and a Japan-style scenario of stagnant real incomes, high unemployment and deflation. I doubt that many Irish voters will.

Chart showing firms debt burden

Update, 12:30: I see the ratings agency Standard and Poor's has similar fears for Ireland's economy, which partly explains their decision to downgrade Ireland's sovereign debt, yet again. Here's a few nuggets from today's press release:

"As a consequence of the high overhang of private debt, fiscal austerity, and the uneven outlook for external demand in Europe, Standard & Poor's now expects close to zero nominal GDP growth for 2011 and 2012. We do not envisage GDP exceeding 2% a year in real terms before 2013."
 
"While export performance is forecast to remain firm over the medium term, we are of the further view that domestic demand will most probably stagnate, thwarting any immediate recovery in tax revenues.
 
"In our view, downside risks of deflation remain. These depend partly on the external environment and the speed with which the financial sector can recover sufficiently to contribute to the economy again. Meanwhile, uncertainties surrounding the timing and extent of imposed burden sharing by EU institutions have raised refinancing costs. In our opinion, these refinancing costs are likely to remain high until investors perceive the forecasts for primary fiscal balances as much improved."

 

Of course, the value of the assets sitting on the banks' balance sheets will be affected by the state of the property market and the overall economy. So will the state of the budget. It's a simple point but an absolutely crucial one. If the economy doesn't get better, then neither will the banks or the national budget. Right now, international markets don't seem to have much confidence in any of them.

Comments

  • Comment number 1.

    Stephanie

    I find it hard to believe that most economists and the EU are pushing for an Irish bailout. If the EU / IMF bailout of €85 Billion is passed then Irelands sovereign and banking debt will stand at approx €345 Billion. On average Ireland may have to pay back at a rate of 5% which may equate to approx €15 billion per year interest alone. As a proud Irishman (ashamed at the same time) I believe Irelands only recourse is to default. A default is our only way forward so why cannot Europe and the IMF agree to this?

  • Comment number 2.

    I have one question, are they or are they not going to have to raise corporation TAX.

  • Comment number 3.

    Stephanie schadenfreude is not appropriate!

    We (in the UK) need to urgently look to our own debt crippled economy. We are ourselves very near an economic tipping point.

    So far as I can ascertain none of the stress test done on the British banking system can sustain the inevitable downwards valuation of assets that must happen. (Indeed had to happen from 2003 onwards.)

    Our 'wonderful' 'strong' banks are in fact hollow debt crippled mice being kept alive on the life support of free money from the Bank of England (who itself created the problem!)

    WE have to get UK property prices down to at least as low as Irish and US levels for the country to be able to compete internationally - the more their property prices drop the further ours must drop. When this inevitably happens what of our entire financial system! Further more as the UK is so 'strong' as a centre of international banking the falls overseas will also cripple the UK banks - just look at the 150 £bn 'investment' in Irish banks by RBS.

    We must take the hit, get our property prices down to a competitive level, bail out the small savers, recapitalise our banks and force the sale of assets secured on non-performing loans. If we do not do it now the IMF will force us to do so very soon. This is a prerequisite for a stable economy and potential recovery.

  • Comment number 4.

    1. At 1:04pm on 24 Nov 2010, dmcallister5 wrote:
    =========================================================================
    If Ireland default then it will start a domino effect with the other PIIGS, also it will critically effect Ireland's standing in the international community. The later could hang around their necks like the proverbial mill stone for decades to come. Lets face it Iceland are still having to take IMF loans and their finacail institutions have no credibility on the international markets and they did not even default although they did toy with the idea.

  • Comment number 5.

    " The official IMF assessment is that Ireland is embarked on a prolonged period of "internal devaluation" to rebuild competitiveness within a single currency

    Real world translation.....They are all about to get a hell of a lot poorer.

  • Comment number 6.

    Ireland should not accept the bail out - go bust Ireland, go bust - default.

    #1 - I just posted this on Peston's blog but perhaps 'What if?' scenarios are more Stephanie's style - require a bit of thought and some figures to support - could we have an article please Stephanie?

    'I think everyone must be more desperate for Ireland not to default than Ireland is.

    Could we possibly have some analysis of a what if? nature?

    Take the two main scenarios - default or rescue package - roll forward 10 years and compare and contrast Ireland in 10 years time under either scenario.'

  • Comment number 7.

    Stephanie, this is very embarrassing for the Irish government, especially since they played by the rules of the Eurozone. We understand why Greece needed the bailout, but not Ireland.

    However, this is more political than economical.

    This is about the European Commission and ECB running scared about the possible contagion effect across the Eurozone. This has more to do with the cost of borrowing in Portugal, Spain and the other Eurozone countries, than Ireland.

    The eurocrats in Brussels don't care about some English speaking island in the Atlantic going bust. Ireland can be sacrificed for the greater good.

    What they do care about is keeping mainland countries in Europe afloat, and supporting their ever increasing EU budget.

  • Comment number 8.

    Is €85 billion going to be enough?

  • Comment number 9.

    Stephanie,

    I would like you to explain the causes of crises.
    The different theories out there.

    Something a bit more scientific than 'Animal spirits', 'silly bankers', 'silly borrowers', etc.

    What's your view?

  • Comment number 10.

    I think that a lot of the reporting on the BBC seems to focuss on what is going wrong within the Euro zone while your own position is much worse than like for example Germany or my country Holland. Of course there is a crisis but compared to many of the Euro countries the UK's is much worse. The way you report seems almost to express a desire for a failing of the EU.Very strange indeed.

  • Comment number 11.

    Stephanie
    I am glad that you are now catching up with the analysis that has been on some of the better economics blogs for quite some time now. Unfortunately the arithmetic does not favour Ireland and those same blogs are questioning as to whether the bailout can ever suceed.

    As to your blog I still recall your statement from eleven months ago

    "I don't think that the likes of Greece or Ireland - or Spain - will default on their debt, or even come close."

  • Comment number 12.

    Phew...it's a good job that it can't happen here.

    Loved the bit about the "Stability of the Euro". It has indeed done what it said on the tin. It's just that everything around it i.e. growth, jobs, social justice, going to hell in a handcart

  • Comment number 13.

    Seems an opportune time to look at Argentina now?

    http://www.bbc.co.uk/news/business-11764535

  • Comment number 14.

    #3. John_from_Hendon
    You are calling for property prices to fall in the UK to the same level as Ireland/US as a prerequisite to recovery in the UK.
    This is an interesting suggestion perhaps you could explain the analysis that has led you to this conclusion and how you anticipate the major pension funds( already in deficit) , Banks , gilts, sterling and UK GDP would all be affected??

  • Comment number 15.

    Ireland is bankrupt, a fact which no conceivable amount of bail-out money is going to change. Partly this is because of irresponsible lending by banks, but it's equally a reflection of irresponsible borrowing by businesses, principally property developers. Yet the substantial private assets of the promoters of such companies sit behind the shield of limited liability. Is this right?

    Realistically, the only way out for Ireland is partial default (a "haircut"), probably combined with leaving the eurozone.

    One can only hope that the politicians, bankers, property developers and similar who caused this mess will be identified in a public inquiry. Ordinary Irish people did NOT cause this, but they will be paying for it for decades, which is grossly unfair.

  • Comment number 16.

    IS 85biliion going to be enough? Probably not: Irelands total external debts are 1.2 trillion Euros (that figure includes bank and sovereign debt) I understand they are going to pay 7% interest for most of the 85 billion `facility` which is almost 6 billion p.a in extra interest alone. They are goint to need a full Sovereign bail out by Q2 or Q3 of next year. The 85 billion just buys a little time, while the markets move on to Portugal and Spain. Portugal is already assumed to be bust, Spain perhaps not. The BIG problem for spain is that it has a vast mortgage market which is in dire straits. If Spanish Bond Yields rise above 5% that will be the signal that the market has lost confidence.

    What a farce the European Bank stress tests have proved to be. So many bad lending descisions, suck lax capital adequacy. Now the taxpayers and savers of Europe will foot the bill.

  • Comment number 17.

    Paul Krugman blog today: "Oh, and while the IMF is demanding that Ireland cut minimum wages and reduce unemployment benefits, its mission to Iceland praised the 'focus on preserving Iceland’s valued Nordic social welfare model.' What’s going on here? In a nutshell, Ireland has been orthodox and responsible — guaranteeing all debts, engaging in savage austerity to try to pay for the cost of those guarantees, and, of course, staying on the euro. Iceland has been heterodox: capital controls, large devaluation, and a lot of debt restructuring — notice that wonderful line from the IMF, above, about how “private sector bankruptcies have led to a marked decline in external debt”. Bankrupting yourself to recovery! Seriously. And guess what: heterodoxy is working a whole lot better than orthodoxy."

  • Comment number 18.

    Ah, the credit ratings agencies. Mrs Merkel and Mr Baroso have them in their cross-hairs. On 5 November 2010 the Commission published its consultation on kerbing their power in rating EU sovereigns : sovereigns to be given three days notice of a rating ; agencies to disclose all of their research and calculations ; enforced review of sovereign debt ratings every six months - all in addition to regulations coming in December to "regulate" their methods and standards and affirm civil liability to their actions.

    The noose tightens!

  • Comment number 19.


    We are all becoming frozen with fear ,knowing that the situation in Ireland is slipping out of control of the E C B.

    To default is the only solution for Ireland, but as always everyone is in DENIAL!!! Do it.. and lets move on to the

    final act of the curtain falling ... on the demise of the European Experiment.

  • Comment number 20.

    "WE have to get UK property prices down to at least as low as Irish and US levels for the country to be able to compete internationally "

    There is a fundamental flaw is that argument and it is entirely a function of demand and supply. We have a lot more people per acre (or hectare as I suppose I must use metric measures) than either Irish or US. Logically our land prices should therefore be higher

  • Comment number 21.

    The Irish Governments failure to raise corporation tax or amend the corporate tax regime is a failure. Even a modest change could have saved the poeple of Ireland from the worst of the hardship.

    Another example of political incompetence in a whole range of them for Ireland.

  • Comment number 22.


    It is increasingly incredible that this money-go-round of debt being taken on to finance debt can ever generate the income necessary to pay it all off.

    The current strategy appears to be little more than keeping the balls in the air long enough for massive inflation to kick in, by which time the professionals will have fled the scene with their profits - leaving the rest of us to deal with price inflation and falling wage (and unemployment).

    The problem is that it is the professionals who are calling the tune: dictating policy to Governments who seem wedded to the monetarist philosophy and economic policy instruments.

    A time will come, if it has not already, when Governments will have to re-assert their soverneignty over the markets and impose solutions by Regulation - nationalisation and so on. The only question is how low our economy has to be beaten-down before they get round to this, and whether the current crop of political leaders have the gumption to do it. If not, then maybe people will start to look for others who will.

    What's the betting on Sin Fein in the promised Irish Election: what's the betting on UKIP and the BNP in five years time?

  • Comment number 23.

    I strongly agree with dmcallister5. Ireland can't afford the cost of servicing the "bailout" loan on top of its other debts, especially if, as you suggest, deflation is on the cards. Default is the only option, which will probably destroy some US, UK, German, French banks. It is no wonder Mr Osbourne is keen to help out and the EU want Ireland to take more cash. It is really just to save their own interests. Unfortunately Ireland will ultimately have to default and this could lead to further economic woes around Europe (and the rest of the world).

  • Comment number 24.

    The net cause of the bubble still exists... House prices are hugely over inflated. That is why banks won't loan out money. They know that.

    The government (by the name of the Bank of England) can't keep putting it off... soon interest rates have to rise... we printed more money, inflation is rising, fuel is rising, rail fares are rising, the cost of living is rising... People already don't have enough 'disposable income', we have a whole world of hurt coming our way.

    A one percent rise on a mortgage of £150,000 mortgage is nearly £100 per month. (I see interest going up by 3% over the next few years) We need to reign in inflation and also house prices.

  • Comment number 25.

    #24 bankerbet - I don't see anyone reigning in inflation - this is the ticket out of here without anyone really noticing too much???

  • Comment number 26.

    #25 GRIMUPNORTH77 - you are probably right.

    Given the measly interest rates on offer for bank deposits and the possibility that banks will collapse - taking depositors money with them - it makes me wonder how long it will be before savers take money out of bank deposits and put in household safes or under the mattress. Maybe all it takes is for Mr. Peston to go on TV and talk about it.

  • Comment number 27.

    #14. tao-das précis: UK can have insane property prices and it all OK.
    #20. Justin150 précis :UK property prices are the result of supply and demand.

    Let me for the umpteenth time explain basic economics.

    If I employ a worker anywhere he gets paid, and out of his pay a substantial proportion is spent on somewhere to live. Are you with me so far. Now if somewhere to live costs double what it costs in one country compared to another then I have to pay the worker more. So the output a worker produces is far more expensive and so less competitive in a high property price country (the UK at present). Still with me I hope.

    Right it therefore follows that to be competitive house prices need to be roughly equivalent - all other things being equal.

    Let me turn to the nonsense about a 'housing market setting prices'. House prices are the direct function of the price of money and have very little to do in anything with demand of any sort in the UK as the demand is always and has always been higher than availability. Believe anything else and you are simply ignoring the blindingly obvious.

  • Comment number 28.

    "In these days of financial crisis"

    Stephanie,how does this square with your previous narrative of "continuing recovery"?

  • Comment number 29.

    27 John from H - Good analysis of the UK housing market. Way too much income is used to support unsustainable house prices and rents, and the rest of our economy suffers. There is no shortage of empty and derelict buildings in the North of the UK, but they need to be used for productive enterprise, not yet more housing where people do not have jobs to go to. The local economy of a place like Bradford is dire, and this is the future for much more of the UK unless we move away from our obsession with housing.

  • Comment number 30.

    27. At 7:27pm on 24 Nov 2010, John_from_Hendon wrote:
    #14. tao-das précis: UK can have insane property prices and it all OK.
    #20. Justin150 précis :UK property prices are the result of supply and demand.

    Let me for the umpteenth time explain basic economics.

    If I employ a worker anywhere he gets paid, and out of his pay a substantial proportion is spent on somewhere to live. Are you with me so far. Now if somewhere to live costs double what it costs in one country compared to another then I have to pay the worker more. So the output a worker produces is far more expensive and so less competitive in a high property price country (the UK at present). Still with me I hope.

    Right it therefore follows that to be competitive house prices need to be roughly equivalent - all other things being equal.


    ===================

    The key phrase here being "all other things being equal"

    All other things are not equal and never will be in a complex system. Yes our property costs are higher but other countries have similar disadvantages for other things (health care costs in US would seem to be good example).

    You are also forgetting the theory of comparative advantage.

    Short of either killing 50% of the British population or creating out of thin air several hundred thousand acres of new land you are never going to get to a situation where we have roughly the same number of people per acre as US or Ireland. Simple economics tells you that this will result in one of two things (or more usually a combination of both) higher prices for property in UK than in US or Ireland or smaller properties in UK compared to elsewhere (Japan and HK are classic examples of the smaller property concept).

    My problem with the UK housing market is two fold. Firstly everyone keeps calling their house an investment - it isnt it is a home. What my house is worth is completely irrelevant I need a house for myself and my family, how much is costs to keep that house is what is relevant. This leads me onto my second problem with UK housing market. Everyone wants to buy (because a house is an "investment"). There is nothing wrong with renting and as a nation far far too few people rent

  • Comment number 31.

    27. At 7:27pm on 24 Nov 2010, John_from_Hendon wrote:
    Let me for the umpteenth time explain basic economics.
    Let me turn to the nonsense about a 'housing market setting prices'. House prices are the direct function of the price of money and have very little to do in anything with demand of any sort in the UK as the demand is always and has always been higher than availability. Believe anything else and you are simply ignoring the blindingly obvious.
    ==================================
    So John, how do you explain the fact that house prices are falling although the price of money remains at its lowest level since records began?

  • Comment number 32.

    pedants corner...
    may I just clarify
    reign is what the Queen does
    rain is what falls out of the sky wetly
    rein is what is used to control horses
    So if we are to rein in bankers, oirish or anything else let's be careful out there.

  • Comment number 33.

    @31 "....So John, how do you explain the fact that house prices are falling although the price of money remains at its lowest level since records began?...."

    Interesting isn't it. Bank rate at 0.5% should have started such a stampede for loans you would be foolish to stand in the doorway of any bank. The rate has been at an all-time low for over 18 months and T.C. Mits is paying off his debt, not increasing it.

  • Comment number 34.

    #31
    House prices are going to continue to fall for a long while yet, regardless of interest rates.
    When your banks are allowed (i.e. not regulated or controlled) to get super rich by lending the rest of us money that we have to work a lifetime to repay, then the price of money becomes irrelevant.
    What does matter is that the banks have now returned to lending against salary and built in deposits to make sure these new loans will have a chance of being repaid as interest rates (inevitably) rise and house prices (equally inevitably) continue to slowly fall. Oh, and they have found out the party is over – although somehow the bonuses remain.
    It's not rocket science - in 1998 the average house was just over 3x average wage, but by 2008 it was 7x average wage. A few bankers got super rich; the rest of us got super debt levels and overvalued houses. A few licks of paint shouldn't really have added £150k to my house over 10 years, even if they were nicer colours :)
    Re-balancing this has to take years - 50% house price drops to reflect reality and you are Ireland - at least years of inflation and slow house price reductions may feel less painful.
    Let's just hope someone in power has the courage to call the end to this crazy thought that the "markets" will sort it all out in some mystical way.

  • Comment number 35.

    @34 said " Oh, and they have found out the party is over – although somehow the bonuses remain."

    If the bonuses remain the party is still in full swing and it won't be over until the shareholders or the Government, or both , say it's over. Just can't see that happening any time soon. Maybe when the attention switches from Ireland to Portugal and Spain.

  • Comment number 36.

    30. Justin1350: "There is nothing wrong with renting and as a nation far far too few people rent"

    Apart from the fact that you are in effect paying the mortgage for the thousands of get rich quick BTL mortgages! Do you own your own house? Let me guess, you are happy to rent for 25 years paying so much rent (+insert tax list here) you cannot get a mortgage together. Then somebody says you need to move now, because you have paid off my mortgage and I am selling my house(s). Property portfolios: wake up!

    GB wanted to give tax relief on the damned things to offset the pension pillage! What a nice way to put an end to the property boom and bust - GB's first ever speech. The tories won't do any better of course.

    If you wish to live in a bubble - go ahead, tell us all that you have it figured out, as you know economics is simple. When you are squeezed hard assuming middle class please don't complain. If you are in the upper class then please don't dictate how things should be for those that are just trying to secure a roof over their own heads: TRUTH - house prices got silly (Tulip bubble anybody??). It was bound to end in tears, prices created winners and losers. Do you have a mortgage? If so why??? Please answer!

 

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