Wednesday, February 17, 2010
I have held up Ireland as an example of successful economic growth, having averaged 7% a year from 1990 to the start of the present recession. Now their "bubble" has burst & it is widely thought of, not least by the Irish themselves, as having been a mirage. This letter appeared on Jerry Pournelle's site & I wish to give my opinion.:
The early stages of the Irish Celtic Tiger boom were certainly built on export growth. At the height of the boom Ireland was the largest exporter of software in the world (India was second). Intel, Dell, HP, Google, Microsoft, Apple and PayPal, amongst others, all had significant presences here and still do, with the exception of Dell.
However a funny thing happened on the back of all the export growth. Wages went up and interest rates dropped to very low levels. In addition the banking market opened up here and so 100% mortgages became much easier to get. In some cases it was possible to get 110% mortgages for a new property. Also, the government offered significant tax incentives to developers to build in certain areas of the country. Finally, property here is only taxed when it is sold, in the form of a stamp duty on the sale. In addition a capital gains tax is payable on the profit made from selling any property that is not one’s personal private residence. So, you had a workforce with rising wages and access to cheap money, builders incentivised to build and a government incentivised to encourage building because it collected taxes on each transaction. The consequence was a huge increase in demand for property and a consequent inflation of property prices.
The resultant property bubble can be illustrated as follows: A developer decides to build a new housing estate in three phases. Let’s say phase one is sold for €500,000 per house. Typically phase two will sell for €600,000 and phase three will sell for €700,000. During the property bubble phase three houses would sell just as quickly as phase one. An astute buyer could buy a phase one house for €500,000 but not transfer title to their name. When phase three was released at €700,000 that buyer would put their (never occupied) house back on the market at €650,000. They were guaranteed an instant profit of €150,000 with minimal tax implications because title for the property would transfer directly from the developer to the eventual buyer. My figures are probably not quite right but this sort of thing went on all the time: It was a Ponzi scheme. Despite these tax dodges the government raked in huge amounts of money and there was no incentive to slow the market down. The government used the extra cash to expand the public service sector. Notably, funding to the public health service doubled but I for one cannot see any increase in efficiency or improvement in patient service. Iron Law, anyone?
So, at the height of the bubble the banks were lending stupidly large amounts of money to both developers and private buyers who had no hope of paying back the loans unless the bubble continued. Of course it didn’t. Once the subprime crisis in the US started, the exposure of the Irish banks became obvious. The banks very quickly stopped lending but were still left with exposure to a whole bunch of loans that couldn’t be repaid. In late 2008 we came within 12 hours of a total banking collapse with a subsequent exposure of €400 billion. That’s half a trillion dollars and it’s a lot for a small country with a population of less than 5 million. Luckily the collapse didn’t happen but right now the government is buying up €50 billion in bad loans from the banks in the hope that they will start lending again. However it won’t work as the banks desperately need to recapitalise so they are pocketing the money from the government and are not lending to anyone. Worse still, the banks are likely to go cap in hand to the government looking for more money to recapitalise. Meanwhile the government is having to contend with an overpriced public sector and also nearly half a million unemployed people.
Are we in a death spiral? Not yet, but we are perilously close. Tax revenue is still dropping and unemployment is still rising. While both trends are slowing down they need to reverse, and soon. The cost of unemployment benefit is approaching €100m per week. We can’t raise taxes because salaries are dropping. The banks won’t lend money to keep small businesses going. Currently we are very exposed to Greece going down as the market will almost certainly come after Ireland next. If we were outside the Euro we could devalue our currency but that’s not an option. Finally, no-one has a clue how to get half a million people back to work. And the reason we’re called PIIGs is probably because we’re up to our ears in the brown smelly stuff.
Watch this space.
I feel the disappointment with the Celtic Tiger is greatly overblown. There is considerable schadenfreude among economists, politicians & the anti-free market ruling class in the rest of Europe who did not manage to get their economies into the same happy state of growth & had thus been predicting, for at least a decade, its imminent collapse. Their joy is clear because it alleviates them from having to explain to their own people why they couldn't.
However It should be remembered that Ireland went from 2/3tds to 4/3rds of British per capita GNP by achieving an average 7% growth (we managed 2.5%, usually). Their economy has now declined by 12.4% over the last 2 years whereas Britain's has fallen 4%. However we are borrowing money at 12.5% of GNP annually while Ireland is making strenuous efforts to balance its budget. Without that artificial stimulus we would therefore be in a similar position, as would the USA & many other countries.
Ireland's growth to a point where it matched the per capita income of the USA was not a bubble. It was achieved by cutting corporation tax to 12.5% & cutting regulations, particularly those on housebuilding. It achieved nearly 20 years of growth which is longer than bubbles last. If there was some overselling of houses - well so what - they are now in a market correction but it will correct itself. The fact is their government is solvent, at least by comparison to ourselves, its markets are free and its taxes are low. All this suggests it will be back into growth before us.
A problem they do have is that they are part of the Eurozone whose value is run in accord with the needs of all the Euro economies of which Ireland as a very small part indeed. That meant they couldn't earlier set interest rates at a level which would discourage housebuilding speculation & they can't now allow their currency to fall, as Britain & America's is. They would be better off out but that is their decision & while it makes the process of cutting government spending much more painful than it need be it does not affect the underlying strength of the economy.
The one place where Ireland's economy is in danger & which is not discussed, is their energy supply. They have gone hysterical about nuclear, partly because the English plant in Sellafield across the Irish Sea makes it patriotic to be anti-nuclear & partly because it is generally fashionable (remember Ireland fashionably led off in Europe in making smoking in public places illegal). At present they produce $7.75 of GNP per kwh of electricity. This is the highest ratio of any developed country (Britain is 3rd at $6.14) & it is likely to get worse because part of their power comes from the Hunterston nuclear power plant in Scotland which is being extended beyond its official retiral age. When Britain faces blackouts it looks unlikely we will be willing to export electricity there. That could, of course, be settled by Ireland by making a decision to go nuclear or even expand their conventional power. Indeed seeing how well they have done with that much power shortage already it is clear they have the potential to grow even faster than they have been doing.
So do we if we adopt the policies that have worked there.
Jerry Pournelle has also reprinted this as part of the ongoing discussion. He conclude in response to my last paragraph that
Cheap energy plus freedom equals prosperity.which covers it succinctly. I wish most Nobel prize winning economists knew as much.
Who is this "their", I wonder?
Their decision unless they make the wrong one, I think, in which case they are sent back to try again until "their" decision comes out right.
Still and all, at least they get to pretend to make the decision themselves, which is more than we have been allowed.
In every other respect I think you are pretty much spot-on, thank you!