Ireland takes the pain

13 May 10
A while back, Ireland's economy was at risk of going the way of Greece. But drastic action to tackle the deficit – including public sector cutbacks – has begun to turn things around. Paul Gosling offers some lessons for the UK
By Paul Gosling  

13 May 2010

A while back, Ireland’s economy was at risk of going the way of Greece. But drastic action to tackle the deficit – including public sector cutbacks – has begun to turn things around. Paul Gosling offers some lessons for the UK

If you want to see the future for the UK’s public sector it is possibly written in events across the Irish Sea. Taoiseach (prime minister) Brian Cowen and his government have spent the past two years grappling with a fiscal crisis that could have brought the government to collapse. It might now be coming under control but at a painful cost to the country as a whole.

After a decade in which gross domestic product grew at 6% per year, the ‘Celtic Tiger’ collapsed in 2008. GDP fell by 8% last year and might drop by 14% over the period of the recession. Average house prices halved.  Tax revenues – heavily reliant on the property sector – fell by a third. 

Unemployment rose to 13.4%, causing big increases in welfare payments.

Ireland’s fiscal deficit as a percentage of GDP became the highest in the eurozone at 14% and was heading towards 20%. At this point, said finance minister Brian Lenihan, ‘the very financial survival of this country would have been at risk’. Only Greece – now being bailed out by the European Union’s eurozone countries and the International Monetary Fund – had a worse fiscal deficit.

Now – as a result of tough action ­proposed by a team of experts led by economist Colm McCarthy and accepted by the government – the underlying deficit has stopped getting worse. The austerity measures so far have involved more than e15bn in spending cuts – equivalent to £174bn in the UK (allowing for population differences and using current exchange rates). And the economic outlook for 2010 has ‘improved significantly’, says Lenihan. ‘Most commentators, including the Central Bank and the Economic and Social Research Institute, forecast positive growth for the Irish economy in the second half of this year,’ he adds. ‘Indeed, some analysts are forecasting that the economy returned to growth in the first quarter of 2010.

‘We have been commended by the ­European Central Bank, by [German chancellor] Angela Merkel and by everyone else in Europe for what we’re doing because we’re doing the right thing. And we’re restoring our economy to growth and confidence.’

Lenihan is open about further cuts being on the way, with the McCarthy report – properly termed The Special Group on Public Sector Numbers and Expenditure Programme – not yet implemented in full. ‘The government is committed to reducing the General Government Deficit [fiscal deficit] below 3% of GDP by 2014 and the Special Group’s recommendations will inform the government’s decisions this year and next year,’ the finance minister says.

McCarthy was a contentious choice to head the review. Although he is an economist based at University College Dublin, he is no ‘ivory tower’ intellectual. He already had a reputation as an advocate for lower public spending and was founder of economic consultancy DKM (he is the ‘M’), as well as being a former staff ­member at the Central Bank of Ireland.

McCarthy is satisfied with the progress towards implementation of his team’s recommendations. The report identified potential savings of e5.3bn in a full year – 9.3% of departmental expenditure – by cutting more than 17,300 public service jobs and closing one department (Community, Rural & Gaeltacht Affairs) and possibly a second (Arts, Sport & Tourism). But it accepted that some cuts would take several years to bring about.

‘The report was aimed at the medium term,’ McCarthy explains. ‘The exit for the fiscal consolidation is in 2014 and it started in July 2008. So it was not our intention or expectation that every single item would be implemented the following week. Of the big long list of cuts we recommended, it was never necessary to implement all of them in [last ­December’s] budget and some of them were not ­capable of being implemented in that timetable. So box-ticking your way through the report to check what has been implemented gives a misleading impression. And the government did not reject any parts of it.’

Other radical changes will come, says McCarthy, including big public sector job cuts. Some measures – such as the abolition of many quangos – are being undertaken away from the glare of publicity, ‘under the radar’, as he puts it. 

McCarthy accepts, though, that his team’s proposals have caused difficulties between the Department of Finance and other departments. ‘You always get this tension in a fiscal correction,’ he argues. 

The early savings, included in the budget in December, were ‘really in public sector pay and rates of payment in parts of the welfare system’, McCarthy says. ‘They make a big impact in the overall figures. I think in the next budget you will see some of the other items being addressed, particularly in restructuring and the reform of public administration generally. I am not surprised this was not included in the last budget. It takes some time to be acted on and for it to be negotiated with the unions. That is ongoing.’

Those December measures imposed real hardship on many. Public sector pay was cut, starting at 5% for lower earners, rising to 15% for the highest paid (including ministers). The pay cuts saved more than e1bn from the annual budget, with another e1bn in savings coming from spending programmes and a further e1bn from planned capital investment. 

Earlier in the year, a pension levy was imposed on public sector workers. This was effectively a pay cut – starting at 3% of gross pay, rising to nearly 10% for top earners.  Additional public sector pension changes announced in the budget included raising the minimum retirement age by a year to 66 and changing from final salary to ­career average pay calculations.

Some €760m was cut from welfare programmes, with penalties on unemployed people who reject job offers, big r­eductions in the rate of benefits for new claimants and reductions in other benefits, such as maternity pay and child benefits (by more than 10% for those ­receiving the minimum rate).
McCarthy says that the painful budget was only the first step. ‘You have to stop the bloody thing from getting worse, then the next stage is to get the deficit down to manageable figures.’

The government is now focusing on ­reducing the size of the public sector to lower costs on a continuing basis. In addition, and importantly for the public mood, most active politicians who receive pensions for past ministerial posts – worth as much as €80,000 a year – are giving them up.
But the biggest attention of all is being given to fixing the banking crisis. As with the UK, it was the crisis – or annihilation – of the banking sector that turned a bad situation into a catastrophe. The government had to rescue three banks – Bank of Ireland, Allied Irish Bank and Anglo Irish Bank – and two building societies: Irish Nationwide (unconnected to the UK’s Nationwide) and EBS. Anglo Irish, Irish Nationwide and EBS were nationalised in the process and BoI and AIB now have substantial government shareholdings.  The government had to pump e12bn into Anglo Irish to keep it going – and expects to provide another €10bn later this year. Eventually, the government might have to close down Anglo Irish at a total cost of about €70bn.
Anglo Irish’s collapse is the worst of the failures and indicative of the ­country’s economic self-destruction. The bank loaned substantial sums not only for unwise speculative property investments, but also to very wealthy (and well connected) individuals to buy shares in the bank. This helped the bank’s share price escalate, but made the subsequent crash much worse. One of Ireland’s wealthiest businessmen, Sean Quinn, borrowed substantially from Anglo Irish to buy shares in the bank, using funds held by his insurance firm, Quinn Insurance, to guarantee the acquisition. With the collapse of the bank, the insurer has gone into administration, leaving the state with a large indirect ­interest in one of the ­country’s largest ­insurance companies.

As a means of unwinding the losses across the banks and building societies, the government established the National Asset Management Agency to take over non-performing assets, buying them from the financial institutions at an average discount of around 50% on the original value. Nama has taken over e16bn (at their original value) of non-performing loans, representing 1,200 individual loans awarded to just ten Irish borrowers (mostly leading property developers). But this is only the tip of the non-performing iceberg. Eventually, Nama will take over e81bn of non-­performing loans.
This is an important step in the right ­direction, believes McCarthy, and is helping the markets and the credit ratings agencies take a more benign view of the country than of Greece and other southern European states. ‘The bank thing is heading towards resolution, fiscal consolidation has been under way for 18 months or more – 21 months really. More broadly, the balance of payments deficit will be around zero. So there is no payments ­pressure. So that is why the credit ratings agencies are not going to get upset.’

But McCarthy accepts that the crisis in Greece could spill over into Ireland. It is already raising Ireland’s cost of borrowing. ‘The situation here is less scary than for Greece because the overall debt is lower,’ says McCarthy. ‘What is more, the Irish government does not need to borrow huge amounts from the market and it could survive without issuing new debt for the moment.’

Ben May, an economist at Capital Economics, agrees that Ireland is doing better. ‘Clearly they have done quite well: they took pretty early steps to get the public finances under control,’ he says. ‘They began to tackle fiscal policy in June 2008. To some extent that early action has been seen as encouraging by the markets. The forecasts seem to be fairly reasonable – some governments have been criticised for having very optimistic forecasts – though looking far out, they [the Irish forecasts] do look optimistic.’

He adds that the country ‘has been ­willing to take some fairly tough decisions and in general they have done well in taking other political parties on board with them and a good chunk of the electorate, who recognise that something needs to be done’. However, the deficit is still ‘very large’ and the process is ‘by no means over’.

While the markets might be reasonably content, the trade unions are angry.
David Begg, general secretary of the Irish Congress of Trade Unions, ­complains: ‘Government inaction and failure has seen the numbers out of work triple and ensured that long-term ­unemployment and emigration are central features of Irish life, once again.  This is as drastic an indictment of official policy as it is possible to get, in 2010. The spectre of the 1950s and 1980s now haunts working families all across Ireland.

‘The government is just not working.  There appears to be a bottomless pit for the senior bankers that caused this mess – and the jobless are told to wait in line, literally.’

It seems, though, that trade union anger is more tolerable for the ­government than a crisis in market confidence. And, for the moment at least, the markets have stopped panicking about Ireland.

Colm McCarthy will be speaking at the CIPFA annual conference being held on June 8–10 at Harrogate International Centre

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