Irish recession – Is the worst over?

Brian Lenihan introduced the budget for 2010 with the statement that “the worst is over”. This astounding declaration was accompanied by rising unemployment, attacks on public and private sector wages, and the admission that the savagery of the 2010 budget will be matched in 2011 and 2012. There is no question that for working people, the worst is far from over. Part One of a three part article.

However, is there any basis for the view that the economic crisis has now hit its lowest point in Ireland and 2010 will see an improvement? The latest Economic and Social Research Institute’s (ESRI) Quarterly Review contradicts the notion that the worst has passed, predicting a decline in the southern economy of 1.5% in GNP (a decline of 0.25% in GDP) for 2010, but it does suggest that the final quarter of 2010 will see minor economic growth.

Similarly, the impression is now being given in the media, that, in contrast to the other troubled PIGS (Portugal, Ireland and/or Italy, Greece and Spain), Ireland has ingested the necessary bad medicine, and that recovery will follow. Even internationally, Ireland is increasingly being used as an example of the road that these countries must follow. Nouriel Roubini and Arnab Das writing in the Financial Times on 2 February declared:

“The best course would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes and loophole closures that depend on historically weak compliance.”

In this three part article, Paul Murphy investigates the basis of these claims, highlighting some of the key pitfalls that will face the Irish economy in the coming years. The first part focuses on the international backdrop and the strategy of Irish capitalism. The second part will investigate the claim that Ireland can export its way into economic growth as well as describe some of the major problems facing the southern economy – the drag that rising unemployment will exercise on the economy and the prospect of a major debt crisis. The final part will critique the recovery scenarios offered by the establishment and examine the political consequences of the bleak economic outlook.

Is the world recession over?

Two assumptions underlie all of the analyses that foresee economic growth for Ireland. The first is that the world recession is over and that the world’s key economies will see economic growth in the coming years. The second is that the Irish economy will be able to connect itself to this growth via increasing exports and push the Irish economy into growth.

This three part article focuses primarily on the second of these assumptions. However, it is necessary firstly to briefly point to some of the weaknesses within the first assumption – that of world recovery.

To paraphrase Mark Twain, tales of the worlds recession’s demise are much exaggerated. There is no question that the $18 trillion (30% of world GDP) pumped into the world’s economy in stimulus packages has had an important impact. Many of the key capitalist countries are now experiencing low levels of economic growth. However, as the Socialist Party and Committee for a Workers’ International have elaborated elsewhere See Lynn Walsh on “Where is the world economy going?” http://www.socialismtoday.org/134/world.html, the world economy is not out of danger yet.

The recent crisis in the eurozone, originating in Greece and quickly spreading to Portugal and Spain dramatically underscores the weaknesses with the recovery that is underway. This is rooted in the indebted nature and weak economies of these countries. However, this problem is not limited to those on the outskirts of the Eurozone. While Greece faces a crisis because of its near 13% GDP deficit, the USA has an expected deficit of over 10% in 2010. The dollar will not face such a crisis immediately, because of its key role as a world currency, but it does highlight the precarious nature of world growth.

Even in those European countries that are officially out of recession, the growth is anaemic if it exists at all. So much so that the 12 February Financial Times’ “Recovery Watch” column threatened that it may have to rename itself “Waiting for Godot”. In the last quarter of 2009, the German economy failed to grow at all, with Britain growing just 0.1% and France only experiencing growth of 0.6%. The eurozone economy as a whole grew only by 0.1%.

The growth that has been registered remains very reliant on the stimulus packages, with both private investment and consumption remaining low. The rising levels of unemployment worldwide undermine the basis of any potential recovery, with consumer spending likely to be severely hampered by this and the overhang of debt built up in the previous boom.

It is universally accepted that the withdrawal of these stimulus packages poses real complications for the health of the economy. The debate over the so-called “exit strategies” divides those who favour an earlier or later withdrawal. On the one hand, a withdrawal that is too early contains the danger of precipitating a double dip collapse. However on the other hand, delaying a withdrawal and continuing to pump money into the economy via low interest rates and financial packages contains the danger of run-away inflation.

So any assumption of a strong worldwide recovery is extremely optimistic. Even if a double dip is avoided, it is very likely that the growth will be weak, held back by the high levels of unemployment and the effect of debt. Any of the more negative possible variants in terms of the world economy would strike a decisive blow against the prospects for Irish recovery, as there is no suggestion that Ireland can fuel a recovery on its own.

The particular features of the crisis of Irish capitalism

However, even allowing for a low level of world economic growth in the coming year, which this article does, Ireland is by no means guaranteed to benefit to the extent of achieving real consistent economic growth. Because of the particularly speculative nature of the growth that Ireland experienced since 2001 and the dramatic nature of the crash from that height, combined with the historic weakness in Irish capitalism, there is a particular crisis of Irish capitalism that will hamper any recovery.

The bubble nature of the growth that the southern economy experienced since 2001 went far beyond that experienced in most other countries. The recent paper on “The Irish Credit Bubble” by Morgan Kelly (a UCD based economist) points out that borrowing from banks to the non-financial private sector rose from 60% of GNP (compared to an average of 80% in most Eurozone economies) to more than 200% of GNP by 2008 (compared to an average of around 100%). This was similarly matched by a boom in consumer spending.

The lack of a strong domestic industrial base and the weakness of native Irish capitalism has not been overcome by the boom years. The crucial impetus for the Celtic Tiger was given by Foreign Direct Investment in Ireland. This in turn led to an expansion of domestic economic activity, particularly in the services sector. However, compared to the importance of FDI and consumption, domestically owned industry plays a relatively insignificant role. This is highlighted by the fact that of all exports from the Irish economy in 2009, only 10% come from domestic producers.

What is the strategy of Irish capitalism?

In the absence of a strong domestic basis for recovery, the options for the capitalist class are limited. Traditionally in these circumstances, a favoured tactic of capitalist establishments facing economic difficulty would be devaluation, i.e. making their currency fall in value against the dollar and other major currencies, therefore making exports more competitive.

However, with Ireland a member of the euro, this option does not exist for the Irish political and economic establishment. Instead, following the advice of the OECD and international capitalist commentators, they are attempting to mirror the effects of a currency devaluation, through what is known as an “internal devaluation”. In concrete terms, this means trying to force wages down as quickly as possible, in the expectation that prices will similarly fall – thereby increasing Ireland’s competitiveness in export markets. The hope is then that this increase in exports would give a boost to domestic markets.

This approach was summed up in the ESRI’s last quarterly economic commentary:

“Ireland now needs to generate an internal devaluation, with prices and wages falling, mirroring the impact of a currency devaluation which is, of course, no longer possible.”

In essence, therefore this is what the strategy of the capitalist class boils down to – attack the wages of working class people, starting with the public sector, to drive down wages and then prices to increase the competitiveness of Irish exports. This is the strategy that lies behind the savage assaults on public sector workers, resulting in wage cuts of up to 19%. As Colm McCarthy later admitted, a vital role of “An Bord Snip Nua” was to influence the official opposition parties and media to create an environment where people would accept that there is no alternative to cutbacks and wage cuts.

This strategy is not driven by an abstract interest in recovery for the Irish economy – this approach, in particular the slashing of wages, is a strategy to protect and increase the profits of big business in Ireland. Part of this is a deliberate overstatement of the importance of wages as a source of “competitiveness”, as part of a propaganda battle to lower wages. This is an attempt to shift the share of national income further towards profits and away from labour.

Will an “internal devaluation” work?

Despite this strategy being unanimously endorsed by the establishment, there are major flaws with it. In effect, the government’s strategy means calculated deflation in the Irish economy.

By withdrawing money from the economy and attacking wages, domestic demand and consumer spending are immediately impacted on negatively. For example, it is estimated that the withdrawal of €4 billion in the latest budget had a deflationary impact of 2.3% on GNP. This creates the real danger of a downward spiral in the economy. In addition, deflation has the potential to seize up an economy, whereby people opt not to spend today, given the expectation that prices will continue to fall.

However, it is not simply these general problems with deflation that will present problems. The critical reasons that the strategy of “internal devaluation” and exporting Ireland’s way out of the crisis is unlikely to be successful relate to the fundamental premise of the strategy and the question of debt.

Ireland is an immensely indebted country. Private sector debt is three times GDP, while public sector debt is close to 70% of GDP. Deflation in Ireland will have the effect of increasing the burden of this debt significantly. This is because while wages and prices are declining, the debt will remain the same. Therefore paying it off will become more burdensome. As Martin Wolf outlined in an article on “Why the eurozone has a tough decade to come” in the Financial Times on 6 January:

“Yet, at worst, a lengthy slump might be needed to grind out a reduction in nominal prices and wages. Ireland seems to have accepted such a future. Spain and Greece have not. Moreover, the affected country would also suffer debt deflation: with falling nominal prices and wages, the real burden of debt denominated in euros will rise. A wave of defaults – private and even public – threaten.”

Finally, and perhaps most fundamentally, the strategy of relying on exports to drag the Irish economy out of recession is highly problematic. As will be outlined in the second part of this article, Irish exports have actually performed remarkably well in the context of the economic crisis, however it has not led to economic growth. The problem is not the volume of exports alone, rather the nature and ownership of these exports is important. As will be explained further later, some of these are fictitious in the sense of “transfer pricing” of exports that are really coming from elsewhere, while others are exports of goods which provide relatively little in terms of “value added” to the Irish economy.

The Irish establishment has in effect put all of its eggs in the basket of an “internal devaluation” and primarily export-driven growth. Any failure in the world economy to deliver that growth would be a major blow to Irish economic prospects. However, even given world growth, the twin problems of debt and consumer spending will be exacerbated by this strategy. The second part of this article will explore the nature of the exports from the Irish economy and explain the very real potential for a massive debt crisis in the coming year.