In the 1990s, Ireland benefited from good economic policy. It was already blessed with a young population, EU subsidies and a location between the UK and US – leading economies with which it shares a common language. To this it added investment in education and science, social partnership agreements to ensure a fair sharing of prosperity while preventing wage-driven inflation, and targeted incentives to attract and bed-in foreign multinationals in sectors like electronics, software, chemicals, pharmaceuticals and biotech. In consequence, GDP grew at six percent.
But from about 2003 boom turned to bubble. Low corporation taxes, having already served their purpose, now just attracted hot money. Having joined the euro, there was no independent monetary policy to tighten in face of asset- or consumer- price inflation. Banking supervision was light-touch to the point of being absent. The result was speculation that pushed housing prices up five-fold in places and saw the balance sheet of the banking sector grow past ten times GDP.
After global credit markets froze from 2007, the Irish bubble burst and GDP started contracting – having now slid by almost a fifth. The government, meanwhile, has enacted a series of ever-harsher austerity packages to trim spending and avoid too large a deficit. Some economists have slammed this as contrary to the Keynesian doctrine that government policy should run counter to the economic cycle – such as by running deficits in recessions and surpluses in booms – to prevent either expansion or contraction from getting out of hand. To them, Ireland is an example of what not to do; with its spectacular fall from grace being largely the result of government austerity undercutting demand and GDP. But is this a fair view?
There is little doubt that Keynes – who knew markets can behave irrationally and need government to moderate and guide them – would have approved of Ireland’s policies to encourage and channel growth in the 1990s and before. There is likewise little doubt that he would have disdained the near complete lack of any brake on speculation in the 2000s – a situation rare in any developed country.
But his views on Ireland’s response to the collapse might surprise. When the banking sector has been allowed to grow to the point where it dwarfs GDP, there is little hope that government can stem a collapse. If 30 percent of the value of assets is wiped out – not unlikely after a colossal bubble – the state must take on debt equal to a multiple of GDP if it is to recapitalise banks hit by defaults on loans secured against these assets. Markets will probably baulk at this and refuse to finance sovereign deficits – especially for a small country whose bonds lack reserve asset status. There is thus a choice between letting the banks go under; collapsing the economy, or trying to rescue them and having financial markets push the sovereign into default, also collapsing the economy. Even if the country had its own currency to expand and devalue, any stimulatory effect would be lost through markets dumping its bonds as the currency took a nosedive.
The only option may be to trim other areas of government spending while recapitalising the banks in the hope that this will persuade markets to bear with the country long enough to stabilise the financial sector, or long enough for outside help to arrive – which may ultimately be the only way to turn the tide. This is what Ireland has done and, if we interpret Keynesian economics as simply doing whatever you can to stabilise an unstable economy, it may be a very Keynesian solution. Ireland has run deficits of more than 10 percent of GDP in the past three years, in large part to support its banks. Talk of austerity has largely been because this is what the markets needed to hear. These are not the marks of a true anti-Keynesian, who would aim for budgetary balance even in the most straightened times.
The recent EU-IMF bailout of Ireland may or may not succeed in stabilising its economy. Regardless of its success or failure, the current government will deservedly be voted down as architects of the era of lax regulation in the 2000s. But at least, in the moment of crisis, they were as Keynesian as possible – and we can expect their successors to remember his doctrines much better.