Baseline Scenario : The (very bad) luck of the Irish

Simon Johnson and Peter Boone turn their attentions to Ireland – their analysis is truly shocking and is informed by a valid (and obvious) adjustment. They use GNP in preference, as a superior indicator of Ireland’s ability to repay debt, to GDP. I’m surprised this hasn’t been used more commonly when discussing the deficit.

When we adjust Ireland’s figures accordingly, the situation is dire. The budget deficit was about 17.9 percent of G.N.P. in 2009, and based on European Commission projections (and assuming the G.N.P.-G.D.P. gap remains the same) it will be roughly 14.6 percent in 2010 and 15.1 percent in 2011, while the debt-to-G.N.P. ratio at the end of this year is expected – by our calculation – to be 97 percent, and 109 percent at the end of 2011. These numbers make Ireland look similarly troubled to Greece, with a much higher budget deficit but lower levels of public debt.

Ireland’s politicians, rather than facing up to their problems, are making things ever worse. Simply put, the Irish miracle was a mirage driven by clever use of tax-haven rules and a huge credit boom that permitted real estate prices and construction to grow quickly before now declining ever more rapidly. The biggest banks grew to have assets twice the size of official G.D.P. when they essentially failed in 2008. The government has now made a fateful choice: rather than make creditors pay some part of the losses, it is taking the bank debt onto the national balance sheet, effectively ballooning its already large sovereign debt. Irish taxpayers are set to be left with the risk of very large payments to make on someone else’s real estate deals gone bad.

There is no simple escape, but if the government hopes to avoid a sovereign default, the one overriding priority should be to stop bailing out the banks. Instead, the government should wind down existing banks in a “bad bank,” while moving their deposit base and profitable businesses into new, well-capitalized banks that can function without a taxpayer burden. This will be messy, but it is far better than a sovereign default.

I agree with this approach. Creditors who lent to delinquent banks were not niave – the dogs in the street knew their was a property bubble and the banks were highly leveraged. The creditors should take the pain of the bulk of the adjustment. More controversially they argue Ireland should leave the Euro –

Finally, the Irish need to consider seriously whether being in the euro zone is worth the cost. The adjustment to this awful situation would be far easier outside the euro zone — even though leaving the zone might have adverse repercussions for other nations. Once again, a comprehensive program with European Union/I.M.F. support might make this the least worse option.

, ,

  • Anon

    On the GNP thing, are there revenues coming in form the GDP gap? Are they signficant? Are they likely to go anywhere in the medium term? If it’s yes, yes and yes, then going to GNP to make things look worse makes no sense.

    Another question: what the hell is the rationale behind not having creditors take a hit? The guarantee made sense at the time, but irc it was time limited. Is there any sane reaosn why the whole lot would go to the taxpayer?

    I think things wll need to get a bit worse before leaving the Euro becomes an option.

  • Mack

    The gap will be taxed at 12.5% or so (not sure if that is what the effective rate will be – i.e. if all transfer payments can be taxed). But, that tax will be spent in the economy and therefore the spending of those revenues are accounted for in the GNP figures (not sure if that effect would be time delayed, would make sense if it was).

  • I have a few issues with this. It’s like a 2.1 essay at college, it’s almost got the key issues but is lacking a few crucial details, such as understanding of chicken and egg re unemployment and the nature of Ireland’s FDI base.

  • Mack

    Hi Ronan,

    In some respects it was very negative (overly so) – but do would you disagree with using GNP for the deficit figures? We leap frog to the top of the queue on that basis..

  • The context in which creditors lent the banks is the real elephant in the room in all this. They knew the precise configuration of the banks and the bubble but lent all the same. They took a risk and no-one seems to be calling them on to take their share of the responsibility. Both cheap credit and irresponsible bankers helped foment the crisis. It would be a dramatic step to take, but judging by the way the Germans are inching forward an EU wide threat to default may happen sooner rather than later, since one state threatening to default would be eaten alive by the Wolfpack.