Alexandra Zeitz (Global Economic Governance Programme, University of Oxford)
What lessons can be learned from the Irish financial crisis? The question is particularly pressing as negotiations continue over the terms of the Greek bailout. Speaking at PEFM in early March, Ajai Chopra offered an insider’s perspective on the crisis and rescue, and shared words of caution about treating the Irish experience as a model that can be replicated elsewhere. Chopra, now with the Peterson Institute for International Economics, was head of the IMF’s mission in Ireland and had a front seat to the crisis and negotiations over policies for recovery.There is a prominent European narrative about the Irish financial crisis and recovery. European policymakers, especially Germans, have implied that Ireland ‘did its homework’ and quickly implemented the needed reforms and fiscal consolidation. They suggest that this explains Ireland’s path back to stability and growth. Chopra says that this narrative is ‘misleading,’ ignoring the unique dynamics of Ireland’s boom, bust and recovery. Deriving simplistic ‘lessons’ for other crisis countries from this narrative would be misguided. Instead, more nuanced lessons should be drawn from Ireland’s experience.
According to Chopra, Ireland’s recovery was due to a reorienting of the economy. In the pre-crisis boom the economy had become skewed towards the housing and construction sectors. When the housing market crashed, sectoral reallocation and wage flexibility allowed the economy to refocus towards export sectors. Ireland was also lucky: the economy rebalanced towards export sectors just as its top export markets, the UK and US, were recovering. Chopra also stressed that the human cost of the crisis has been immense. Unemployment remains high: recent figures put unemployment at 10.3%, albeit down from a 2012 peak of 15%, but youth unemployment remains very high, at around 23%.
And yet, Ireland was able to stop its banking crisis from entirely destroying the economy and the road to recovery has been quicker than many anticipated. What were the secrets of Ireland’s success? Ireland was faced with pernicious feedback loops that by 2010 had turned the systemic banking crisis into a sovereign debt crisis. To address this, Ireland required a credible program for bank stabilization, with the eventual objective of regaining market access. This is where the troika, the IMF, European Central Bank (ECB) and the European Commission, came in.
Chopra gave a rigorous overview of the stabilization measures that Ireland underwent: an asset quality review and stress test of Irish banks to determine the health of Irish banks. The banks’ €24 billion capital shortfall (15% of Irish GDP at the time) was met largely by the government, which carried €16 billion of the cost.
There was disagreement as to the degree of losses that should be imposed on the banks’ senior creditors. Chopra has stated publicly and argued again in the PEFM seminar that senior creditors ought to have shared a greater portion of the burden, reducing the cost to the public sector of the banks’ failure and removing some of the moral hazard of bank rescues. Chopra described how the ECB and European Commission’s anxiety about spillover effects in the bank funding markets led them to oppose burden sharing with senior creditors. As Chopra tells it, in the end the IMF compromised on the issue of burden-sharing, and Ireland took on significant public costs to stabilize the banking sector.
The Irish banking sector has not yet fully recovered. While banks are performing well on stress tests and capitalization indicators, they remain slow to resume their inter-mediation function.
What about the other component of the Irish success trope, fiscal consolidation? Fiscal cutbacks did help Ireland’s debt problem, but Chopra stressed that this had come at a social cost, and that cutbacks had been far less severe in Ireland than elsewhere. Real per capita primary expenditure increased 2.8% in Ireland from 2007 to 2014, while it decreased by 4.8% in Italy and fell by a drastic 23.8% in Greece over that time. On fiscal adjustment too, Chopra described tensions between the IMF and the European bodies. The IMF sought a longer and slower timeline for fiscal adjustment, while the ECB wanted adjustment frontloaded—aiming for Ireland to meet the 3% primary surplus target by 2014. After negotiations with Ireland and the IMF, the deadline was ultimately set for 2015.
The picture that emerged from Chopra’s remarks was that the IMF’s Troika partners (the EC & ECB) were under-skilled in their approach to handling the financial crisis—overly insistent on deflationary macroeconomic policies and insufficiently focused on structural reform. Chopra pointed to research by Eichengreen and Panizza that challenges the credibility of European debt targets, demonstrating the historical rarity of significant primary budget surpluses.
Given that Ireland’s experience was unique, what lessons then for other crises? Chopra highlighted several. For systemic bank crises, losses must be identified and allocated quickly. He also concluded that it is unfair to impose the burden of supporting banks primarily on domestic taxpayers. Greater euro area solidarity could help to address adverse feedback loops. Gradual fiscal consolidation is necessary for a return of market confidence. But most importantly: government design and ownership of policies was a key feature of the Irish program which contributed to its success.
It’s that final lesson that seems is yet to be learnt in the ongoing negotiations with Greece. So far, it doesn’t seem that the ECB and Germany are willing to concede that, unless government (and the people it represents) feel it has ownership of its own program, the program is unlikely to succeed …