Ireland, Small Open Economies and European Integration

Lost in Transition

D. Begg

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137559609
• Topic: Politica e relazioni internazionali
• Subtopic: Commercio e tariffe

David Begg examines how four small open economies- Finland, Denmark, the Netherlands and Ireland- have managed the stresses and strains of Europeanisation since the single market came into being, and as fault lines begin to appear within the European integration project. In particular, he drills down into the Irish Polity to see how its institutions have engaged with Europe and how decisions on critical issues like integration, EMU and Social Partnership were reached. He finds that both Ireland and Europe are at a critical juncture for different but interconnected reasons, and identifies the options that are available to them.

1

Introduction

On 18 November 2010, the Irish public awoke to hear their Central Bank Governor, Professor Patrick Honohan, announce on the Morning Ireland radio programme that the country was shortly to be a ward of court of the European Union (EU) and International Monetary Fund (IMF). The fact that the governor was the messenger was symptomatic of the state of disarray of the Irish government. All the previous weeks, ministers had denied that this event was in prospect. It was symbolic too that he was speaking from the headquarters of the European Central Bank (ECB) in Frankfurt. It emphasised who was in charge (Donovan and Murphy, 2013: Appendix 1).

Ireland had been the poster child of Europeanisation and globalisation. The rapid transformation of the Irish economy from one with high unemployment and emigration, persistent budget deficits and a debt to GDP ratio of over 100 per cent in the 1980s to full employment, net immigration and a debt ratio below 40 per cent by 2000 earned it fulsome praise. For this reason, the rapid onset of the 2008 crisis, and the consequences that flowed from it, came as a great shock.

This was, moreover, in marked contrast to the other small open economies in Northern Europe, in particular Finland, Denmark and the Netherlands. These were champions of free trade and globalisation too and, while hard hit by the global downturn, were better able to alleviate the domestic consequences of the crisis. An extraordinary range of policies were deployed to ease stress in the financial system and, in the case of the Nordic countries, these were accompanied by fiscal stimulus. Generally speaking, the Nordic and continental small states have an impressive record of combining economic efficiency and social cohesion including the highest levels of employment and most generous welfare systems in the affluent world (Gylfason et al., 2010; Hemerijck, 2013; Schmidt, 2011). This book traces and compares the evolution of the development models of Finland, Denmark, the Netherlands and Ireland over the quarter century, spanning the years from 1987.

The key question of this book is how these four countries managed the process of Europeanisation. European integration picked up pace in the late 1980s, and Ireland’s achievements seemed to parallel it. German policymakers and bankers had urged Europe towards financial integration since the 1950s. The course of this trajectory took an upward swing in June 1988, when the European Council agreed to liberalise all capital movements. In effect, this was formal financial integration, which was copper-fastened by the Maastricht Treaty which came into force in 1994. Its effect was to elevate capital to the same legal status as goods, services and people which had enjoyed free movement within the borders of the European Economic Community (EEC) for 40 years (Abdelal, 2009).

The ECB subsequently became the premier institution of Economic and Monetary Union (EMU) under the terms of the Maastricht Treaty. The single currency came into force 10 years later in 2002. EMU did not, however, involve any institutions for fiscal or banking union which subsequently were revealed as serious deficits. The ECB received the singular mandate to maintain price stability. The Stability and Growth Pact (SGP) and Excessive Deficit Procedure (EDP) were intended to control fiscal sustainability, with the Maastricht Treaty explicitly proscribing bailouts of imprudent members. These rules were believed to be sufficient to foster real economic convergence. It didn’t work, not least because the architecture failed to take into consideration current account competitiveness divergence across the Euro area. The fiscal rules were ignored to allow Greece and Italy to join the currency union and deficit limits were ignored when exceeded by France and Germany in 2004. Moreover, the EMU’s design bias towards public budgetary discipline let policymakers take their eye of the ball of private debt. In short, there were serious design flaws in EMU (Hemerijck, 2013).

These were exposed following the collapse of Lehman Brothers bank in the United States on 15 September 2008. Allowing Lehman to collapse without stabilising the banking system turned out to be a costly policy mistake. Shortly after the Lehman shock, the full effects of the market concerns began to be felt in Europe. A number of European banks – Dexia, Fortis and Hypo Real Estate – had to be rescued. Within days Ireland was pitched to the front of the gathering crisis. Up to that point, it had enjoyed the sobriquet ‘Celtic Tiger’, but inappropriate risk-taking by banks had built up unsustainable financial exposure to a falling property market. Ireland’s banks had borrowed short from the European banks and lent long to developers and homebuyers. The collapse of Lehman Brothers caused a crisis of confidence such that interbank lending froze. This meant that Irish banks could not roll over their loans. Initially, this was seen by the authorities as a liquidity crisis. Being under pressure from the ECB not to allow any bank to fail, the Irish Minister for Finance guaranteed all bank liabilities at six financial institutions, an approximate potential liability of €440 billion.¹ This was equivalent to 250 per cent of Ireland’s GDP. In the event, the liquidity crisis turned out to be a solvency crisis, and banking debt turned into sovereign debt crippling future generations of Irish citizens fiscally. The Celtic Tiger was dead (Hemerijck, 2013; Lewis, 2010; Marsh, 2011; Mason, 2009).

Membership of the Eurozone meant that the policy of adjustment adopted was to engineer an internal devaluation in an effort to bring down wages and prices. The peripheral countries were judged ineligible for what they really needed, that is, outright debt relief via Eurobonds or other mechanisms. Such options were opposed because of a kind of moral distain on the part of the creditor countries as well as of a fear that any such action might be judged illegal by the German constitutional court (Hemerijck, 2013; Marsh, 2011).

The speed of change in Ireland took people by surprise. Unemployment rose quickly from 4 per cent to 15 per cent. This was most acute in the construction industry where employment fell from a peak of 286,000 to about 80,000. Overall some 365,000 jobs were lost. Net immigration turned quickly to net emigration. Wage cuts were imposed or negotiated in the public service and in some industries like construction, newspapers, radio and television, and aviation. A series of harsh budgets took about €25 billion out of the economy, and this contributed to reducing domestic demand by 26 per cent.

Looking back at Ireland’s economic performance since achieving independence, this is the fourth occasion on which the country’s very survival has come into question. The first occasion was in the 1930s when the first Fianna Fáil government responded to depression by transitioning from an agrarian economy to import-substitution industrialisation. The small scale of the Irish market and inept attempts to build viable indigenous industry behind tariff walls meant that by the 1950s the country was again in crisis. This time the solution involved a volte-face on industrial policy moving to export-orientated industrialisation. Opening the economy gave access to Marshall Aid and led first to the Anglo-Irish Free Trade Agreement of 1965 and then to membership of the EEC with Britain and Denmark in 1973. The initial 10 years of EEC membership did not transform the country or achieve the catch-up on the post-war ‘Golden Age’ that Ireland had missed out. In fact, by the mid-1980s Ireland was again in deep trouble with high unemployment and emigration and unsustainable public finances. This time the solution involved a combination of neo-corporatism in the form of Social Partnership, a global economic upswing and two currency devaluations. The second of these was 10 per cent devaluation within the Exchange Rate Mechanism (ERM) in January 1993. Still, although the macroeconomic indicators began to come right after 1987, employment levels did not begin to rise until after 1994. Between then and 2001, over 400,000 new jobs were created. This was the beginning of the Celtic Tiger² period, and nobody expected it. Actually, in the early 1990s, people were beginning to doubt whether Ireland was a viable economic entity at all and whether the entire independence project had been a failure (Adshead et al., 2008; Ahern and Aldous, 2009; Garvin, 2005; Kirby, 2010; MacSharry and White, 2000; Murray, 2009; O’Donnell, 2008; Ó Riain, 2004, 2008; Smith, 2005).

To an extent, this uncertainty about economic development was influenced, not just by disappointment at the stagnant economy, but by comparison with the achievements of other small open economies in Europe. This caused the National Economic and Social Council (NESC) to commission a Norwegian academic, Lars Mjoset, to conduct a comparative study of Ireland with other countries with a view to determining why they had done so well and Ireland had done so badly.

In his report, Mjoset (1992) argued that Ireland, by comparison to small Northern European economies, had failed to develop a national system of innovation. An auto-centric national economy had not emerged, and therefore the dynamic of socio-political mobilisation and economic performance combining to generate pressures for a widespread Fordist system of production and consumption had not materialised in a manner redolent of the comparator countries. Moreover, a weak national system of innovation contributes to social marginalisation and mass emigration, which in turn lessens the possibility of sociological pressures to improve the system of innovation. Mjoset further argued that reliance on FDI, and earlier on live cattle exports to the United Kingdom, militated against building a national system of innovation. These factors were compounded by the conservative nature of society influenced by the church and the populist nature of Irish political parties based on competing versions of nationalism arising out of the civil war in the 1920s (see also Ó Riain, 2004: Chapter 3).

The three other comparator countries in this study were not without their difficulties at the time of Mjoset’s report, but they were better placed than Ireland.

Per capita growth in Finland stayed in positive territory for the most part throughout the post-war period with the exception of a banking crisis in 1992–1993, when unemployment rose to 17 per cent of the labour force. The period until the mid-1980s was a phase of catching up and mobilisation of resources. The policy regime relied on state intervention in the manner of the Asian tiger economies. Public savings were an important factor in capital accumulation. Credit rationing was used to promote manufacturing investment, and a corporatist incomes policy underpinned export industry profitability. The geopolitical constraints of the Cold War were a major influence on public policy. Mjoset notes that trade with the Soviet Union was of major importance being a continuation of post-war reparations. The rising of oil price in the 1970s served to consolidate this trade which was organised on a semi-barter basis in which Finland swapped manufactured goods for Soviet oil. This created a beneficial countercyclical effect (Gylfason et al., 2010; Mjoset, 1992; Vartiainen, 2011).

Denmark, unlike Sweden, Finland and Norway, had no banking crisis to speak of in the late 1980s or early 1990s. While there were problems in the sector, they never amounted to a full-blown crisis. The two post-war episodes of mildly negative per capita growth coincided with the oil crisis of 1973–1974 and 1979–1981. Domestic demand in the economy was sluggish in the aftermath but accelerated in 1985–1986 as the savings rate reduced. This eventually developed into a consumption boom prompting a rather extreme policy response. The so-called potato cure adopted by parliament in 1986 took the form of a 20 per cent surcharge on the net interest rate payments of households. This curtailed consumption severely and increased savings again. Unemployment actually reduced, and the budget returned to surplus in 1986. Nevertheless, balance of payments problems caused growth to stagnate, while the rest of Europe grew at the rate of 3 per cent. This in turn caused employment to stagnate, and Danish firms began to lose market share internationally and at home. The resolution of Denmark’s structural balance of payments problems in the early 1990s paved the way for long-term prosperity (Goul Andersen, 2011; Gylfason et al., 2010, Mjoset, 1992).

In the 1980s, centre-right coalition governments in the Netherlands relied on price-incomes policies and exchange rate stabilisation for macroeconomic adjustment. The emphasis of policy was on shoring up corporate profits rather than sharing the burden of adjustment across societal cleavages or socio-economic groups. It was only in the mid-1990s that analysts reinterpreted the Dutch model as being a consensual one. For a time, the effectiveness of the ‘Polder’ model as a consensual adjustment strategy remained controversial. The effect of the two oil crises of the 1970s in the Netherlands was to drive up inflation, reduce exports and increase unemployment. The fact that the currency was pegged to the Deutschmark did mitigate inflationary pressures as the German currency appreciated after 1976. But appreciating exchange rate movements harmed exports competitiveness in circumstances of declining world markets. By 1984, unemployment had reached a record high of 800,000 or 14 per cent of the labour force. This was compounded by similar numbers on disability benefit or early retirement. Nevertheless, within ten years the unemployment figure had been halved (Jones, 2008; Visser and Hemerijck, 1997).

It would appear that not a lot of attention was paid to Mjoset’s report by the policymaking community in Ireland. One senior minister of that period interviewed for this research had never heard of it. It may be that the technical nature of the report made it difficult to access or that more likely the rapid expansion of the economy began soon after its presentation, and perhaps people felt that the source of their concern had dissipated.

However, the events of 2008 have reawakened those old fears again. The difference now is that we know that Ireland not alone performed well for over 20 years but became the toast of Europe, or at least of neo-liberal cheerleaders and commentators. On the other hand, there were those who had doubts about whether the feted Irish model was built on solid foundations. Seán Ó Riain (2008) questioned the Celtic Tiger explanation for the phenomenon of the 1990s expansion given its roots in the vicious circles described in the Mjoset (1992) analysis. Perceptively, he also identified that during the 1990s new institutional spaces emerged via Social Partnership where movements for developmentalism and public participation were able to establish themselves. This created a virtuous circle where an improved national system of innovation³ combined with local demand for growth created jobs and better wages. Problematically, though, the 2001 dot-com crash created a hiatus in which the central state and market began to reassert control over the spaces for developmentalism that had emerged in the 1990s. The effect of this was to shift the dynamic of growth away from developmentalism and towards construction and consumerled growth.⁴ Peadar Kirby (2002, 2010) was also unconvinced about the Celtic Tiger. He argued essentially that long-standing weaknesses in the economy, society and political system were simply camouflaged during the boom and became apparent again amid economic decline. These separate critiques can be characterised by Ó Riain’s argument that Ireland can, in the right circumstances, be a developmental network state but that liberal forces are constantly trying to drag it in a ‘competition state’ direction. Kirby’s view is that Ireland is already a ‘competition state’ although he would wish it to be otherwise.

The pity is that Mjoset’s work was not really completed. He wrote about Ireland:

Are there any lessons to be learnt from the contrast cases? This would be the traditional field of the applied social scientist. The long-term problems can be understood and they can be specified as complicated vicious circles, and a more thorough analysis might specify how many ‘small’ causes accumulate to create them.

(Mjoset, 1992: 20)

He specifically identified the question of the role of institutions as requiring further in-depth study. No studies of this nature were proceeded with, but if they had been, they might have captured the shifting emphases about to take place in the models of the comparator countries revealing a richer source of inspiration for Irish policymakers.

Purpose of the book

Ulrich Beck (2013) makes the point that a purely economic analysis of the European crisis which started in 2008 neglects the dimensions of society and politics and our prevailing ways of thinking about them. This resonates with the thinking of Karl Polanyi who 60 years earlier advanced the concept of embeddedness, meaning that the economy is not autonomous, as suggested in economic theory, but subordinated to politics, religion and social relations (Polanyi, 1944).

The purpose of this book is to explore the core Polanyian tension between markets and social protection, with particular reference to the capacity of selected small open economies – Finland, Denmark and the Netherlands – to manage that tension, and to compare these countries with Ireland.

This tension between markets and society is an acute dilemma for small open economies. Coping strategies to deal with it have long been central to the polities of the Nordic countries in particular.

By comparison, Ireland appears to be an outlier in Europe. It is the sole liberal market economy within the Eurozone, the most distant geographically of the northern member states from the heart of Europe, and one of only three countries not part of the continental land mass (...

Table of contents

• Cover
• Title Page
• Contents
• List of Figures and Tables
• Acknowledgements
• List of Abbreviations
• 1. Introduction
• 2. Katzenstein’s World
• 3. 1994–2001: The Age of Employment Miracles
• 4. 2001–2008: European Integration Intensifies
• 5. Beyond 2008: Coping with the Crisis
• 6. Unpacking Ireland’s Polity from a New Institutionalist Perspective
• 7. Conclusions
• Notes
• Bibliography
• Index