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11/29/2010: "An Overview of the Irish Debt Crisis, Part I"

I wrote this last week before Thanksgiving for a class that I am taking with Kevin Desouza. I am not a financial expert by any means, but I am quite concerned over what is happening to Ireland and plan to write more articles about the situation.

An Overview of the Irish Debt Crisis, 11/23/10.
On November 21, 2010, the government of the Republic of Ireland applied for a bailout of over $100 billion dollars from the European Union and the International Monetary Fund. This bailout is due to a combination of the effects of the worldwide recession, the housing bubble bursting and the guarantee by the government Ireland to bail out troubled Irish banks in 2008. There is speculation that the European Union and the International Monetary Fund will, in addition to demanding large government spending cuts, demand that Ireland raise it’s corporate income tax as a condition of accepting the money. Ireland’s 12.5% corporate income tax is one of the main factors that attracted many American firms to do business there. Will Ireland be “saved” at the cost of its sovereignty? What is even more disturbing to contemplate is the possibility that if these measures aren’t enough, will they cause a chain reaction that could destroy the Euro currency and the European Union itself?

Ireland declared its independence in 1916, ending hundreds of years of colonial rule by the United Kindgom. Ireland became a republic in 1949, consisting of 26 of the 32 counties, while the other 6, Northern Ireland, are still part of the United Kindgom. It became a member of the European Union in 1973. For years it was one of the poorest countries in the EU. A combination of EU investments, low taxes, subsidies, demographics, and a favorable time zone differential lured many large American computer and IT companies to do business there in the 1990s and 2000s. The resulting economic boom that turned Ireland overnight into one of the wealthiest countries in the EU was referred to as the Celtic Tiger, in homage to the Asian countries that experienced similar rapid growth. For a time, Ireland had sustained prosperity and it seemed as they were finally stepping outside of the shadow of the UK.

The Celtic Tiger stopped roaring in 2007, when several events coincided: the effects of the worldwide economic downturn, the bursting of the Irish housing bubble burst and the insolvency of leading Irish banks and financial institutions. In the midst of this, the Irish government pledged to bail the banks out. This decision, it turns out, was to have long-lasting repercussions. The total cost of the Bank bailouts for the Irish government is $97.7 billion dollars, or 47% of the GDP of Ireland. In addition the high unemployment meant an increase in social services and a loss of tax revenue.

Ireland attempted to solve their financial problem through austerity measures in order to balance their budget, including cuts to social services while still continuing to bail out the banks. Despite these efforts, Ireland has found itself in the position of Greece and Spain of having to ask for a bailout. There are currently widespread protests planned for this weekend in Ireland, and there is no confidence in the current government among the people. Taoiseach (Prime Minister) Brian Cowan said that he would call new elections in January, or as soon as the budget and bailout issues were settled, but not before, as the dissolving of the government during the bailout process could cause further panic among investors.

The situation in Ireland looks like a no-win situation all around. Their guarantee to bail out Irish banks was a nice idea, but one that they could not deliver on. Some of the Irish banks that received taxpayer funds were not only affected by the economic downturn and housing bubble, but engaged in unethical behavior as well. These banks that were “too big to fail” got the Irish government to accept the moral hazard of their bad investments, and this guarantee has forced Irish citizens to bear a huge financial burden not of their own making. It has also brought the European Union and the international financial community much closer to the brink of financial disaster. Ireland is the fifth and latest EU member country to receive a bailout. How many more countries are the rest of the EU willing or able to bail out?

As a condition of accepting a bailout, the Irish government has to submit a balanced budget, and much of the forthcoming cuts will effects their citizens in the forms of massive decreases in social welfare spending and increased taxes. One of the issues on the table is that Ireland’s creditors might insist that their low corporate tax rate be increased. This would be a huge blow to Ireland in the long run as it is one of its main sources of competitive advantage compared to other EU countries. If it is raised, many of the American companies that moved their specifically to take advantage of the low corporate income tax would leave, so forcing Ireland to raise it would create a long-term vicious circle that would hamper their economic recovery.

To say that Ireland’s future is looking gloomy would be an understatement. This is just the first few days in the bailout process. The high unemployment rate in Ireland, along with the spending cuts that the citizens feel they have to endure in order to fund the bank bailouts has already in effect brought down the government. There is also the possibility of widespread popular opposition to the cuts, as public anger has yet to manifest itself.

How did this happen? While part of it is due to the effects of the worldwide economic downturn, the Irish government’s subsidy of the moral hazard of Irish banks is the main contributor. While the United States was able to bail out their financial institutions in2008-09, what happens if other ones need to be bailed out? If the cost of a future bailout is half of the GDP of the United States, would the government go through with it? Why would any small country be willing to bail out banks in their country if the risk is ending up in a situation like Ireland is right now? Is it better to let a bank fail than to let it drag down the economy of an entire country? Which one is worse for the international economy as a whole? Also, if a country accepts a bailout, especially from the IMF, there are certain conditions imposed. Is it worth accepting the bailout money if it impacts the sovereignty of the country and its ability to make its own economic policy in the long run?

There are many other questions that are swirling around right now that have no easy answers but the responses to them will affect the fate of Ireland, the European Union, and possibly the worldwide economy. I can only hope that the solutions that are enacted will help the people of Ireland and Europe, and that we can all learn from these events and prevent their reoccurrence in the future.

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