Fiscal austerity in Ireland – a working example
Ireland’s first-quarter GDP growth represents an amazing recovery from one of the deepest recessions of the developed economies, which followed from severe fiscal austerity and full-blown deflation. The example shows that austerity policies can work, restoring competitiveness and growth along with fiscal stability. However, Ireland’s reliance on external demand for growth highlights a key dependency and indicates that there are limits to how far its success can be used as an example.
A 6.9% increase in exports was the key driver of Ireland’s 2.7% first-quarter growth. Domestic demand continued to contract, by 0.5%, led by a 13.8% decline in investment as house building fell to half last year’s levels. Government spending was down 0.9%. Consumer spending was resilient, down by just 0.2%, though retail sales remained dismal, down 6%.
The Irish economy contracted by a total of 15% in real terms from its peak at the end of 2007 to its recent trough. The collapse in activity left the government with a huge deficit, which hit 14.3% of GDP in 2009. This prompted a series of severe budgets cuts, incorporating pay cuts for all civil servants, starting with 20% for the Prime Minister, and a 4% cut in welfare payments. In total the government’s austerity package amounted to 4.5% of GDP. Meanwhile, the National Asset Management Agency was set up to acquire €68bn of troubled loans from Irish banks and other financial institutions, equivalent to some 40% of GDP.
Some might say that Ireland is just lucky, in that they are recovering due to exports, as demand recovers elsewhere. There is some truth in this - Ireland is a small economy that therefore has an ability to use exports to achieve growth in a way that larger countries would find more difficult and that would raise more complaints from trading partners. However, this would be to miss the point that the Irish economy scores highly in terms of openness and scale of exports. Additionally, much progress was achieved even before the recent collapse of the euro. In our 8 June Daily Theme we highlighted that Ireland, with its large export sector and over 60% of its exports outside the euro-zone, would be a key beneficiary of euro weakness. Hence, we expect a further boost to export growth to sustain Ireland’s current recovery.
While Irish sovereign bond yields have risen again this year, they are still below the peak levels seen at the beginning of 2009. This demonstrates the benefit of Ireland having a credible plan for fiscal consolidation and delivering on it. While spreads over German bonds have widened this year, the major driver has been a flight to safety against the backdrop of an uncertain global economic outlook and the Greek crisis. The comparison with Greek bonds this year is informative, demonstrating the clear advantage that Ireland has derived from its decision to address its budget deficit.
Conclusion
Ireland has taken the tough route of austerity, with massive fiscal cuts, deflation, a collapse in its property market and a huge bail-out of its financial system. That it has regained competitiveness and growth, while retaining creditworthiness, is a tribute to its political leadership and the flexibility of its economy. The fall in the euro should provide an additional boost, which suggests that growth should now be sustained. This is a very considerable achievement, but the question remains whether other euro-zone member states will want or be able to follow this route.
Disclaimer
Issued by Coutts & Co, which is authorised and regulated by the Financial Services Authority. Coutts & Co is registered in England No. 36695. Registered office: 440 Strand, London WC2R 0QS.
The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance should not be taken as a guide to future performance. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down.
The information in this document is not intended as an offer or solicitation to buy or sell securities or any other investment or banking product, nor does it constitute a personal recommendation. The information is believed to be correct but cannot be guaranteed. Any opinion or forecast constitutes our judgement as at the date of issue and is subject to change without notice. Any Coutts company, or a connected company, its clients and officers may have a position or engage in transactions in any of the securities mentioned.
The analysis contained in this document has been procured, and may have been acted upon, by Coutts & Co and connected companies for their own purposes, and the results are being made available to you on this understanding. To the extent permitted by law and without being inconsistent with any applicable regulation, neither Coutts & Co nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such analysis.
Not all products and services offered by the individual Coutts companies are available in all jurisdictions, and some products and services may be available only through particular Coutts companies.
None of the overseas Coutts companies or offices is an Authorised Person subject to the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors and depositors, and compensation under the Financial Services Compensation Scheme will not be available in respect of business transacted with them.
