Ireland: “Responsible” Policy Punishes Citizens for Bankers’ Sins

Poor Ireland.  For some unknown reason, the Irish seem doomed to suffer under the misguided rule of others, despite being the source of great music, culture and a brew so good      For centuries, the oppressor was the English.  In this century Ireland has fallen under the boot of the bankers and The Powers That Be (TPTB) who have have fallen under the sway of “responsbile austerity”.  There is a lesson here for America if we would only listen and pay attention.

Earlier in this century, before 2007, Ireland apparently had left it’s history of poverty and oppression to become the poster child for success via globalization. It’s GDP boomed (see graph). It attracted foreign direct investment and many foreign firms, including Google and others. It was called the Celtic tiger. GDP per capita had risen to the second highest in Europe behind Luxembourg. It was following the recommended path towards financial globalization that conservative right-wing economists have been pushing for several decades.  The right-wing Heritage foundation praised it’s financial deregulation, low tax, and nearly non-existent taxes on foreign corporations as the key to success.  And by conventional measures like GDP it appeared to work.

But in 2007, things began to turn down.   Seems Ireland had developed a highly skewed and unequal distribution of income (like the U.S. today). It had become overly dependent on a property and housing boom with 12% of GDP resulting from new construction (kinda like the U.S.).  And much of the apparent GDP increases were illusion – the result of the difference between GDP and GNP – meaning life really wasn’t as good as the GDP numbers suggested.  (See  GDP vs. GNP to learn the difference between GDP and GNP and how it distorts things for Ireland but not the U.S.).  Then the Global Financial Crisis came.  Ireland got hit pretty hard. The housing market tanked. Bank loans started going bad in large numbers.  Now it should be noted that these were all private-market loan decisions.  They were the result of foreign investors making private contracts to take on the risk and make loans to people in Ireland (and outside) to buy Irish property.  But when the loans began to go bad in large numbers, the large (mostly) Euro banks’ who had made the loans had their solvency threatened.  And with that, the profits of Euro investors in those Euro banks were threatened.  The Irish government was urged to be “responsible” by taking the responsibility away from the banks and investors who made the loans.  The Irish government guaranteed the banks’ loans after the fact.  As Paul Krugman recounts:

The Irish story began with a genuine economic miracle. But eventually this gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations.

Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations.

Before the bank bust, Ireland had little public debt. But with taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation’s creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts.

When the Irish government took on the bad debts made by private banks in order to save large international investors from the consequences of their bad choices , it naturally led to a large increase in the Irish government debt to GDP ratio. So in return for the good (?) deed of rescuing international investors, banks, and bond buyers from the consequences of their investments, those investors, banks, and bond-buyers have punished the Irish government by driving interest rates on Irish bonds to high levels.  The speculators smell another Greece.  Talk of bailouts began earlier this month. And, finally with interest rates rising and the speculators circling like sharks, the Irish government accepted a “bail-out” earlier this week from the Euro central bank and IMF, the usual TPTB.

I’m not sure that it should really be called a “bail-out” though.  It’s actually a strange deal like something out of  Alice in Wonderland or a George Orwell novel.  In return for the Irish government agreeing to cut spending even more, raise taxes, and punish it’s already suffering people, the Irish government gets a large credit line so it can borrow even more money in the future.  Of course, by cutting spending and raising taxes in the middle of a serious, deep recession and when it has no control over it’s monetary policy (Ireland is in the Eurozone), it will, of course have even larger deficits than is planned or expected and will need to borrow that money.  Which will only kick the can down the road to some point in the future when another “bail-out” is necessary.  God save us all from such “bail-outs”.

What  could the do instead?  Well, first off, long-term policy should be focused on growth by investing in infrastructure and education and research, much like Finland does and not in globalization and chasing multi-national banks and corporations who play shell games.  More directly, the Irish government should consider what Iceland, that other small European island in the North Atlantic did.  As Krugman also observed in the same article:

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.” Meanwhile, Iceland helped avoid a financial panic in part by imposing temporary capital controls — that is, by limiting the ability of residents to pull funds out of the country.

And Iceland has also benefited from the fact that, unlike Ireland, it still has its own currency; devaluation of the krona, which has made Iceland’s exports more competitive, has been an important factor in limiting the depth of Iceland’s slump.

None of these heterodox options are available to Ireland, say the wise heads. Ireland, they say, must continue to inflict pain on its citizens — because to do anything else would fatally undermine confidence.

But Ireland is now in its third year of austerity, and confidence just keeps draining away. And you have to wonder what it will take for serious people to realize that punishing the populace for the bankers’ sins is worse than a crime; it’s a mistake.

But to follow the Iceland example requires two things.  First, Ireland would have to leave the Eurozone and return to issuing and controlling it’s own currency. And, second, it’s politicians would have to the well-being of the Irish people above the claims and self-interest of the banks and large international investors.  I say not gonna happen.

GDP vs. GNP

Gross Domestic Product (GDP) is the measure economists typically use to indicate the total size or value of economic production in an economy.  There is a similar measure called Gross National Product (GNP).  Older readers from the U.S. will probably remember learning something about GNP when they were younger.  That’s because until a few decades ago (within this aging author’s memory), GNP was the measure most often cited as the lead measure in the U.S. to describe the health of the economy.  That shifted. Now GDP is generally the preferred measure.

So what’s the difference?  Well, first let’s look at the similarities.  Both GDP and GNP measure “the market value of all goods and services produced for final sale in an economy”.  The difference is in how we define “the economy”.  GDP focuses on domestic production.  In other words, it defines a nation’s economy in geographical terms.  Whatever is actually produced inside the country, regardless of who is doing the producing or who owns the productive capital that produces it.  In the case of the U.S., it means whatever is produced within the 50 states.  GNP however focuses on the production by nationals.  In other words, GNP defines the nation’s economy in people or resident terms.  It counts whatever is produced by the residents or citizens of a nation regardless of where those people may be doing the producing.  In the case of the U.S., this means that GNP measures anything produced by Americans or American-owned capital wherever it may be in the world.

So in practical terms it’s multinational or transnational corporations where the differences arise.  Let’s consider the auto industry.  If Ford, a U.S. company, produces in cars in Dearborn, MI, then the value of the cars counts toward both GDP and GNP.  Similarly, when BMW, a German corporation, builds cars in Germany, it counts towards both German GDP and GNP.  But when Ford produces cars in Cologne, Germany, it counts toward U.S. GNP (Ford is American producing in Germany) but not toward US GDP. Instead Ford production in Cologne counts towards German GDP since it is geographically produced in Germany. Likewise, BMW production in Alabama in the States counts toward US GDP and German GNP, but not German GDP.  Clear?

Examples:

Normally the differences between GDP and GNP aren’t that economically significant.  Wikipedia reports the differences between the GDP and GNP for the U.S. in 2003 – a difference of less than one-half a percent of the total:

GDP and GNP

Main articles: GDP and GNP

Gross domestic product (GDP) is defined as “the value of all final goods and services produced in a country in 1 year”.[4]

Gross National Product (GNP) is defined as “the market value of all goods and services produced in one year by labour and property supplied by the residents of a country.”[5]

As an example, the table below shows some GDP and GNP, and NNI data for the United States:[6]

National income and output (Billions of dollars)
Period Ending 2003
Gross national product 11,063.3
Net U.S. income receipts from rest of the world 55.2
U.S. income receipts 329.1
U.S. income payments -273.9
Gross domestic product 11,008.1
Private consumption of fixed capital 1,135.9
Government consumption of fixed capital 218.1
Statistical discrepancy 25.6
National Income 9,679.7
  • NDP: Net domestic product is defined as “gross domestic product (GDP) minus depreciation of capital”,[7] similar to NNP.
  • GDP per capita: Gross domestic product per capita is the mean value of the output produced per person, which is also the mean income.

Occasionally, though, the differences can be significant and lead to wrong conclusions if the wrong measure is taken.  For example, in the case of Ireland in the early 21st century, much of it’s economic growth was actually somewhat of a sham.  What appeared to be GDP increases were in fact, the result of fancy acccounting and bookkeeping by several major multinational corporations (notably Google) who wished to take advantage of Ireland’s very low corporate taxes as a way to launder profits earned in other countries before bringing those profits back to their non-Irish home (often the U.S.).  In Ireland in 2007, GDP was as much as 23% higher than GNP (source Irish National Accounts)  This is means that when that the Irish got to work hard but the fruits of that labor went in large part as profits to foreign owners with no offsetting foreign income available to the Irish. The Irish have once again become laborers for absentee foreign “landlords” (maybe we should call them  “corporatelords”).  As Bill Mitchell has noted on his blog at  The Celtic Tiger is not a good example and The sick Celtic Tiger getting sicker,

Boone and Johnson offer this interesting insight to further their contention. They show how the growth miracle that led to the “Celtic Tiger” reference was in large part a mirage and driven by major US corporations evading US tax liabilities by exploiting massive tax breaks supplied to them by the Irish government. They conclude that”

… 20 percent of Irish gross domestic product is actually “profit transfers” that raise little tax for Ireland and are owned by foreign companies … 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 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 following graph is taken from the latest Irish National Accounts which cover up to the fourth quarter 2009. Flash estimates for the first quarter 2010 are available but not broken down like this.

The graph shows the difference between Gross Domestic Product (which counts all output produced) and Gross National Product (which exclude the profits of foreign residents) for Ireland. Once you make that correction, then you can see how much worse the domestic contraction has been in the Irish economy.

So GDP was 7.1 per cent lower than in 2008 while GNP was 11.3 per cent lower than in 2008.