It All Depends On Ireland?

Ireland is either the poster child for austerity, or the best argument against it. Take your pick.

The reality is that Ireland has emerged as a sort of Rorschach Test through which supporters of economic austerity measures and those who advocate additional stimulus spending are projecting their dueling positions.

All of this is, of course, a proxy for the debate in the U.S. over whether the economic recovery will be stalled if the austerity movement currently sweeping Europe gains traction in the U.S.

That debate is only going to intensify given Friday’s disappointing U.S. jobs report, which provided further evidence that the economic recovery is in fact stalling. Advocates for additional stimulus will certainly view the dismal numbers as fuel for their argument.

As the charter member of Europe’s fledgling austerity club, Ireland has been at the center of this simmering debate for months.

In short, the proxy battle over austerity can be summarized thusly: success in Ireland ostensibly bodes well for success in Europe, which bodes well for success in the U.S. Conversely, if austerity in Ireland is a failure, it will fail in Europe and the U.S., as well.

The Wall Street Journal, whose editorial writers have long argued for less government spending and lower national debt levels, recently dedicated half of its editorial page to a column titled, “The Irish Example,” essentially a call to arms directed at European nations (and undoubtedly U.S. fiscal leaders) to follow Ireland’s lead in addressing its untenable finances.

At the other end of the spectrum there’s Nobel Prize winning economist Paul Krugman, a virulent opponent of austerity, elaborating on what he describes as the “Irish debacle” in a recent blog: “All that savage austerity was supposed to bring rewards … But the reality is that nothing of the sort has taken place: virtuous, suffering Ireland is gaining nothing.”

The argument for austerity holds that reduced government spending on things such as public wages and benefits will free up money to cover sovereign debt loads. Financial markets will theoretically reward nations that take this path by freeing up credit, making borrowing cheaper and easing the path to renewed economic growth.

The flip side of that argument is that austerity will lead to higher unemployment and reduced consumer spending, which will only serve to stall growth and scare off investment, ultimately blocking recovery for the foreseeable future.

Ireland decided early on that the only way it could avoid defaulting on its sizable sovereign debt load was to start cutting spending. And that’s exactly what it did. Nearly two years ago, as the rest of the world was just starting to realize the scope of the global economic crisis, Ireland’s leaders began scaling back on the wages, benefits and pensions of public employees. Many of these labor contracts had been negotiated during flush years on the Emerald Isle, the period between 1994 and 2007 during which the Irish economy was known as “The Celtic Tiger.”

According to the Irish economist Constantin Gurdgiev, government spending rose by 138% in the decade leading up to the 2008 economic crisis. At the same time Ireland’s economic growth was humming along at a much lower rate of 72%.

To head off defaulting on its sizable debts, Ireland in October 2008 started cutting: since then some public employees have seen their salaries cut by 20%, welfare benefits for children have been cut by 10%, and a range of other social programs have also fallen under the knife. And Irish lawmakers didn’t stop with cuts: they raised taxes, as well, targeting minimum-wage earners while leaving corporate taxpayers alone, a controversial strategy.

The truth is that it’s too early to say whether Ireland’s austerity measures are a success or a failure.

But what’s significant right now is that Ireland actually followed through on the austerity measures it said it put in place. That will go a long way toward building credibility in financial markets and among potential lenders.

Unfortunately, the same thing can’t be said for the other so-called PIIGS of the European -- Portugal, Italy, Greece and Spain -- all of which have also made vows of austerity in recent months.

Axel Merk, president of Merk Mutual Funds and an expert on foreign economies, provided some insight into the credibility of European countries that have also made vows of austerity. According to Merk, there is considerable doubt that Greece can implement the policies its government has promised given the widespread threat of public unrest if lawmakers act on proposed salary and benefit cuts. The governments of Spain and Portugal, while more credible than Greece, also invite skepticism because the groups pushing for austerity are in the political minority.

Elsewhere in Europe, France also suffers from credibility problems because, as Merk noted, traditionally, whenever the government proposes cutbacks in spending, French truck and tractor drivers block highways and the government backs down.

Germany and Finland, meanwhile, are widely trusted, according to Merk.

So the most important thing “regarding Irish policies is that they are credible,” according to Merk. “You may like them or not like them, but you can trust what you hear coming from Irish policy makers. And trust, of course, is at least as important as whether the policy is good.”

By Dunstan Prial