The state of play in Irish economy -- the IMF tells it like it is

People line up for unemployment benefits in Dublin last summer. 

As you probably know, last week Ireland passed its most recent review by the IMF-EU-ECB troika of officials -- they visit us every tree months to check the nation's finances.

It's the humiliating part of getting the bailout.  They have the right to come in, examine how we're doing and tell us off to smarten up if we're not sticking to the program.   Any back sliding and they could turn off  the money flow until we came to our senses.

So far that has not been necessary.  In fact we have been such good bailout recipients that we've passed every examination, and we're being held up to other EU countries in trouble as the model to emulate.
Once again we passed last week's quarterly exam -- the seventh since the November 2010 bailout -- with flying colors.  In fact we've been so good at meeting our targets and keeping the troika happy that it's almost boring.   Every three months they come in and tell us we're making great progress and to keep it up.

There is a down side to this, however, because it has generated a false sense of achievement and security among people here.  It's true that we have managed to keep more or less on track so far in the program, but the reality is that the toughest part of the process still lies ahead of us.  

The minor adjustments we have made so far have been mere trimming rather than cutting.   All the low hanging fruit in the garden of state spending has been picked.  In the future we are going to have to make cuts where it really hurts.

We're not near the end of our rebalancing of the nation's finances.  In fact we're not near even the halfway point.

The fact is that despite the cuts in some state spending and the modest increases in some taxes over the past three years, Ireland still has the highest budget deficit in the eurozone.  Not that you would think that listening to the government ministers complacently expressing "satisfaction" after getting the troika's approval again last week.

We may be hitting the targets in the bailout plan, but the fact is we're still broke.  And we still can't quite accept the idea.

We go on running a tax system that is porous with avoidance schemes, and we go on insisting on a level of state spending that is way beyond our means.  All suggestions of higher taxes and all attempts at making serious cuts in state spending are met with howls of anguish.  
The result is that progress in rebalancing our books -- getting rid of the yawning budget deficit -- has been painfully slow.

Under the bailout program we're supposed to have the gap down to a 3% deficit by 2015.  If we are to achieve that we need to stop the fiscal baby steps and take a few massive strides in cutting spending.

Even if we manage to get a deal on our bank debt from Europe which will lower the interest payments we have to make (due to reach around €10 billion a year within the next three years), we still have to rein in spending in line with our much reduced revenue.

Maintaining spending at near boom time levels even though tax revenue has collapsed is not a sustainable situation.  That's why the markets stopped lending to us and why we had to take the bailout.  
The fact is that if we are to regain our economic sovereignty the first thing we have to do is to start living within our means again.  

That means we will have to go through at least three more draconian budgets over the next three years, budgets in which we implement real hikes in tax and real cuts in spending.

It's not going to be easy and it's not going to be popular (just wait until they make major cuts in welfare benefits and replace the present token property charge with a real property tax that takes big money from anyone living in a half decent house.) But that's what's ahead of us from next year, and favorable reports from the troika won't make the medicine go down any easier. It's going to be a very rude awakening from our present national torpor.

Rather than scare people with the reality of what lies ahead, the government has been saying little and hoping for a miracle of some kind.

Over the past year they have been clinging to the hope that growth in the economy would start to lift tax revenues and lower the welfare burden as more people found jobs.  That would narrow the deficit gap and mean less cutting would be needed.  

But it ain't happening.  At over 14%, unemployment remains at a catastrophic level.  The latest figures from the state's Central Statistics Office, which also were published last week, show that the Irish economy contracted in the first quarter of this year.

So there is not going to be any easy growth-led solution for us in the immediate future, the kind of solution that would allow us to wriggle through this correction process without feeling any real pain.

So let's look at some of the things we have to do here. First on the revenue side, we have to move away from the present tax system which is riddled with reliefs that allow many high earners to avoid much of their tax (dodgy property investment  driven by tax reliefs was an example, contributing in a big way to the boom).
We need a simple, fair, progressive system with no get outs.  A bonus would be that the army of lawyers and accountants who now get rich by undermining the system would have to get a real job for a change.

We also need a similar approach to the forthcoming property tax next year -- no exceptions, everyone pays, thereby keeping the average as low as possible. Charges for many state services now provided free (water for example) will also have to be introduced, even in taboo areas like health and education.  The old adage that you never appreciate something you get for nothing has been proven by the rampant waste in the system at present.  

On the spending side, even bigger changes have to be made.   The two big untouchables, welfare and health, account for two thirds of all state spending, with the last one third going on everything else.
So to make any real progress in reducing the state spending we can't pay for, we have to start making cuts in these two areas.   There's simply no other way.

It's not just a matter of cutting welfare rates. It's also a matter of limiting who is eligible, thereby drastically reducing the numbers who are claiming.  

Our unemployment benefit, or jobseekers allowance as we call it these days, is one of the highest in Europe and has no limitation on how long someone can claim.  People learn to work the system and develop a powerful sense of entitlement.  Work, especially a regular job at or just above the minimum wage, becomes something to be avoided.

For those with children and who qualify for a range of free state services and payments, the cumulative benefits that come with being out of work are so high that it's hard for an employer to better them in pay.  

"It wouldn't be worth it for me to take a job," these people say.  "I'd lose my rent allowance and my fuel allowance and maybe my medical card.  I'd have to pay for transport to a job and I'd have to pay for childcare.

“It wouldn't be worth it.  I'd rather stay at home with the kids."

This situation is a real problem here now, although everyone tries to deny it.  One economist who used to work for the Economic and Social Research Institute, the main state-backed think tank here, recently let the cat out of the bag by writing a report detailing exactly what was going on.  The reaction here from the liberal consensus now running the country was to try to discredit him.

The other area that has to be tackled in a big way is the state sector.  There are too many people on the state payroll here (about one-fifth of the national workforce!), they're being paid too much, and when they retire they have guaranteed high pensions we can no longer afford to pay.  On top of that, efficiency in delivery of state services is poor.

Instead of instituting major cutbacks and reforms in the state sector, the government has continued with the Croke Park Agreement negotiated by the last government.  The state sector is the last bastion of union power in Ireland and the present government, like its predecessor, is terrified of stirring up trouble which could cause strikes and disruption of basic services.

The Croke Park deal, which guarantees no forced job losses and no pay cuts in return for increased flexibility and efficiency, is bogus.  It's largely controlled by the state workers themselves, and so change is resisted and takes forever.

Last week, for example, we had more statistics which showed that sick leave in the state sector is now twice as high as in private industry.  Why? Because they can get away with it.

And despite all the talk about keeping state pay under control, it turns out that pay among state workers is now higher than it was at the peak of the boom in 2008.   This is largely a result of the system of automatic annual increments in pay in the state sector, in contrast with the private sector where pay has been squeezed over the past few years as companies had to fight for survival.

All that has to change in the state sector, with management brought in from the private sector, performance related pay, cutbacks in pay and pensions to mirror what has happened in the private sector, and so on.
Instead, the state workers have been allowed to negotiate a reduction in their numbers, with people taking deals to get out on their golden pensions for life which are guaranteed at close to two thirds of salary.  

The immediate savings for the state are very small, although the government is insisting that long-term savings will be substantial, with smaller numbers.

The IMF has watched in mild horror as this has gone on.  They even suggested publicly that it might be better to reduce pay and pensions in the state sector rather than cut numbers so that the level of state services for the ordinary citizens could be protected.  

Obviously they are right.  But instead the state workers have been allowed to protect their pay, pensions and poor efficiency as the bogus Croke Park Agreement carries on and gets nowhere.  

The government claims savings are being made and reforms are underway.  But no one in the private sector believes them.

In the next budget in December -- assuming we don't need an emergency one before then -- the government has to find another €3.5 billion in savings and extra revenue to meet the bailout targets.

This time, even with a new property tax and other tax changes, major cuts in spending will be needed.  The untouchables of the state sector pay and pensions, welfare and health will have to be tackled.  There's nowhere else to go to get the budget deficit down by the amount required over the next year.

And if our government hasn't the bottle to do it, the troika will be stepping in to tell them to man up and get on with it.

It's sad but true that we are unlikely to get real reform here until it's shoved down our throats by the EU and the IMF.

Germans need to pay for much of Irish bailout after Euro crisis -- Finally, some hard facts hit home as reality dawns for Merkel

German Chancellor Angela Merkel

The agreement reached by European leaders in the small hours of last Friday morning can be seen in two ways from an Irish perspective.

The shift in European policy allowing the trillion euro European Stability Mechanism (ESM) to be used to directly recapitalize bust banks rather than routing it through the governments of the countries in question is something that Ireland has been seeking for the past year without success.

Now it's going to happen, which is great news for us.  From that perspective, it is a hugely significant development.

But there is another way of looking at it, which is rather humiliating.  The fact is we've been begging, cajoling and demanding the EU to give us something like this for a year, pointing out that the bailout deal that was imposed on us by the EU and the IMF was grossly unfair and was crippling our economy.

What was really killing us, we pointed out, was the massive cost of fixing our bad banks, which had been turned into sovereign debt in a way that was not only questionable but immoral. Something needed to be done to change that, or we would be stuck in a depression for decades.

But all our pleading got us nowhere.   No, no, we were told.  Or more precisely, nein, nein, since it is the Germans who hold the purse strings.

Of course they knew that turning our bank debt into sovereign debt made the Irish state liable and therefore put an enormous burden on the Irish taxpayer.

Of course they knew that making the Irish taxpayer pay back all the bad debts of the Irish banks was unjust because a lot of those billions were owed to German and French banks who had speculated on the Irish property bubble, lending recklessly to their Irish counterparts to get a slice of the action.  Now the EU was insisting that they be repaid in full.

Yes it was very tough, we were told.  But we could not be given a break because other countries in trouble would want the same, it would set a bad example, the euro might collapse, we created the mess and now we must pay the price while it is being cleaned up.  And so on.

Everyone was sympathetic, but sadly nothing could be done.

Except that now it is clear that something could have been done.

Our problem was not that we did not have a strong case.  Our problem was that we are too small.   So we could be ignored or bullied, like the Greeks.

The Italian and Spanish prime ministers at last Friday's critical EU summit were not going to put up with any of that.  With their bond yields climbing to unsustainable levels, Monti, the Italian leader, laid it on the line for Angela Merkel and the rest of them.  Either the EU did something, or the euro would soon be history.

Loading the cost of shoring up Spanish and Italian banks on to the sovereign debt of those countries would lock them out of the markets and the cost of rescuing them would take the euro down.  A different solution had to be found, Monti said.

Spain and Italy were too big to ignore.  They were certainly not going to be bullied.   So Merkel blinked and at around 3 a.m. that morning the deal was agreed.

Our Taoiseach (Prime Minister) Enda Kenny called it a "seismic" shift.

Our Tanaiste (deputy leader) Eamon Gilmore said it was a "game changer."

They both implied that the deal was a confirmation that their policy of appeasement (or should that be abasement?) in relation to Europe had paid off.

Which of course is garbage.  We are riding on the coattails of Spain and Italy, in the hope that whatever they are given we will get as well.

Our policy seems to be to rely on the misfortunes of others, as we did last year when we got a reduction in our bailout interest rate only because a lower rate was being given to Greece.

But however we get it, the fact is that this new deal is likely to be the best thing to happen to us since the property collapse.

The last government's decision at the end of 2008 to give a blanket state guarantee to all the deposits and bonds and debts of the Irish banks was a national disaster.  As the hole in the banks got deeper over the following year, the cost escalated to unbelievable levels.

Eventually, combined with the collapse of tax revenue because the property boom had ended, it brought the country to its knees, begging bowl in hand.

Enter the EU/ECB/IMF troika to rescue us with a bailout that tied us into repaying all our bank debts in full, with the taxpayers carrying the can.

The austerity program started as we battled to get our budget deficits down and cut spending to match revenue.  A huge part of our spending, of course, is now our interest payments on the bailout deal, dead money that does nothing for our economy.

The cost of bailing out our banks is over €60 billion, and the repayments on that part of the bailout have wiped out the effect of the spending cuts and tax increases we have had to suffer for the past three years or more.

The painful corrections we have made in the recent hairshirt budgets have been offset by the huge cost of our bank debt.  We're running to stand still.

The situation is so grim that there has seemed to be little point in staying here since we are being bled dry to pay off the bailout, much of which has been used to pay off bank debt.

Now, however, there is hope.  Exactly how much hope we don't know yet because the detail of what was agreed by the EU leaders last Friday morning is far from clear.

But if the headline agreement is followed through and applied fairly, then the deal will allow us eventually to step off the fiscal treadmill we have been on.

Allowing the ESM to invest directly in failing banks in Spain will stop Spanish sovereign debt reaching unsustainable levels.  Similarly in Italy. Under EU rules, the same deal will have to be made available to any EU country which needs it.

And in Ireland's case equality of treatment, which is a basic EU principle, will mean the deal will have to be backdated to cover what happened in the Irish banks.  If that happens, the €60 billion plus in bank debt the Irish state and taxpayers are carrying will have to be taken up by the ESM.

That means that Irish government debt could be reduced by up to €64 billion, which would drastically reduce our Debt/GDP ratio, the key indicator watched by the international money markets.  That would enable us to get back into the markets sooner than expected, rather than taking the bailout cash.

In fact this Thursday Ireland will be auctioning three month Treasury bills, the first time we have gone to the markets since they refused to lend to us and we were forced into the bailout. It's not the same as selling a few billion of our longer term state bonds, but it's an important first step.

So are we off the hook?  Well, not really.

We still have to get our budget deficit down as fast as possible.

Since our revenues collapsed with the property bust, the gap between our spending and revenue has been huge.

Taking the bank debt interest payments out of the equation will help, but the annual deficit in our state finances is by far the biggest part of the problem.  So our austerity regime will have to continue until our finances are back in balance.

Before we put the champagne on ice we also need to see the detail of what was agreed by the EU leaders. That is still being worked out.

But it seems that if the ESM is going to take on our bank debt, that EU fund will replace the Irish taxpayer as owners of our banks until the debts are cleared some time far into the future.

The other factor is that the Germans will never allow the ESM to put money directly into ailing banks without the construction of a pan-European bank regulatory system.  That will mean that our banks will be monitored, not only by our own regulator or by the Irish Central Bank, but by a new EU bank regulator who will be the ultimate boss.

This is to prevent a repeat of the mad speculation the Irish banks got up to during the boom and given the abysmal performance of our own regulator at the time, it may not be a bad idea.

All we got from the EU leaders as dawn broke last Friday morning was a headline agreement of the principle involved.  The devil will be in the detail.  It is likely to be extremely complex and it will take months to work out.

One final point -- money does not vanish, it just gets shifted around.

 So where will the €60 billion plus of Irish bank bad debt end up?

The ESM fund is being accumulated by contributions from all the EU nations, but Germany will be by far the biggest donor.

What is happening is a sort of mutualization of the bank debt of bust countries like Ireland, Spain, Portugal and Greece.   That means the taxpayers of Europe will end up carrying the can, especially the taxpayers of Germany.

The German taxpayers are already critical of Merkel for the cost to them of propping up the euro, and this new deal will increase their anger. They want countries like Greece and Ireland to pay their own bills.

The financially responsible Germans have little sympathy for what they see as irresponsible spending in Ireland and massive failure to pay taxes in Greece.  But they need to look closer to home for the guilty party where Ireland is concerned.

The fact is that the German banks funded the boom in Ireland by lending to the Irish banks so that they could get a share of the much bigger returns that could be made here at the time. They poured money in here.

If we were irresponsible, so were they.  On that basis, it's only fair that the cost of sorting out the mess in the Irish banks should involve the German taxpayer as well as the Irish taxpayer.