A Tale of Two Countries

It was the best of times, it was the worst of times …

The famous beginning of Dickens’ Tale of Two Cities comes to my mind when I think of the two countries which I regard as home, Ireland and Germany. This weekend Germany is celebrating the 20^th anniversary of the reunification of its eastern and western parts. This weekend Ireland is trying to come to terms with the practical ramifications of the final bill now estimated for the Irish taxpayers to bail out their national financial institutions, destroyed by the crash; 50 billion euros (around 65 billion dollars).

Following the euphoria of reunification, Germany looks back at twenty difficult years, dominated by the effort of paying for it and adjusting the country’s economic system to cope with the effects of globalisation, at the end of which (despite increased strains on public finances as a result of the events which began with the collapse of Lehman Brothers two years ago) it is enjoying healthy economic growth and falling unemployment. Ireland looks back at eighteen years of unprecedented prosperity followed by two years of increasing stress as it has become clear that the Celtic Tiger was constructed entirely out of paper and that this paper consists entirely of IOUs, the economy, such as it is, in free-fall and unemployment rocketing.

At the beginning of the millennium, Germany was regarded by most experts as the sick man of Europe. The former GDR had turned out to be a gigantic economic ruin, its industry (which had provided full employment under the communist system) destroyed by its monumental inefficiency. Shortly after unification, Kohl had promised “blooming landscapes” and claimed that the price could be paid from the petty cash account. That had turned out to be a classical case of whistling in the dark. Unemployment in the east, ten years after reunification, was running close to 20% and billions of tax earnings were being funnelled annually from west to east. West German industry was stagnating; crippled by restrictive practices and high wage costs it was increasingly unable to compete on the global market with products produced in Eastern Europe and the new tiger economies.

At the beginning of the millennium, the Celtic Tiger was really getting into its stride. Given a kick-start by generous structural funding from the EU at the beginning of the 90s, Ireland – long a land whose greatest export was its children – was nearing full employment. Multi-national corporations were rushing into the country – companies like Microsoft, Dell and Intel – eager to establish bases within the European single market, attracted by an environment with a young, well-educated, English-speaking population, moderate wage levels and very low corporate taxation. International financial institutions were setting up subsidiaries in Dublin’s developing financial district and domestic banks too were getting into the exciting game of financial products which seemed to able to grow profits like mushrooms in the dark as long as they were being fed a steady diet of bullshit. Drawn by the boom, immigrants were starting to come to Ireland, most of them from Eastern Europe, attracted by good wages in the building and general services area.

By around 2003, the Social Democrat/Green coalition in Germany realised that major reforms were necessary in the labour area and social services if the country was going to be able to bring its spending under control and make itself competitive on the world market. The so-called Agenda 2010 was pushed through against fierce opposition (particularly internally among the Social Democrats themselves), ushering in harsh controls and cuts in the area of social spending, liberalising the labour market by creating opportunities for the development of a low-wage sector and cutting taxes. Unemployment, which had peaked at 5.2 million at the beginning of 2005 is today down to 3 million and before the crash threw everything out of kilter Germany was expecting a balanced budget by 2010/2011.

I’m not going to get into a discussion of the specific issues and measures involved in the Agenda – many of which I am decidedly critical about. I won’t even begin to comment on the creation of a new caste of working poor, the dismantling of whole areas of basic workers’ rights, the continuing structural weaknesses in the former GDR. I will remain silent about the growing gap between rich and poor in the country. We went through hard years and there are many – very many – who still have it tough. But (seen at least from a classical economic perspective) the cure worked. The price for those who pushed it through was high; the Social Democrats faced a party split with many of its more left-tending members leaving to join a new left-wing party formed together with the remnants of the former East German communists, and Gerhard Schröder, the SPD Chancellor who championed the reform, lost power in 2005.

Throughout the first decade of the century, Ireland continued to boom, growth being increasingly driven by the property sector. There was building going on everywhere and real estate prices were rocketing. Ordinary people were paying more than half a million for normal homes, sometimes far more than an hour’s drive from their places of work. Various financial institutions had no problem lending them the money (in many cases all the money) for the purchases. Government revenue was buoyant, basically as a result of stamp duties, a tax on property sales.

It was a classic bubble scenario, but the few voices of warning were ridiculed. In an overheating economy, wages were rising and – following Ireland’s accession to the Euro zone – the conventional strategy for controlling such a bubble (basically allowing interest rates and inflation to increase) wasn’t possible; the European Central Bank was keeping interest rates low to stimulate growth in the rest of the zone, where it was stubbornly sluggish, and to keep inflation down. The competitive edge which had started the tiger roaring in the 90s was long gone. Seen from an international perspective, Ireland was pricing itself out of the market.

Few people in Ireland (and, to be fair, few international observers at that) noticed, instead many Irish were losing all contact with reality. It became fashionable for thousands to fly to New York to do their Christmas shopping – the dollar being weak and the euro strong. Visiting Ireland during this period, I was ever more bemused at the way money was being thrown around and, simply, at the horrendous cost of everything. While I sometimes wondered wryly at my own stupidity at having left a poor country for a rich one, only to see my host country grow poorer and my homeland grow steadily richer, at the same time, I had the niggling feeling that this couldn’t last. Ordinary people were paying more for a house an hour’s drive or more from Dublin than a well-off professional would pay for one in the most fashionable district of Munich! Who was actually earning all this money?

Nobody, as it turned out. Most of the money flying around was being lent on the basis of notional profits, generated by complex financial schemes nobody understood. When the crash came, the Irish financial institutions and the Irish people were left holding the baby. It was like a game of musical chairs when the music stops and there’s no chair left for you. The property market crashed and the revenue which it had been generating – which had been keeping Ireland’s public finances afloat – vanished.

Like nearly every other country in the world, Germany took a hard hit from the crash too. It has a strongly export-driven economy and the uncertainty worldwide meant that, in the short-term, orders plummeted. The goal of balancing the budget had to be abandoned, extra funds provided to help businesses let hundreds of thousands of employees go on short-time work (much preferable to complete lay-offs), various stimulus measures implemented to keep up a basic domestic demand, above all, billions to bail out the banks. But Germany had a large, fundamentally healthy economy, based on production and manufacturing, mostly in the hands of small and middling sized businesses rather than mega-corporations and could, once the dust started to settle, borrow the money for these measures pretty cheaply. Two years after the crash, the German economy has bounced back better than even the optimists had predicted. And the government is continuing to try to consolidate the public finances – although the methods being proposed and implemented are the subject of heated public debate. But that’s another aspect of issues (about which I do have decided opinions) I don’t want to go into here.

Ireland’s political leaders would love to have Germany’s problems. Those they have to deal with are of another dimension entirely. Ireland doesn’t have toxic areas of the banking system to deal with, the whole Irish financial system is, at the moment, one gigantic bad bank. And the Irish government has guaranteed all the resultant debt from the public purse. Boiled down to per capita terms, this means € 10.000 for every man, woman and child in Ireland. This is not the national debt, mind you, it’s just the cost of sanitizing the financial sector. And this means that the Irish people are facing not some very hard years, but some very hard decades.

Amazingly, Ireland’s political leaders still seem to be more concerned with spin and power than talking openly about and tackling the consequences of the fecklessness of the past two decades. If the Irish are to deal with their problems rapidly and in a dignified manner, fuelled by hope, solidarity and hard work, they need inspired, open, honest, principled leadership. Looking at the quality of the present incumbents (and, indeed, most of the current parliamentary alternatives), I could easily tend to despair. But then I think of the basic decency, generosity, creativity and capacity for hard work of most of my compatriots and begin to think that they will, somehow, manage.

Europe will bail Ireland out; out of self-interest more than anything else, because Ireland is a member of the euro-zone and the alternative would be far more expensive. But Europe will demand a price, and that price will be stiff. The signs are already firming up; Ireland will have to present detailed budgetary plans for the next four years, at the end of which the deficit may not be more than 3% of GDP (one of the basic Maastricht criteria). In return, Ireland will be guaranteed affordable financing to clean up the banking mess.

But one of the many pounds of flesh which will be demanded involves a central aspect of Irish economic policy, one that has been a thorn in German eyes, in particular, for many years; Ireland’s low rate of corporation taxation (12.5%). Transnational corporations have found Ireland very attractive in the past decades for tax-avoidance. The recipe is very simple – through internal accounting, you ensure that your profits are low in countries where taxation is relatively high and high were taxation is low. Germany has had to accept many corporations making poor returns in Germany while their Irish subsidiaries were recording large profits. To add insult to injury, it was a spectacular case of fumbling investment irresponsibility by an Irish subsidiary, which led to the most spectacular almost-crash of a German bank, the Bavarian Hypo Real Estate, and cost the German exchequer billions following the Lehman fiasco.

Irish politicians have stated in the past few days that Ireland’s corporation tax policy is not open for discussion and have been making noises about sovereignty. Understandably, it’s one of the few major incentives Ireland still offers foreign companies to locate there. It means drastically necessary investment and jobs. But beggars can’t be choosers and, to mix my metaphors, Germany, as the largest and arguably healthiest economy in the euro-zone, will be paying the piper. And the EU economics commissioner, Olli Rehn said two days ago; “It’s a fact of life that after what has happened, Ireland will not continue as a low-tax country, but it will rather become a normal tax country in the European context.

“You ask about tax increases, I do not want to take any precise stand on an issue which is for the Irish Government to decide, but I would not rule out any option at this stage.”[1]

It may, in the long term, even be a blessing in disguise. For the past forty years, Ireland has relied almost exclusively on attracting big foreign companies to invest in the country. They have come when it suited them and gone when it suited them, first bringing and then destroying jobs, long before anyone apart from a few financial specialists knew the name Lehman. Maybe the time has come for the Irish to rely more on their own talents and capabilities. But, one way or the other, the next years are going to be very difficult. I’ll finish this as I started it with a Dickensian allusion; Hard Times. Indeed.

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[1] Quotation retrieved from the Irish Times, http://www.irishtimes.com/newspaper/breaking/2010/1002/breaking6.html