Ireland Considers the Benefits and Drawbacks of Additional Austerity Measures

BusinessWeek: Draghi Says No Alternative to Austerity as Economies Shrink
FT: Ireland Revises Growth Forecast Down
Herald: We got it Wrong on Austerity and Made Things Worse – IMF
IMF: Ireland Staff Report For the 2012 Article IV Consultation
Irish Examiner: €3.5bn budget Plan to Stay Despite IMF Admission
Irish Examiner: IMF Chief: Don't Sacrifice Growth for the Sake of Austerity
Irish Examiner: IMF: Failure to Act Could Tip Ireland into Recession
Irish Times: ECB 'Cannot Print Money'
Reuters: Irish Consumer Confidence Sags, More Austerity Feared
WSJ: For Ireland, More Austerity Is a Strain
WSJ: Irish Economy Skirts Recession

There is currently a debate in Ireland about whether or not the Irish government should move forward with an accelerated round of austerity measures (policies designed to reduce federal deficits through cuts in government services and/or increases in taxes). Austerity measures are used to stimulate economic growth by reducing government deficits down to sustainable levels and increasing investor confidence in government finances. Ireland, which experienced a severe financial crisis in 2007, has implemented a series of austerity programs over the last four years. Despite these efforts, the Central Bank of Ireland recently warned that Ireland’s gross domestic product (GDP) will only grow by 0.5% in 2012, 0.2 percentage points less than previously anticipated. Additionally, the Bank forecasts that Ireland’s GDP will grow just 1.7% in 2013, down from a prior forecast of 1.9%. This slowdown in growth, driven by a decrease in demand for Irish exports due to weakness in the global economy, is putting additional pressure on Ireland’s budget. As a result, the Central Bank of Ireland, the European Central Bank (ECB), and many business leaders believe it is important for Ireland to continue reducing its budget deficits through austerity measures in the short run. Others, including some economists and labor unions, believe that additional austerity programs will actually slow Ireland’s economic growth, and that generating tax revenues by increasing domestic demand is the easiest way to reduce deficits in the long run.

Ireland first initiated austerity measures in 2008 to reduce the budget deficit created when the country invested billions of dollars in its banking sector during the 2007 financial crisis. Prior to the financial crisis, Ireland’s deficit-to-GDP ratio was just 25%; however, by 2010 it had increased to over 90% and GDP had fallen by 8%. Between 2008 and 2010, the country managed to reduce its budget deficit by over €15 billion through cuts in government services and increases in taxes. To further reduce its deficits and spur economic growth, Ireland negotiated a €67.5 billion bailout agreement with the European Union (EU) and the International Monetary Fund (IMF) in 2010. This agreement required Ireland to implement an additional €15 billion of austerity measures through 2015. Ireland’s austerity efforts helped pull the Irish economy out of its recession in 2009, and reduce Ireland’s budget deficit by 4.1% between 2009 and 2011. As a result, some analysts have said Ireland has the best chance of all the bailed out countries in the Eurozone to recover from its financial crisis.

To meet the IMF’s €15 billion austerity target, Ireland must implement a final €8.6 billion of austerity measures through 2015, which includes €3.5 billion of deficit reductions in 2013. The Central Bank of Ireland recently advocated accelerating these cuts to reduce the length of time Irish companies will need to worry about the uncertain impact of future austerity measures. The Bank believes the uncertainty surrounding these measures has curtailed many companies’ willingness to invest in growth opportunities in Ireland. The Bank also believes that certain austerity measures, such as cutting public sector pay, will ultimately make Ireland more competitive. The implementation of more austerity measures in Ireland is also supported by the EU. Mario Draghi, the President of the ECB, recently commented that there is no alternative to continued austerity measures for countries receiving bailout funds. He argued that one of the original drivers of the European financial crisis was the “unsustainability of deficits and debt levels."

Unfortunately, due to the amount of cuts Ireland has already made to its budget, new austerity measures are placing increasingly heavy burdens on Ireland’s population that threaten the country’s domestic demand for goods and services. For example, future austerity measures will likely require cuts in child welfare payments and increases in payroll taxes. Other proposed austerity measures include cutting social security and health benefits, and introducing a new tax on households. Some economists and labor unions within Ireland believe these drastic measures will do more harm than good to the Irish economy, and are encouraging the government to reconsider its austerity program. Ide Kearney, an economic research professor at Ireland’s Economic and Social Research Institute, believes additional austerity measures will not improve Ireland’s struggling domestic economy given its dependence on exports to the rest of Europe. Additionally, Jack O’Connor, the leader of Ireland’s largest labor organization, believes that given Ireland’s almost 15% unemployment rate, further cuts to welfare payments might reduce the deficit in the short run, but will weaken domestic demand and prevent Ireland’s economy from growing in the long run.

The IMF also questioned the wisdom of additional austerity measures in a recent academic report that found for every €100 a government saved through an austerity program, it reduced its country’s GDP by between €90 and €170. The IMF admitted that reductions in economic growth resulting from prior austerity measures “worsened [Ireland’s levels of] poverty and inequality.” Future austerity measures are likely to have a similar effect, and media speculation about additional welfare cuts in September of 2012 already caused a 20% drop in Ireland’s consumer expectations index (a measure of the degree of optimism that consumers feel about the future of their economy). Christine Lagarde, the Managing Director of the IMF, summed up Ireland’s difficult choice between reducing its deficit through austerity and encouraging growth in domestic demand to generate tax revenues. She noted that “reducing public debt is incredibly difficult without growth” and that high debt “makes it harder to get growth.” Therefore, she said countries like Ireland have a “very narrow path” to take and must make their spending cuts at just the “right pace” in the medium term in order to sustain growth in the long term.