Ireland Is Not An Example Of Expansionary Austerity

Europe is in the grip of austerity fever where all governments are convinced that reducing the budget deficit must be their main priority. However, despite the strong consensus, little thought has been given to whether or not it will work. Some economists have proposed that austerity could improve the economy if businesses and consumers believe are impressed by the government’s action and begin spending of their own. This is called “expansionary austerity” or “expansionary fiscal contraction”. Subsequent research has discredited all examples of expansionary austerity, with Ireland in 1987 being the only exception. But Ireland is no poster child for austerity, but just another example of the harm it does.

Now the proponents are to some extent correct. Ireland did undergo austerity throughout the 80s, most notably between 1987-8 and later experienced massive economic growth starting around 1994. However, correlation is not causation and just because two events occurred at similar times does not mean they are linked. First of all, a look at the data shows there is a strong lag between the austerity and the beginning of the Celtic Tiger, a seven year lag to be precise. Until 1994 unemployment was enormously high and growth was limited. So even once the budget deficit was greatly reduced, the economy was still in dire straits. This should be a warning against excessive emphasis on budgetary matters, even if they do improve, there is no guarantee that the rest of the economy will follow.

It is necessary to examine all the aspects of the Irish economy at the time in order to understand its dynamics. First of all, there was enormous emigration which greatly reduced the unemployment levels as record levels of Irish people went to England and America. This reduced the social welfare bill and eased the burden on government finances. Second of all, there was a large devaluation of the currency in 1986 and 1993. Both would have greatly boosted Irish exports (which were a key aspect of the Celtic Tiger) and were implemented before key years of growth. As Ireland is such a small open economy, it is heavily dependent on the state of the world economy. The 1991 recession caused unemployment to jump while the following boom in the 90s greatly contributed to the expansion. The state of the UK, Ireland’s largest trading partner is important in this regard, it went through a boom in the late 80s which increased its importation of Irish goods.

A major agreement was achieved between the government, trade unions and business associations on wages. This became known as social partnership and by moderating wages and providing industrial stability and certainty helped the economy through the rough period. There was also strong reduction in tax evasion which had been rampant during the 80s. This came in the form of a tax amnesty and better surveillance. By broadening the tax base, it not only increased revenue but also increased official GDP levels.

Europe had a strong impact on Ireland at the time, not only through large EU funding but also through lower interest rates. Irish interest rates dropped considerably over the time period making the Irish debt more manageable and facilitating expansion. Going hand in hand with this was the large inflow of credit from European countries (Germany in particular). Closer ties to Europe (which would culminate in adoption of the Euro) certainly benefited the Irish economy. The opening up of the single market in particular gave Irish exports a boost. This period is notable for the increased level of investment coming from Europe which formed a crucial part of the Celtic Tiger.

The spending cuts were almost entirely focused on capital spending, which is fine as a short term solution to a budgetary problem but causes long term damage to the state of the economy. Major investment was required in the 90s and 00s in order to repair the under-investment in health, education and infrastructure. The budget deficit is not the only debt future generations will inherit, under-funded infrastructure is just as great a burden as the national debt, though it receives far less attention. Avoiding problems today by storing up problems for tomorrow is hardly an economic model to be copied.

However, by far the most interesting point comes from Stephen Kinsella who points out that

“the average industrial wage rose by over 14% in the period 1986-1989, or an annual average of 4.6%. Public sector pay rose by a similar level. These wage increases had a two-fold effect: they boosted government revenue, and increased economic activity through increased private consumption. Rather than being a role model of expansionary fiscal contraction, the 1986-1990 period looks more like a  proto-Keynesian story, where a laggard country converges rapidly to OECD averages of per capita consumption, output, and (real) growth.”

The consensus on austerity has been overwhelming negative. Time and time again it has been found that austerity, especially during recessions, only makes the recession worse and leads to lower growth and more unemployment. It is only during booms that austerity can avoid damaging the economy. Expansionary austerity is merely an illusion, countries grow despite austerity, not because of it. Ireland grew in the late 80s not because it cut long term investment but due to a mixture of devaluation, low interest rates, booming world economy, inflows from Europe, tax reforms and wages rises. Austerity did not help Ireland in 1987 and it is not helping us now. 

1 Comment

Filed under Economics

One response to “Ireland Is Not An Example Of Expansionary Austerity

  1. Do you have any thoughts about why the post-WW II transition, when government spending cuts coincided with rapid consumption and investment growth, was so successful?

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