Ireland's Economic Crisis in 2008

IRELAND AND ITS ECONOMIC CRISIS

Ireland is an independet republic with parliamentary system since 1919.For a generation after Ireland achieved independence from the United Kingdom in 1922 it started being economically self-sufficient.Ireland´s first economy primary relied on agriculture,exports to the U.K. market and manufactures.Thanks to trade barries such as high Tariffs ,make its economy successful during this first period.

Some relevant periods in the irish economy should be considered before analizing other data, the following periods are explained by Antoin E. Murphy in his article The “ Celtic Tiger”- An Analysis of Ireland´s Economic Groxth Performace ( EUI working papers) :

During 1932-38 it was the era of protectionism.In this period there was an economic war with the U.K and a attempt to bild infant industries behind higa tariff walls.The Control of Manufactures Acts were introducs prohibiting the ownership of Irish industry by foreigners. Then,between 1939-45 the Worl War II took place during wich Ireland remained neutral.
Afterwards, among 1946-57 it was the period of economic stagnation marked by heavy emigration-net emigration averng over 40,000 during the 1950s. Later and continuing with ireland´s economic growth in 1957 was the year in which occurred the removal of the Control of Manufactures activity.

Morever,in 1970 for the first time after the independence,the Irish population increased by 15 % for a decade.This first growth in population was accompanied by a national increase in income and contrary to the previous decades by a decrease in unemployment.According to Sean Dorgan an expert on the topic “ The 1970s also saw a rapid expansion in public (state) expenditure on social welfare, health and education, housing, telecommunications and other infrastructure, and administrative services. Public-sector employment represented a third of the total workforce by 1980” .

All the data mentioned above happened during a period of high inflation,which according to Sean Dorgan “ averaged 13.6 percent per year from 1971 to 1980” and it was partly caused by the oil crises,domesctic trade and an expansionary fiscal policy.Besides,public budget shortcoming and high public borrowing were come relevant characteristics of the latter years,originating the basis for the recession that appeared in the 1980s.

As regard Ireland´s economic developments, Ireland joined the European Economic Community (EEC) in 1973.After this union,it went from being one of the poorest country in the group to be among the country with the highest per-capita incomes in the community.This phenomenon took place in the late 1980s and is known worldwide as the “ Celtic tiger ”. This boom was characterized mainly by sustained growth in employment,income and construction.The boom in construction boom was financed by Irish banks which in turn where financed by other external financial markets.

Besides,the entry of Ireland to the European Union caused that many foreign companies start setting their businesses in the country.These companies favored the begining of a new era where business had free access to a larger market,and exports could be focused away,not only on the U.K. During this growing period the government introduce a new banking model named “ originate to distribute” that allowed banks to make loans and do not need to hold them because they were lent by other financial insitutions.This new model resulted in an unprecedent increasement in the liquidity of banks.

Furthermore, the agricultural sector also benefited out after the junction to the EEC due to the EEC´s Common Agricultural Policy which promotes access to wider markets and as a result improved Ireland´s living standards.So, in other words, in a short period Ireland ceased to be one the poorest countries in Western Europe to become among one of the most successful.Succesful economic policies and important fiscal consolidation measures helped Ireland to mantain the growth.

Migration should also be mentioned as part of this new decade because immigration increase for the first time in Ireland due to the period of high growth. According to Klaus Regling and Max Watson who wrote a Preliminary Report on The Sources of Ireland’s Banking Crisis “A long period of high growth attracted a large number of immigrants for the first time in Irish history and resulted in the highest population growth - by far - of all EU member states with positive demand and supply effects.”

In order to continue analyzing the economic situation before the crisis it is quite important to take into account the expansionary macroeconomic policy that was used during 1977-81 in an attempt to achieve full employment.The job creation has been one of the biggest success of Ireland´s economy,from 1990 to 2005 according to Sean Dorgan “ employment soared from 1.1 million to 1.9 million” (See chart 2.)

Regarding wages,”trilateral” wage alliance between unions,workers and the government arranged wage moderation,competitiveness and a peaceful industrial situation which was instrumental in order to attract substantial amounts of external direct investment.In this situation,Irish economy took advantage from the launch of the European Union Single Market that denoted openness in the EU and an improved access to key markets.Wage agreements accelerated substantially from the late 90s leaving back the ” trilateral” wage agreement.

To conclude,Ireland became a member of the Eurozone the first of january 1990 and it joined the euro initiative in january 2001. Irish economy experienced a high economic growth over the period 1994-2006 and its economy grew rapidly with a GDP growth averaged 7% annually placing Irish living standards in the fourth place in he OECD.Despites this growth,Ireland started loosing competitiveness and the pro-cyclical changes in fiscal policy and the baking system,once the cycle cut,were bound to cause a meaningful slowdown.On top of that,this process was already initiated when it was aggravated by the cruelty of the Lehman Bros schock.
By the end of the period 2006-2008, in which Ireland had shown a very positive economy, it was starting to be discovered, however, some weakeness that will take the country to the crisis. Until that time, Ireland was one of the countries in the EU with highest GDP growth of 5.312% in 2006, according to the international monetary fund. As well, the unemployment rate of the country positioned in the EU as one of the lowest unemployment rates with 4.3 %, which was about half the average rate in the EU, with an unemployment rate of 7.9%. The construction and services sectors were the main drivers of this economy. Also, the personal consumption kept increasing from 2005. But, suddenly and with the overconfidence of the country, the systems started to crash and the increases in oil prices as well as the interest rate, did ultimately reduce the positive pace of the growing economy.
Let’s analyze the consequences that the whole crisis, with its causes already mentioned in previous sections, suffered and how the system was transformed from its previous economic growth.
First of all, let’s start talking about the GDP growth of the country. From the period of 2005 until the end of 2007, Ireland had showed a very positive growth in GDP according to the important pace in growth that the country was having at the moment. Despite this continuous increase in growth during these years, the huge drop comes by mid 2008, going from a postive growth of 5.312% in GDP in 2007, to one of the lowest rates in history of negative growth, getting to the level of – 2.972% by 2008, as the economic and social research institute reported once. Moreover this caused big impacts on tax revenue due to the change in composition of growth which went from the domestic to the external sector.
Going as far as in early 1990’s, the huge economic growth of this country was reflected in the size of the real GDP which double in no much more than a decade. Many had been the reasons that took the country to this successful period, such as entering the EU, the importance of mulitinational companies, the high proportion of people of working age actually working, the increase in inmigration rather than emigration, or the low corporation tax rates. Furthermore, the construction and service sectors make the growth to acelerate even more. However, here came the problem when the global housing markets bubble as well as the financial crisis, starting with the broke of Lehman Brothers. This put Ireland on a back position by 2007, mainly due to the fact of the big reduction of housing construction. The first consequence we got by this bubble was the collapse produced in the financial sector, previously oversaturated to the property market. This showS the huge drop from the GDP growth rate which turns to be a big decifit. Therefore GDP in 2008 was sharply down to -2.972%, taking its recession to its deepest in 2009.
In 2008, according as well to the economic and social research institute and his report about the Irish impact of the crisis, it is showed how output fell for the first time since 1983, with the recession at its deepest in 2009. House prices raised drastically by the end of 1990’s. Therefore, since the housebuilding had been the main moving factor of the economic activity as a how, being the construction sector affected, produced a huge impact on the reduction of the GDP in 2008-2010 on the overall economic growth.Meanwhile, the interantional financial markets were going through hard times as well, starting in 2007, and keeping those difficulties over the next 2 years, made Irish economy deal with even more controversial issues.

Already in the 2009, talking about the worse economic situation of the country would be more than necessary, as reported in the annual Ireland monthly report in 2009.
Talking now about unemployment, the labor market is one of the markets in which the crisis has hit harder. Regarding to the years previous of the crisis, the country enjoyed of a healthy employment growth of 3.9% in 2007 having been growing year on year. Sharply going down, the employment rate when to have a year on year growth with a rate of 2.6% by the first quarter of 2008, to a heavy reduction of 4.1% by the fourth quarter, after the crash around September of the same year. (This sharply reduction is shown in the graph below). Therefore, big difficulties had been exposed for the Irish economy by this time. From the period 2000-2007 , the rate of unemployment was 4.3% average and it moved around the same percentage, with only a low rate in 2001 of 3.6%, and a high one in 2003 of 5.1%. However, as consequence of the financial crisis that was just starting to take shape, the difference in unemployment rate along the 2008 showed it clearly. By the first quarter of the year, the country reported a rate of 4.9%, and after the it, by the fourth quarter; the unemployment rate speeded until 7.9% unemployment.

By the last quarter of 2008 there were 2,052,000 people employed in Ireland (going from September to november in order for the Quarterly National Household Survey, reported by the CSO). That means that 86.900 lost there job on 2008, a drop never recorded before since 1975 in the labour market surveys made by the CSO. Despite most private sectors were affected by the drop, the construction one standed out with a loss of 16.5%. Also hotels and restaurants lost around 7.9%, ans wholesale and retail sector decrease a 5.8%.
As already mentioned, the service and contruction sectors continued the drivers and motors of the economy. Actually as the central government reported on its public balance outllok in 2008, around 11% of the labour force where foreginers. This entire situation started to change when the country stated to see itself into a recession and financial crisis. The standards of living started to get distorsioned and the levels of competitiveness falling sharply, and basicaly its high costs. As consequence of labour costs, they have moved Ireland productivity to a postion on the back. The increase in housing prices, deterioring the construction sector, which was probably the strongest in the economy, made the employment rate to fall rapidly. As well the the lost of confidence in the market that people had, took them to a high reduction in their consumption, so firms had to reduced widely their production and labour demand fall. To this point the current recession descreased importantly the labour market. By the second quarter of 2009, the employment had been reduced 7.9% in comparision to the same period in the previous year, meaning a loss of about 166.000 jobs, affecting specialy to the construction, manufacturing and retail sectors. By 2010, the labour market kept falling and around 75.000 jobs were lost. Therefore, labour supply was falling because of the fall in labour demand prefering either an increase in migration or a lower participation rate, as the public balance outlook in November 2009 reported. In September of 2010, unemployment rate was at 14.40%.

We will focus right now on prices, and the consequences that the crisis had over the inflation in the economy of the country. First let’s mention about the rapid growth of the country that ended in very high levels of CPI inflation by the first years of this decade. During 2004 and 2005 inflation was kind of low, but around 2007 the raise in interest rate by the ECB, along with the increase in commodity prices and the bubble in the construction sector, took inflation to rise until high levels of inflation. For the first nine months in 2007 this inflation was of 4.7% and it continued to rise for the following years. Nevertheles, things went in the opposite direction after the crisis suffered in the country starting in 2008 and along with the global recession. Prices of commodity goods went down sharply and the levels of interest rate reduced a lot. Consequently, due to this fall in prices and interest, the level of inflation started to fall leading itself to a deflation position. In the first quarter of 2008 inflation was at 4.1% and consumer prices fell drastically since the last three months of 2008. During 2009 prices of commodity good decreased a 4.5%. Acording to the HICP, in the first quarter of 2010 prices fell by 2.4%, and 2.1% in the second one. Comparing it with the EU HICP, prices had increased 1.1 and 1.5 % in the first and second quarter respectively. The fall in wages was the the main cause of the difference in growth of inflation in Ireland compare with the euro zone, according to the monthly Ireland report in Marh 2009. By 2010 the country went into a persistent deflation.

Furthermore, the Irish financial crisis has also caused complications for the EU currency, the euro. A devaluation of the external value of the euro (mirar si se puede) caused by the crisis and mainly because of the reduction in speculative investment which did take most stock markets in Europe to be under a huge pressure. So, when the economy of one country varies and fluctuates, it instantaneously affects the rest of economies from the EU, due to the fact that they are kind of joined through the EURO.
Before Ireland got deeply into a financial crisis, it had only little surpluses but always around o very close to zero. But after the crisis, as a consequence of all the bailout costs for banks, by 2010 the deficit was getting to its highest, and a 20% additional was added.

So as we already mentioned, the, at first banking system crisis, was turned by the circumnstances into a financial crisis. The gap between expenditure and revenue, which was increasing everytime more and more, was something that the country had to challenge with. The quick budget breakdown was taking Ireland to an even worse situation. If we take a look back to 2003, current expenditure levels are now 70% higher than in that period, and also the as the departament of finance reported in an informational note about the general governement´s deficit in 2009 it said , “The underlying General Government deficit for Ireland for 2009 is 11.8% of GDP. However, for technical reclassification reasons associated with the banking sector, the headline deficit is 14.3% for 2009 as set out in the Information Note below. It is important to point out that there is no additional borrowing associated with this technical reclassification”(http://www.finance.gov.ie/viewdoc.asp?DocID=6287&CatID=14&StartDate=01+January+2010 ). So this diference showed and published by Eurostat of 2,6% in the GDP, can be specified that the 2,5% of it, is the money spent by the governement is nationalise the Anglo Irish bank in 2009. They realised by that time that if they would keep borrowing at such high levels in order to short distances between revenues and expenditures, it would turn out to be untenable in the middle long run.
To compare the Ireland crisis, we will mention the US one, which is closely connected to the Irish crash. According to the author Gregory Connor and others in an article comparing US with Irish economies, can be extracted that because of the the different causes that took each country into a recession, they have also different consequences on the economy. The US economy which was the first in crashing was caused because of a credit risk along with the mis understanding on liquidity. It already announced a global liquidity crisis. By the the second quarter of 2007 due to the dafault mortgages were suffering, the crisis was already all brighted. On the other hand, but this time Ireland had not felt yet this recession, and didn’t do either until the broke of the Lemhan Brothers provoque hard shocks in their economy entering through the international path. So was the diminishing in liquidity sent by US economy which causes the Irish financial sector to start crashing. However this also comes from the banking system that had over exposed the housing and construction sector when lending assets. One consequence that had the Lemanh Brothers fall was the impossibility of Ireland to make his huge foreign earnings.
One important and relevant difference between these two country recessions was actually the problems that they got into because of the assets. After the US crisis in 2007/2008 the country follows a period of constant innovations. Nobody understood it, since a credit liquidity crisis had been announce as possibility to go next. On contrast, since the Irish crisis emerged from a tradicional boom, it consequently acts in a different way.

However the crisis and the negative consequences brought in, to a long term extent, Ireland was better positioned in relation to some other countries’ crisis. According to a long term view, Ireland in many points is in advantage relative to other countries such as Greece , and Portugal. Regarding to the export sector, Ireland exceeds 100% the exports of goods and services in the GDP. Comparing with Portugal with only has 31%, and a lower Greece rate of 21%. Pointing out some of the advantages of Ireland over the other countries, the Irish economy had a much better qualified workforce, along with a nice environment working business and a tax system more adequate with minor tax wedge on labour as well as lower corporate taxes. The product and labour markets are also more flexible and the regulation of this market is better carried out. Related to the cost in competitiveness, these have improved over time.

As shown in the above graphs, Irish’s economy is strong enough to resist reform conditions, compared to the economies of Greece and Portugal.

Personal consumption
In the year 2005 Irish personal consumption had a positive rate since the last years, this trend seem to be continued in 2006. According to the data that appears in the National Accounts the personal consumption in the first part of the year 2006 was 6.5% higher than the previous year. This percentage of growth represents that that the economy has suffered a stronger disposable income, which in turn, is caused by a continued growth in employment and in per capita earnings.
As we I have already mentioned this trend continued some years and in the year 2008 the National accounts showed that the country has experiment an increase of 5.8% in the first half of the year. This was due to an employment rate relatively strong and an increase in the earnings of the households, although a relatively high inflation reduced in some way the purchasing power.
By the moment the economic situation is pretty good but the market is starting to realize that the economic future is not good, even though in the case of the personal consumption continued growing with a 6.46% in the year 2008.
As the market start felling in 2008 the personal consumption decrease drastically in the next period with an annual rate of 8.3%. Consumers’ disposable incomes have been reduced but not as much as the fall in consumption. This fall in consumption could be viewed as a precautionary measure increasing savings.
As we can see in the chart, personal consumption maintain high from the year 2004 to the 2008 when the consumption decrease drastically until a minimum in the year 2009.

Public consumption

If we compare the net current expenditure by local and central government on goods and services in the years 2005 and 2006 we see a huge difference. The expenditure in the first half of 2006 was 4.2% higher than the previous year.

Over the period 2007-2008 the Irish economy experience an increase of 4.5% in net public expenditure. Other spending components like transfers also increase substantially in volume terms. The government consumption will continue increasing, this means that the economy is not able to consume as much as it should and thus the government decide to consume not to suffer so much the personal decrease in consumption. This policy didn´t maintain so much because in the year 2010 the government spending started decreasing with an approximate rate of 2%.

Investment

The Irish recession in 2008-2009 was due to a huge decline in construction investment together with other factor, the decrease in the domestic consumption. In Ireland, in the previous years to the crisis, the main source of investment has been the House building sector, but as we know this sector is suffering a huge contraction and this trend is expected to be the same for the next years. From the year 2003 to the year 2007 the investment represents a 30% of the GDP and it comes mostly from the construction. Then a massive collapse of the investment happens and it falls to the 10% of the GDP. The house building sector was still being the main source of investment despite the crash of the sector. As we can see in the graph, the Irish economy, as well as other economies in the world, suffered from the house building sector. From the year 1994 until 2006-2007 the percentage that housing investment represent in the national GDP increase from 4% to almost reach the 13% of the GDP.

Exports

The irish economy is one of the world most open economies. Before the crisis it was one of the best In this case due to the financial crisis in international markets, the irish exports have gain importance.

In the first half of 2006 the exports rose around a 6%. The sector that make this growth possible is the sector services, this sector grow a 18.9% in the first half of the year. In contrast, there is other sector, merchandise, that experience such a different growth, in this case only 1.5% increase.

In the next year the exports of ireland continue being the economic sector in best situation, this year the service sector didn´t increase as much as the previous year but it maintain a 7.7% of growth. By the other hand the merchandise sector increase a bit more than the previous year, in this case it increase a 5.5%.

Some exporting sector have performed well such as the pharmaceutical and medical sector that their exports rate increased nearly a 20% in the year 2009. Instead the computer equipment sector and the electrical and industrial sector decrease around a 30%. Despite the significant increase in the exports of some sectors in 2009 the overall level of exports decrease a 3%.

Imports

As well as the exports, imports are quite important for the Irish economy. So much so that the amount of good and services imported is a bit higher than the ones that are exported. In the first part of 2006 the amount of goods and services imported in Ireland increase 7.2% in real terms. More particularly the value of services imported increase about a 15.3% and at the same time the amount of merchandise imports grow at 6.9%.

National accounts information show that there were an increase of 5.6% in the imports of goods and services in the first six months of the year 2007. The amount of imports in the services sector increase by 4.2% while in the merchandise imports rose by 7.2%. This increase in the amount of merchandise imports is probably due to the purchase of aircraft from abroad. On the other hand the increase in the import of services is attributable to the imports of business services.

During the period 2010-2011 Net exports increase 20.6% at constant 2009 prices.

In this table we can see Ireland’s trade imports, exports and surplus. The trade surplus rose by 8%, seasonally adjusted in the last month, to 4.079 € which is the highest surplus register in the Irish economy ever.

This second graph shows us the evolution of economic trade, seasonally adjusted. Here we can see the evolution of Total net export along the crisis, in the period 2004-2007 net exports were not too high but after that, imports decrease and exports increase so net exports increased markedly.

In the first half of the year 2011 exports have increase 6% to 38.565m €. Medical and Pharmaceutical products are the ones that more money represents but are the dairy products the ones who have experimented a higher increase, 47%. The 52% of Ireland´s exports in this period went to Great Britain, Belgium and USA.
On the other hand, imports have increase by 12% until reach 21.123m €. In this case the one which more money gave and the one which experience a higher increase is the same, the transport equipment products.