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Analysis/Comment Last Updated: Sep 12, 2010 - 10:28:00 AM

The euro, Ireland and the quest for instant competitiveness
By Michael Hennigan, Founder and Editor of Finfacts
Jan 12, 2010 - 9:03:46 AM

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Green: EU countries using the euro: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain

Mauve: EU countries not using the euro

The debate on the role of the euro in the crash of the Celtic Tiger and proposals for Ireland to reintroduce the punt as an option to produce instant competitiveness, is seldom bolstered with the challenging task of examining scenarios that would follow the exit. TCD's Prof. Brian Lucey on the Irish Economy blog, has recommended a paper by American economist Barry Eichengreen, who in 2007, looked at different scenarios on leaving the common currency system.

Willem Buiter, former professor of economics at the London School of Economics and member of the Bank of England's Monetary Policy Committee, who is now Citi chief economist, said in Dublin on Monday that it would be "suicidal" for a "weaker country" to exit the Eurozone as it would also have to leave the European Union - -  that is a point of debate, relating to obligations to other member countries.

"The only risk to the Eurozone is not from our weaker brothers and sisters - - it's the stronger countries, Germany, saying, 'I am fed up having to face the risk of bailing out the weaker'," the native of the Netherlands said. For "political and historical reasons," Germany is the least likely country to leave, he added.

Economist David McWillaims in the Sunday Business Post last Sunday posed a question: "So the question I have for those who rightly suggest that we need to get our wages and prices down by 30% to claw back the competitive losses we suffered since joining the euro is: how are we going to do it? In particular, how are we going to do this without leaving the euro?"

Even if devaluation, a new currency and default on euro debt, was attractive for the American companies that dominate Irish exports, unless Ireland was willing to embrace fundamental reform, it would only be a temporary palliative.

Just consider Argentina, which defaulted in 2001. The economy is still in a mess having benefited as a commodity producer initially from devaluation. The country in trying to get back into international lending markets again; the president sacked the central bank governor last week as the government wishes to get control of currency reserves; on Monday the governor returned to his job after a court order.

Ratings agency Fitch said if negotiations with debt holders are successful, it could raise Argentina's credit rating from "restricted default," however, "sovereign ratings are likely to remain in a highly speculative category due to its weak macroeconomic policy framework, limited financing flexibility as well as still-high government debt ratios" relative to similarly rated countries.

Reform hasn't yet been tried in Ireland. Why do we need devaluation to bring down the price of electricity from among Europe's highest? 

The sheltered private sector with for example lawyers earning thousands of euros each day, remains unchanged; ditto for the public sector and the broken governance system.

McWilliams wrote on Sunday: "For a currency union to work for a country, the most important thing is that the country trades overwhelmingly with the other members of the monetary union."

Germany, the Eurozone's biggest member, published its latest export data on Friday last, which showed that in November, 41% of goods exports went to other Eurozone countries.

In 2009, 42% of Irish goods exports went to the Eurozone.

The main weakness of the Eurozone system is that members retain freedom with fiscal policy while wayward members are not subject to a strong regime of sanctions.

Only three countries  -- Ireland, Spain and Greece - - from sixteen in the Eurozone, have ongoing severe economic problems.

Each country was badly misgoverned during the international credit boom but the Spanish central bank insisted that the big Spanish banks build extra capital provisions during their property boom.

The banks themselves engaged in much more serious risk management than their Irish counterparts.

Spain's biggest bank, Banco Santander, has come through the crisis in robust shape and is the biggest bank in the Eurozone.

  • There is an argument that Ireland shouldn't have joined the EMU (European Monetary System) as the common interest rate was unsuitable for the Irish economy. That is true but Iceland had a much higher interest rate, which attracted big capital inflows; Its politicians were as reckless as the Irish ones and it is risible to argue that Bertie Ahern and Charlie McCreevy, with the small party, the PDs, egging them on to cut taxes and hugely extend property incentives as the boom was accelerating, would have behaved more prudently outside of the euro.

  • It is a fact that an export boom followed a 10% devaluation of the Irish punt in January 1993; however the boom was caused by the big influx of America's world class companies; graphical data shows that exports from Irish-owned firms flatlined in the years following the devaluation.

  • Comparisons with Iceland and Argentina on the benefits of devaluation are not valid; Iceland's fisheries account for more than 50% of its goods exports, while Argentinean exports of metals, wheat and beef, boosted by demand from China and financial support from Venezuela, benefited as devaluation has a fast pass-thru on commodities. In contrast, the benefit of lower prices on finished products, comes much slower. It's only "armchair experts" who believe that developing new overseas markets for finished products or services, is an easy task.

  • The Irish public sector has a poor record in handling big projects; the return to the punt would involve a huge logistical challenge.

  • How would a siege economy be put in place temporarily to prevent capital flight?

  • How high would interest rates be compared with the ECB rate?

  • Why are our main exporters such as US chipmaker Intel, not pushing for a return to the punt?

  • While the Irish-owned export sector is small, public companies with international operations, would likely move their main listing from Dublin.

  • Would exiting the euro increase or reduce the likelihood of necessary fundamental reform?

  • What would the implications for a default on our euro debt be?

  • International reputation is crucial for a country that would have a rump export sector without foreign direct investment; how would it look if Ireland was abandoning the euro while smaller Estonia replaced us in the system?

  • Why do we not see the opportunities that a reformed Ireland could have in a market of more than 300 million in Europe, using the one currency? 

  • The value of shopping in Northern Ireland is equivalent to 0.4% of Irish annual exports.

  • In 1973, 55% of total Irish exports went to the UK and the percentage is almost 20% today. However, more than 50% of current exports from Irish-owned firms - - mainly producers of food and drink - - are to the UK market. The countries Germany, France, Benelux, Italy and Spain collectively represent a GDP 3.9 times the size of the UK, yet the non-food exports by Enterprise Ireland clients companies to these countries, is 40% of that of the UK. Exports by Irish-owned firms to China in 2007, were 6.7% of total exports from Ireland to China.

  • In 2008, Germany grew its food and drinks exports by 15%, despite the recession while an Irish sector dependent on the UK, contracted.

  • According to the ECB, Irish unit labour costs rose by 33% in the period 1999-2007, compared with Germany’s 3% and Finland’s 11%.

FT Video: Gary McGann, chief executive of Smurfit Kappa, on the decline of Ireland's competitiveness

Further background information from Finfacts articles:

The challenge of creating 160,000 new Irish jobs

Iceland: People before profits and people before banks!

Ireland exiting the euro and the risk of setting the Irish economy on fire

The 2001 economic consensus that paved the road to economic ruin

Irish Central Bank declared its impotence before launch of the euro; Why Spain's biggest banks survived huge housing boom

IBEC delivers Irish tribal conservatism not needed radicalism

ICTU calls for return to 1980s era Irish income tax rates with combined top rate of 65%

Ireland: A "smart" economy in food better than pie-in-the-sky aspirations

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