Monday, November 15, 2010

The New Politics of Economic Aid

How quickly and thoroughly times change

Recently, EU governments bellyached about establishing the European Financial Stability Facility. Now they, especially Germany, want to force it on unwilling recipients. What is going on and why?

Ireland is allegedly under pressure to accept money from the fund. Why would it resist? Accepting money from the fund is politically equivalent to accepting money from the IMF. The money handed over is enveloped with the stench of political failure, both at home, and internationally. In the latter case, the country's entire economic philosophy comes under attack.

Ireland has a history of strongly defending national sovereignty when it feels that the EU has gone too far in the demands it makes on national economic policy. Throughout the 2000s, the European Commission made regular demands that Ireland rein in its overheating economy with tax increases and restrictions on public spending. It did this in the context of annual economic reviews contained in the Broad Economic Policy Guidelines (BEPG). The Commission wanted every country in the EU to have the same levels of growth and inflation, and tried to use the BEPG to expand its power from countries with huge budget deficits (where there are indeed rules) to countries like Ireland, where there are no such rules. Ireland, as a typical catch-up country, had higher growth and inflation levels than more established economies, and underlined its continued sovereignty over economic policy. It is not about to let that principle go down without a fight. Aid always comes with strings attached that Dublin has always rejected in principle.

Beyond this constitutional angle on accepting, rejecting or demanding use of the Facility's aid, there are strong ideological principles at stake with regard to choosing Ireland. Ireland has seen itself since the 2000s in particular as living proof that market forces are the best means of economic and social development. It benefited greatly from foreign investment into the country during the last decade, and is holding true to the creed of market first by drastically cutting public borrowing, spending and wages, so that private capital will return to Ireland. If it succeeds, it will bolster those who insist that structural adjustment policies in Europe must be radically strengthened to ensure higher levels of economic growth and employment.

It will correspondingly weaken the other camp, which has chosen to make financial market participants at least partially responsible for the financial and economic crisis, which wants to see a number of regulations and restrictions on their activity imposed, and which wants to leave social security nets left largely intact. The name of this game is not adjustment, but stabilisation and prudential regulation

And to make that work, it would be best for that camp to lure, or cajole Ireland down the other path.


  1. I'm interested in how both 'camps' as you describe it view the problem of the one-way bet that investors have on government bonds of the struggling Euro countries.
    The risk of (partial) default is priced into the interest rate called on bonds issues, yet the event of default may never happen due to the EFSF.
    If Ireland truly adheres to that 'markets first' doctrine, would it sooner default on interest payments than accept aid from the fund?

  2. @Wouter: indeed, if the Irish truly allowed market forces to sort things out, they would let the banks (and their shareholders and their depositors) pay the price for failure, as happened in Iceland.

    What the Irish government are defending is a business environment that is as capital-friendly as possible, as it is this money that is responsible for Ireland's development. That means a competitive lowering of regulation and tax rates to draw business away from other EU countries, and massive budget cuts to reassure investors that the cost of doing business there will not rise. So you're right. The market first call is an ideological weapon that is used when it's convenient. Otherwise, the bailouts are a massive subsidy to banks, and a huge source of moral hazard. A topic for another post...