The EU Financial Crisis: Austerity and Expansion

Using the example of Ireland


Seminar Paper, 2013
17 Pages, Grade: 2

Excerpt

Index

1. Introduction

2. Irish Bailout

3. Current Statistics

4. Outlook

Abstract:

In this paper I analyse the recovery plans for Ireland by the EU Commission and the Irish
government, as well as the developments of the Irish economy throughout its crisis. I find
that both the austerity and growth measures are of vital importance to the country's
recovery and as such the same can be said for the rest of the European Union. Ireland is on
its way back to a stable economy. The GDP, inflation and the current account are rising, but
the country still faces challenges with unemployment and an ever increasing pile of debt.
Greece and other countries affected by the crisis and now under the Troika programme,
should take Ireland as an example, but the EU will have to do its part to help these
countries with their growth programmes, instead of persisting on strict austerity measures alone.

1. Introduction

There has been a long lasting debate on how to handle the current European financial crisis. As with most debates, two particularly strong sides have emerged, which exclude the other side's ideas from their concept. I am of course referring to the debate around austerity measures and expansionism. Many European countries have either imposed austerity measures or are in the process of introducing them. The implementation of these measures decreases the overall GDP and in extreme cases the social and welfare spending of the states, thus lowering the standard of living in a country. To make matters worse, austerity measures are not only not guaranteed to succeed in raising the GDP, but also take a very long time to take effect. Time in which the population is being submitted to hardships.

On the other hand, austerity measures seem to inspire confidence in international investors (although there is no real proof of that) and are necessary if a government is continually increasing its debt.

Expansion is what some consider to be the answer to the crisis. Instead of cutting spending, one should use smart reforms to incentivise economic growth. This would prevent all the nasty side effects of austerity measures and help countries out of a crisis. However growth rates in the western part of the world have been steadily decreasing, suggesting that economic growth is no longer possible on levels like India is experiencing at the moment. Additionally there is the looming question, which nobody dares to answer: What happens if countries continue to increase their debts instead of paying them back? Do we want to find out? Is it responsible to future generations to only plan for the next few years?

In truth, the only way to determine which way is the best, is to try them out and compare the results. I will analyse the austerity measures taken thus far by the European Union in response to the financial crisis, in order to find whether they have helped in mitigating the impact of the crisis, or even helped steer back into stability.

For the purpose of this short essay, I will focus on the developments in Ireland, since its crisis began as far back as March 2008. First, I will take a closer look at the Irish government's implementation of the so called Troika plan. In Chapter 3 I will compare the over-time changes in Ireland with the EU, using various statistics. I will conclude this paper with my personal opinion on the situation and my outlook on the near future.

2. Irish Bailout

In 2008 the Irish market slowly started destabilising, until the government was finally incapable of receiving international loans at viable rates. In November 2010 Ireland asked for help from the so called “Troika”, consisting of the International Monetary Fund (IMF), the European Commission and the European Central Bank (ECB). Ireland was authorised to receive 22.41€ billion by the IMF, of which only 3.36€ billion have remained undrawn. (cf. IMF, 2013, p.4) In exchange, Ireland agreed under the MoU (Memorandum of Understanding) to be bound to an austerity programme. “The key objective of the programme is to restore financial market confidence in the Irish economy's banking sector and the sovereign. Breaking the pernicious feedback loops between the fiscal and financial crises should enable the economy to return to sustainable growth.” (European Commission, 2011,p. 19) “The crisis has exposed important weaknesses in the public finances which had been masked by strong growth in the boom years. These include a narrow tax base and strong reliance on cyclical tax revenue - in particular related to property transactions - used to finance structural increases in expenditure.” (European Commission, 2011,p. 15)

The programme consists of four main components, which are supposed to ensure the restabilisation of the Irish economy:

- “A financial sector strategy comprising fundamental downsizing and reorganization of the banking sector. Addressing market perceptions of weak capitalization, overhauling the banks’ funding structure, as well as gradual downsizing and deleveraging the banking system will be required. These steps will be backed by the availability of programme funds both for recapitalization and deleveraging.
- A strategy to restore fiscal sustainability. Building on the authorities' National Recovery Plan, the consolidation strategy will rely to a large extent on broad-based expenditure restraint. International experience shows that this is a typical characteristic of successful and sustainable fiscal consolidation episodes. At the same time, the tax system will undergo profound change. The formerly narrow tax base will be broadened, raising revenue stability and, together with increases in specified tax rates, contributing to the generation of additional revenue. Specific measures will be chosen also with a view to limiting the inevitable knock-on effect of consolidation on domestic demand, thereby contributing to the economy's return to balanced and sustainable growth.
- A structural reform package to underpin growth. The programme includes measures to remove potential structural impediments to competitiveness and employment creation. Specifically, labour market related measures such as adjustments in the minimum wage and an intensification of activation measures will boost the growth potential of the economy. Product market reforms will include the opening up of sheltered service sectors.
- The external financial assistance will support the achievement of these policy objectives. It provides the government with ample time to implement a comprehensive consolidation strategy that will underpin a sustainable path for gross government debt, by narrowing and eventually closing annual budget deficits and assuring a return to economic growth.” (European Commission, 201 l,p. 19)

To be able to fulfil the first part of these objectives, 35€ billion have been made available under the programme; in order to ensure a swift overhaul of the banking system, allowing for the creation of smaller, more robust banks, which can stand on their own feet. 10€ billion of these funds were used in January 2011 for recapitalization of the banks. 2€ billion were used to free the banks of some of their debts. (cf. European Commission, 2011, p. 23)

In order to achieve fiscal consolidation 15€ billion will be required in the years 2011-2014. 7€ billion come from reduction of government spending, including cuts in public service pension, public sector payloads, departmental cuts and a decrease in welfare spending, which had risen before 2010. 3€ billion are saved by reducing the capital expenses and 5€ more billion are expected to be taken in through stronger revenues. For this purpose, the personal income taxes were risen in 2011. More increases in VAT, carbon taxes, property taxes and capital gains taxes are/were planned for the following years. However the corporation tax rate of12.5%is not planned to be raised, presumably to encourage investments from the industry. (cf. European Commission, 2011,p. 26f)

In addition, the deadline for the consolidation of debt down to 3%of GDP was extended from 2014to2015,in order to allow for the economy to properly recover. (cf. European Commission, 2011,p. 29)

Not only will public service pensions be decreased, but further measures to reform the pension system are planned for the coming years. Starting in 2014 the age requirement for state pensions will rise from 65 to 66 years, then to 67 in 2021 and 68 in 2028. (cf. European Commission, 2011,p. 29)

In my opinion this pension reform is not the right way to go. Forcing people to work longer does not guarantee that the state has to pay out less money to these people. In fact it does quite the opposite. In most cases, elder people are no longer considered as productive as their younger counterparts. Whether that is true or not, the fact remains that younger workers perform better under pressure, fall ill less frequently and receive far lower wages, not to mention they are more likely to be able and work with the company for a longer time. This causes employers to dismiss their older employees in favour of new generations. Many people already lose theirjobs at 40 and not many manage to get back on track. Raising the bar for pension requirements only means that those people are more likely to live longer off the state's unemployment programme. Instead of this reform, I would suggest implementing a new system, comprising of a pension account, which allows people to work for as long as they desire, accumulating a certain monthly amount they will be eligible to receive, once they decide to retire. In addition, it should be possible for retired citizens to work part-timejobs if they so desire, to earn additional money. This measure would enable elder citizens to consume more and add to the economic growth, as they are more likely to receive part-time or seasonal work, than full-timejobs and additionally free up other positions for young graduates, which they may instead have held on to, if their contracts had allowed. My suggested reform would thus be more likely to help the economic recovery. While there most likely would not be any visible savings, the unemployment rates would be lowered, decreasing state expenditures on that side, while also incentivising increased levels of consumption and production, which will cause the GDP to grow as a whole, while also being fair to the people. The detour profitability should not be underestimated.

The structural reforms focus on the labour market and the unemployment problem. The minimum wages are decreased by 12%, reflecting the decrease in prices, in order to combat the strong unemployment rates, which are mostly located in low productivityjobs. Moreover employment incentives have been introduced for the unemployed to find ajob, including more strict conditions on unemployment pay. (cf. European Commission, 2011, p. 34f)

[...]

Excerpt out of 17 pages

Details

Title
The EU Financial Crisis: Austerity and Expansion
Subtitle
Using the example of Ireland
College
University of Vienna  (Institut für Europäische Integration)
Course
Political Economy of European Integration
Grade
2
Author
Year
2013
Pages
17
Catalog Number
V232334
ISBN (eBook)
9783656488729
ISBN (Book)
9783656493419
File size
685 KB
Language
English
Tags
financial, crisis, austerity, expansion, using, ireland
Quote paper
Dominik Kirchdorfer (Author), 2013, The EU Financial Crisis: Austerity and Expansion, Munich, GRIN Verlag, https://www.grin.com/document/232334

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