DUBLIN – Much of Ireland has been riveted this summer by recordings of phone conversations from 2008 that revealed not only shocking levels of greed and bad breeding among some of the country’s top bankers, but a deliberate effort to snooker the government into bailing out the country’s banks by concealing the extent of their insolvency.
As Dan O’Brien, the business editor of the Irish Times observed, the tapes gave new life to a simple narrative that many Irish desperately want to believe: that Ireland was put on the path to financial ruin on a single night five years ago when a small group of regulators and politicians, pressured by bankers and European leaders, foolishly decided to guarantee all of the outstanding debts of all Irish banks. In this telling, it was that one boneheaded decision that wound up bankrupting the government and plunging the economy into a prolonged recession.
In the world beyond its emerald shores, meanwhile, another simple narrative about Ireland’s economy has found a receptive audience, this one about the Draconian spending cuts and tax increases that have been forced on Ireland by its creditors in order to reduce an annual government budget deficit that had reached 32 percent of the country’s annual economic output. The Irish themselves have long since accepted the urgent necessity of belt-tightening. But to Keynesian critics who believe in the healing power of fiscal stimulus, the country’s recent slide back into recession is offered as proof of the futility of austerity.
Neither of these fables — the one about the bank bailout, the other about austerity — is adequate to explain the rise and fall of the Celtic Tiger. You don’t have to spend much time here before discovering that the real story turns out to be both more complicated and more interesting.
In fact, you might say that what’s holding back Ireland’s economy is the same thing that is now holding back the once-fast growing economies of Brazil, Russia, India and China. It is the same thing that afflicts Greece, Italy, France and the other struggling economies of Europe. And, to a somewhat lesser degree, it is the same problem bedeviling the U.S. economy.
In each, it is the inability to make fundamental reforms to political and economic institutions that now prevents them from rebalancing their economy, from taking the next leap in terms of their productivity and efficiency, from creating a new, more sustainable model for economic growth.
The global credit bubble created the illusion that countries could continue growing their economies without making the fundamental reforms to institutions crafted for an earlier era. The bursting of that bubble has revealed the full extent of that political and economic mirage.
“We need to talk not about recovering the economy but recasting it, since in some important ways, what we had before was a disaster,” says Jim Browne, the president of the National University of Ireland at Galway.
The story of the Celtic Tiger begins with a small and once-poor island nation that, following an earlier financial crisis in the 1980s, was masterful in using targeted incentives, a low corporate tax rate and a heavily subsidized entry into the European Union to lure multinational corporations to open factories and back-offices in Ireland. In the span of 15 years, a country whose chief exports had been beef and butter suddenly turned itself into a modern, industrial economy that boasted the highest output per person in Europe.
Ireland began to lose its way following the bursting of the tech bubble in 2001. Rather than use that opportunity to move on to a different growth model, one more focused on its lagging domestic economy and homegrown companies, Ireland opted to double down on the old formula of foreign investment and government spending that had worked so well before.
To lure banks, insurance companies and accounting firms from New York and London to its Dublin financial services hub, officials offered special tax breaks and an explicit promise of “light touch” regulation.
Tossing aside the fiscal restraints imposed after the ’80s financial crisis, the government embarked on a spending spree, stepping up investments in infrastructure and education, renewing tax breaks for real estate development and dramatically increasing the pay of government workers.
The Irish economy also got a boost from the European Central Bank, which kept interest rates artificially low to bolster the lagging economies on the continent even as Ireland was beginning to soar again. At the same time, British, French and German banks began tripping over one another to make loans to households, banks and property developers, as well as the Irish government.
All of these developments combined to create a giant credit bubble in Ireland that, in turn, fueled a real estate and construction boom. At its peak, this real estate frenzy probably accounted for 25 percent of the economy’s output and employment and generated a third of the government’s tax revenue. Households flush with paper wealth and borrowed cash went on a spending spree, as did a government suddenly flush with tax revenue. Wages and prices soared and a country that once boasted it was one of the cheapest places to do business suddenly was one of the most expensive.
Only when the credit bubble burst did Ireland discover how bloated and misshapen its economy had become, how much capital and talent had been misallocated and wasted, how unsustainably inflated its wages and prices and tax revenue had become. It also revealed that most of its biggest banks were insolvent. The cost of guaranteeing the obligations of Ireland’s privately owned banks brought the government itself to the brink. And the rescue loan from the European Union and the International Monetary Fund came with a demand that the government move quickly to bring its annual budget deficits to within 3 percent of the country’s GDP.
The financial crisis and the ensuing recession dealt a serious blow not only to Ireland’s balance sheet but also to its national pride. Many here are quick to blame it all on greedy bankers who caused the bubble and feckless politicians who approved the bank guarantee. But when collective anger — and there is plenty of it — gives way to more sober individual reflection, most people come around to the conclusion reached by John Allen, an economic development official from the west of Ireland, when he says: “We lost the run of ourselves.”
The most obvious thing to say about Ireland today is that it has two economies that maintain a somewhat separate and uneasy coexistence.
One economy is the old Celtic Tiger, the globally competitive, highly productive export machine centered in the large companies and located in the major cities. While a few are homegrown — Kerry Group in food processing, Smurfit Kappa and Ardagh Glass in containers, CRH Construction and Ryanair — most are European and American. All benefit from Ireland’s low corporate tax rate, flexible labor laws and English-speaking workforce, supplemented by a steady flow of modest government subsidies for job creation and research and development. The fall of the euro, the decline in real estate values and the moderation of starting wages have combined to make Ireland an even more attractive place for new foreign direct investment, which hit record levels in the past two years.
Any doubts about the vibrancy of this economy are easily dispelled on a Friday night when tens of thousands of young workers from companies such as Google, Facebook and Citigroup spill onto the street from the bars and restaurants of Dublin’s once-seedy Temple Bar neighborhood or into the modern plazas and redeveloped warehouses of the city’s Dockland area. Many have emigrated from elsewhere in Europe, lured by the prospect of good jobs at global companies, the opportunity to polish their English and a city full of people just like themselves.
Mark Gantly, managing director of HP’s Galway operations, said one reason for Ireland’s success with U.S. multinationals is that Irish workers tend to thrive in the bureaucratically “flat,” egalitarian organizations favored by American companies. No doubt, he said, it also helps that Irish managers come culturally equipped with the charm to maintain smooth relations with difficult and demanding superiors back at corporate headquarters.
One important facet of that globally competitive sector includes Ireland’s top universities, which engage in extensive research collaboration with industry and government. Certainly the best known, and most lavishly funded is the Center for Research on Adaptive Nanostructures and Nanodevices (CRANN) here at Trinity College. CRANN boasts 300 researchers from 45 countries, working hand in hand with more than 125 companies such as Intel and Merck. The companies make use of CRANN’s research and facilities, while CRANN’s students and post-doctoral fellows gain insights, experience and jobs at the companies.
Because of the continuing strength of this globally competitive export sector, there are clear signs that Ireland’s economy has begun a modest, if tentative, recovery. Some companies report having trouble finding highly skilled workers or experienced managers. And in the Dublin and Galway real estate markets, where values fell as much as 50 percent, shortages for certain types of housing and offices last year led to a 10 percent bounce off the bottom in real estate prices.
These days, in fact, foreign investors are swarming all over Dublin and Galway, looking to buy buildings put on the market by the National Asset Management Agency (NAMA), the government entity set up to take over $90 billion in bad loans to property developers after the banks were nationalized. The complaint from the real estate industry is that NAMA is not moving fast enough to dispose of the properties. But NAMA’s boss, Brendan McDonagh, is determined not to repeat the mistake made by the U.S. government following the savings and loan crisis of the early 1990s, when it sold off its inventory too quickly, allowing investors rather than taxpayers to reap the bonanza when the market rebounded.
NAMA officials have been remarkably disciplined and flexible in balancing the sometimes conflicting goals of maximizing the recovery for taxpayers, creating a sustainable rebound to the commercial property market and fostering a broader recovery of the economy and the Irish banking system. But the agency has been criticized for workout deals negotiated with many of the bankrupt and reviled developers whose lavish lifestyles — flying around the country in their helicopters buying up old manor houses and racehorses — came to symbolize the excesses of the bubble economy. As part of these settlements, NAMA has hired back some of those developers to manage their old projects and agreed not to go after money and houses they transferred to their wives just before the crash.
“I understand that people want retribution, but my job is not that,” McDonagh said. The negotiated settlements, he said, “achieve the optimal outcome for taxpayers.”
Danny McCoy is adamant: “The Celtic Tiger was not a mirage.”
McCoy is the president of the Irish Business and Employers Confederation, the Irish equivalent of the chamber of commerce. He is inclined to focus on Ireland’s record exports, the continued flow of foreign direct investment and the bounce in the urban property markets. He looks at government pay scales, which have been reduced by as much as 25 percent over three years, the government deficit, which is on target to fall to 3 percent of GDP in 2014, and the government’s ability once again to borrow money from global capital markets. And what McCoy sees are the signs that Ireland is getting its economic mojo back.
If only, he laments, Irish consumers would get past the fear and anger stirred up by their underwater mortgages and start spending again.
If only Irish banks would get on with restructuring the mountain of nonperforming loans on their books so they could begin lending again.
If only the cream of the crop from Irish universities would see the opportunities at home rather than heading abroad in search of better ones.
But to Constantin Gurdgiev, that’s precisely the point. As the Trinity College economist sees it, those “if onlys” are not merely hiccups. Rather, they are symptoms of much deeper structural problems in Ireland’s domestic economy that were at the root of the financial and economic crisis and must be fixed if the country is to return to a path of robust and sustainable growth.
For unlike the highly productive, globally competitive export economy, which directly accounts for less than 15 percent of the labor force, Ireland’s domestic economy is relatively inefficient, unproductive and uncompetitive.
Sectors such as retail are highly fragmented, with local stores protected from competition from large chains by zoning and planning rules. Costs of insurance, legal and other professional services are among the highest in Europe, largely because of laws limiting competition.
A big part of the domestic economy is a government that, even after significant spending cuts, still rivals Sweden’s in terms of its size but doesn’t come close in terms of the quality of its services. The health-care system is not particularly cheap or particularly good, leading many people to turn to private insurance and private health providers. Welfare and pension levels are among the highest in Europe, left largely untouched during the recent cutbacks. And while there are a number of world-class programs in Ireland’s higher education system, even those who teach in it acknowledge that it puts greater emphasis on the quantity rather than quality of graduates it produces.
Structural problems — some legal, others cultural — also stand in the way of a full recovery of Ireland’s financial system.
Stringent — some would say Dickensian — bankruptcy laws make it extremely difficult for borrowers who cannot repay their debts from ever getting out from under them. Even in the best of circumstances, it takes a decade for insolvent borrowers to have debts written off — and carries a social stigma for far longer.
At the same time, the collective memory of British landowners throwing Irish farmers off their land creates social and political pressure on banks not to foreclose on mortgages that, in all likelihood, never can be repaid.
The result has been a stalemate between lenders and borrowers in a country where a quarter of mortgages are in arrears — and nearly all of them for amounts in excess of the current value of the property. Nobody really knows what property prices will be once all those problem loans are resolved. Nor can anyone know whether the ensuing write-downs will put the banks into insolvency again, requiring yet another government bailout. Because of this prolonged game of “extend and pretend,” banks have been reluctant to make new loans even to sound businesses, while apprehensive households hoard their cash and pay down debts.
“The domestic consumer is beset by fear,” says Michael Coyle, a former banker who heads the Galway Chamber of Commerce. At Dublin’s most venerable high-end department store, Brown Thomas, sales are off 20 percent from their peak. Mid-priced stores are doing even worse.
Even the Irish punter is in retreat. “The cash has gone out of the game,” said veteran bookie Daragh Fitzpatrick surveying the disappointing crowd at this year’s Irish Derby at the Curragh. “The ordinary person ain’t got any disposable cash anymore.”
As it happens, it’s not only Irish households that are burdened by real estate debt. As many as a half of all small and medium-size firms are also in arrears — not necessarily because they don’t have healthy core businesses, but because they took out loans to speculate in the real estate market on the side.
The Irish fixation with real estate investment has roots going back to the days of British rule. Since independence, however, this fixation has contributed to a series of speculative bubbles and robbed the rest of the economy of the domestic capital it needs to grow. The Irish stock market, for example, remains tiny, while the few venture capital and private-equity firms rely heavily on government money and foreign investors. As for the banks, they’ve relied on real estate lending for so long that they have never developed the expertise and confidence required to make loans to businesses in other sectors.
The lack of private financing for entrepreneurial ventures reflects, in part, a cultural bias. Irish mothers traditionally wanted their sons to go into the church, medicine, law or government — anything that was “permanent and pensionable.” Starting a business, or working in a small firm, was way down on the list.
That began to change in the 1980s with the arrival of U.S. multinationals. Before long, some of their Irish employees, fortified with an idea or a supply contract, left to start their own businesses, and some of those businesses began to take off. An entrepreneurial ecosystem began to develop.
What strikes an American visitor, however, is how few of those successful Irish start-ups have grown into large Irish corporations. The normal pattern is that once the firms reach sales of $10 million, the founders sell out to a bigger firm, usually foreign, that is willing to pay a premium for the product or the customer base. The riskier course — taking the company public, making a big push into foreign markets, creating a billion-dollar company that spins off other firms and creates a cadre of Irish millionaires who invest in other Irish startups — rarely happens.
As John O’Shaughnessy puts it, it’s not the lack of financing or ambition that explains this urge to sell out so much as the fact that Ireland is simply at a relatively early stage of its economic development.
In many ways, O’Shaughnessy is typical of the today’s successful Irish entrepreneurs. Back in the 1980s, he was general manager of a Swiss company making stents in Galway when it was sold to Minnesota-based Medtronic. He left soon thereafter, helping to launch two medical device companies that were also sold to big U.S. corporations. Now he’s out raising money for a third.
O’Shaunessy says it’s only natural for those of his generation, which grew up in a small and relatively poor country, to seize the opportunity of financial security for themselves and their families by selling out to multinational corporations that come knocking. But he vows that the next time he’ll be swinging for the fences, and he expects the next generation of Irish entrepreneurs will have the confidence and financial security to do the same.
Certainly that’s what Andrew Murphy has in mind. After working for eight years as a chemical engineer for a German conglomerate, Murphy went back to school for an MBA, where he got the idea for a software company that would create paperless medical records with the look and feel of the old medical charts, dramatically improving hospital efficiency and quality. Since its launch in 2010, Slainte Healthcare (Slainte means health in Gaelic) has doubled in size every year.
Now with $20 million in annual revenue and 80 employees, Slainte is at precisely the point at which many Irish start-ups tend to sell out. To fund a splashy entry into big markets such as the United States, Slainte will need additional capital, and hardly a week goes by that he doesn’t get a call from an investment banker or private-equity firm. But Murphy, a boyish 37 dressed for work in jeans and a T-shirt, is not interested in taking money off the table or giving up control. He’s determined to list Slainte on NASDAQ and build a billion-dollar global enterprise based in Ireland.
It will take many more Andrew Murphys for Ireland to finally overcome its overreliance on foreign direct investment and “branch-plant” orientation. Unfortunately, the most pernicious long-term effect of the recent financial crisis and recession may be that it stalls that transition by reaffirming the old bias against risk-taking and entrepreneurship.
That same bias is also reflected in Ireland’s tax code, which imposes relatively high taxes on incomes of the self-employed (55 percent) and capital gains (33 percent) but infamously low taxes (12.5 percent) on the profits of domestic and foreign corporations. The low corporate rate has become such an integral part of the Irish “brand” that even the deputy prime minister, a one-time socialist, dismisses any consideration of raising it even temporarily to deal with the government’s fiscal crisis. Yet it’s hard to find a small-business owner or venture capitalist who doesn’t volunteer, without prompting, that high taxes on personal income and investments are driving away entrepreneurial activity.
And it’s not just entrepreneurs who are leaving. Among more than two dozen economists and business leaders, I found that virtually all of their grown children live outside of Ireland. While young Europeans may be flocking to Dublin, many more young Irish are flocking to England, Australia, Canada and the United States. The net outflow of 35,000 people last year, most of them young, has become an emotional issue, a symbol of national failure for a country that still remembers the days of raising its offspring “for the boat.”
There’s no doubt that some have gone abroad just to have a bit of fun and expose themselves to different cultures. But the consensus among their parents and their school chums back home is that the longer they are away, the less likely it is they will return.
The Irish Times, in fact, has an entire section on its website called “Emigration Nation.” And it is not lost on anyone here that one of the two teams competing for the championship of the All-Ireland Gaelic football league this year was from London, which boasts a thriving Irish community.
Reading through the postings from abroad at “Emigration Nation,” it’s clear the expats aren’t merely discouraged by the lack of jobs back home, but frustrated by a political and economic establishment they view as insular, unresponsive and incapable of carrying out fundamental reform of the country’s outdated institutions.
This frustration is shared widely back home as well, where the deep anger with what has happened has yet to translate into meaningful reform.
“This is a country that, economically, has ruined itself three times since independence,” said Karl Whelan, an economist at Trinity College, Dublin. “Yet nothing seems to have changed in the political system.”
Time and again it was described to me as a system characterized by mediocrity, nepotism, secrecy and a lack of genuine competition. It is a system in which the governing philosophy of “social partnership” has morphed into nothing more than an excuse for buying off special interests. And it is a system in which the top priority of those who run it is preserving their powers, perks and prerogatives.
In a new book, “The Fall of the Celtic Tiger,” economists Donal Donovan and Antoin Murphy look beyond the property bubble and the bank meltdown and argue that the root cause of the crisis was “the absence of sufficient questioning and internal debate” within a political, economic and media establishment too easily prone to “wearing of the green jersey.” That comfortable consensus and cheerleading culture stifled serious analysis or criticism of what was really going on during the boom years. A stubborn “lack of transparency in the political decision making process,” they write, undermined the political legitimacy of the government’s response to the crisis.
“We have a very insular political system here,” agrees Alan Dukes, a former finance minister and leader of the parliamentary opposition. “The influence of interest groups makes politicians incapable of making hard decisions. We wind up doing a little of everything and not enough of the things that really matter.”