<p><em>Viv Daview interviews Kevin O'Rourke for Vox</em></p>
<p><em>January 2011</em></p>
<p style="padding: 0px 0px 0.5em; margin: 0px;"><em>Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/6017]</em></p>
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<p><strong>Viv Davies:</strong> Hello and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from the Centre for Economic Policy Research. It's the 13th of January, 2011 and I'm speaking to Kevin O'Rourke, professor of economics at Trinity College Dublin about how the financial crisis has affected Ireland and what the implications may be for the future. I began by asking Professor O'Rourke to explain why, in his view, Ireland changed so quickly from being the Celtic Tiger economy to an economy in financial meltdown that accepted a $100 million bailout.</p>
<p><strong>Professor Kevin O'Rourke:</strong> I think some people might say that it took a surprisingly long time for this to happen. Ever since September 2008, the state has been liable for all of the debts of our rotten banking system and, in a sense, financial meltdown was baked in from that moment. A lot of people, at the time, were worried about things like bank runs, for the simple reason that the banks were now being guaranteed by a state whose credit worthiness was itself being undermined by the guarantee that it had extended to the banks. People may not have said that openly for obvious reasons, but people were, I think, very worried from the election of 2008 that we had bitten off more than we could chew. So, in a sense, to me, the surprise is that it's only in the last couple of months that we have to go to the IMF.</p>
<p><strong>Viv:</strong> There's an issue of extended credit and the housing bubble didn't help, I guess.</p>
<p><strong>Professor O'Rourke: </strong>Yeah. So, if you want to talk about the Celtic Tiger economy, I think most academic economists now agree that Irish growth can be divided into two periods. There's the 1990s, which was a period of genuine economic growth based on investment, largely by multi nationals, but also by domestic firms. So that was real growth.</p>
<p><strong>Viv:</strong> Growth averaged around six or seven percent or something in those years.</p>
<p><strong>Professor O'Rourke: </strong>Yeah. Exactly. It was very high. We moved to full employment, we grew our way out of the debt problems of the 1980s and so on. And then something changes around 2000 2001. Different people date it differently, but essentially in the &quot;noughties,&quot; as they say, we switched from a growth model based on investment to a growth model based on borrowing money and building houses and apartments and other such things. So, that was when the rot set in and I suppose once the bubble really got underway, then we were in a very different world.</p>
<p><strong>Viv:</strong> That period you mentioned, the beginning of the noughties, sort of relates almost to the time just after Ireland joined the single currency. Do you think that process had something to do with Ireland's difficulties now?</p>
<p><strong>Professor O'Rourke:</strong> So, there's a famous historian who is supposed to have said that if you only try to understand Ireland, you won't even understand Ireland and that's certainly something that I try to drum into my students when we talk about economic history in Trinity. So, yes, if you want to understand the Irish crisis, for sure, you can talk about Irish crony capitalism. You can talk about old boys clubs, where everybody's looking out for everybody else and where there's a whole web of overlapping relationships between senior politicians and bankers and developers and all the rest of it. And I think Irish people themselves are more aware than anybody else of all of the things that are rotten with the Irish system and that need to be changed.</p>
<p>But, at the same time, if you look at the map of Europe and you look at the countries that are currently in difficulty, you see Ireland, you see Portugal, you see Spain, you see Greece, and there's a pattern there that's plain as the nose on your face, I think. I think EMU is a part of this story.</p>
<p>What happened in Ireland when we joined EMU is that overnight our interest rates were cut from seven percent, roughly, to three percent, something like this. And I can remember, at the time, there were people who were worried about this because we had, as you were saying earlier, already seen a period of unprecedented economic growth. A huge monetary shock like that didn't seem to be what the doctor would have prescribed.</p>
<p>It was around that time that people like the <em>Economist </em>magazine--the<em> Economist</em> was, I think, Euroskeptic enough started sending reporters to Dublin looking at the housing bubble and started worrying about whether trouble was brewing. So yeah, I think EMU is part of the problem, but when you look back at the literature in the 90s on EMU, there's a lot of debate about asymmetric shocks and how different countries would respond to asymmetric shocks in a monetary union. And then some very clever people tried to argue that, for various very complicated and clever reasons, being in EMU might mean that we would have fewer asymmetric shocks.#</p>
<p>But, I think in retrospect, it seems clear that the big asymmetric shock that we've all been subjected to here is EMU membership itself, which got rid of the interest rate margins between the core and the periphery, which made investors feel that there was no risk associated to investing in the periphery. And so, one way or the other, the periphery has been collectively borrowing from the core and that has led to real exchange rate appreciations and all the rest of it. So, yeah, there's an EMU dimension to all of this, for sure.</p>
<p>There are two caveats maybe, since I'm an academic and I don't like being excessively clear. One caveat is Iceland, which is clearly not a member of EMU and a second caveat is Thailand, which is even more clearly not a member of EMU. What's happened in Ireland is the latest in a long series of crises associated with capital pouring in, doing bad things to your domestic economy and then being withdrawn.</p>
<p>But, in a way, the European single market and the single currency project and so on are the local manifestations of a global trend towards unfettered capital mobility and I think that's a major political problem for Europe, which is the fear that the European political project is now perceived as being part of these broader problems associated with unregulated globalization.</p>
<p><strong>Viv:</strong> Kevin, what does history tell us, if anything, about what may be the best way out of the current crisis for Ireland?</p>
<p><strong>Professor O'Rourke:</strong> Unfortunately, I think the major lesson of history is that it would be really, really helpful if we could have a devaluation of 30 or 40 percent or something. I'd feel a lot more optimistic about our growth prospects if that policy option were available to us and that's what we did in 1987, it's what we did after the currency crisis of 92 93 and obviously we can't do it now. So, even apart from the debt overhang that has threatened to completely kill this economy, we still have a problem of major budget deficits and having to correct that in a situation where we can't devalue, so that's a major, major problem for us right now.</p>
<p>I suppose the other, more positive, lesson from history is that if you are insolvent, then it's best to recognize that as soon as possible, get the restructuring out of the way and move on with the rest of your life.</p>
<p><strong>Viv:</strong> But, that's going to be a difficult thing to do because once you start talking about restructuring and default, etc., it almost becomes a self fulfilling contagion and it could easily spread then to other countries and potentially bring down the Euro perhaps. I don't know. What are your thoughts on that?</p>
<p><strong>Professor O'Rourke:</strong> Well, I think the reality is that the markets are already talking about default and restructuring and that contagion is already occurring. I think the opportunity costs of being honest about our situation are diminishing all the time. I think the other point, of course, is that the opportunity costs of being honest about Irish insolvency are largely going to be incurred by non Irish people, whereas the opportunity costs of not being honest about our insolvency problem are going to be incurred by Irish people. And that may sound like a nationalistic viewpoint, but I think that the nature of European intervention in Ireland in November was very shocking to a lot of people. I think we realize now that if Ireland can be hung out to dry for the sake of core banks, we will be hung out to dry, that we're in a struggle for national economic survival here and that we need to put our own country first. And so from that point of view, I think pretty obviously, the sooner the contagion happens, the more generalized the contagion and the more dramatic the contagion, the better for us, because what we ultimately need here is a European solution to what is a European problem.</p>
<p>Mr. Olli Rehn has the metaphor that he's very fond of. He's used it twice in the last year. He used it in May in regard to Greece and he used it in November in regard to Ireland when he said that what we have here is a bush fire and what's important is to stop the bush fire from spreading into the forest. And that may seem like a very compelling metaphor if you're living in Brussels, but if you're living in the bush, it's rather less compelling.</p>
<p>Ireland is a burning bush right now and we don't need firebreaks. If a forest fire is what it takes to bring the fire brigade along, then that's what is in Ireland's interest. Sorry to have to speak like that, but European leadership has been so irresponsible during this crisis that you do begin to think that only a major, major crisis will allow the Eurozone to sort out its problems.</p>
<p><strong>Viv:</strong> How would you describe Ireland's reaction to the bailout last November?</p>
<p><strong>Professor O'Rourke: </strong>What I think disturbed people in Dublin about the European position in November was that the IMF came to town and, as the IMF always does, it advocated that the state not pay back all of the unguaranteed senior debt owed by Ireland's banks and this sort of common sense approach was vetoed by our European partners and that's left an indelible impression on the Irish population that actually what the Europeans were concerned about was not so much the Irish themselves as the health of core European banks and that is, I think, doing tremendous damage to Europe's image in Ireland.</p>
<p>I think that even those of us who would be the most critical of our own government's stupidity for having guaranteed all of the banks' liabilities in the first place are very angry with Frankfurt and Brussels for their attitude here. Our feelings about Europe aren't smoothed when we hear, or read reports in the newspapers, that European bureaucrats are assuring investors that even if a new government comes in after the general election with a mandate to not pay back whatever unguaranteed bank debt may be still outstanding, that such a new government would be prohibited their words by Brussels and Frankfurt from reneging on the unguaranteed bank debt. And that kind of attitude is completely toxic.</p>
<p>And what I would say is that it's also completely incompatible with the traditions of political economy upon which the European Union, or the European Economic Community, I suppose, were founded in the first place.</p>
<p>I mean, if you look at the kind of Europe that people like Monnet and Schuman were trying to construct, it was a Europe in which the economy was pretty firmly embedded in its society and in politics and in political economy. It was a union that used the market to create wealth, but it was very clear about what the political constraints were facing governments, that was very clear about the need to bring ordinary people on board and make sure that markets worked for them.</p>
<p>When you have, then, the institutions of the union today, saying that, essentially, the only people they really care about are bank creditors. And that if social welfare recipients have to see their payments cut and ordinary people who have nothing to do with the banking system have to pay more in taxes and get fewer benefits and so on, just to keep bank creditors whole. I mean, they're betraying the basic traditions of our union. And I think that is something that has to be addressed over the next few years.</p>
<p>The other point that I'd make about this is that what this crisis, I think, is showing is the importance of politics. I don't believe that the Union's response to the crisis would have been the same if the left had been in power in more governments, and especially in Germany. I mean I thought that Steinmeier and Steinbruck had a very useful contribution to the debate in the Financial Times late last year. And I think that if the SPD had been in power in Germany, while they obviously would have defended Germany's interests, they probably would have done so in a more enlightened manner.</p>
<p>So, if I were to take one hopeful thought from all of this, it is that there is the potential now to get Europeans to realize that politics matters and that European politics matters. That the real cleavage right now within Europe isn't between core taxpayers and periphery taxpayers that's how the thing is being set up, but it is not the real cleavage. The real cleavage is between ordinary taxpayers and ordinary people everywhere and financial interests on the other hand. And there's clearly a role for European Union politics to do something about addressing the balance there because right now, all the advantages are with the financial side.</p>
<p><strong>Viv:</strong> The crisis in Ireland and in Europe, in fact, came as a shock to many academic economists and the economic think tanks. It simply wasn't predicted, even by Ireland's main economic think tank, the SRI. Do you think that this might suggest that traditional ways of doing economic research might need to be reconsidered?</p>
<p><strong>Professor O'Rourke:</strong> Well, this is a question that is probably above my pay grade as a mere economic historian. But, there are obvious things that one can say. Most of our models have for the most part got flow variables in them, current income, current consumption, current prices and so on. And when you're in a debt crisis you realize that actually balance sheets are pretty important. So, trying to bring balance sheets back into the analysis would seem to be a good thing.</p>
<p>I think that in the Irish case, we need better statistics. And that's something that all Irish economists always say, because we have lousy statistics in this country. And then we need to process statistics differently. For example, during the noughties, people, for the most part, weren't concerned with our balance of payments because, after all, we were in a monetary union. And when they did look at the balance of payments, they maybe looked at the current account. And the current account only, really, started deteriorating sharply in 2005, which means that you'd only have noticed that, unless it was your job to monitor these things on an ongoing basis, at the start of 2006. Well, 2006 is when the housing bubble peaked, so it was already too late by then.</p>
<p>And so I guess what that suggests is that the current account is not necessarily the correct place to draw the line in the balance of payments, that you should be looking more carefully at sub components of the balance of payments. Looking at, you know, short run liabilities of banks and so on.</p>
<p>We need to monitor the economy in different ways. But, this is not the first crisis like this that has happened. It isn't the last crisis, either. Crises have been with us for hundreds of years. And you can set in place all the systems that you want, but ultimately, when people get swept away by euphoria, then this is what you have happen.</p>
<p><strong>Viv:</strong> So, this time is not different. Are you saying it's not different from previous times in history?</p>
<p><strong>Professor O'Rourke: </strong>Well, I think what's interesting about this crisis is that it is a Thai style crisis with capital inflows and crony capitalism and all the rest of it, but within the context of a monetary union and in the context of an economy whose population is extremely mobile.</p>
<p>And I think the interaction is between levels of debt and labor mobility has the potential to kind of empty out of this country in the next couple of years unless people are given really strong reasons, young people especially, to stay at home.</p>
<p><strong>Viv:</strong> So, do you think generally that bailouts, sovereign debt bailouts, actually help or do they perhaps make things worse by adding more debt on top of an already high debt burden? Like the bailout helps temporarily with liquidity, but perhaps worsens longer term solvency.</p>
<p><strong>Professor O'Rourke:</strong> If Ireland were suffering from a liquidity problem and the markets believed that, then the yields on Irish bonds would have fallen after the IMF EU intervention. And they didn't fall, they rose. And the reason that they rose is that the markets don't believe that Ireland is facing a liquidity problem. They believe that it's facing a solvency problem. And if you're facing a solvency problem, the best thing to do is to face up to that straightaway. At the risk of sounding biblical, the truth will set us free.</p>
<p><strong>Viv: </strong>Are you confident, Kevin, that the European Monetary Union and the European project as a whole is the best way forward for Ireland and for Europe? Or would you see more success for Ireland if it was not part of the euro but perhaps linked to sterling somehow, perhaps, for example?</p>
<p><strong>Professor O'Rourke:</strong> Well, firstly, I wouldn't say that a link with sterling is the only option available to us. In the 1990s, after the breakup of the old EMS when we moved to the wide bands and so on, the Irish Central Bank steered a course between the deutschemark on the one hand and sterling on the other.</p>
<p>So, it ran a basically independent monetary policy and it did so pretty successfully. So, I don't think sterling is the only option available to us in a counterfactual world. That is the first point.</p>
<p>And the second point is that, in the 1990s, there was a debate in Ireland about EMU membership. And economists never get timing right and actually the debate happened about five years too late. The right time to have the debate was before the Maastricht Treaty referendum rather than on the eve of EMU membership.</p>
<p>But anyhow, we had the debate. A lot of people, I think the majority of academic economists, were skeptical about joining EMU, especially if the UK didn't join. The feeling was that this would leave us excessively exposed to exchange rate fluctuations with the EMU vis &agrave; vis sterling. And there was also the standard fear that not having the devaluation option available to us could turn out to be costly in the long run.</p>
<p>And I think that that prediction has obviously been borne out by our current situation. What people didn't foresee was the sort of bubble inducing effects of the EMU. I can't remember anybody who talked about that at the time.</p>
<p>However, it's one thing to have these debates before you're in a monetary union. Once you're in a monetary union, there are clearly big costs to exiting. And politically for Europe, now that they have monetary union, I think there are big costs as well for the continent as a whole in terms of the damage that it would do to its self confidence and so on.</p>
<p>On the other hand, the way that this crisis is being handled, I think, is also doing potentially very serious damage to the European body politic. And that also has to be borne in mind.</p>
<p>So, to be crude about it, you have a largely insolvent periphery and you have a core banking system that may be partly insolvent as well. So, how do you fill these holes? You could fill them through the ECB printing money. You could fill them via debt, bank debt, being turned into equity or some other form of bondholder haircuts. Or you could fill them with taxpayer funds. An optimal solution of how to fill these holes would probably involve some combination of all of these three policies.</p>
<p>But, what we're doing right now is we're ruling out any sort of quantitative easing for understandable reasons, I suppose, political reasons. We're ruling out bondholder haircuts for reasons that escape me. And so what you're left with, then, is a situation where the entire cost of this debacle is supposed to be borne by taxpayers.</p>
<p>Now, in that situation, the only interesting question is whose taxpayers pay? Is it core taxpayers or is it periphery taxpayers? I mean if you wanted to do as much damage as possible to European political solidarity, you couldn't think of a better way of doing it.</p>
<p>And so it's no surprise to me when I go to France and I find all my friends talking about Irish fiscal dumping. You'd expect that. And it's no surprise to me when you see nationalists in Ireland complaining about our having to pay to bail out German and French banks. You'd expect that as well.</p>
<p>So, they are not just mismanaging this process economically, they're mismanaging it politically as well. And of course, because the EMU is ultimately a political project, that could end up being fatal for EMU. My hope is that 2011 sees this problem being sorted out. But, it's going to take a sort of big systemic, big bang approach to sorting the problem out that people like Willem Buiter and many others are calling for.</p>
<p><strong>Viv:</strong> So, final word, Kevin, do you think the way forward for Ireland is together with its European neighbors rather than alone?</p>
<p><strong>Professor O'Rourke: </strong>Look, Ireland is a small, open trading nation. Our miracle of the 1990s was largely based on the European single market. We have always been among the most pro European of Europeans. All of the Euro barometer surveys and so on have shown that. Whether that survives this crisis is another matter, but I hope it will.</p>
<p>So, yes, I think that Ireland's future is with Europe. But, Europe needs to get its act together now and not pretend that this crisis is anything other than an extremely serious one that could ultimately kill monetary union and do serious damage to the whole political project.</p>
<p><strong>Viv:</strong> Kevin O'Rourke, thanks very much for very much for talking to us today.</p>
<p><strong>Professor O'Rourke:</strong> Thank you.</p>