- Both Ireland’s and Spain’s housing bubbles burst, challenging the countries’ economies.
Photo: “Concrete Forms” on flickr.com
It is worth noting, however, that the Spanish banks have proven to be far more resilient to the global financial storm than their Irish counter-parts. Partly as a consequence, the two countries’ responses to their economic woes have been dramatically different. Whereas Ireland, constrained by the measures taken to support its banking sector and its narrow tax base has been forced to cut expenditure and increase taxes, Spain has taken an approach based more on stimulating the economy with increased investment.
Ireland – The Death of a Celtic Tiger
Ireland as an open, globalised economy, reliant on exports and financial services with a high level of household debt and increasingly dependent on a housing bubble was particularly vulnerable to the crisis in global economy. A decline in exports, the crisis in the financial sector and a significant drop in consumer spending all contributed to a fall off in economic growth. Yet perhaps the most important factor in the rapid decline in the Irish economy remains, nonetheless, the bursting of the housing bubble. Its subsequent correction has led to a rapid slow-down in economic activity, a swift drop in housing prices and a reduction in incomes. The government has been forced to adopt a succession of measures to support the banking system including guaranteeing all bank deposits, recapitalization of the two largest institutions and nationalization of a particularly weak bank, the specialized property lender Anglo-Irish Bank. Most recently, in the second emergency budget of this year, the government created a “bad bank”. the National Asset Management Agency (NAMA) ,which will relieve Irish banks of an estimated €90 billion worth of property loans.
The result of this perfect economic storm has been a spectacular fall off in economic growth, rapidly rising unemployment and a crisis in the public finances. The Irish exchequer was particularly reliant on tax revenues flowing from the property and construction sector while successive cuts in income tax throughout the period of the Celtic Tiger led to a particularly narrow tax base. The collapse of the property market and the construction sector led to a rapid drop in tax revenue while increased numbers of unemployed resulted in increasing social welfare costs. The result is a growing gap between the Irish state’s income and expenditure. Despite introducing two emergency budgets this year alone and taking such drastic measures as imposing a 7.5% pension levy on public sector workers (in effect a pay cut) and raising taxes, the budget deficit is still set to reach up to 10% of GDP this year. This growing public deficit is expected to lead to a rapid increase of the public debt, expected to climb to over 60% of GDP in 2010. As would be expected, the political fallout from this dramatic change in fortunes has been significant. The social partnership process whereby unions, employers and the government would form agreements covering defined periods of time collapsed at the beginning of the year when trade unions pulled out, feeling unable to agree to spending and pay cuts proposed by the government.
- Irish Taioseach Brian Cowen shortly after the rejection of the Lisbon Treaty by the Irish electorate.
Photo: Audiovisual service of the European Commission.
The government having been in power for over ten years is widely considered responsible for what is seen as an economic disaster and confidence in the Taoiseach (Prime Minister) and the main government party (Fianna Fail) has plummeted. The main opposition parties of Fine Gael and Labour in particular, have been the main beneficiaries. Fine Gael for the first time in the history of the state has overtaken Fianna Fail as the most popular party and Labour is making significant gains in the opinion polls on the back of strong parliamentary performances by its leaders. Support from the junior party in government, the Greens, has remained solid over the crisis and some wonder if it will be Fianna Fail’s own backbenchers, facing increasingly hostile constituents, who may prove to be the weakest link in Brian Cowen’s majority. It remains to be seen if this government will be able to stay in power for the foreseeable future and it is expected to fare poorly in the upcoming local and European elections. One unexpected result of the crisis has been a reversal in the public’s attitude towards the Lisbon Treaty with a majority now supporting ratification the Treaty. Most attribute this to a perception by voters that the EU and the Euro provide a degree of security and support for a small economy in the current global environment.
Spain – The Denied Crisis
- José Luis Rodriguez Zapatero, Prime Minister of Spain, long denied the desperate state of the Spanish economy.
Photo: European Parliament.
On 9th March 2009 the Spanish government, led by Prime Minister José Luis Rodriguez Zapatero (Socialist Workers’ Party -PSOE-) reviewed the first year of his second term. After winning the elections in 2008 with a moderate majority (although not absolute), the electoral campaign, the elections and the following months were characterized by the Government’s denial of the crisis. Only on 8th July the President mentioned for the first time the previously taboo word in a TV interview. In March 2009 the Executive defined this first year as ‘reasonably positive’. However, despite this extraordinary lack of realism vis-à-vis the disastrous economic data, nobody in Spain seems to question Zapatero’s government resilience.
The key to understanding the magnitude of the Spanish crisis is the housing sector’s bubble and the large imbalance in the current-account deficit. Even in the rather optimistic macroeconomic forecast the Government made in mid January 2009, no economic sector showed signs of recovery. A contraction of 1.6% in real GDP and an unemployment rate of 15.9% are expected for 2009. The expansionary fiscal policy has focused so far on expenditure increases in infrastructure and investment, the stimulation of the enormous housing sector and the financing of SMEs. However, it risks being exhausted in the short term. Spain’s credit rating has been downgraded from AAA to AA+ in January and the government will face significant international borrowing constraints. In addition to that, during the first months of the crisis the Government used the resilience and healthy situation of the Spanish banks (Santander and BBVA published solid results in 2008), as evidence to publicly deny the crisis. However, at the end of March 2009 the Bank of Spain already announced the first public intervention in the regional savings bank of Castilla La Mancha.
Despite these devastating economic results, social unrest is not expected in the medium-term. Trade Unions are surprisingly restrained in their demands and public opinion perceives the Socialists as the best placed to offer welfare support in times of enormous unemployment. The main opposition party, the conservative Popular Party (PP) has been suffering for some months from a lack of clear leadership after defeat in the general elections. However, after the two regional elections on 1st March, they regained control of Galicia and will govern in coalition with the Socialist Party in the Basque Country (excluding the nationalist PNV from power for the first time in three decades). However in response the Basque nationalists have stopped to vote in favour of the socialist proposals, reducing the Government’s support in Madrid. The Socialists are now facing serious difficulties in gaining approval for the economic measures proposed from the beginning of March, which is for the first time raising some doubts about the Government’s resilience. There are already calls for a change in government after the European Elections in June. These elections may come to mark the beginning of a political crisis that will only become clear in due time.