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EU leaders' latest plan bad for Ireland and the EU in the short, medium and long term

Proposals seek to address a major issue but insist the cause of the current crisis must be allowed to continue

The latest proposals from the EU Heads of Government (published December 9, 2011) focus on reducing the borrowing of countries so that they will be forced to balance their budgets and pay their way in due course.  This approach fails to recognise the real cause of the current crisis lay in the moral hazard situation that prevails in which banks and bondholders will never lose. Not alone does it not recognise the major cause of the problem but the agreement insists that this cause must be kept in place in the new dispensation.  This is an approach that is doomed to long-term failure no matter what its short-term successes may be.

Developing an accurate analysis

The approach followed by the EU leaders is based on a misunderstanding that the present crisis was caused by excessive government borrowing. This is a false analysis for most countries.  In the case of Ireland, in the lead up to the crisis, government had failed to broaden the tax base and to curb property speculation.  It had also failed to monitor and control the activities of banks.   However, it wasn't failure to balance its budget that put Ireland into its present mess.  Ireland's Government borrowing fell dramatically in the decade prior to the crisis of 2008. Our national debt was among the lowest in the developed world by 2008.
The acute problems that emerged in Ireland followed from the decisions of the Irish Government firstly, not to insist that bondholders should share part of the burden for restructuring the banks in whom they had gambled and lost; and secondly, to take over the debt accumulated by these reckless banks.  These 'investors' had gambled their money and lost. The Irish Government took on this debt when it introduced and subsequently confirmed the bank guarantee and Irish people are now seeing their income and services reduced dramatically so that reckless financial institutions in Germany, France and beyond can be repaid in full.  When, belatedly, the Irish government sought to share the burden of bank restructuring with senior bondholders, permission to do this was denied by the ECB and EU Commission.
Ireland does have a budget problem in that the collapse in Government revenue since the housing bubble imploded means we have been spending more than we collect in taxes. This imbalance would have to be rectified in any case but it would have been a manageable challenge if Ireland didn't also have to pay back the debts accumulated by the financial and developer sectors.  
There is a very serious issue also concerning whether or not the firewall to be constructed as part of this new agreement is remotely adequate to achieving the desired outcome. We return to that issue below.
The issue of 'moral hazard'
However, the real structural issue concerns the moral hazard of banks and financial institutions.  Moral hazard is the situation in which an individual or institution is insulated from risk while others pay the negative consequences of the risk.  In such a situation those insulated from risk have a tendency or an incentive to behave inappropriately. This is what happened to banks and financial institutions in Ireland, Germany, France and beyond in the years prior to 2008. The same is likely to happen again in the future if much more serious institutional safeguards are not put into place.  However the latest agreement reached by EU leaders does the opposite – it proposes to lock in this moral hazard because it rejects the idea of bondholders having to share a part of the burden of restructuring.  If this approach is accepted and becomes part of the final agreement to be reached by March 2012 then we can be assured that banks and financial institutions will again return to their wayward ways in due course and reprise their crazy activity of the past decade and produce similar consequences.
The basic model is flawed
The model underpinning the decisions taken by EU leaders on December 9 is not viable where Ireland is concerned.  As Social Justice Ireland pointed out in its 'Analysis and Critique of Budget 2012' Government was not focusing on the longer term or the wider issues that urgently require attention. Among those we highlighted were declining domestic demand and public debt sustainability. We also wrote at length on the fact that budgetary policy continues to run down the economy. All sectors of the economy continue to contract with the exception of exports.  As spending cuts and tax increases take effect, households are spending less, investment is falling and it is only export growth (entirely driven by non-domestic demand factors) that is pulling the economy out of recession.  Is this approach viable in the long run? Not really.  Government claims it will reduce its borrowing from 10.1% of Gross Domestic Product in 2011 to 2.9% in 2015. To achieve this outcome would require incredible growth in exports at a time when Ireland's major export markets (UK, EU and US) are all struggling.  Domestic demand should be given a chance to recover through policies which promote government or European Investment Bank-led investment while further building domestic economic confidence through addressing the unemployment crisis via the Social Justice Ireland proposal on a Part Time Job Opportunities Programme which would take 100,000 people off the dole queues.  But this approach would appear to be unacceptable if the proposals of the EU leaders are to be implemented.  The basic model underpinning the leaders approach is deeply flawed.
The 'firewall' is inadequate
We have already noted there are doubts concerning the adequacy of the resources available to the EFSF to provide a euro 'firewall'.  Many market analysts and governments believe that a firewall of €2 trillion is needed to ensure that doubts about the long-term viability of Italy Spain and other EU countries that may need support. But not even a third of that amount is available.  Only €500m will be available to the European Stability Mechanism (ESM) which will succeed the EFSF.
Democratic decision-making and accountability are threatened
Beyond these concerns the proposals set out by EU leaders raise huge questions about what, in effect, is the construction of a new legal framework outside the EU (because the UK's veto means it cannot be within the EU law) focused on monitoring budget rules set down within EU law.  Does this in effect mean that an EU-type structure is to be established to carry through a very intrusive economic oversight role?  If so where is the democratic balance for all the power concerning each country's budget that is being handed over to this new body? 
More than the single currency is at risk in these proposals.  Democracy itself seems to be at risk as well.  That should be of major concern to the 300 million people who are impacted on directly by these proposals.
The full text of the EU leaders statement on December 9, 2011 can be downloaded below
PDF icon EU leaders statement118.17 KB