Opinions & Ideas

Category: Crisis


Keynote Speech at the Trinity Economics Forum ,  in the Long Room Hub, in Trinity College, Dublin on Saturday 15 February at 4.15pm

I propose to speak here today in a personal capacity, and not on behalf of any organisation with which I am privileged to be associated.
The recent economic crisis has been good for economists. They are in demand as members of panels of all kinds, to explain what went wrong. 

But it has not been so good for the science of economics, in the sense that so few people with economic training foresaw either the scale, or the timing, of the collapse.


It is possible to argue that foreseeing the timing of the collapse was a lot to ask. Sometimes a  random event can occur, which  will set off a chain of events that will topple an economic set up that was already unstable,  and it is difficult to know which random event will be the one to have that effect, or to predict when it will happen. Obviously the sooner   it happens the better, because a lesser adjustment will then be necessary.

But it is less easy to understand why the bulk of the economics profession worldwide, did not grasp the fact that the scale of the imbalances in the world had grown so great, that the  gradual “soft landing” , that most  seemed to have assumed would happen, was inherently unlikely. Virtually all the major international bodies expected a soft landing.

Given that everyone knew that paper money itself is based on confidence and trust (the paper itself is worth nothing), and that most money in use is actually bank credit, and that few banks anywhere are strong enough to resist a sustained bank run, it is hard to see how so many economists could have assumed that unsustainable positions could be unwound slowly, over a long period, without somebody panicking at some stage, and thereby precipitating a bank run.

 Yet, that seems to have been the general assumption.


In Ireland’s case, there was published data which showed   clearly to all who could read that, although we were part of a single currency which we had no power to devalue, we were running a large balance of payments deficit. In other words we were spending more abroad than we were selling. Ireland had a very large balance of payments deficit in 2005, 5690m euros, and been running a deficit in every year since 2000. Meanwhile, new house prices had risen by 64% since 2000, whereas consumer prices (excluding mortgages) had only risen by 18%. These figures were known at the time. Economists and others believed, mistakenly, that the balance of payments did not matter in a currency union, and the potential danger of private sector imbalances was ignored 

Some Irish economists, and non economists, may have sensed that there was something radically wrong here, but the consensus remained that the position would unwind slowly and relatively painlessly. 

But HOW was it supposed to unwind?

How were exports supposed to accelerate and catch up with imports, which was the only way the balance of payments could correct itself without a domestic recession being used to curb imports? 

How were incomes of households in Ireland   supposed to catch up with house prices, without a fall in house prices which would undermine the basis on which people were contracting mortgages, and without thereby creating a banking crisis(which is what happened)?

What economic strategy or projection was there for such a major increase in incomes in Ireland?  What economic strategy was there for an increase in exports sufficient to overtake imports and eliminate the balance of payments gap? Given that we were buying the imports on credit, surely this raised questions about our banking system?

I have no doubt that some economists were asking these questions, but they were not being heard. 

Why is this?


One reason is that people did not take the time to listen. They were too busy,  busy making money, meeting their quarterly targets, winning votes, or doing all the other things that make up a modern crowded life. Most people did not have, or did not make, the time to think things out.

Furthermore, I believe any economist who sounded a warning was not being heard, because of a good trait of human nature, which serves us well in normal times, namely optimism. If humans were not optimists, they would not have taken the risks which, after much trial and error, brought about advances in technology from the earliest times, from the domestication of wild animals to the invention of the world wide web. 

But lack of time, and optimism, were also present in other countries which did not have property bubbles, countries like Canada, and Germany.

There may thus be other factors to look at, principally the recent economic history of Ireland.


We had been blinded by success, a success we did not fully understand.

In Ireland’s case, we had had, from 1994 to 2000, a surge in economic growth, which was based on solid technological advance, and improved cost competitiveness and productivity. 

In fact this surge was the result of improvements that had been made long before, but that was not widely understood, and we thus drew the wrong conclusions from our growth performance in the 1994 to 2000 period. Our growth in the 1994 to 2000 period was, in good measure, a one off harvesting of the fruits of previous investment, a harvest that had been artificially delayed by extraneous events. 

Ireland had been held back relative to the rest of Europe in the post war decades, by poor education, by protectionism, by over dependence on one market and a few products, and by a neglect of technology. Up to 1970, we were a long distance from the “productivity frontier”, which could be assumed to be the levels of productivity being achieved in the United States.

In the 1966 to 1973 period, these defects were put right.  And in a sense, the Celtic Tiger should have happened in the mid 1970s, rather than in the mid 1990’s. Remember there was a big return of emigrants to Ireland in the 1970’s, many of whom were children, which was a good sign for the future.

But the Celtic tiger was then postponed by external developments.

In1974, we were hit by the oil crisis, which dramatically worsened our balance of payments and public finances.

In the 1980s, we were hit by the huge hike in interest rates, initiated by Paul Volcker of the Federal Reserve, to squeeze inflation out of the system. This rise in interest rates caused a crisis in the public finances of Ireland in 1981, because we had exposed ourselves needlessly, by unwise government borrowing  in the late 1970’s.

Then, in the early 1990’s, when we should have been recovering quickly, we were hit by renewed higher interest rates.  This arose from currency exchange rate instability in Europe. 

There was another factor at work, demography.

Ireland’s birth rate had been very high in the 1970’s and peaked in 1980. So we had a disproportionately large number of children in the country in the 1980’s. These children were too young to earn anything, and had to be provided for by a relatively small working population.

By the mid 1990s, some of these young people were entering the workforce, and furthermore women were taking up paid work much more than before, where previously they had worked outside the paid economy, at home. As a result of the combination of these two changes, the workforce in Ireland in the 1990s, was almost twice, what it had been in the 1980’s. 


So the exceptional growth rates, in the 1994-2000 period, were a form of one off, catching up. 

Once external constraints, like artificially high oil prices and interest rates, were removed, and the working population increased, all was set for a surge forward in economic activity. But this also meant that we came much closer to the global “productivity frontier”, beyond which further advance is only possible through profound technological advances. 

Looking at how we responded to the crisis, in the period from 2008 to date, it is important to stress that the fundamental structural advantages of the Irish economy, the base of high tech industry and services, and the flexibility of our work force, were preserved. 

Indeed competitiveness was improved quickly, and the success in negotiating pay reductions and economies in the public sector was remarkable. Some progress was made in reducing private debt , which had reached around 220% of gross disposable income in 2010. 

On the other hand, Government debt rose from 40% of GDP in 2008 to 125% today. While some of this was due to the cost of recapitalising banks, the bulk of the increase in debt was due to borrowing to bridge the gap that had suddenly grown between previously inflated spending levels, and presently depleted revenues.


Responsible finance is neither a left wing nor a right wing idea. It is common sense.

To escape from the debt situation we are in, we need to reach a point where our nominal GDP is rising faster than the rate of interest we are paying. 

The Department of Finance says that our nominal GDP growth rate this year is 2.8%, whereas our interest rate is 4 %, and our deficit to be met by Government borrowing will be at 4.8% of GDP. 

But by 2018, they expect our nominal GDP growth rate will be in 5.4%, as against an interest rate of 4.4%, and that we will have a budget surplus of 0.5% of GDP. Thus, we should, in 2018, be in a position where our Debt/GDP ratio will be falling, rather than rising. 

Obviously, if the Department has over estimated our like nominal growth rate, or if we fail to meet the targets for reduced borrowing, that happy outcome will not happen. We are not in complete control of any of these variables.

The one we have most control over is our gap between spending and revenue, but even that can be affected by international trade and interest rate conditions, which can increase spending or reduce revenues.

Interest rates could be raised above the expected level, as they were in the early 1980’s, if either Central Bankers start worrying about rising inflationary expectations, or if lenders are hit by a sovereign default somewhere else, either in the euro zone or otherwise.  This could become a problem when we have to roll over existing fixed rate borrowings. Conversely, if deflation sets in, the real value of our debts would start to rise, even though we had not increased them in nominal terms.

Nominal growth can be raised in two ways, by inflation, or by real increases in output.

Inflation, which would also reduce the real value of our debts, seems unlikely.

So we will have to rely on real output increases, which we can either sell abroad as exports, or sell to ourselves.

Some see a boost to domestic demand as part of the solution, but that would be counterproductive if it meant that we stopped reducing our very high household debts, or increased salaries and wages in a way that diminished our ability to compete on export markets. We rely on export performance to bring in the money that will enable us to get our debts under control. Much of any “stimulus” to domestic demand would seep away into imports very quickly. We would be stimulating someone else’s economy. 

In the longer term, we are also bound by a Treaty, approved in a referendum by the Irish people, to reduce our debt/GDP ratio at a steady pace, down to 60% of GDP, from its present level of 124%. 


This will mean running primary budget surpluses year after year. A primary surplus is a surplus of revenue over all expenditure, except debt service. This will not be an easy sell in an ageing society, where demands for more spending, especially on health, will be very strong. 

It is important to reflect on the present inbuilt tendency of Government spending to rise, even when no policy decision to raise it, is taken.

As Brendan Howlin TD, Minister for Public Expenditure , pointed out in his budget speech recently, with no policy change since 2008, the number of  people of pensionable age  increased by 13.5%,the number of medical card holders by 40%, and the numbers in schools and universities by 8%. 

This year alone, Social Welfare pension costs will increase by 190m euros and public service pension costs by 77 million. Meanwhile next year, some of the Haddington road pay savings will expire, when the agreement itself expires.

So even if there are no tax cuts, and no new spending ideas, keeping spending down to the level required to meet the deficit targets will be hard work.

Indeed it will be important that election manifestos are compatible with the Treaty obligations we have undertaken.  One suggestion is that Election Manifestoes should be costed in advance by the Fiscal Advisory Council.


Matching the pressures of national politics, with mutual Treaty obligations to control debt for the sake of our shared currency, will be a challenge in every democracy in euro zone, including in countries like Germany, France and Italy, which have a lower long term growth potential than we do. 

Indeed it will be in our interest that others are seen to respect their Treaty obligations too, because doubts about the viability of sovereign borrowing in any euro zone country could have an immediate knock on effect on the interest we would pay on our sovereign borrowing, and that could throw our plans off course.

Our future is, of course, inextricably linked up with the future of the euro, and thus of the European Union. Worries about the future of the euro have diminished, but have not disappeared. 

The fragility of the EU lies in the extent to which, as new items have  come on the agenda, for which inadequate provision has been made in existing Treaties ,  power has gravitated back to the big member states at the expense of the common EU interest, as expressed through the  Commission, Council of Ministers, and Parliament. Power has been renationalised, and that suits big states, not small ones. 

Ireland’s rejection of previous EU Treaties has, entirely unintentionally and indirectly, contributed to this process, by making EU leaders reluctant to propose Treaty amendments that might restore more initiative to the traditional EU decision making process, which works better for small countries. . 


Economists understand the power of incentives.

In the European Council, where the real power now lies, no member has a strong political incentive to put the collective interests of Europe, before the interests of his/her own country.

Even the Commission, because of its method of appointment, has an incentive to consult  the interests of the big states first. 

That is why I believe, if the EU is to succeed, it needs some form of supranational democracy, that will create a political mandate, derived from all the people of Europe, that will be large enough to take precedence over even the biggest state. Improving scrutiny of EU policies in 28 national parliaments is not enough.

I believe that either the President of the Commission, or the President of the European Council, should be directly elected by the people of Europe. 

If something radical like that is not done, I fear that the EU and the euro will continue to be blamed for the consequences of failures of national policies, failures that will have only a slight connection with the euro. If that happens, the permissive consent of citizens, which allows the EU to exist and grow, will disappear.

That would be an economic and political disaster, for the EU and its neighbours, far greater than the crash of 2008.


The issue of growing inequality in some western economies is different from the issue of whether or not we should live within our means.  Yet they are often confused in public debate by people who want to be popular, and dodge the true implications what they are demanding. 

We need to look at the factors that are driving inequality, because if the outcomes of economic policy create unduly wide divergences between winners and losers, the whole system will be undermined. 

Taxation is one factor that can aggravate inequality, but in Ireland we already have a relatively progressive tax system. We are also beginning to tax property, which is only fair.  We have to remember that people can move residence to avoid unduly progressive taxes. Some high earners, coming here from abroad, bring jobs for others into the country, and we would like them to stay here.

It is arguable that quantitative easing, by boosting share prices, has added to inequality, because only the better off tend to have a lot of shares and financial instruments and are thus in a position to benefit from the increase in their nominal value 

It is also arguable that systems of executive compensation, which reward short term gains in share prices, encourage business managements to favour the buying back of shares over investment, add to inequality, and depress long term growth.  Pay systems that reward short term results are particularly noxious in the financial sector. 

The celebrity factor has also added to income inequality, because all sorts of businesses, like football clubs, recognise the importance of holding on the celebrity managers or players, as a means of boosting stock prices, match attendances, or TV revenues.

Given that we live in a globalised world, it is difficult for one country to deal with these issues on its own, without provoking a flight of capital and talent to other countries. Imagine what would happen to the success rate of football clubs in a country that decided unilaterally to cap the pay rates of players in the interests of equality!

To address some of the causes of the growth of inequality, international understandings will be necessary. The OECD and the EU are the venues in which some of the causes can be tackled, but it will not be easy.


I will turn, finally, to the things we might do to boost economic growth. 

As far as I can see, this is not an area in which economists have reached a final consensus. 

The prevailing view is that the best way to promote growth is to encourage labour and capital to move freely from one activity to another, so as to find the activities with the highest rate of return.  High legal costs, restrictions on entry to professions, state monopolies of particular activities, and big barriers to redundancy of workers, all work against freedom to allocate resources efficiently, and thereby inhibit growth. In Ireland’s case we still have high legal costs, and a problem of monopoly pricing in the energy sector.

But it is also possible that markets can be TOO efficient, at least in a short term sense. For example, banks were too efficient in lending money here during the boom!

Returns to pension funds have declined, notwithstanding the additional sophistication of the independent fund managers used by the funds. UK pension funds earned a 5% return on capital between 1963 and 1999. But between 2000 and 2009, they earned only 1.1% return. That’s not financially sustainable. Why did this happen? Low interest rates promoted by Central Banks are part of the problem.

Incentives to unduly rapid turnover of investments are blamed by some for this decline in the return on investments by pension funds. To remedy this, suggestions for reform of the incentive structure of fund managers have been made. Worries have been expressed about bonuses earned from artificially rapid turnover in shares held on behalf of pension funds, and about “momentum trading,” where an attempt is made to make gains by anticipating the momentum of the market, rather than by focussing on underlying returns.

I do not feel able to judge these matters, or to say what, if anything, we should do about them in this jurisdiction, but the fundamental point I would make is that capitalism works best when it is subject to good, clear and simple rules, which strike the right balance between promoting lively competition in the here and now, the taking a long term view of investments that will yield the best returns over time. 

The international financial service sector is part of Ireland’s export success story. Exports of services now make up 52% of all Irish exports, with financial services, software and business services making up the bulk of this. Opportunities are enormous.

The global middle class, the class that saves for a private pension, is set to treble by 2040. This is a major market opportunity for the Irish Funds Industry.

The urban population of the world is set to increase by 75% by 2050. This will require huge infrastructural investment in roads, water treatment, electricity, and other forms on infrastructure. As a centre of excellence in both finance, and sustainable technology, this is also an opportunity for Ireland, and particularly for the Green IFSC.

The International Financial Services industry needs to make a big investment in IT and social media. For example, Ireland is getting a leading position in IT through the design, by Intel in Ireland, of the Quark X 1000 chip. 

If a country is able to host the designers of big technological breakthroughs like this, it is breaking through the “productivity frontier”, to which I referred earlier. Again this is an opportunity for Ireland to connect its financial service expertise with its IT expertise, and it’s hosting of firms like Google, Facebook, and Paypal.

This is, I believe, the key to promoting economic growth….making new connections. Economic growth is about a state of mind, in individuals and in society. About failing, and still trying again.


The  European Union is facing a crisis because of the loss of confidence in the debts issued by several member states. This is related directly to the problems and activities of Europe’s banks.
On 9 December in Brussels, the Heads of Government of the 27 EU member states meet, yet again,  to come  forward with a solution to the  escalating loss of confidence in the debts owed by European  banks and  governments. Each time leaders meet, and come forward with proposals that, within days,  prove to be inadequate, further confidence is lost  both in the leaders themselves, and in the  European Union, as a functioning  and competent  political authority capable of managing the  affairs of its peoples. 
This is corrosive. It undermines political solidarity within and between Europeans, and it encourages   reversion to 1930s style nationalism, and to  general  anti politician sentiment, which could eventually erode the tolerance that is essential to democracy itself.
There is a limit to the number of failed government bond auctions we can endure. Many further such bond auctions are due in January and February. In February there will be a General Election in Greece, and the campaign in that election will be critically influenced by the perceived effectiveness of present EU arrangements and the  steps Greeks are having to take to comply  with these arrangements. If there is to be a good result in that election, the EU needs to show electors that it is in control of the situation.

The European Central Bank needs to take note of the situation. It has a mandate under EU Treaties to maintain price stability, defined as around 2% inflation.  There is a growing risk that the problem Europe will face next year will be deflation, not inflation.
If industrial orders and consumer confidence continue to decline, prices and incomes will start to fall, and the situation of those in debt will worsen further because, even if they pay all interest, the real value of their debts  will increase as a consequence of the  fall in prices and incomes relative to the unchanged level of their debts.
If these circumstances are likely to arise, the ECB has a duty, in the interests of price stability, and in full accord with its Treaty mandate, to initiate quantitative easing to prevent it. An immediate statement to that effect from the ECB would go a long way towards resolving the short term crisis.
Failure to act could lead to a break  up of the euro. This could be devastating , because a lot of the debts owed by Europeans are owed  in euro to other Europeans. With the euro gone, the uncertainty about who owed how much, in what currency, to whom could lead to endless legal dispute.
Governments trying   to establish new national currencies could face huge problems stopping  outflows, which could  lead to  limitations on bank withdrawals, reintroduction of exchange controls, and  tariff walls against their exports by other countries  in the EU aimed at countering  competitive devaluations of one  new currency against another. 
The legal order on which the EU is based could break down. We should not forget how inherently fragile that legal order has always been. If one country refuses to implement a judgement of the  European Court of Justice in an important matter, and gets away with it, the EU has no  meaning anymore because  the EU has no police force to enforce its  rules. Everything is based on consent.
Against this background, one must ask oneself if further EU Treaty change could be part of the answer.  Treaty change could take, at the very least, a year to effect.  But we do not have that much time.  So the best we can hope for is a political commitment  by Governments to seek consent to a Treaty change from their parliaments or peoples.

There has  been agreement  that a  proposal to improve the  governance of the  euro zone would be presented by the  President of the European Council, Hermann Van Rompuy to the EU Summit on  9 December. In advance of this, the leaders of the two biggest euro area states have set out their requirements. 
In her speech today, Chancellor Merkel has called for Treaty changes that would make sanctions on  states who breach  debt and deficit limits  automatic and  capable of  being enforced  directly through the  European Court of Justice.  It would take the issue out of politics and make it a legal one. This would require a change in the Treaties.
President Sarkozy, on the other hand, said yesterday that European integration must be pursued, and the problem has to be solved , inter governmentally. This is because he believes that only elected heads of national governments have the required political legitimacy to make the necessary decisions.
These two positions are quite far apart, and there are difficulties  with both of them.
The difficulty with Chancellor Merkel’s approach is that it will involve the European Court of Justice in making economic judgements. 
In the case of a disputes, is  the Court really qualified to judge whether  a deficit is excessive by reference to the point at which a country is at in its economic cycle? Can it adjudicate on whether estimates of future revenue are valid or not?
Even economists have difficulty with these issues.  So the framing of a Treaty change in this area will could be challenging.
President Sarkozy’s preference  inter governmentalism  will bring economic judgements into the realm of power politics, the sort of power politics that prevented any  sanctions being imposed on France and Germany when they became the first to breach the original Stability and Growth Pact. His approach would diminish the role of the European Commission.
Both the Chancellor and the President are paying too little attention to what has been already agreed in the “six pack” regulations. These, which require no Treaty change, will already make it more likely that a state, with and excessive deficit ,will be fined,  because a qualified majority (66%) would have to be found to agree NOT to impose a fine.
Neither  the Chancellor nor the President pay enough attention to the huge failure of  EU wide banking supervision that allowed all this foolish cross border lending to take place within the single currency area. Neither of them addressed the lack of implementation, from the very outset of the euro, of the ECB’s responsibilities in the Treaties , to  supervise the  activities of banks and the impact those  activities have had on the stability of  the European economy. Both of them spoke as if the problem  today was solely one of Government finances ,when it is also a problem of  bank finances


But what of the more  detailed proposals for Treaty change  advanced so  far.  How relevant and helpful are they?  It is suggested that  we must amend  the  EU Treaties, because it is argued that the existing  Treaties either
a)    prevent  us doing what is necessary to resolve the situation, or
b)    provide us with insufficient assurance that  we will not get into the same difficulties again.
The German CDU has demanded Treaty changes to provide for

  • automatic sanctions for breaches of the  Stability and Growth Pact( 3% deficit and 60% debt/GDP ratio),
  • a procedure for insolvency of EU states,
  • the direct election  by the people of the EU of the President of the European Commission,
  • taking away the exclusive right to initiate EU legislation from the Commission,  and allowing the Parliament and the Council  an equal  right with the Commission to initiate legislation,
  • more seats for bigger countries in the European Parliament based on their bigger populations.

They also want Europe to unilaterally introduce a tax on financial transactions.
The Dutch Prime Minister has suggested Treaty changes that  would

  • allow a European Commissioner for budgetary discipline to force  states running excessive deficits  adjust their policies and
  • to impose  sanctions  including reduced payments from Cohesion and Structural Funds, national budgets requiring  EU  approval before introduction,  suspension of voting rights in EU institutions,  and  ultimately expulsion from the  Euro  zone. 
It is important that any proposals for Treaty change are based on an honest appraisal of what  our problems actually are, and are not put forward  as  tokens to soothe domestic  opinion in particular countries. Our problems are too serious now for that sort of thing. 
Given that Treaty changes in the EU require all members states to ratify them, the way proposals are put forward is almost as important as the proposals themselves. 
If proposals seem to be one sided, or to emanate from a small cabal of big countries, rather than  from an inclusive process of which all member states have equal  ownership,  then the  proposed Treaty changes may be doomed from the  start, whatever their merits.
On the specifics of the CDU and Dutch proposals, I would  respond as follows.


The difficulty with automatic sanctions for supposed breaches of the Stability and Growth Pact is that, if the country on  whom they were to be imposed objected, the dispute would go to the European Court of Justice, not to the Council of Ministers for arbitration. Breaches of the Pact would include  questions about whether  assumptions about future economic growth and thus revenue were  too optimistic, the point at which a country was on in its economic cycle, and the like.  These are questions on which economists, who are studying these matter all the time, usually  cannot agree.  There is little chance that the judges in the ECJ, many of whom have no background at all in economics, will make sensible judgements  in such cases.
A treaty provision for the insolvency of states, as suggested by the CDU, will be very difficult to draft and will be highly controversial.  There may be some merit in establishing rules in this field, but I wonder if this is the time to be doing it.  The issue will not be being debated in an academic setting, but in the midst of febrile market conditions. There is a strong risk that the twists and turns  in a public debate on the  state insolvency   will have a  negative and unintended influence on the markets.
 We should not forget that ,when  the issue of so called  private sector involvement in resolving the Greek debt  crisis was first mooted by Germany , it had an immediately damaging effect on the capacity of some other  smaller countries to borrow.

The direct election of the President of the European Commission by the people of Europe is a vey good idea. I advocated it when I was  President of the European Council in  1996, and again when I was a member of the Praesidium of the Convention of the Future of Europe. Interestingly, the only member of the Convention who gave the proposal any support at that time was George Papandreou. It is very good that the CDU is supporting this proposal now.
A direct election of this  kind is what we need to create a  genuine European  demos, or  sense of shared destiny, among EU  citizens whatever their nationality or language . Without such a demos or  shared  identity, we will be unable to persuade Europeans to make sacrifices for one another, and that is something we need if Economic and Monetary work.


On the other hand, the CDU proposal to take away from the Commission the exclusive right to propose legislation, and  to require it to  share that with the European Parliament and the Council of Ministers,  is a thoroughly bad idea.
It would  weaken the Commission even further than the rampant intergovernmentalism of Europe’s response to the financial crisis has already  done. 
The European Commission seeks to put forward proposals that will command  support  from  all countries , large and  small. It formulates compromises in advance.
If the  Parliament and the Council could table competing legislative proposlas on the  same  subjects as the Commission, this would make the search  for subtle compromises much more  difficult. It would  enhance the power of the bigger delegations of the bigger countries in the  European Parliament  and would encourage  crude nationalistic  majoritarianism in that body. 
The Commission is the protector of the interests of  smaller  member states within the EU, and this  CDU proposal will be seen by them as provocative and subversive of the community method on  which the EU was founded.
The CDU proposal to increase  the relative representation in the European Parliament of  countries with bigger populations, but without reducing the  extra voting weight that bigger countries enjoy in the  voting system of the Council of Ministers,  overturns one of the central compromises reached in the  drafting of the   European Constitution and the Lisbon Treaty.
 The CDU should remember that ,even if the United States which is a fiscal union, all states have equal representation in the  Senate while populations have  equal weight in the House of Representatives.
 Under  the Lisbon Treaty, the EU has struck a similar compromise.  Bigger states have bigger representation in both the Parliament  and the Council, but there is a system of “degressive proportionality” which compensates smaller states by  giving the proportionately bigger representation than their population would strictly  justify.
 I cannot understand why the CDU wants to reopen this  difficult matter, unless of course it want  to use the proposal as a negotiating  weight to gain traction on some other issue. Frankly, I think our situation is serious enough without that sort of gamesmanship being introduced.
The suggestion of a financial transactions tax has populist appeal. It may slow down financial transactions and allow a little more time for reflection in the markets. It would curb automated  transaction systems by making unduly frequent buying and selling slightly more expensive. It could  provide the EU with a new source of revenue, which would be very welcome.
But  It would also lead to  financial sector activities moving out of Europe, and the tax revenues that those  activities generate for  EU states going into the treasuries of   non EU countries. Given that unanimity must be obtained for this proposal to go through, I wonder if it is not, like the proposal to redistribute seats in the European Parliament,  being put forward as a  negotiating  ploy .  Again, one must ask if this displays the sort of seriousness that out parlous situation requires.
Turning to the Dutch proposal to enhance the Commission’s control over the budgets of states running excessive deficits, it is hard to argue against the principle of what they are seeking to achieve.  The CDU has argues that fines for excess borrowing should be automatic.
But one might wonder how urgent  the proposal is.
 Financial markets are already imposing very harsh discipline, through demanding higher interest rates of countries with excessive deficits.
 It will be a long time before any EU country will ever again be able to borrow money at easy rates of interest unless their fiscal policies are demonstrably sound. Do we really need to reinforce what the markets  are already doing with Treaty changes at this stage? 
It is also worth noting that the reverse majority procedure now applies to both the Excessive Deficit and the Excessive Imbalance procedure. So a country, that is liable to be fined for running an excessive budget deficit, or an excessive balance of payments surplus or deficit, will automatically have to pay a  fine,  unless it can persuade a qualified majority in the  Council NOT to let the fine go ahead. Perhaps we should see how that new procedure works before going for Treaty change?
 In any event, levying a fine on a country, that is already in financial difficulty , will add to the difficulties.  It will be too late to be an effective deterrent
The Dutch proposal to reduce payments from the Structural Funds to  countries with excessive deficits  will  fall more heavily on poorer countries than on richer ones.
 Excessive deficits or economic imbalances in richer countries can be just as damaging as they can be in poorer countries, perhaps more so. For example, the Netherlands is less reliant on structural funds than is Estonia, so a proposal to reduce structural would hurt  Estonia  proportionately more than it would the Netherlands, even though their  excessive deficits  might be of  the same proportionate scale. That is unbalanced.
The proposal that budgets of deficit countries require advance EU approval is also potentially unbalanced.
 One country can only run a trade surplus if another country runs a deficit. If a country is deliberately managing its economy in order run consistent surpluses, it is contributing to deficit problems of other countries. That needs to subject to EU surveillance too.


The proposal  by the  Dutch Prime Minister to suspend the voting right in EU institutions of a country which has excessive debts or deficit is tantamount to reintroducing colonialism within Europe, because it  would involve imposing decisions, in which they have  had  no vote, on  countries who joined the EU precisely because they  thought it was a democratic organisation.  The existence in 21st century Europe of a mentality that would make such a proposal is deeply troubling.
I am unclear about the merit of changing the Treaty to allow for the expulsion of a country from the euro zone. It would imply that the euro itself is a temporary expedient. It would aggravate speculative pressure, without any compensating benefits.
I believe the proposals from the CDU and from the Dutch Governments to  change the Treaties are not adequate to the problems we face, and in some cases are a distraction.
 The so called six pack proposals, recently agreed go a long way to strengthen disciplines on fiscal policy, and do not need Treaty change. They should be given a  chance to work, before we contemplate additional Treaty changes for control of national budgets.
But the CDU proposal for a direct election of the President of the Commission does deal with an important problem that underlies our present problem, namely the lack of a sense ,on the part of ordinary Europeans,  that they can, through their vote, influence the direction of EU policy.
 If citizens could  directly vote the President of the EU  in or out of office , that will give them a much more direct sense of control of the direction of the EU than they get  now from just voting  for their local or national MEPs.
None of the proposals on the table so far deal with the issue of banking, which is at the heart of our economic difficulties today. It was foolish lending decisions be banks that caused our problem.
The original Maastricht Treaty  of 1992 envisaged the ECB taking an overall role in overseeing the prudential supervision of  banks, especially banks that were lending across borders within the euro zone. This provision in the Maastricht Treaty was never brought into effect , because activating the ECB’s powers in this matter required unanimity. Some countries did  want not anyone else enquiring into their banks, and that reluctance continues even  to this day.
 Any Treaty change now should include
1.)  much tighter EU wide supervision of  banks,
2.)  restriction on the size of banks, and 
3.)  an EU  wide deposit guarantee scheme.

This is a critical week for Ireland and for Europe.

The publication of the bank stress tests will require careful decision making. Stress tests are estimates, estimates of what assets might be worth at some time in the future .
Estimates can be made on either very pessimistic, or very optimistic, assumptions about economic developments in the future.
The hope in some quarters is that the EU exercise of stress testing banks will generate confidence in banks based on certainty, but we should be careful here. Certainty about the future is a logical and philosophical impossibility. All banking, everywhere and always, is a matter of confidence, not of certainty.
In Ireland’s case, the credit of the state itself has unfortunately become entangled with that of the banks. It would be no solution to anything to enhance the credit of the banks, by diminishing the credit of the state.
I hope EU decision makers will also see that the Irish banking problem has been influenced by the requirement of free movement of capital within Europe since 1990, and the deep interdependence that that has created, with all its good and bad aspects.
I would like to return now to a topic I have developed elsewhere, the lessons that need to be learned from our banking crisis, and to show that there is a European, as well as an Irish dimension, to Irelands current problems.
Let me reiterate at the outset that the main responsibility for Ireland’s plight rests with Irish institutions.
Private sector institutions were first and foremost responsible, especially the property development industry for it’s reckless borrowing, and estate agency community for encouraging the bubble.
The boards and managements of banks for the reckless lending share responsibility, as do the media, with their reliance on property advertising ,for encouraging people to climb the so called property ladder, as if one place on this ladder was a measure of one’s place in society.
The Irish economics profession has a responsibility for, generally speaking, not calling attention to the obvious unsustainability of the borrowing , and of the level of construction activity, which could not possibly have been maintained.
It is obvious that the Irish Central Bank, the Financial regulator, and Government made major errors.
But , if we are to overcome the crisis and avoid a new one, everybody must be self critical, including the ECB and other European institutions.
To make that point is not to argue for Irish institutions trying to avoid their financial responsibilities.
A bond is a promise, and promises should not be broken, especially if ones economy is based on the provision of international services, in which trust is vital.
A single currency for 16 or more separate nations was always a challenging project, intellectually, politically and economically. If there were design flaws in the project, these must be remedied. If powers to act existed, but were not used, that too must be acknowledged.
Risks inherently flowed from the decision to allow free movement of capital within the EU. Exchange controls at national level were no longer available as a means of preventing bubbles developing. That gap had to be filled at a higher, EU wide , level.
Some of these topics were addressed in an interesting speech in Lucca on the 11th March by one of the Executive Directors of the ECB, Lorenzo Bini Smaghi.
He noted that the financial crisis had caught Europe unprepared in some respects. The institutional design of the single currency did not take into account a crisis like the present one. But he defended the euro, using the analogy that the first ever cars in the road over 100 years ago did not have reinforced bumpers or airbags. Like the early motor cars, the euro, as a single currency for many nations, is a pioneering venture, and all pioneers must learn from experience. I agree with this.
He also criticised both the content and the timing of the Franco /German proposal for states to be allowed to declare themselves insolvent. Again I agree. He suggests a different approach, requiring all future debt issuance by member states in the euro should have approval at EU level, a radical proposal, but we need radical thinking.
He says that the errors and negligence of the Irish regulation and supervision of its financial markets have
“been paid for by the taxpayers of that country, but they expose others to enormous risks”.
Again I agree with him.
But he then seems to disclaim all responsibility of the ECB. He says that, in the euro area, banking supervision is not
“subject to supranational control”
(ie. The control of the ECB) , and then he goes on to talk of a “former Irish Prime Minister” having the “honour of front page headlines”
“when he reproached the ECB for not having sufficiently monitored the Irish banking system, when it is well known that in Europe the powers of prudential supervision are the responsibility of national authorities, a power they do not want to give up”
This is a reference to my speech in the LSE recently in which I drew attention to the power the ECB had, under Article 14 of the statute of the ESCB, to issue instructions to the Irish Central Bank, and to other euro area central banks.
Dr Bini Smaghi claims that the ECB’s powers are confined to monetary policy, and do not extend to prudential supervision of risks in the banking system.
On the basis of this speech, the ECB seem thus to believe that, in the period from 2000 on, it could not have given instructions under Article 14 to the Irish Central Bank in respect of the obvious credit bubble that was developing in Ireland, and the unjustified, speculation driven, increase in house prices here.
I respectfully suggest that Dr Bini Smaghi is wrong, and that a reading of the statute of the ESCB shows that he is.
Article 3.3 of the statute of the ESCB says that the ECB
“shall contribute to the smooth conduct of policies pursued by the competent authorities relating to prudential supervision of credit institutions , and the stability of the financial system”.
Note two phrases here… “the prudential supervision of credit institutions” and the “stability of the financial system”
Furthermore, Article 25.2 of the ESCB statute says that the ECB
“may perform specific tasks relating to prudential supervision of credit institutions”
and Article 34.1 goes on to say that the ECB may make regulations to implement Article 25.2 ie concerning prudential supervision.
I would read all that as meaning that prudential supervision was, and is , in fact , a core responsibility of the ECB.
I, therefore, believe that
1.) The ECB could have issued instructions to the Irish Central Bank in respect of its supervision of Irish banks, when it saw the explosion of credit in Ireland, and the imprudent concentration of that credit in one volatile sector, construction.
2.) It could also have issued instructions to the Central banks of the other euro area countries, whose banks were availing of the free movement of capital to lend imprudently to the Irish banks in a way that fed the Irish property bubble, to rein in that lending.
I would argue that, under any reading of Article 3.3, these things were the ECB’s business, as well as of course being the business of the Irish authorities and the authorities of the countries whose banks lent irresponsibly into the Irish property bubble.

Clearly, as we now know all too well, the expansion of credit in question did affect the “stability of the financial system”, in the words of Article 3.3 of the ESCB statute. So I would argue that my reference to Article 14 and the responsibility of the ECB was in fact correct.

I repeat that this does not mean that the ECB had the primary responsibility for failures of supervision of individual institutions ,like Anglo Irish Bank, but it does mean that it could, and should , have seen the overall imbalances in the lending patterns to and within Ireland, and their potential to upset the stability of the financial system, which is clearly the ECB’s responsibility.

Even if the ECB did not use Article 14 or Article 25.2, it also had power under Article 4(b) to submit opinions to the Irish authorities, and if it felt it was not getting enough information from the Irish authorities to form to form a judgement, it could have used Article 5.3 to obtain better statistical information.

I do not think it is to be either nationalistic or populist to say that, between 2000 and 2006, the ECB was in a better position to know what was going wrong in Irish credit markets, and to do something about it, than was the average Irish taxpayer , who now has to deal with the consequences. Some Irish taxpayers may have benefitted from the boom, many did not. All have to pay.
I accept that the EU institutions, including the ECB, are helping to resolve the situation, but this help is in the form of loans which will have to be repaid, and is also being accompanied by self serving demands from some other countries.
I fully accept that it would not have been politically easy for the ECB to have used its Article 14 powers in 2003 or 2004 . I have no doubt there would have been an outcry from many in Ireland decrying “interference from Frankfurt”, and all that sort of atavistic nonsense. But one should not forget that it precisely so that the ECB can ignore that sort of thing, that it was made politically independent under its statute, more politically independent even than is the European Commission.
The ECB’s power to give “instructions” to the member state central banks also seems, on the face of it, also to be greater than any power the Commission or Council had under the existing Treaties.
A suggestion has appeared in the Irish media that, when Anglo Irish Bank was on the brink of collapse, the ECB told the Irish authorities that it did not want any bank to be allowed to fail.
I wonder if this could be true, and if it is true, if it influenced the then Government to give such a wide guarantee to the banks as it gave. In light of the powers of the ECB, which I have cited above, the Irish authorities could not easily have ignored such a view from the ECB. But with power comes responsibility, and if the ECB did say this to the Irish authorities, it can hardly argue now that the sole responsibility for what followed rests with the Irish taxpayer .

I repeat that I do not make these points to out of any wish to shift blame away from where it belongs. There is a great deal of blame due to the Irish authorities and people, the majority of the blame by a long distance. The recent election result shows that the Irish people know that. So also does the fact that substantial austerity has been accepted.

But if the EU is to learn from the crisis, it has to look at the whole picture. Part of that picture is the role of the ECB and other EU institutions.
These institutions should be willing to consider reasoned criticisms, from any quarter, even from Ireland!
Having said all that, it is important that Ireland approach this week’s meetings in a realistic frame of mind.
Other European countries have problems too. For example, almost all of them have budget deficits of their own. Many of them have more severe immediate problems with the fiscal cost of the ageing of their societies and workforces than Ireland has. They are also aware that the original justification for the cohesion and regional funds of the EU, to which many were net contributors and we were net recipients, was precisely to prepare countries like Ireland to be able to face the rigours of a single currency. If we now discover we were ill prepared, the first responsibility is our own.
We also have to understand that other EU countries have domestic political constraints too. For example, Germans have a justified horror of inflation after their unique experience in the 1920s when inflation peaked at level higher than were seen in Zimbabwe recently, and destroyed the saving of all thrifty families. Reactionary anti EU sentiment, of the kind we saw here during the Nice and Lisbon referenda, is rising in many countries, and transferring money to countries that are perceived as not having managed their affairs well, feeds those sentiments. Irish people must understand these political realities, just as others must be realistic about what we can do.
It makes no sense for them, in their own interests, to make counterproductive demands of Ireland. Demanding that we change our corporation tax system is counterproductive. Corporation tax is one of the ways whereby we will be able to repay the loans we have received. Our 12 and a half percent corporation tax raises an amount equivalent to almost 3% of Irelands GDP, more than France collects in corporation tax, and a lot more than Germany collects, which comes to just over 1% of German GDP.
More importantly, low corporation tax rates to attract foreign investment , mainly from outside the EU, has been the core of Ireland economic model since 1956, before the EU had even come into being, and before many of the leaders sitting at the European Council were born! Lending us money, and simultaneously asking us to dismantle the economic model that enables us to repay the money, would not be good banking practice, to put it mildly.
At home, we must avoid the errors we see in the US, where so many areas of spending and revenue have been ruled out of consideration for closing the deficit, that all that is left is so called discretionary spending, that only comes to about 20% of all spending.

Speech by John Bruton, former Taoiseach, to the Irish Institute of Chartered Accountants at 8am on Tuesday 22 March

Is the panic justified?

The  recent panic in the markets about the sovereign debt of peripheral euro zone countries , like Ireland and Portugal, lacks objective  justification.
Bondholders are afraid they will not be repaid in full because of a proposal by Germany to amend the  EU Treaties to allow for bondholders of  euro zone countries , that  get into difficulties and have to get EU help, to have haircut or discount applied to the amount they are repaid. This would be part of a new crisis mechanism(ECRM)
Markets seem to be reacting as if this proposed mechanism could be applied to existing bonds or to bonds issued before the proposal  became law.  I believe they are wrong.
The Brussels based think tank, Breugel, has produced a paper on the subject, which is worth reading.
It says
“The creation of the of the ECRM would likely need to be established by a treaty. The mechanism would, therefore, only apply to future debt issuance”
I believe the European Commission and the German  Government would do themselves, and everybody else, a  big favour by making this clear.
It is a fundamental principle that laws cannot be applied retroactively, and the markets need to be told that.

Financial Services in Ireland


I am looking forward to helping the international financial services industry in Ireland make an even greater impact on job creation in this country, when I take up my role as Chairman of IFSC Ireland in September. In the meantime, I am reading and listening.

The industry already provides about 25000 jobs directly in banking, funds management and insurance, and supports many more jobs indirectly in back up services like accounting, law, and hospitality.

Wholesale financial intermediation creates about 7% of the GDP in Ireland as against 2% on average throughout the EU, and 4.5% in Britain.

About 10% of all EU funds under management , are managed here in Ireland ,a country with only 1.4% % of the EU’s GDP.

This is a highly competitive industry. Modern communications mean that these services can be provided in any number of places or time zones. They will continue to be provided in increasing quantity in Ireland but only if Ireland continues to offer a top quality financial, social and regulatory environment. This is a people based industry, so a supply of well educated and motivated young people, who want to work in Ireland ,is crucial.

A key figure in the industry, Willie Slattery, pointed out last weekend that the economic downturn has had a side effect of making Ireland more competitive because it has led to a significant reduction in relative labour , office accommodation, and other costs in the past two years. The reduction in housing costs will also have helped in attracting staff here from overseas.

I believe it is critical that Ireland have a reputation as a thorough, rigorous, and pragmatic regulator of the industry. These three characteristics complement one another. Nothing is to be gained either by laxity or rigid formalism. At the end of the day, it is all about winning and holding trust, and in that there is no divergence of interest between regulator and regulated.


The success of the endeavour depends very much on Europe’s success in restoring economic growth. The financial crisis affecting banks and Governments is no more than a symptom of a deeper problem. That problem is a loss in relative competitiveness of both Europe and North America vis a vis the emerging economies of China, India, Brazil and others over the past twenty years. The loss of competitiveness was accompanied by an unwillingness to face up to long term problems like the eventual cost of ageing societies, and the ephemeral nature of some of the innovations of the so called “new economy”.

The boom- driven expansion of credit was like an anaesthetic that concealed an underlying loss in competitiveness from us until 2008. Now that the anaesthetic has been withdrawn, after such a long time, the pain is acute. The human cost is all too real.

The answer to this for all European countries is, I believe, to work to increase what economists would call the total factor productivity of our economy, the productivity of the way in which we use all our resources, public and private, capital and labour, tangible and intangible. We need a new way of thinking , an enhanced orientation towards finding ways to earn a living from meeting the needs of the rest of the world.


As many of you will know, I am a strong believer in the European Union, the world’s only historical example of an entirely voluntary, and democratically sanctioned, pooling of sovereignty between different nations, many of whom were at war with one another in living memory. No other part of sthe world has attempted anything as ambitious, or as successful as the European Union.

I know that there is not a little concern at the difficulties of the euro and complaints that the EU’s policy makers have been slow in rectifying what may be seen as substantial omissions in the original design of European Monetary Union.

But all of this should be kept in proportion. In January 2001, the euro was worth 92 US cents. It subsequently rose as high as $1.59, thereby affecting euro zone exports as anyone living along the border with Northern Ireland can confirm. It has recently fallen back from that to a lower, and perhaps more sustainable, level. But that is a level well above where it was in 2001.

The arguments that are now taking place in the EU now about bail outs, about surveillance of national budgets, ECB bond purchases, about supposedly pro cyclical budget cutting, about moral hazard, about the need to devise a workable resolution mechanism for large but insolvent entities, and about the exact amount solidarity which member states of the euro owes one another, are all real arguments, concerning real choices ,on which there are legitimate grounds for disagreement . There is nothing wrong with the fact that there are vigorous arguments between countries about these issues at EU level, just as there are at national level. That is normal politics.

The criticism of the EU that has the greatest validity, in my view, is that it has waited for foreseeable problems to become acute before tackling them.

It is not so much the EU’s decisiveness, as its foresight, that has been open to criticism.

It was foreseeable that the combination of a single centralised monetary policy, with divergent and decentralised fiscal policies would create contradictions.

We must not make the same mistake again. We must show foresight, and intellectual rigour, in regard to the problems looming on the horizon.


There is one matter affecting the euro, and the solidity of the European economy generally, on which foresight is now needed. That is a decision the German Constitutional Court might take on whether the proposed closer fiscal policy integration in the euro zone is compatible with the German Basic Law or constitution. For understandable historical reasons, German Courts take democratic norms and the sovereignty of the people very seriously.

Issues that may be at stake before the German Constitutional Court are whether

1. The increased EU surveillance of the German budget, or

2. The large new German contribution to the special vehicle being set up to help euro member states with funding difficulties,

run afoul of the German constitution or Basic Law. It is important for markets ,and for the economic stability of Europe and the world ,that the EU not be taken by surprise by any decision the German Court may take on these vital matters that are now underpinning the euro.

The Court has already addressed this sort of issue in 2009, in its judgement on the Lisbon Treaty. So we have a preview of its thinking. It emphasised its belief that the sovereign state is still the main vehicle presently available for democratic governance.


It said then that “an increase in integration(in the EU) can be unconstitutional (in Germany)l if the level of democratic legitimation (in the EU) is not commensurate to the extent and weight of the supranational power or rule” at EU level

And it has added that, for it, the test of democratic legitimation is whether “the allocation of the highest ranking political offices” takes place by means of “competition of Government and opposition” in a free and equal election . Essentially the question it posed was ..can the people vote the EU government out of office? Even though the European Parliament is directly elected, it not believe that the EU yet passed that democratic test. And they are right, the people of the EU do not have an opportunity to vote the EU government out of office.

The Court was therefore very reluctant to agree to further EU integration, beyond that proposed in the Lisbon Treaty, without a qualitative improvement in democratic governance at EU level. Otherwise it favoured keeping power at the level of the states because it argued that the states of the EU have a more developed democratic practice than the EU does ,at the moment.

I am certain this issue of whether there is sufficient democracy at EU level will arise again in any appeal to the Court against the proposed closer integration of Germany in responsibilities to, and for, the rest of the euro. Such an appeal will take place and has the potential to destabilise financial markets unless something is done to forestall the problem.

I have long advocated a simple remedy to this problem.


The Stability and Growth Pact, governing the euro, was finalised at the Dublin Summit of 1996 during the Irish Presidency. During that same Presidency, I commissioned a study on the possible direct election of the President of the European Commission by the people of Europe in a free and equal election of the people of the EU.

I really do not believe that it would be wise for EU leaders to sit and wait to see what the German Court might say . Its jurisprudence is already published in its judgement on the Lisbon Treaty.

That judgement should now be studied carefully, and urgently, by The European Council, the Commission ,and the Eurogroup.

The European Union must further improve democracy at EU level, to an extent that would make whatever further EU integration is necessary to underpin the euro, acceptable to the German Constitutional Court. It is as simple as that.

This could, for example, be achieved by providing for a electoral competition, among all the people of the EU, for the posts of highest ranking political actors in the EU.

The European Council could decide, without changing the Lisbon Treaty, that in future it will only nominate as President of the European Commission, as President of the European Council, and/or as President of the Eurogroup, a person who has won a majority of votes in an EU wide election for that post, held on the same day as the European Parliament election.

That would create a similar level of democracy at European level to that we each enjoy at national level.

Finally, the idea of a direct EU wide direct election is not as radical as it might seem. In December 2002, the Laeken European Council specifically asked the European Convention to examine this matter, but that never happened . All the emphasis was put on increasing the powers of the European Parliament, but direct election of a President by people themselves was never seriously considered. Nor was any change in the electoral system to the European Parliament itself.

The present crisis is an opportunity ,not only to deal with long hidden fiscal problems, it is also an opportunity to make the European Union even more democratic.

Speech by John Bruton, former Taoiseach, at the Annual lunch of the Federation of International Banks in Ireland on Wednesday the 2nd June at 12.50 pm in the Westin Hotel, Dublin

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