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Ireland and Iceland Outline Iceland and Ireland: similarities and differences Ireland Iceland Starting points Putting the house in order: the 1980s Impact of “the death of distance” The boom and the bust Euro member Basics The boom and bust No euro Features of the two busts Similarities and Differences Ireland Iceland Size 27,400 sq miles 58,000 sq miles Population 4,400,000 315,000 Per capita GDP - 2010 $46,000 $39,000 Year of independence 1922/1949 1944 Ireland Ireland History in Brief 1846-50 Irish Famine (pop. peak :8 million) 1919-22 Partial independence for Ireland from UK; Civil War 1930-1950s Industrial policy of “self sufficiency” Government: mildly “socialist” Favored small farmers and agricultural interests Promoted Irish language Ireland – History continued 1956 • Government seeks to attract foreign investment in export manufacturing industries: profits will be tax free for 15 years 1964 • Restrictions on foreign ownership of industry abolished Industrial Development Authority • Market Ireland to foreign direct investors • Lobby government on behalf of investors (taxes, education, telecommunication, etc.) Ireland: Inherited Factors Population (1985) 3.5 million; very young Area 27,400 sq miles Language English; some Irish Legal system English common law Government Parliamentary EARLY INVESTORS IN IRELAND General Electric (1963) Digital (1971) Wang (1979) Mostek (1979) Apple Westinghouse (Thermo King, etc.) External Economic/Trade Agreements Not an original member of European Union Anglo-Irish Free Trade Agreement (1965) Entry into the European Union (1973) Joined Euro in 2002 Impact of 1973 EU Entry Overall subsidy level roughly equal to Greece and Portugal Substantial subsidies for Irish farmers Helped finance refocusing of higher education Expanded Irish export markets, e.g. beef Made Ireland even more attractive as a “stepping stone” into Europe for foreign investors Tax Policy Changes 1978: EU objects to “discriminatory” effect of low taxes just for export manufacturing Irish solution: reduce corporate tax rate from 15% to 10% for all manufacturing (Now around 12%) Key Economic Indicators Annual Averages 1961-1980 1961-1970 1971-1980 Real GDP % 4.2 4.8 Employment Growth 0.0 0.9 Unemployment % 4.8 6.8 Consumer Price Inflation 4.8 13.6 -165,000 +96,000 Net Migration PUTTING THE HOUSE IN ORDER - I 1980: An Bord Telecomm One of the worst European telephone systems Largest employer in Ireland Both consumer and foreign investor complaints Independence from Post Office, but still state enterprise PUTTING THE HOUSE IN ORDER – II During 1980s: Major upgrading of technology at time of fiscal restraint Focus: To become the lowest cost provider of quality international telecommunications services in Europe PUTTING THE HOUSE IN ORDER - III 1987: Focus on budget/debt control in Ireland New minority government Controlled deficit, e.g. postponed pay raises for civil servants Forgiveness to taxpayers if they paid overdue taxes (58% marginal rate) Agreement with unions on pay increases Then 10% corporate tax rate extended to international financial services PUTTING THE HOUSE IN ORDER - IV Reform of education Reform of higher level education to stress sciences, engineering Two new universities Technical college system emphasizing electrical engineering and information technology IRISH ECONOMIC POLICY, 1987 Not ideologically “free market,” e.g. like Margaret Thatcher in England Very pragmatic Emphasis on agreement with unions: Modest increases in nominal wage Real wages would not decline Reductions in personal tax rates to help workers keep pace with inflation Exchange Rate Policy Before and After the Euro Small country dependency Irish currency historically tied to British pound sterling Upon entry into EU, Irish “punt” created and valued within EMS Enthusiastic member of Euro bloc Downside: no independent monetary policy Key Economic Indicators Annual Averages 1981-1986 1987-1993 Real GDP % 4.1 4.8 Employment Growth -1.3 1.1 Unemployment % 13.8 15.2 Consumer Price Inflation 10.8 2.9 -70,000 -94,000 Net Migration KEY EVENT: “THE DEATH OF DISTANCE” c. 1990 A chance event for Ireland - but “fortune favors the well prepared” Technology events High capacity, low cost optical fiber High speed routers and switching networks. Internet/worldwide web Competition among suppliers of international telecommunications services REINFORCING EVENTS OF THE 1990s Uniform corporate rate of 12½% for all firms (1998) Personal tax rates cut for individuals Impact on labor force participation rates especially women 1980: 30% → 2002: 44% Young Irish abroad return to work in Ireland In-migration from other EU countries Ireland's Boom Annual Averages 19942000 2005 2006 2007 Real GDP % 9.0 5.5 5.75 6.0 Employment Growth 5.1 4.7 4.5 3.6 Unemployment % 9.5 4.4 4.3 4.5 Consumer Price Inflation 2.5 2.5 3.9 4.9 -72,400 55,100 71,800 67,300 Net Migration Policy Implication of the Irish Boom Get the fiscal policy fundamentals right Positive attitude towards investment, foreign and domestic, with special attention to taxes and educational requirements of private sector employers Create an environment for the rapid deployment of modern telecommunications technology, e.g. encourages investment and entrepreneurship Policy Implication of the Irish Boom (continued) Sometimes crises can be helpful (necessary?) Get the fundamental fiscal policies right Reform/investment for telecommunications infrastructure critical “Luck” plays a role … . . . but “fortune favors the well-prepared” Booms have a tendency to get out-of-hand Boom to Bust: The Housing Bubble 1992-2006: Housing stock rises by 150% Demand factors: Favorable demographics Rising real incomes No property taxes Mortgage interest deductibility Favorable capital gains on housing Low interest rates Financial institutions aggressive in liberal lending terms (e.g. no money down) – but very little subprime lending Boom to Bust (continued) Property-related lending goes from 40% to 60% of banking system credits by 2007 Substantial speculative demand, e.g. “buy-to-let” mortgages were 26% of residential lending Late 2007: home prices began to weaken October 2008: Lehman Bros. failure seizes up interbank lending market; Irish banks lose deposits Irish government guarantees all deposits and debts in Ireland of 6 largest banks Housing prices soared relative to rents (Bank of Ireland 2006) Actual and Predicted Long-run Irish House prices (Bank of Ireland 2006) The Bubble Begins to Burst IRELAND HOUSE PRICE Source: Central Bank of Ireland Ireland's Housing Crash Ireland Today Annual Averages 2007 2008 2009 2010 Real GDP % 6.0 -3.0 -7.5 -1.0 Employment Growth 3.6 -0.4 -4.6 Unemployment % 4.5 6.2 9.4 13.4 Consumer Price Inflation 4.9 4.1 -1.6 -1.5 Net Migration 67,300 Ireland Real GDP (YOY) Ireland CPI Ireland's Currency – the Euro Ireland's Asset Bubble - Housing Boom to Bust • Average national house price in Ireland fell 18.5% in 2009 vs a drop of 9.1 % in 2008 • A 48.2% drop since the peak in 3rd Q 2007 to January 2012 Ireland CDS Source: http://www.spiegel.de/international/europe/0,1518,670294,00.html Iceland: Key Economic Data Population: 320,000 (less than 10% of Ireland’s – about the size of the City of Pittsburgh) Area: Twice Ireland Integrated into EU via European Economic Area, 1994 – Not a member of the EU or Euro Fisheries an important (usually 12% or more of GDP, 40% exports +) and a protected sector (e.g. no FDI allowed) Aluminum production also very important Finance not so much . . . . any more Relatively high per capita incomes $40,000 vs $65,000 at its peak in 2007-08. Opening up the Economy Joined GATT in 1964 Privatization of key sectors starting in 1980s Trade and financial sectors liberalized in the 1990s Multinational aluminum company investment in 1990s Krona floated in March 2001 Substantial investment and lending abroad by Icelandic companies in 2000s A Formerly “Fishy” Economy .... peaked in 2007 Iceland's Bubble - 2003-2007: foreign funded boom lifted GDP 25%, strengthened krona - Beginning in 2004: Rapid expansion of three major banks into overseas markets – borrowed ~$100 billion to buy foreign assets - Further expansion funded with short-term deposits, e.g. from UK retail branches of Icelandic banks - Other corporations and individuals became heavy borrowers in foreign currencies (lower interest rates than 16% charged on krona debt) Iceland's Bubble (continued) 2006: hedge funds attack krona as overvalued; attack unsuccessful Mid-2008: Global re-evaluation of financial risk led to interbank lending drying up Icelandic banks couldn't refinance $62 billion in foreign debt – lost access to overseas ST funds (similar to European banks later) Central Bank of Iceland has insufficient foreign currency assets to assist private banks, though it tried: One September 28 2008 government injected capital into Glitnir Bank (taking 75% stake) Run on UK branches of other Icelandic banks Iceland's Official Foreign Exchange Reserves (About $7.2 billion) ICELAND’S BUBBLE - cont. Krona devalued (60 ISK → 125 ISK – now about 116.8 ISK/USD) GDP growth 2009: - 6.5%, 2010: ~ -3.5% 2011: 2-3 % 2009 : Arranged a $2.1 billion IMF facility ICELAND’S BUBBLE - cont Government has not quite reached agreement with UK and Netherlands to repay over $5.3 billion in debts owed depositors of failed Iceland banks Iceland President refused to sign agreement, forcing referendum on repayment In March 2010 93% voted against repaying debts under existing terms. Voters continue to oppose repayment Meanwhile, Parliament voted to pursue EU membership – no real movement Iceland (Volatile) Real GDP Iceland Real GDP Growth Rate Iceland Krona Iceland Total Public Debt (% of GDP) Iceland Unemployment Rate Iceland CPI Iceland CDS FEATURES OF THE TWO BUSTS Common features Sustained booms; rapid bank expansion, e.g. increasing leverage Bank reliance on foreign short-term deposits Liquidity crises for major banks Massive government intervention in the banking sector FEATURES OF THE TWO BUSTS Distinguishing features Irish banks’ over-expansion was in domestic real estate lending Ireland government took over banks assets and liabilities Icelandic banks over-expansion mainly in lending overseas, frequently to Icelandic companies Iceland had major FX crisis (not a Euro member) Large depositors in Icelandic banks in the UK lost substantial sums; Irish depositors still whole Iceland in pictures . . . . Why Iceland was Different .... via Bloomberg interview Zimbabwe Japan Saint Kitts and Nevis Greece Lebanon Jamaica Iceland Italy Singapore Barbados Belgium Ireland Portugal Sudan Canada Germany France Sri Lanka Hungary Belize Egypt Dominica Nicaragua United Kingdom Israel Austria Malta Bahrain Cote d'Ivoire Jordan Netherlands United States Morocco Cyprus Spain Albania Brazil Croatia Bhutan Mauritius Vietnam Guyana Uruguay Philippines Seychelles Poland El Salvador Malaysia India United Arab Emirates Government Debt (as percent of GDP: 2010) Source: CIA 250 200 150 100 50 0 US Government Budget Deficit as Percent of GDP Greece Total Public Debt (% of GDP) Ireland Total Public Debt (% of GDP) Italy Total Public Debt (% of GDP) Spain Total Public Debt (% of GDP) United States Total Public Debt (% of GDP) United States Total Public Debt (% of GDP) United States Total Public Debt (% of GDP) United States Total Public Debt (% of GDP)