Ed Balls and Irish austerity: what you didn’t hear at party conference

May the growth rise to meet you

Ed Balls used to cite Ireland as exhibit A in his argument that ‘austerity’ would cripple the British economy.

A year ago, when Ireland’s economy had just shrunk by 1.2% Balls, then making his unsuccessful run for Labour leader, said

“These figures are a stark warning to governments across Europe including our own. An austerity programme of deep cuts now, when our economic recovery is not secure, risks lower growth and higher unemployment”

Perhaps he was busy drawing up his plan for British economic recovery which he announced at the Labour conference this week (easily summed up: spend more money) or maybe he was keeping his head down following poll numbers from ComRes which showed just 27% of voters thinking he would make a better Chancellor than George Osborne with 43% disagreeing.

Either way we were denied his reaction to the latest set of figures from Ireland; second quarter GDP figures showing growth of a healthy 1.6%.

A lively (in economic terms anyway) debate has kicked off over what these figures mean.

Free market economist Tyler Cowen led by claiming that such growth following such cuts disproved the Keynesian theory. Paul Krugman responded for the Keynesians arguing that Keynes always said this would happen, it was just question of how much damage was done in the meantime and how long it took. In the long run we are all dead, after all.

There is much truth in what Krugman says. The problem in Ireland, as in Greece and elsewhere, lies mostly on the monetary side of the economy. As Patrick Honohan, a former Trinity College academic now governor of Ireland’s central bank, wrote

“Until about 2000, the growth had been on a secure export-led basis, underpinned by wage restraint. However, from about 2000 the character of the growth changed: a property price and construction bubble took hold. This boom sustained employment and output growth until 2007 despite a loss of wage competitiveness”

A slump in interest rates when Ireland joined the euro saw a borrowing boom which bid up prices and wages. As a result, given that Irish prices are now relatively high, Ireland will be unable to export. It will need to get its prices down to a level approximating those of its competitors. This devaluation can be internal or external.

An external devaluation works by inflating the money supply so that prices rise and the real wage (the amount of goods and services the money wage can purchase) falls that way. Britain has eagerly pursued this course and sterling has lost about 25% of its value since 2007. This was not an option open to Ireland. As a member of the euro the money supply of the Irish Republic is controlled in Frankfurt.

This left the option of internal devaluation where prices and wages are reduced to competitive levels by simple cuts in nominal wages and, thus, the real wage.

There are two things to note.

First, both internal and external devaluation are different paths to the same destination, devaluation. Both entail a fall in the real wage and a decline in living standards. The difference is that if it is not possible to reduce nominal wages (if they are ‘sticky’ in the odd Keynesian parlance), say because of trade union opposition, then any attempt at internal devaluation will only succeed at the price of great unrest and unemployment; as falling prices depress companies’ incomes they will reduce their wage bill with layoffs if they cannot cut wages.

Secondly, it should be clear that Ireland’s problem was a monetary one not a fiscal one. For Ed Balls to point to Irish austerity as a warning for Britain is either breathtaking cynicism or economic ignorance. Take your pick.

This article originally appeared at The Commentator

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