New research released by the Institute of Economic Affairs today shows that Portugal and Ireland are both failing to enact the reforms needed to restore growth to their economies.

Their adoption of the euro, and the loose monetary policy that it entailed, led to a vast expansion of the state, an abundance of ‘rent-seeking’ behaviour and gross fiscal irresponsibility. Today’s research demonstrates that these bad practices have yet to be reformed.

Portugal

• Portuguese accession to the EU was greatly motivated by ‘rent-seeking’ motives – i.e. being part of the EU ‘paid out’


• While Portugal enacted limited but important liberalisation and privatisation reforms in the early days of EU membership, the influx of EU funds allowed for a steady growth in public expenditure and fostered a substantial expansion of public and private debt levels


• The later adoption of the euro brought with it inappropriately low interest rates and thus even more cheap money


• This money was co-opted by the most effective ‘rent-seekers’, causing huge imbalances in the economy and undermining any political will for fiscal discipline and the introduction of pro-growth reforms. In fact, many pro-growth reforms previously enacted were subsequently removed


• For Portugal to avoid the possibility of default it must embrace labour market liberalisation, introduce pro-growth reforms and demonstrate fiscal responsibility; something it is not doing thus far

Ireland

• Ireland’s brief period with an independent currency (1979-1999) saw unprecedented growth
  
  
  
  • Between 1987-1997, it created 23% more jobs compared with 17% in the USA, 5% in the UK and 3% in the then 15 EU member states
  
  
  
  


• As with Portugal, adoption of the euro brought low interest rates – this time to an already booming economy – and with it a tide of cheap money


• This was co-opted by the best ‘rent-seekers’ – those in banking and construction. Public and private debt levels soared
  
  
  
  • These vested interests were shown to wield huge power over the Irish political class when the hugely expensive and misguided bank guarantee was enacted
  
  
  
  


• The IMF/EU reform measures are necessary but not sufficient for the reform of Irish economic policy and institutions


• Ireland must radically reform banking, bank regulation and the public sector, and reform its bureaucracy so as to remove the influence of ‘rent seekers’ who, in recent times, have held great sway over the establishment

Lessons for the eurozone

• Most of the institutional incentives in the eurozone are currently lined-up to facilitate fiscal irresponsibility


• Therefore, it is no surprise that countries with a tradition of large deficits and a strong anti-liberalisation bias fail to show fiscal restraint and to enact pro-growth reforms

Solutions

1. Internal adjustment mechanisms must be allowed to operate within the monetary union if the eurozone is to have a sustainable future


2. Bankrupt financial institutions must be allowed to fail so as to allow for an orderly correction of accumulated malinvestments, and also to protect against further moral hazard


3. Any future bailouts must be conditional not only on immediate fiscal restraint, but also on creditors taking a substantial haircut

Dr Richard Wellings, Deputy Editorial Director of the IEA and guest editor of the latest issue of Economic Affairs, says:

“Portugal and Ireland desperately need to engage in the radical economic and fiscal reforms that are essential to their recovery. The adoption of the euro led both countries to loosen their grip on fiscal policy and it is specifically this restraint that must be relearned.

“Repackaging debt and refinancing liabilities and simply spreading them around the eurozone will do nothing to solve the fundamental economic problemsof these countries – or of the eurozone as a whole. The problems must be tackled head on.”

Notes to editors

To arrange an interview with Dr Richard Wellings, IEA Deputy Editorial Director, please contact Stephanie Lis, Communications Officer, 020 7799 8900, slis@iea.org.uk.

Copies of the report can be obtained by contacting Stephanie Lis, Communications Officer, slis@iea.org.uk.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.

The IEA is a registered educational charity and independent of all political parties.