The Celtic Cougar

Why Ireland's economy only looks good from afar.

The Eurozone is back in the news this week with what at the surface level is a good story -- Ireland is leaving the European Union/International Monetary Fund bailout mechanism and regaining its economic sovereignty. Five years after it became the first European country to enter a post-financial crisis recession, Ireland is being heralded as a model for how austerity can put a nation back on its feet. There is no question that the country's temporary sacrifice of economic freedom halted what was one of the steepest declines in relative wealth in modern history. However, the reality is that Ireland has yet to hit rock bottom, and when it does, it will likely remain there for a very long time. Irish Prime Minister Enda Kenny may have been right when he said that leaving the bailout sends a "powerful signal internationally, that Ireland is fighting back, that the spirit of our people is as strong as ever." But the government has not prepared the public -- or potential outside investors -- for dangers that continue to lurk in the Irish economy or the stark choices that lie ahead.

The roots of Ireland's economic crisis are relatively straight forward: The country's roughly 4.5 million people needed a $117 billion bailout in 2010 because key banks had no money, the nation had gone on a spending and credit binge, and the government could not finance its borrowing to fund its public sector without an outside infusion of capital. Necessary as it was, the bailout struck deep in the Irish psyche because it meant the country had lost its economic freedoms The bailout struck deep in the Irish psyche -- it meant the country had lost its economic decision-makers in Brussels after being praised for so long as the "Celtic Tiger." To sustain its bailout commitments as a member of the Eurozone, Ireland embarked on a deep economic austerity program -- widely praised in financial capitals -- that cost each Irish citizen roughly $13,700, on average, though the final cost will be far higher.

Ireland subsequently witnessed skyrocketing unemployment, deep economic recession, and painful budget cuts combined with rising taxes and fees. But the economy has since started to stabilize. Unemployment today is down to a still staggering 12.8 percent (although it would be much higher if Ireland didn't export so much of its talented labor force to help build other nations' economies.) The country's borrowing rates on 10-year bonds have also dropped considerably -- to 3.47 percent -- down from a Eurozone high of 14.2 percent in 2011. There have also been improvements in the housing market, at least around Dublin. Yet through the third quarter of this year, an unsustainably high 18.5 percent of Irish homeowners had missed a payment on their mortgage, and three quarters of those in arrears more than 90 days had yet to be restructured. Against this precarious backdrop, insisting on a return to economic sovereignty could very well put Ireland's modest gains at risk.

Ireland's government recently rejected the option of sustaining an EU credit line as a backstop, should internal or external surprises make self-financing of borrowing to sustain the economy impossible. In effect, it gambled that a strong statement of confidence will be popular at home and attract investment from abroad. But the opposite is just as likely to happen -- that questions about the sustainability of Ireland's economic stability will deter the same international investment. Either way, external investment in Ireland has done little to advance its economy since 2001 -- when an unregulated property binge began to fuel high levels of growth -- and is not the solution to the country's continued economic crisis. Foreign direct investment has helped sustain existing employment levels in that sector, but because of Ireland's low corporate tax rates it has had only a marginal effect on the country's deeper economic problems. Ireland wins bragging rights for hosting the headquarters of major European business operations for Google and Facebook. But these companies don't employ large numbers of Irish people and they put little money back into the Irish economy. 

In fact, Ireland's tax policies, long criticized in Europe, have raised questions among some of the country's closest allies in the United States. Earlier this year, Sen. John McCain (R-AZ) and Sen. Carl Levin (D-MI) referred to Ireland as a "tax haven" and alleged that it was inappropriately shielding American companies like Apple, which they said was holding $44 billion in off-shore accounts, in part taking advantage of Irish tax rules, from tax liabilities at home. Ireland has since indicated it will close loopholes in its tax laws which allowed companies like Apple to pay an actual tax rate of 2 percent. Still, the U.S. senators remain skeptical, saying in October: "Hopefully, the answers will demonstrate that Ireland is ready to close the door on these egregious corporate tax abuses enabling multinational tax avoidance."

Ireland's central challenge is a sustained lack of indigenous economic growth, due in large part to the unwillingness of banks to support risk taking and lend money to small and medium-sized businesses. Meanwhile, rents and operating costs are high, making it difficult for many businesses to survive, let alone grow. Ireland's public sector wages remain among the highest in Europe. A failure to address this problem means that even deeper budget cuts are likely, as are heftier taxes on an already heavily burdened public. Meanwhile, Ireland has the third highest deficit in Europe and its debt to gross domestic product (GDP) ratio is 117.4 percent; both are unsustainably high.

Ireland's 2014 budget cuts about $3.4 billion more from domestic government spending. But if Ireland is to sustain self-financing on the open markets, these cuts may actually be woefully insufficient. Deeper cuts, however, might rattle the existing governing coalition, which includes a sizeable Labour Party minority that draws its political backing from constituencies most harshly impacted by budget cuts. Whatever the final number for continued austerity, the country faces a serious dilemma because the same cuts that are necessary to make self-financing possible will also further deflate the domestic economy, inhibit domestic spending and constrain economic growth.

At its current rate of economic growth -- about 0.2 percent for 2013 and an optimistic projection of 1.8 percent for 2014 -- Ireland is not even on track to meet assumptions on interest terms for the bailout it just departed. The government has raised capital in reserve -- roughly $34 billion -- which it says will keep Ireland solvent through 2014. Having thrown away its credit lifeline to Europe, however, Dublin will likely find it much harder to secure a new bailout should it need one in six months or a year.

The tragic reality often lost in Ireland is that the bailout it just exited was not designed to help the country's economy recover; it was designed to contain the Irish crisis so it would not spread further in Europe, while also protecting against foreign exposure from Ireland's dodgy banks. The tragic reality is that the bailout Ireland just exited was not designed to help the country's economy recover.Today, Ireland's banks are capitalized -- although the banking sector remains weak and under considerable international scrutiny -- while public sector spending, private debt, and underwater mortgages all remain high. If the government does need another bailout, the terms aren't likely to be favorable to the Irish people and could put its low corporate tax rate at risk -- something that might have been avoided by accepting the European Union's precautionary credit reserve line. No question, Ireland's decision is a welcome one in Europe, as the country's restored economic sovereignty takes the European Union off the hook for sustaining the Irish economy.

As it exits the bailout, the government and media in Dublin understandably want to promote a new image of Ireland -- one that is back on its feet and has learned hard lessons. However, the harsh realities and serious risks to the Irish economy that remain cannot be swept under the rug. Widespread inability to meet personal debt obligations, high unemployment, heightened food insecurity, and soaring murder and suicide rates are just a few examples of the depth of searing pain that has left a tragic imprint on the Irish landscape. 

Meanwhile, Ireland has only a limited capacity to promote investment in areas that could grow the domestic economy. Ireland could, for example, position itself as a global higher education hub while also investing heavily in wind and wave energy production -- leading the way for a new kind of globalization and progressive economic development. But in a climate of further austerity -- required to restore and sustain Ireland's economic sovereignty -- the country's capacity to invest in future economic development is much diminished.

In 2009, Irish economist Morgan Kelly, one of a handful of economists who was consistently right in warning of Ireland's economic collapse, wrote: "By 2015 we will have seen what happens when jobs disappear forever.... Ireland is at the start of an enormous, unplanned social experiment on how rising unemployment affects crime, domestic violence, drug abuse, suicide and a litany of other social pathologies." Little has changed since then to suggest this timeline of assumptions should be changed. The only difference is that now Ireland's leaders are flying without a net -- understandably hoping for the best but so far failing to plan for the worst.  

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Democracy Lab

Too Much of a Good Thing

Did local democracy help or hinder post-2001 Afghanistan? An MIT study comes up with some surprising insights.

At the end of 2014, most NATO combat forces will have been withdrawn from Afghanistan, marking a disappointing end to an extraordinary exercise in nation-building. Despite over $100 million in development aid to the country, achievements in strengthening Afghanistan's economy and institutions have fallen short of expectations. Paeans to an "Afghan miracle" have given way to hand-wringing post-mortems. Attracting particular criticism have been efforts -- at both the international and local level -- that promoted Jeffersonian democratic ideals over the hierarchical decision-making structures that have governed Afghanistan for hundreds of years.

But did the imposition of democratic structures in Afghanistan really make things worse? In a recent experimental study, "Do Elected Councils Improve Governance Quality?" we examine whether externally-imposed local democratic institutions improved or worsened governance in rural Afghanistan. Our results indicate that democracy per se was not the problem; when democratic bodies were charged with a specific activity, they produced more equitable outcomes. However, such institutions were often created in parallel to existing customary structures, and this had a different effect. With multiple local bodies, there was a lack of clarity as to who was in charge, which weakened leader accountability and provided opportunities for fraudulent behavior. As an Afghan proverb remarks, "the calf with two mothers gets no milk."

As an Afghan proverb remarks, "the calf with two mothers gets no milk."

Our study was a combination of two experiments: one long and one short.

In the long experiment, we created of democratically-elected, gender-balanced development councils in 2007. As per the randomized controlled trial methodology, we randomly selected 250 villages from a pool of 500 villages to receive democratic councils. These councils supplemented informal yet sophisticated customary structures (which usually include the village headman and an ad hoc council of tribal leaders), but assumed responsibility for implementing development projects in the villages. The remaining 250 villages formed the control group and did not receive elected councils, with governance structures remaining centered on customary local authorities.

We conducted the short experiment four years later, in which we distributed wheat to examine the effects of the councils on leader behavior and local governance quality. Across the 500 villages, we varied the distribution procedures to find out whether directly involving different groups also affected distribution outcomes. In half of the 250 villages with elected councils, the council was directly asked to manage the distribution, while, in the other half, we delegated responsibility to the "village leaders," a deliberately vague term which, depending on who was more powerful in the village, could mean either the elected council or the customary leadership. To examine the effects of involving women, we induced similar variation in the control villages. In half of these 250 villages, we specifically asked women to oversee the distribution, while, in the other half, we did not.

Two weeks after the distribution, we surveyed 10,000 villagers across the 500 villages to obtain data on how leaders behaved in their oversight role and who in the village received wheat. We collected data specifically to enable us to assess whether the wheat truly went to the most vulnerable recipients; how much wheat ended up in the hands of the leaders and their relatives; and the degree of participation by villagers in the decision-making process.

Although somewhat unusual, the wheat distribution outcomes did provide good measures of the quality of local governance. First, unlike other local governance activities, wheat distributions generate objective, quantifiable outcomes that can easily be compared across villages. Second, malign local leaders stand to benefit significantly from distributions at the expense of vulnerable villagers, with anecdotal evidence indicating that as much as a third of wheat is diverted for sale in district markets. Third, as wheat distributions occur relatively regularly in rural Afghanistan, the behavior of leaders in the distribution is representative of their general behavior. Thus, by measuring how much wheat reaches vulnerable villagers, we get a picture of how the creation of elected councils affects the tendency of local leaders to act in an equitable or malign manner.

The results of the study were unexpected, but all the more interesting.

In villages where we specifically asked the democratically-elected council to oversee the distribution, vulnerable households were more likely to receive wheat (relative to vulnerable households in villages in which elected councils did not exist and customary leaders alone managed the distribution). The elected councils had no effect, however, on the level of embezzlement or the inclusiveness of decision-making. We can reservedly say, then, that creating elected councils and putting them in charge of the distribution improves outcomes for vulnerable villagers.

The interesting part, though, is what happened when the prescribed procedures made it less clear who was in charge -- that is, in villages with elected councils where we delegated responsibility to "village leaders," and in villages where we asked women to participate alongside customary leaders. In the first case, levels of embezzlement were higher and decision-making was less inclusive than in villages in which elected councils did not exist and customary leaders alone managed the distribution. In villages where we required that women oversee the distribution alongside customary leaders, levels of embezzlement were similarly higher than in villages in which customary leaders alone managed the distribution.

Embezzlement increased when the responsibility for the oversight of the distribution was not clearly defined.

The key takeaway from the results is that embezzlement increased when the responsibility for the oversight of the distribution was not clearly defined. In villages with elected councils, embezzlement increased when it was not clear whether elected councils or customary leaders were in charge. Likewise, for villages without elected councils, embezzlement increased when customary leaders were asked to share responsibility with women leaders. On the other hand, outcomes were best when responsibility was the most precisely assigned -- that is, when a specific institution, the elected councils, was placed in charge of the distribution.

These results turn out to be quite powerful in demonstrating how development interventions might have inadvertently weakened accountability and governance in rural Afghanistan.

Development programs in Afghanistan have commonly followed a practice of creating new local bodies (commonly termed councils or shura) to manage local projects or interactions. Water management shura were established to manage irrigation projects; the National Solidarity Program created the development councils we studied; the International Security Assistance Force created "reintegration shuras" to transfer detainees back to communities; and a multitude of NGOs created their own shura to manage local interventions. All of this occurred on top of customary structures comprising a village headman, a customary shura, and local clergy. One scholar coined the phrase "shura fatigue" in lamenting the rampant practice that made spaghetti soup out of local governance.

This avalanche of shura splintered governance authority across an array of village institutions, old and new, which made it difficult for villagers to figure out who was in charge. Our results suggest that this in turn triggered a "common pool" problem, where leaders reacted to the diffusion of accountability by engaging in rent-seeking behavior that left ordinary villagers worse off.

Our results relay a solid piece of advice: if development actors want to empower communities to sustain change, they should think twice about creating new institutions when options exist to strengthen the accountability of existing institutions. While democratic institutions like elected councils can improve outcomes, reformers must first clarify these institutions' relationship with existing bodies. And whatever the institutional form -- be it democratic or customary -- governance outcomes are best when the population is able to tell who is in charge and who will hold them accountable.

Aref Karimi/AFP/Getty Images