Ireland can help teach experts to be modest

WHAT lessons can Britain draw from Ireland? Institutions in Crisis: European Perspectives on the Recession is a new book edited by monetary economist David Howden, presenting essays on how the financial crisis has played out across Europe. I have a chapter on Ireland, in which I make a fairly simple argument. In 2007, Irish real gross national income per capita had overtaken the UK’s. Academics clamoured to explain the Celtic Tiger. Some downplayed the role of EU structural funds, on the grounds that we shouldn’t expect to see sustainable growth stemming from government transfers. With the benefit of hindsight, I suggest that this might have served as a warning that the economy was less healthy than it appeared.

The narrative behind Ireland’s transformation is reasonably clear – a series of policy changes that helped to increase economic freedom helped to deliver strong growth, but this proved unsustainable as a flood of easy money (in the form of government spending and cheap credit) turned growth into boom into bust. The austerity package that the Irish government then enacted is an intriguing test for economic theory. Lest we forget, shadow chancellor Ed Balls seized upon poor growth figures for the second quarter of 2010, declaring that: “These figures are a stark warning to governments across Europe including our own. That is not a credible economic strategy because lower growth and fewer people in work and paying taxes ultimately leads to a bigger deficit, not a smaller one.”

Well, guess what?

• Ireland’s gross national product is now growing

• Domestic demand is rising

l• ank deposits are rising too

• Bond yields are now under 10 per cent

• Unemployment has continued to rise, but has slowed from the spring 2008-autumn 2009 spike

In short, as the economist Tyler Cowen has documented, the scare stories have yet to materialise. Commentators such as Paul Krugman were wrong.

And yet it is harder to establish the direct influence of a set of austerity measures. Despite economists’ pretensions of scientism, you still cannot disprove the claimed economic benefits of a different policy as you may disprove the claim that ice will stay frozen at 20 degrees celsius. Although economic analysis is grounded in what-if stories or counterfactuals (for example, opportunity cost is defined as the highest-value opportunity given up to pursue another action), the dominant, quantitative methods give us plenty of measures of what happens but can’t resolve arguments about what else might have been. All we can ask, as with Ireland, is whether anyone correctly anticipated what actually transpired.

Progress in our theoretical models will only come when those on both sides of the debate do two things: stop seizing on data to prove their own prior beliefs; and learn how to conduct serious counterfactual analysis. Ireland doesn’t prove that austerity is harmless, but it should give pause for thought to those who warn of doom.

Anthony J. Evans is Associate Professor of Economics at London’s ESCP Europe Business School, and Fulbright Scholar-in-Residence at San Jose State University. His website is www.anthonyjevans.com.