Dominic Hannigan (Meath East, Labour)
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On behalf of the committee I am pleased to welcome Professor John FitzGerald from the Economic and Social Research Institute, ESRI. Today's meeting is a continuation of the debate we are having on Ireland and the European Union. Today's session will focus on the implications for Ireland of an evolving European Union in terms of the proposed completion of the economic and monetary union and necessary steps to bolster democratic accountability and legitimacy. Committee members will be very aware of the recent views expressed by the ESRI on this matter and we are looking forward to hearing Professor FitzGerald's views on developments in the euro area and beyond.

Before we begin, I remind witnesses and members of the long-standing parliamentary practice to the effect that they should not comment on or make charges against an individual or entity either by name or in such a way as to make him, her or it identifiable. By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they give to the committee. If a witness is directed by the committee to cease giving evidence on a particular matter and he or she continues to do so, he or she will be entitled thereafter only to a qualified privilege. I invite Professor FitzGerald to make his opening remarks.

Professor John FitzGerald:

I thank members for their invitation. It is a pleasure to attend. I will address three of the modules that have been identified and try to answer questions on the fourth module, economic policy and integration.

I will make a few brief remarks on the first module, financial integration. This is important for the creation of a single financial market in Europe. The costs of the disintegration of the Single Market are high. For example, pequeñas y medianas empresas - small to medium-sized enterprises, SMEs, in Spain - are paying interest rates that are 3% higher, under similar conditions, than those paid by SMEs in Germany. There are also problems in that regard in Ireland. It is impossible to have a level playing field with competitiveness in Europe if firms with the same risk characteristics are paying higher interest rates in one place than they are in another. If one visited a branch of Bank of America in Palo Alto in the US with a set of risk characteristics, one would get the same terms as one would from a Bank of America branch in Newark or New Jersey. We do not have that situation in Europe. For this reason, banking union is necessary.

We refer to banking union in terms of our legacy debts. In a paper that I published with colleagues from the National Institute of Economic and Social Research in London, we considered the costs of a European banking system versus national banking systems. The former makes a sizeable difference for all of Europe. It is important that we make progress. By European standards, it should be rapid.

Once European regulation is in place, there must be a European resolution system. If the regulator screws up, the costs of a European failure cannot be imposed on a national entity. The costs must be socialised across the EU. A range of steps must be put in place. By 2020, I hope to see similar credit conditions for firms in Ireland as obtain in France, Italy and Poland.

On budgetary integration, my inclination is to do less rather than more where possible. However, we saw how the bond market vigilantes were unleashed on us. Since there was no European system to deal with the crisis, the bond markets priced Ireland out of the market and wrote us off as no-hopers in 2010. Our colleagues in Europe helped to rescue us. Europe has put in place a system that is better than using the bond market vigilantes to police fiscal policy, but they are always out there. The current set-up is not ideal, but it is better than the alternative.

We have changed the rules of the Stability and Growth Pact. I am unhappy with what occurred in this regard and in which respect we needed to pass a referendum. The rules that have been put in place across Europe would not have prevented Ireland and Spain's disasters, as they focus on problems in fiscal policy. The single best indicator of a pending crisis in Ireland, Greece, Portugal, Spain, Lithuania, Latvia and Estonia was the balance of payments current account. This is one of the measures that the EU uses. One reason for its omission is that the symmetry would imply that countries running large surpluses should take remedial action as well as countries running large deficits. This failing weakens the process that has been put in place.

One can make a mistake relying on rules. We obeyed the Stability and Growth Pact. That was the problem. When the IMF and the EU visited the ESRI, we asked whether they would give Ireland a speeding ticket in 2004, 2005 and 2006. They replied that they could not, as it was obeying the speed limit, namely, the Stability and Growth Pact. Had there been no pact, the IMF would have been making more noise about our mistakes in 2004, 2005 and 2006. An interesting paper by Dr. Jim O'Leary of NUI Maynooth goes through the advice given by the IMF and the EU and identifies this problem.

I wish to make a final remark on budgetary integration. I have gone through the blueprint produced by the European Commission and President Van Rompuy's statement. Only once does counter-cyclical fiscal policy appear, and that is in respect of the suggestion of setting up an insurance fund. The elephant in the room is that European fiscal policy is profoundly pro-cyclical. Any basic economics 101 class would teach that this is not what should be done. In February, as part of the EUROFRAME group of institutes, including two German institutes - the Kiel Institute for the World Economy and DIW Berlin - the Centraal Planbureau in the Netherlands and the national institute in London, we analysed the stance of fiscal policy last year, this year and next year in the eurozone at an aggregate level. The effect of fiscal policy this year will be to reduce the growth rate of Europe by 1.5%. Europe would be growing by 1% this year, not falling by 0.5%, were it not for an inappropriate fiscal policy. There is nothing in the European Commission's proposals to bring about more co-ordination of fiscal policy. When there is a cyclical downturn in any standard economy, one pumps money into it instead of removing it. Ireland and Spain have no choice, but aggregate fiscal policy should be run in Europe's interests in the standard way as set out in a basic textbook. That there is nothing in the EU documents on this is a failing.

We do not have answers on my final point, but it is a considerable risk for Ireland. By accident or design, the UK has decided to consider leaving the EU. The political implications will dominate the economic ones and I will leave them to politicians. The UK is unlikely to apply for associate membership, as it would need to obey all of the EU's rules on the Single Market without being at the table when those rules were decided. This is not an option for the UK if it leaves. In that case, we would need to impose the common external tariff on everything coming from the UK. This means a customs barrier on the Border with the UK on this island.

The economic implications for the UK and Ireland are considerable. I suspect that the vultures are already gathering over the UK's economy. The IDA is probably knocking on doors in the City in London and inviting companies that would prefer to be in the EU to come to the safety of Dublin. The French vultures will be gathering around British aerospace in Bristol, where the wings of the Airbus A380 are made and from where they are taken, with great difficulty, to Toulouse to be assembled. Why not do all of that work in France? Nissan produces cars for Europe. Suddenly, it will be subject to the common external tariff.

There would be major problems for the UK and potential opportunities for Ireland, but it is a lose-lose situation. What would happen to public procurement? Irish firms selling to British firms are currently treated equally as EU firms. Will British firms start buying British? What rules will govern access for agricultural produce? Will they be different, making access difficult? This island has a common electricity market. Will we need to erect customs barriers to check the electrons going through the wires? This is unlikely, but it would disrupt us. In terms of energy security, all of our gas comes through a pipeline through the UK. The rules of the EU mean that, if there is a gas shortage, Irish people must be treated fairly like people in the UK. If the UK is not a part of the EU, how can we ensure energy security?

There are major issues for us. There would be some wins, but probably many losses. I have no answers. We should be considering this matter.

Dominic Hannigan (Meath East, Labour)
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I thank Professor FitzGerald.

Bernard Durkan (Kildare North, Fine Gael)
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I welcome Professor FitzGerald and thank him for his frank appraisal of the situation. He stated that he had no answers, but he set out a clear picture of a situation that needed to be attended to within the EU as a matter of urgency, that being, Britain's proposal to hold a referendum on exiting the EU. The consequences would be serious. The concept of the European entity that we have all discussed, lived with, worked for and strived towards for years could disintegrate. I cannot see how it would be otherwise. To postpone a decision of that nature is more debilitating than anything else that could be done. The worst case scenario is likely to emerge.

We have discussed another matter ad infinitum, that being, the degree to which each EU member state is willing to co-ordinate its efforts in economic and fiscal policy. In our naivete, we believed that this co-ordination had been in operation for the past five, seven or ten years. We now know better. Professor FitzGerald's point is important. To what extent are we serious about co-ordination now and how effective will it be?

My last point is on taking money out of the economy to re-inflate or pump it up. How effective will that be without some price controls? Let me give an example. In 1978 house property prices were removed from the consumer price index because it was felt that they would distort inflation and so on. In the most recent boom house property prices increased by between 300% and 400% in a short space of time. That happened in an insidious manner as far as the economy was concerned. Many commentators, along with ourselves as political representatives, were unaware of the accelerated speed of inflation and the damage it was doing to the economy. The property market became the bank and the financial institutions became the collateral.

Dominic Hannigan (Meath East, Labour)
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I thank the Deputy and call Senator Healy Eames. Before she commences I ask Deputy Donohoe to take the Chair.

Fidelma Healy Eames (Fine Gael)
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I welcome Professor FitzGerald. I was struck by what he said about EU fiscal policy and its effect on reducing growth rates by 1.5% this year. We all seek growth. We examine the unemployment levels across Europe and in Ireland, particularly youth unemployment, the size of the deficit and the amount of cuts that we must continue to bear. A little bit of growth in the economy would make a great difference to everything. How can we influence growth in Europe? What can Ireland do to influence EU fiscal policy?

The professor spoke about the reasons for banking at the beginning of his presentation. Would a banking union make a difference to growth? I would like to understand the matter a little bit more.

Eric Byrne (Dublin South Central, Labour)
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I can assure the committee that economics is not my strong point so I shall ask baby questions. I concur with the professor's fearful outline of what might happen if the Conservative Party gains an overall majority in Britain and goes ahead with its opt in or out scenario in regard to Europe. The committee invited a witness here from the British Conservative Party who is a spokesperson on the role of Britain in Europe. Some of us found his position worrying, to say the least. What mostly worries us, having spoken to members of the Labour Party in England, is the sense of fatalism that even British industry, which Professor FitzGerald said would lose out, does not seem to be launching a defensive strategy on behalf of membership of Europe. Does the professor have an opinion on England opting in or out of Europe?

We, as politicians, have been confronted with the simple slogan "Austerity doesn't work." We need growth in jobs in the European arena and we have always argued for that. I understand - perhaps this links to what Senator Healy Eames said - that we have spent nearly every penny of the National Pensions Reserve Fund, or it has been set aside for job creation. We have also agreed that if we nationalise certain parts of the State and public sector, some of the money will fund growth in employment. We are also compelled to do so by the troika.

People have proclaimed loudly that austerity is not working. Interestingly, the Lithuanians undertook very severe measures and now have relatively healthy growth. Does the professor have an opinion on that? Can he suggest what we can do domestically? What else can we do, other that what we are doing under the terms of the troika agreement, to create growth in jobs and development?

Professor John FitzGerald:

Deputy Durkan made a good point that the UK referendum is on the agenda for the next five years and it is bad for them, for Europe and for us. Also, Deputy Eric Byrne asked whether anyone in the UK had examined the implications, and I am afraid it might be the case that they have not. I asked two colleagues in the United Kingdom whether they were studying the issue and both said that they would not go near it. In order to understand the implications for us we need to understand the implications for them. For instance, BAE Systems in Bristol and Nissan in the north of England are at risk, as are many other firms. My suspicion is that when these companies think about it, and if I am right about their being at risk, there will be change in view and, hopefully, a more realistic response.

No more than ourselves, Britain needs a national debate. We know about having national debates on these issues for referendums. Britain may need to try twice to get the right answer but it has a lot of work to do. What can we do about it? That is a scary question. Barring acting like a marriage counsellor and trying to reconcile two warring parties, Ireland must examine the matter as an insurance policy and examine whether we can do anything. For example, there has been talk about major investment in Ireland in wind power in order to export it to the United Kingdom, but the concern is as follows. Let us say €3 billion is invested in Ireland in order to help Britain meet its EU obligations under the renewables directive, but Britain then changes its mind. Are we left with €3 billion worth of dud windmills? Contracts that are enforceable in London are needed in order to guarantee such investment. We need to start thinking about how to protect ourselves from such a hopefully limited possibility.

In terms of co-ordination and whether we are serious about the co-ordination of fiscal policy at a European level, we have been forced to go down that route because, for understandable reasons, the people who lent the money want to be certain that they will get it back. That is a fair cop. I spoke to one colleague who is a very good German economist. When he was faced with the idea that Europe had to regulate French fiscal policy he said that he did not want to go near it. When one comes down to it, each country wants to protect its own independence in this regard. If we want to go down the co-ordination route then we must examine the issue of a co-ordinated fiscal response to a crisis like the current one. If one is going to have all sorts of regulation regarding fiscal policy then one must have regulation that will ensure the one acts counter-cyclically and not pro-cyclically within Europe.

Senator Healy Eames raised the issue of a banking union. It is a long-term issue but we have a particular interest in it and in terms of legacy debt we want to see it done. However, it is important to get it right in the long term. Europe, not Ireland, faces a big problem with its banking system. What if something suddenly happened to it next year? Nobody is sure where there will be problems. If something happened it would be better to have a European framework to deal with the problem. The short-term issue refers to the short-term banking problem, not so much in Ireland but in other countries. We must have a mechanism in place in order that we do not have continuing crisis.

Deputy Eric Byrne asked about Ireland's fiscal path and people claiming that austerity does not work. Last January I published a paper in a French journal that examined the history of major adjustments in Europe. Interestingly, in the 1990s Finland undertook a major adjustment programme, but there was no improvement in public finances.

In fact, they got worse for the first few years, but borrowing abroad improved dramatically. It is really only when one eases off on the fiscal adjustment that one sees the benefits. It is similar to the United Kingdom in the late 1980s and early 1990s, or Ireland in the 1980s, where the first two budgets of the coalition government between 1982 and 1987 were really tough - probably tougher than anything we have seen in the current crisis - but they eased off after that. One did not see the benefits, or the fact that fiscal policy was being improved. There was very little progress. Once one eases off, one sees the adjustments. It is only when we have largely completed the adjustment - and if Europe recovers - we will see recovery here. Austerity works in terms of getting one's public finances right, but one does not see the benefits quickly.

Deputy Eric Byrne asked what we can do to create jobs. We must do what we have to do, and I published something yesterday on this issue. One thing we did not address, which my colleagues and many others have thought about, is how one does it in a smart way which is more employment-friendly. One of the things we recommended, which is being implemented and is generally accepted, was a move to property tax. We have to raise taxes somewhere. Property tax is better than taxes on incomes and it is less negative to jobs, although it is pretty unpleasant. If we have to raise taxes, we must do so in a way that is jobs-friendly.

I refer to Irish Water. We are under-investing in water and should be investing more in it. Every cent we invest in water is a borrowing requirement and it is a drag on us. If we manage to set up Irish Water as an independent entity like the ESB, which is not part of the Government accounts, can borrow on its own account and has revenue-raising powers so it covers all its costs from its bills - this is why we need water charges - then it is out of the Government accounts. If one capitalised Irish Water at €5 billion, to include €2 billion of Government equity, and if it was able to borrow €3 billion on the market to buy the assets, it could undertake a much bigger investment programme which would not be part of the Government accounts and would be fully funded by future charges on people, which would be very unpopular. However, there is a smart way to do this and we must think a bit more about that.

Paschal Donohoe (Dublin Central, Fine Gael)
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I thank Professor FitzGerald for his contribution. I agree completely with the point he made about the UK, its environment and its relationship with the European Union. One of the challenges we face is that we are so immersed in the here and now and that the political and government systems are so immersed in the unemployment crisis, the fiscal crisis and the social challenges with which Professor FitzGerald will be familiar, that we do not have the space to engage in the what if question. One of the biggest "what if" questions is the one Professor FitzGerald mentioned, namely, what happens if the United Kingdom decides to leave the European Union?

I spend a lot of time in the UK, as many Irish people do. There is a wonderful argument to be made as to why the UK should stay in the EU. It is all about the thing which has always mattered to the United Kingdom and which Mrs. Thatcher realised was the great jewel in the crown, namely, access to the Common Market. The big question is whether anybody in the UK is willing to make that argument. We will find out the answer to that question in the next 12 to 18 months in terms of what the Labour Party decides to do and what happens in the Conservative Party. One of the consequences of the terrible difficulty we are in is that we have forfeited the ability to think about the big issue, to which Professor FitzGerald referred. I would be interested to hear his view on that.

I refer to three economic points Professor FitzGerald made, including the point about the balance of payments and the fact it is absent in the kind of current eurozone thinking. I always interpret balance of payments quite crudely as being the difference between what a country sells and what it takes in. Since the eurozone was created, it has made that mistake. Nobody ever talks about the balance of payments. The most amazing example of that was when all sorts of self-styled experts proclaimed Ireland would default. Their attention was never drawn to the fact we had a balance of payments surplus. The fact that is absent currently is entirely consistent with the history of the eurozone. Nobody ever talks about that issue. It is one of the big problems we need to address.

I refer to fiscal policy and would like to develop a point Senator Healy Eames made, which cuts to the heart of it. Whenever I put the case to people that co-ordination of fiscal policy should not mean everybody doing the same thing, the answer I get comprises two things. The first is another question: if Germany, Holland or another country decided it wanted to re-inflate its economy, who would lend it money? Second, if someone did so, would it leave the country immediately and go to Asia? What is Professor FitzGerald's view on that?

I refer to banking union. To put it very simply, one of the causes of our crisis is that banks stopped lending to each other, the ECB stepped in to provide the money and the ECB is trying to get back its money in different ways from different countries. Banking union should, hopefully, create the ability of banks to lend to each other again. Would the early phase of a banking union not create the capacity to further weaken national banking systems all over again? Implicit in the creation of a banking union is the idea that banks can fail. If that possibility is there, surely that means banks which have that risk hanging over them will find it more difficult to raise money and will have to offer depositors more money to put their money into the bank and so on. Some of the weaknesses which are probably there within national banking systems could be exacerbated in the early phase of a banking union.

I will conclude with an analogy which I put to an earlier guest, who completely disagreed with me. One of the challenges we face is that the bond markets lent to Greece, Ireland or Portugal at the same rate they lent to Germany, but they are not doing that at the moment. People also lent to banks at the same rate, regardless of how healthy the bank was. One of the consequences of a banking union is that might not happen anymore. If that is the case, will the early phase not be a rocky ride?

Professor John FitzGerald:

In terms of what Deputy Donohoe said about the big issue - that is, that we have been so caught up in the crisis that we have not really thought about what comes after - the same is true of Europe in terms of its thinking on fiscal policy. It is about dealing with the current crisis. To some extent, because we are reaching a certain stage, maybe we can start to think again. If one comes from a mendicant country, people expect one to put the Irish case and one finds it very difficult to talk at a European level. Hopefully, we are re-establishing our credentials to talk at a European level.

On the current account balance of payments, if one goes through the Dáil debates in the 1950s, it was the big issue. People wrongly said it would not be a problem with monetary union. Olivier Blanchard, who is the chief economist in the IMF, wrote a very nice article in 2001 in which he contrasted Ireland and Spain and said Spain had a current account deficit which was not sustainable and that Ireland had a surplus and was doing okay. He was right at the time but I felt he was a bit gung-ho in 2001 because things were beginning to head in the wrong direction. He has been consistent. The European Commission now realises it must pay more attention to this.

On the question of fiscal policy and whether Germany or other countries should reflate, this is a problem. If we are going to have co-ordinated policy, that should probably happen. However, my German colleagues make a valid argument that the German economy is rather like a supertanker that is beginning to turn. Labour costs are rising in Germany because of a very tight labour market and over time the German economy will gradually price itself in such a way that the current account surplus will fall. I would not advocate policy in Germany to bring down the current account surplus. However, if we are going to have co-ordinated policy in Europe, it should be to reflate the European economy, which would involve the countries that have a surplus doing something about it. Frankly, that is not going to happen now.

The question is really whether we will have agreement for a co-ordinated policy in place for the next crisis. On that, an important decision was taken by the French Government in May when President Hollande announced that France was not going to and should not meet its target and the Commission agreed. Instead of making further cuts, France was going to let what economists refer to as "automatic stabilisers" work. I see this as a major breakthrough. What the IMF has said in its most recent report and every report for Ireland is that the country has set its target in terms of cuts and that it should do the cuts and make the increases in taxation. However, if it does not meet the targets in terms of borrowing requirements, it should not do more. In March last year, the central planning bureau in the Netherlands produced a report saying the Netherlands was not going to meet its target. On the same day, an article written by the bureau's director was printed in the Financial Times saying the Netherlands should not meet the target. The government disagreed and then collapsed. Another election took place, followed by a further round of austerity - the wrong policy.

On the issue of a weakening national banking system, there is a potential problem. In banking crises, if the issue can be swept under the carpet and growth is achieved, it will all go away. Our problem was too big. It was an elephant in the room and there was no sweeping it under the carpet. The policy across Europe has largely been to sweep the problem under the carpet, but this policy has come unstuck in Spain. I am not sure we can maintain this policy. A bank may need capital, but it is only if it is insolvent that bondholders and others will be burnt. It is a question of putting more money into the bank and whether it comes to the private sector.

We need to think about what type of banking system we would like in 2020. Currently, banks in Ireland and across Europe borrow at different rates, because they have different risks. The cost of borrowing for Irish banks is very high, relatively, and if, for example, Deutsche Bank took over AIB, it would be able to fund itself at a much lower cost. Therefore, while it might not make money on tracker mortgages - on which our banks are losing hugely - it would not lose money on them. It is not that we would let banks go to the wall, but a more integrated system would mean a world where bigger and stronger banks gobble up smaller banks. This is what is happening in the US. This might be better for Europe and would be the way to produce a European banking system. However, we need a lot of things to happen first.

There are issues such as not having national banks. For example, Poland faced a major problem in the current crisis. It came through without any fall in output, but its banks were foreign-owned. The Austrian regulator said that Austrian banks with branches in Poland could not lend money there, but should keep it in Austria. The Poles were faced with the danger that without banks of their own, nobody would provide credit. Contrary to EU rules, the regulators in different countries were saying credit could not be provided in Poland and should be kept at home. It is in situations like this we need a banking union. We need a union so that there is a level playing field. I heard the CEO of UniCredit say he had to charge 2% more in a branch in the Dolomites on the Italian side of the border than in a branch on the Austrian side. That is wrong. We need banking regulation to level the playing field in that regard.

Dominic Hannigan (Meath East, Labour)
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I thank Professor FitzGerald for what has been a very informative presentation and for answering our questions. We look forward to seeing him at this committee again.