One of the most puzzling aspects of the eurozone's technocrats' insistence of austerity for Ireland is the complete lack of math based theoretical support for their actions. According to the Expansionary Fiscal Contraction (EFC) hypothesis, successful austerity during times of global excess capacity is extremely difficult to achieve. In fact, the math of both neo-classical and Keynesian economics shows that government contraction will push down employment under all conditions. (Note: the linked article is in JSTOR, which you should be able to access online through your local library-save and invest the $36.)
American conservatives and European technocrats both claim that permanent reductions in government spending will build private sector confidence so that the private sector growth will accelerate in the longer term. There is some analysis "that support for the EFC hypothesis only applies to large and credible fiscal consolidations." This may be the problem with current efforts as none are seen as credible.
Conservatives have claimed that repeated stimulus causes a "Keynesian Death Spiral" (KDS) where the negative effects of stimulus ultimately lead to contraction. This is interesting as there are no cases of the conservative KDS in the literature while there is a proven economic theory of the Keynesian Death Spiral called the Paradox of Thrift. This occurs when everyone tries to reduce debt resulting in reduced consumption, savings and, ultimately, financial collapse. Recently there have been new economic paradoxes identified that operate only during liquidity traps: the Paradox of Toil, where efforts to work more reduce total employment in a liquidity trap, and the Paradox of Flexibility where the willingness to reduce wages and prices reduces the ability to consume.
Because Ireland is actually a responsible economic partner in the eurozone, it is inflicting programs on its population that are so painful that all three of these paradoxes are in full force. This has resulted in what I'll call a "Super Keynesian Death Spiral".
There is no need for this suffering to save the euro - Optimal Currency Area theory is well understood and shows that international risk sharing is needed (like eurobonds), not austerity in individual countries.
How bad is it? Here's the data from the 3rd Quarter report release on Dec. 12th.
- There was a decrease in employment of -2.5% or 46,000 in the 3rd Quarter 2011. The multi-year trend is detailed below.
- The seasonally adjusted unemployment rate increased from 14.2% to 14.4%.
- The unadjusted unemployment rate increased from 13.9% to 14.8% over the year to Q3 2011. The male unemployment rate was 17.6% and the female unemployment rate was 11.5% in the quarter, up from 16.8% and 10.2% respectively a year earlier.
- The long term unemployed now represent 56.3% of the unemployed. The chart below shows the change from 2008 to the Q3 2011.
In the face of this deteriorating employment situation, the Irish government is trying to enforce a budget reduction in 2012 of €3.8bn, 5.7% of household disposable income (HDI) and plans another €8.6bn reduction (13% of HDI) from 2013-15. This is a very risky strategy with little theoretical support. The analysis that supported the EFC hypothesis concluded:
Fiscal contractions based on marginal changes in taxes and government expenditures are more likely to have depressing effects on the economy in line with conventional Keynesian predictions.
The numerous analyses of the Irish deficit reduction plan shows it focuses on reducing expenditure and increasing taxes on lower income groups without any changes that will decrease economic barriers to growth. This does not support EFC outcomes and will fail, causing increased unemployment and failure to meet deficit reduction targets.
In 1933, Roosevelt went from being a budget balancing conservative to a wild-eyed liberal when it became evident that that there could be mass starvation in America over the winter of 1933-34. If austerity continues in Ireland, politicians may be faced with the same choice - and sooner than they think.
The certain failure of austerity in Ireland makes the partial break up of the eurozone almost inevitable. At some point, politicians will be forced to stop austerity to stop the human suffering and there will be a major crisis that will crush financial markets.
The only questions is, "When?"
It is difficult to make any projection on when Ireland will revolt against austerity. The next elections don't have to be held until 2016 but if austerity continues unemployment can be projected to reach 25% by this time. The government is a coalition, so it will fall apart under the strain well before this.
It's hard to believe that any Irish government will be able to pass another austerity budget if things deteriorate further. At budget time next December, Irish unemployment may be approaching 17% so the crisis should occur before December 2012, possibly much earlier.
There is a unique factor to Ireland: The Irish are fiercely protective of their independence and if things get bad enough, there are still ex-IRA (and some not-so-ex) members who can do significant damage to those they consider enemies.
Bombs going off in Dublin may be the warning signs of a euro breakup.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.