November 28, 2005

We all contribute to the rip-off

Posted in Celtic Tiger ·
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When you touch down in Dublin after your winter break in the sun, the purchasing power of your euro drops considerably. What happens to debase the currency once you pass passport controls at Dublin, Cork or Shannon?

Why does the price of a cup of coffee surge 180 per cent – from �1 in Barcelona to �2.80 in Dublin?

The reason is simple: old-fashioned inflation. Although the official figures do not capture this, Ireland has been in the grip of an inflationary spiral for the past few years.

The easiest way to see this is in the progressive fall in the value of your money in this country and the corresponding increase in the value of the same money when you leave the place.

When the value of our take-home pay begins to shrink, we get worried and look for someone to blame, which explains the success of the excellent Rip Off Republic TV programme.

However, the real enemy of the TV smash hit is general inflation. Of course, the title Inflation Republic wouldn’t have caught the imagination in the same way, but it should.

So why have we been suffering price rises across the board? The main reason is the old-fashioned monetarist adage �too much money chasing too few goods’.

EU monetary union has allowed a deluge of credit to wash over us. We are borrowing money from wherever we can get it, four times faster than even the profligate Americans.

As this credit streams into the economy, it pushes up the price of everything from houses, creches and coffee to Christmas cards, wedding dresses and CDs. The new money has to go somewhere, and it finds its way into every nook and cranny eventually.

The new cash also pushes up the price of labour – which explains why our wages have gone up rapidly.

Interestingly, people do not see the latter occurring, which explains why people feel that they are just getting by despite wage increases. This is called a classic wage/price spiral.

If wages and prices are rising so quickly, why has something not snapped?

Why has there been no implosion, no meltdown, no competitive disaster?

There are two possible explanations.

The first is that EMU obscures the strains that a country or region experiences. When you eliminate exchange rates, interest rates and the balance of payments, you do away with the central disciplining mechanisms of macro-economics.

Before EMU, if we had borrowed so much credit, financial markets would have reacted to the growing inflation by speculating that our currency would have to devalue at some stage in the future to offset the fall in competitiveness.

Investors in Ireland would have concluded that in order to sell their stuff, the Irish would need to make it cheaper for international markets by responding to any increase in Irish costs with devaluation. This very rumour would have caused capital flight, and interest rates would have moved up.

All these factors, once triggered, have a self-disciplining effect.

In contrast, once you are part of a larger currency union, like EMU, none of these signals are picked up because you have no currency, no domestic interest rates and no real balance of payments to worry about.

This is why New York City was declared bankrupt in 1975, simply because no one appreciated its level of delinquency until it was too late. Like Ireland today, there were no typical warning signs.

A second reason why the creeping inflation has not led to any blow-out is that inflation is being superseded by greater forces.

The blow-out approach to economics is based on the idea that eventually stuff runs out. It can be summed up by the �you can’t fool all of the people all the time’ assertion.

But maybe sometimes you can. While there is no doubt that inflation is now in the system, its deleterious impact is being offset because we are also importing money and people at a faster rate than anywhere else in the world.

We are importing credit faster than any other country on earth, but we are also taking in more immigrants than most other countries.

For example, Ireland is absorbing seven times more immigrants per head than France or the Netherlands.

This is causing our national economic capacity to expand. In the construction and services sector, for example, the new immigrants are keeping wages lower than they would be if there were no immigrants.

Cheap credit is financing developments that would not make any economic sense had there been difficulty getting our hands on borrowing.

So we are prolonging the party by importing new money and new people.

In the longer term, economic history tells us that there are two problems with this. The first dilemma is that although we are prolonging the party, the nature of the party is changing. In recent years, inflation and generally higher costs have been causing our manufacturing industry to shrink, relative to everything else.

This development is dismissed by those neo-liberal or free market economists who believe that manufacturing is not important.

These blokes argue that, for example, America’s huge trade deficit is not important. Similarly, they say that it does not matter if Ireland becomes a service economy. Well, it does.

The same argument pertained in colonial Spain when the plundered gold of the Latin Americas flooded Spain. To cope with the demand for finery, Spanish merchants turned to foreign suppliers.

All the gold flooded back out of Spain to Britain and Holland.

In fact, its newly acquired riches went through Spain like a dose of salts. As it became progressively more uncompetitive, Spain experienced three national bankruptcies between 1557 and 1597 – less than 100 years after Columbus had claimed the New World for the Castillian crown.

The message is simple: hard work is better and longer-lasting than easily acquired wealth.

More recently, Germany tried to use immigrants to escape the inevitability of capacity constraints. In its postwar period, known as the wirtschaftwunder, from 1947 to 1967, Germany experienced phenomenal growth. By the early 1970s the Germans were running out of people.

To prevent wages from going through the roof, they imported Turks to do the jobs that newly-rich Germans would no longer do. In so doing, they prolonged the boom for a few years, but when it eventually ran out of steam, they were left with a second-generation immigrant population accused of stealing (now scarce) German jobs.

So next time you arrive home and feel the purchasing power of the euro in your pocket diminish, think about inflation.

Until recently, we reacted to inflation with outrage, as seen in the Rip Off Republic programme. But in reality we are all part of the rip-off. We are demanding higher wages to offset higher costs, while at the same time whingeing for 21st-century wages and 20th-century prices. It doesn’t work like that.

All prices are rising. Cheap credit and immigrants are masking the problem now, and this false sense of security might continue for awhile yet.

But history backs up Abraham Lincoln’s observation: �You can’t fool all of the people all of the time.�


  1. Dan Hayes

    David,

    Over here the American economic “boom” has been driven by
    the housing market, which essentially is a Ponzi Scheme.

    When the market goes south, as it inevitably will, we will
    be left with a lot of foreclosures and an surfeit of
    illegal Mexicans who have been acting as hod carriers. They
    are here to stay and the taxpayer will be left to pay their
    bills in the inevitable economic downturn to follow.A
    harbinger of things to come is already occuring in
    California where American hospitals near the Mexican border
    are saddled with nonpaying Mexicans and forced into
    bankruptcy. Of course their employers get off scot free.

    Isn’t Anarcho-Capitalism wonderful!

    Dan

  2. adrian

    External forces may wash over and drown the party.

    The pyramids of Giza are of a solid construction, built to
    last, stable and not to spikey at the top, solid and load
    bearing at the bottom.

    It would do no harm if central bankers went over to have a
    wee look at them. The pyramids round here just dont look so
    good – wheres the building control?

    Recent excitement in the oil market has been spilling over
    into global inflation figures. The U.S. has been raising
    rates in an effort to head off inflation and take the heat
    off their defecits which have been boiling over of late.

    Such U.S. action is creating a relative weakness on the Euro
    causing oil etc. to be priced up in europe. Europe is
    responding by creating a perception that the interest rate
    escalator is now turned on…. what will happen next who
    knows?
    Are the U.S. and europe heading towards an interest
    rate/currency strength battle? Good fun for the viewers but
    the casualties of war may be heavy. Expect collatoral
    damage and watch out for friendly fire!

    In my view the low interest environment of late has created
    a global pyramid based economy with little underlying
    support.

    At the top of the pyramid excess credit and far eastern oil
    demands are pushing up consumer and asset price inflation.
    At the bottom of the pyramid there are unemployed central
    europeans and global consumers carrying excess debt. The
    pyramid is too spikey at the top, too weak at the bottom.
    An interest rate battle may have the same effect as flying
    an airoplane into a tall building.

    Run!
    P.S Dan go easy on those Mexicans. Not so long ago the
    illegal hod carriers were Irish. Nothing ever stays the same
    Americans may be illegal hod carriers in Mexico one day!

  3. Paul Rux, Ph.D.

    David, I have not been to Ireland since 1968. My wife and
    I hope to get there in 2006. Per your articles, I must
    brace myself for the changes! It is hard for me to
    imagine immigration to Ireland, for when I last visited,
    the export of Irish bodies to other countries was in full
    force. I thank you for your articles which hopefully will
    brace me for the shock of what I fill find. I loved the
    Old Ireland. I have not experienced the New Ireland that
    you describe in your columns. For the Irish to stay at
    home to work is great. I am not sure about importing
    aliens. Hopefully, in 2006 I will have the chance to
    experience what you describe and analyze first hand.
    Meanwhile, I thank you for your updates on Ireland. God
    bless Ireland! Paul Rux, Ph.D. http://www.paulrux.net

  4. Garry

    My, what a cheery bunch :) Remind me never to go drinking
    with economists :)

    Were at some point in the greatest economic period in Irish
    history. Who knows maybe its just getting going, maybe its
    at its peak, but f*** it, but would anyone swap it for the
    1980′s with its dodgy haircuts, 20% unemployment, and mass
    emigration. Remember self aid anyone?

    Enjoy reading the articles and the comments, all the best!!!

  5. Mark

    After reading your article last Sunday the 27th November,
    I was wondering, was it wise for Ireland to enter into the
    single European currency. Since the introduction of the
    euro in 1999, our inflation increased to around 5% per
    annum at the start of the decade. With that, our local
    government set about lowering the tax rates in Ireland
    which were to have an obvious effect on the spending
    patterns in this country.

    Given the fact that we pay the lowest income tax rates
    within the single currency, are we swimming in the wrong
    direction, compared to our European neighbours in the
    single currency? Plus, if our economic fortunes, were to
    take a turn for the worst, will the ECB in Frankfurt,
    consider Ireland’s position and adjust the interest rates
    accordingly, or will they tell the Irish government to get
    on with it, and take appropriate action to sort out this
    mess. I think we know what the answer will be.

    I ask you, Mr McWilliams, do you think there is a future
    for manufacturing jobs in Ireland and the European Union.
    China and other Asian economies are expanding there skills
    at a rapid rate, while in the western world people seem be
    resting on there laurels. While I understand your point
    about manufacturing jobs and trade deficits, there isn’t a
    single country within the single currency that can compete
    with China on costs.

    As we are witnessing in the farming industry in the EU, we
    seem to be content in paying some farmers a monthly cheque
    for producing very little and depress the world market as
    we subsidise these people to stay on the land at the
    expense of the European taxpayer and the poor in the
    developing countries around the world. Subsidies are not
    the way forward for any industry, if it plans to survive.
    Indeed, most European Nations privatise there national
    airline carriers as they couldn’t afford to keep bailing
    out, a lost making organisation.

    I don’t see a great future for the manufacturing industry
    in Europe in the near future. Looking at the manufacturing
    figures in the UK and Ireland, I believe that they have
    been declining year on year, for a while now.

    All parties come to an end, like the German boom in the
    50’s and 60’s and when the lights come on after a hard
    night on the booze, most people are in a state of shock as
    they wonder where the night as gone. Let’s hope the
    hangover won’t be as bad.

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