The lesson of Ireland’s fall from grace is that we must relearn how money and finance really work

Felix Martin's "Real Money" column.

The publication by the Irish Independent on 24 June of taped telephone conversations between senior executives of Anglo Irish Bank in the days after the collapse of Lehman Brothers in September 2008 has served up a sad reminder of the catastrophe that has befallen the country that was once the European Union’s star performer.

 Asked how he had come up with the figure of €7bn for the emergency funding that was being sought from the Irish government, the bank’s then head of capital markets boasted that he had “picked it out [of] my arse” and admitted “. . . the reality is that actually we need more than that”. Asked why they were taking this loan from the public purse, he joked: “This is a €7bn bridging . . . it is bridged until we can pay you back . . . which is never.”

Of all the disasters of the eurozone debt crisis, Ireland’s fall from grace was the most spectacular. Until 2008 Ireland was the “Celtic Tiger” – a rare example of a European economy in which productivity growth rates exceeded those of the US and the government balanced its books. The crisis suddenly uncovered a very different picture: a Ponzischeme economy that had been built on a property bubble, inflated by hypertrophied banks run by a bunch of shysters.

Fortunately, Ireland has another and more positive claim to fame in this context. It happens to be blessed with one of the richest and most enterprising concentrations of economic academics and journalists in Europe today. If understanding what has gone wrong is the first step to building a better future for the eurozone, then Ireland is in the vanguard. An important new book, The Fall of the Celtic Tiger, by Donal Donovan and Antoin E Murphy, is a case in point.

Donovan and Murphy represent the strength and breadth of contemporary Irish economics. Donovan is an experienced technocrat, a veteran IMF staffer with scars from many financial crises to prove it. Murphy is a distinguished economic historian, as well as one of the world’s leading authorities on the history of monetary thought.

The great virtue of their book is that it does not flinch from asking the question that has been uppermost in the general public’s mind from the start but that has proved mysteriously elusive in most official discussion: who or what, at root, was responsible for the crisis? It is a question that is just as urgent in Britain and the US as it is in the eurozone and Donovan’s and Murphy’s study of Ireland provides a compelling answer.

Yet the answer is one that will seem counter-intuitive to many. This is because, as is the case in the rest of the world, there is already a well-entrenched conventional wisdom about the origins of Ireland’s crisis. This is that a cabal of venal financiers colluded with corrupt politicians to bamboozle incompetent regulators. The subtitle of the journalist Fintan O’Toole’s bestselling exposé Ship of Fools (2009) says it all: How Stupidity and Corruption Sank the Celtic Tiger. Or, as the American director Charles Ferguson put it in the title of his Oscar-winning documentary about the US financial crisis, it was all an Inside Job.

There is ample truth to that version of events, as the recently exposed Anglo Irish tapes have once again demonstrated. Yet how was it that these individuals were able to dominate proceedings? How was the presence of a few bad apples able to spoil the whole harvest?

It is in addressing this crucial question that Donovan and Murphy make their most valuable contribution. The answer to what caused the Irish crisis, they argue, is to be found not at the level of vested interests but at the level of ideas.

The problem in Ireland – a problem that will sound familiar to those in the UK, the US and most other developed countries – was not just “a largely passive government, reckless banks and greedy property developers”. Underlying all of these was “the climate of public opinion”, which not only tolerated but actively endorsed the way these institutions operated.

Where did this unhealthy climate originate? Drawing on financial history, Donovan and Murphy show that Ireland is hardly the first society to get caught up in the idea that innovation and endlessly inflating asset prices are sure signs of success.

Drawing on the history of economic thought, they also show that what is distinctive about the 2008 crisis is that, on this occasion, these mistaken judgements were not just improvised in the heat of the moment, as they usually are. They were given the rigorous approval of a uniquely powerful analytical framework for understanding the economy that a generation of policymakers and the general public alike had imbibed with their mothers’ milk: modern, orthodox macroeconomics. The sin was principally one of omission. This dominant conceptual apparatus “saw little role for investigating the inner workings of the financial system since, ultimately, markets could be largely trusted to self-regulate”.

This analysis of what was ultimately responsible for the Irish crisis is of major significance because it urges a different cure from the ones that are usually offered. If the fun - damental problem was at the level of ideas, then it is at the level of ideas that reform is necessary. Economics must relearn how money and finance work and communicate that understanding to the public.

That might not sound as sexy or as im - mediately satisfying as shaking up the regulators, turfing out the politicians and putting the bankers on trial. Yet Donovan and Murphy are right that without an intellectual shift of this sort nothing will change in the long run.

In a summer when already the governments of Portugal, Greece and Cyprus have been straining once again under the pressure of the crisis in the eurozone, that is a message with wide significance.

A man walks past a Bank of Ireland cash machine. Photograph: Getty Images

Macroeconomist, bond trader and author of Money

This article first appeared in the 15 July 2013 issue of the New Statesman, The New Machiavelli

How Jim Murphy's mistake cost Labour - and helped make Ruth Davidson

Scottish Labour's former leader's great mistake was to run away from Labour's Scottish referendum, not on it.

The strange revival of Conservative Scotland? Another poll from north of the border, this time from the Times and YouGov, shows the Tories experiencing a revival in Scotland, up to 28 per cent of the vote, enough to net seven extra seats from the SNP.

Adding to the Nationalists’ misery, according to the same poll, they would lose East Dunbartonshire to the Liberal Democrats, reducing their strength in the Commons to a still-formidable 47 seats.

It could be worse than the polls suggest, however. In the elections to the Scottish Parliament last year, parties which backed a No vote in the referendum did better in the first-past-the-post seats than the polls would have suggested – thanks to tactical voting by No voters, who backed whichever party had the best chance of beating the SNP.

The strategic insight of Ruth Davidson, the Conservative leader in Scotland, was to to recast her party as the loudest defender of the Union between Scotland and the rest of the United Kingdom. She has absorbed large chunks of that vote from the Liberal Democrats and Labour, but, paradoxically, at the Holyrood elections at least, the “Unionist coalition” she assembled helped those parties even though it cost the vote share.

The big thing to watch is not just where the parties of the Union make gains, but where they successfully form strong second-places against whoever the strongest pro-Union party is.

Davidson’s popularity and eye for a good photo opportunity – which came first is an interesting question – mean that the natural benefactor in most places will likely be the Tories.

But it could have been very different. The first politician to hit successfully upon the “last defender of the Union” routine was Ian Murray, the last Labour MP in Scotland, who squeezed both the  Liberal Democrat and Conservative vote in his seat of Edinburgh South.

His then-leader in Scotland, Jim Murphy, had a different idea. He fought the election in 2015 to the SNP’s left, with the slogan of “Whether you’re Yes, or No, the Tories have got to go”.  There were a couple of problems with that approach, as one  former staffer put it: “Firstly, the SNP weren’t going to put the Tories in, and everyone knew it. Secondly, no-one but us wanted to move on [from the referendum]”.

Then again under different leadership, this time under Kezia Dugdale, Scottish Labour once again fought a campaign explicitly to the left of the SNP, promising to increase taxation to blunt cuts devolved from Westminster, and an agnostic position on the referendum. Dugdale said she’d be open to voting to leave the United Kingdom if Britain left the European Union. Senior Scottish Labour figures flirted with the idea that the party might be neutral in a forthcoming election. Once again, the party tried to move on – but no-one else wanted to move on.

How different things might be if instead of running away from their referendum campaign, Jim Murphy had run towards it in 2015. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.

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