Taking the rough with the smooth...

Barack Obama reportedly brought five books on his recent holiday in Martha's Vineyard - a careful mix of fiction and nonfiction, a dose of urban crime and rural tranquility, with a dash of global economic thought and some American history. An ambitious list I would think, as I tend to battle my way through just the one Dan Brown book at a push on my holidays. The global economic insight on Obama's reading list was provided by the NY Time journalist/ author Thomas Friedman in "The World is Flat". Friedman has been a regular commentator on the trials and tribulations that the process of economic globalisation produces for those who choose to participate in it freely.

One of Friedman's theses is that individual countries must sacrifice some degree of economic sovereignty to global institutions (such as capital markets and international corporations), a situation he has termed the "golden straitjacket". The main implication of giving up some sovereignty is that bridging the gap between the attitudes of the voting population of a country and these global institutions can be increasingly difficult - particularly when economic times are tough. Inevitably, though, when it comes to the crunch, local governments will tend to pander more towards their electorates than these global institutions for the obvious reason that political survival depends on votes. Obama himself has a current trade off between trying to protect the domestic job market in the US, and maintaining a strong relationship with the biggest funder of the US budget deficit - China. If he needs to print money to save jobs, but in doing so erodes the value of the dollar to the detriment of the Chinese, he will invariably opt to do that regardless. With the tough global economic backdrop, these sorts of domestic versus international trade-offs are appearing around the world more and more.

This coming Wednesday the Irish Finance Minister, Brian Lenihan, is set to announce the specifics of Ireland's version of the bank bailout plan - NAMA. The specifics he's going to clarify are the average discounts that will be applied to the banks' loan portfolios upon their transfer into this new government agency. The level of discount will be critical in determining how much fresh capital each bank will need - and what level of state ownership they can expect in the future. The larger the discount, the larger the upfront loss that will be triggered in each bank on the transfer of their loans - and the greater the damage to their already stretched capital bases.

Whatever numbers he comes up with he's likely to upset almost everyone - basically it's a lose-lose situation. If he pays too much for the loans then there is a perceived moral hazard that the banks' shareholders and creditors will not have taken a sufficient hit for the risks that they chose to take, and if he pays too little then this will only clarify for the international financial community that currently funds these banks that they are basically insolvent, and will make it very difficult to raise private capital going forward.

It's a very big few months coming up for Ireland. Aside from the NAMA debate, there is a critical second go at the Lisbon treaty referendum (the first answer wasn't the right one). While the terms of the Lisbon treaty in and of themselves are not that significant, the referendum is seen as a symbolic indication of the direction Irish people want to be going with regard to Europe - is it a continued concession of power to Brussels, or is it now the time to say this is far enough, thanks. In practice if both NAMA and the Lisbon Treaty issues go the wrong way, the implications for Ireland could be substantial - to the extent that some commentators think the IMF (at the request of the European Central Bank) may have to be called in by Christmas.

The stakeholders in Ireland Inc. are manifold - but the two biggest are the electorate, who are in control over who is in power, and the multitude of international investors who provide financing into Ireland. The "golden straitjacket" of globalisation have left these two parties running on entirely different tracks it would seem. On the one hand the government is reliant on the electorate for its capacity to govern, but on the other hand the government is reliant on the international capital markets to allow it to manage its finances, and for investment into the Irish companies that will create growth, jobs and tax revenues. Intel, for example, which employs thousands of people in Ireland have a strong interest in Ireland being fully committed to further European integration - they are putting 1mm Euros into the "Yes" campaign for the Lisbon treaty referendum, and the consequences of a "No" vote may result in serious repercussions for Intel's long-term desire to invest in Ireland. There is a very serious trade-off here.

Ireland plotted it's economic path over the past 20 years as a "small, open country" - small in the sense of geographic size and population, and open in the sense that it had realised the benefits of international trade, particularly the benefits of a full participation in the ever extending European Union. During the good times this costume suited quite nicely. Ireland focused on high margin pharmaceutical and information technology businesses, attracting inward investment on the back of a well-educated, English speaking workforce. Lower margin work, was "traded away" in the comparative advantage stakes, and instead of mass producing cheap clothing and the like these were imported from Taiwan and China at mind-blowingly cheap prices. For quite a time this worked well, and Ireland was the poster-child for the high margin export led growth model. Domestically, tax revenues were substantial, credit flowed, asset prices soared and the living was easy.

In the space of alarmingly few years, however, Ireland has fallen from the top of the world economy beauty parade. The evidence shows that Ireland's most respected institutions including the Central Bank, the major Irish banks, the Department of Finance, and others failed to grasp the massive danger to the economy posed by the property bubble.

Whatever happens in Ireland over the next few months, what is increasingly clear is that there is a growing divide between what the electorate want their government to do and what it actually can do. Ireland is running a substantial budget deficit, like most of the rest of the Western world, and unemployment is pushing 13%. Domestically, the bankers are apparently to blame for the situation, and the prospect of further concessions to a European Union that Ireland is now a net contributor towards are a difficult proposition to swallow. The "golden straitjacket" is not going to provide the government with much room to manoeuvre, but there is a serious risk that favouring the views of the electorate too heavily versus international stakeholders will leave Ireland in a worse position over the long run. A no vote to the Lisbon Treaty and a overly harsh approach to NAMA will put Ireland in a very tricky position with Europe and the international capital markets. Having plotted it's economic course and benefitted heavily from economic integration it's now Irelands responsibility to take the rough with the smooth.