Europe has had its Greek tragedy. And the continent now seems to be experiencing an Irish one too. Ireland has taken the course urged by outsiders since it plunged into recession two years ago. The state immediately guaranteed the debts of its giant banks when their reckless loans to the Irish property sector began to default. And in the following months, the government cut public spending drastically to convince the bond markets that Ireland was serious about reducing its ballooning public deficit. Rather than rioting, the Irish public stoically accepted the need for austerity. If Greece was the black sheep of the continent, Ireland was the model pupil.
But Ireland has not been rewarded for doing the "right" thing. The Irish sovereign cost of borrowing remains as high as that of Greece and Spain as bondholders remain unconvinced, despite Dublin's austerity drive, that there will not be a default. Unemployment remains high. The deficit has not fallen. The latest statistics show that the Irish economy contracted again in the second quarter of 2010. And yesterday the Irish finance minister, Brian Lenihan, was forced to announce a further multi-billion euro bailout for its still sickly banks.
The time has come to ask whether the Irish government is on the right path. Ireland's public finances are being crucified by the state's open-ended commitment to its insolvent banks. One of the reasons it remains so expensive for Ireland to borrow is that bondholders can see how much private bank debt Dublin is underwriting.
Mr Lenihan is adamant that those European banks – including Britain's – which lent to Ireland's banks should not be asked to bear any pain as the country cleans up after the bursting of its vast debt bubble. But surely the time has come to consider a restructuring of these delinquent banks' debt in order to ease the strains on the Irish treasury. Some creditors of insolvent banks could see their bonds convert to equity. Others could be forced to take a "haircut" on their original investment (in other words accept a lower return).
As for the deficit, there is no doubt that Ireland must bring down public spending – it cannot borrow 14 per cent of its gross national product indefinitely. But the rapid consolidation upon which Dublin has embarked is crushing demand in Ireland and making the private economy even weaker. It might well be more sensible for Ireland to tap the emergency borrowing on offer from Brussels (the European Financial Stability Facility) and perform this fiscal correction over a longer period, giving the economy more time to absorb the necessary pain.
This change of course would come with risks. Getting tough with bank creditors might result in a panic flight of capital. And the Brussels funding would come with unattractive strings attached. Yet this needs to be weighed against the risk of maintaining the present course. Ireland is suffering gravely under its government's existing policies. And with the nation locked into the fixed exchange rate of the euro and with the rest of Europe now embarking on an austerity drive too, an export-led recovery for Ireland is looking increasingly unlikely. Furthermore, without a robust recovery, it is hard to see the losses of Ireland's banks stabilising.
Mr Lenihan has brought itself some time by borrowing enough money to see the Irish state into next year. The Irish government needs to use this time to reconsider its options, in particular its decision that the Irish public should absorb all the pain resulting from the folly of Irish and European bankers. If the map to recovery proves to be wrong, it makes no sense to continue following it. The sensible response is to find a new map.