Could Ireland force Europe's hand?

With global investors mesmerised by political developments in Athens ahead of the country's general election, events in Dublin have tended to be overlooked.

But tomorrow night, Irish voters will head to the polls to vote on whether or not to accept Berlin's "fiscal compact”, which forces eurozone countries to commit to following strict budgetary discipline.

And, according to GaveKal analyst Francois Chauchat, the outcome of this vote is important for two reasons. In the first place, it is likely to have a direct impact on the upcoming Greek elections.

As Chauchat points out, Ireland and Greece have suffered a similar degree of economic pain. Between 2007 and 2011, Irish GDP per capita fell by 12 per cent (compared with a 14 per cent decline in Greece) and unemployment rose sharply, while pensions and wages were slashed. As Chauchat notes, "the immediate causes of the two crises were different, but in both countries the people endured exceptional suffering”.

What's more, he notes, the Irish and Greek votes are very similar. In both countries, there is broad support for remaining in the eurozone. The question is whether people are willing to accept the terms of participation.

The polls suggest that the Irish will vote in favour of accepting "fiscal compact”, not because they like it but because they do not want to fight the "troika” – the IMF, the European Union and the European Central Bank – which imposed stringent austerity conditions on Ireland in exchange for its bailout.

As Chauchat notes, the Irish vote will likely have an impact on the Greek election. "An Irish ‘Yes' may lead Greek voters to conclude that their hand has been weakened should they reject austerity and engage in a face-off with the troika. Conversely, an Irish ‘No' vote would surely boost poll ratings for the radical left-wing coalition Syriza above 35 per cent, putting pressure on Germany and the ECB to soften their stance.”

But Chauchat argues that the Irish poll is important for a second, and more important, reason. The economic situation in Ireland, he says, will soon force Germany and the European Central Bank to change their approach to dealing with debt-stricken eurozone countries.

He notes that Ireland has been the "teacher's pet” of the eurozone's periphery. The Irish economy clearly doesn't suffer from "competitiveness issues”, it boasts a flexible labour market, and the country runs a current account surplus. All the same, he notes, "Ireland's economy remains stagnant due to constant deleveraging as banks nurse their balance sheets back towards health.”

Indeed, Chauchat points out that capital flight from Ireland has been more severe than in Portugal or Italy, mainly reflecting the exodus of foreign banks from the country.

So even though Ireland has dutifully followed the troika's textbook approach, the economy has failed to respond, and Irish bond yields are still high. As Chauchat points out, "something is not working”.

He argues that the Irish vote will have a double impact. If the Irish vote in favour of the "fiscal compact”, they will signal that, despite having suffered as much as the Greeks, they are prepared to continue with their austerity program in the hope that it will eventually work. "And this is likely to make at least some Greek voters blink, potentially putting a centre-right government back to power.”

At the same time, Chauchat argues that pretty soon both Germany and ECB will be forced to take a hard look at Ireland's economic pain, and conclude that their existing remedies for solving the debt crisis are simply not working.

As he points out, "after all, having endured several years of ‘internal devaluation' and receiving plaudits from the troika for sticking to the plan, there is no good answer to the question: why on earth do Irish bonds still yield 7 per cent?”