After 10 years basking in success, the Irish economy today is in deep trouble. The IMF recently issued a report spelling out what is wrong with the Celtic economy and prescribing bitter medicine to ensure that it recovers as fast as possible.
Gone are the days when business and government delegations from countries aspiring to join the EU flew into Dublin to discover the secrets of the Celtic Tiger's success. Emigration from Ireland is now again replacing immigration, even if at the moment it is mainly non-Irish EU citizens, mainly Poles, who are returning to their counties of origin that are performing better economically.
The symptoms of how deep the Irish recession is are alarming. According to the OECD the Irish economy is forecast to contract by 10 per cent this year. The IMF is predicting that Ireland will come out of its recession only in 2011, and even then growth will be at a rather sluggish 2.5 per cent for several years.
Property prices by the end of 2010 are expected to fall by about 43 per cent from the peaks reached in 2007. Unemployment is expected to reach 15 per cent by the end of this year. The budget deficit will hit 13 per cent of GDP by the end of 2009. No wonder that Standard & Poor's downgraded Ireland's credit rating from AA+ to AA a few weeks ago.
So what has gone wrong with this eurozone economy that up to two years ago was considered a model for aspiring EU candidate countries? The reasons are clearly spelled out in the IMF report. Ireland's frothy economic growth in the last decade was mainly built on property development, financial services and export-oriented manufacturing by multinational companies attracted to Ireland by the country's high level of educational attainment and generous incentives.
One could argue that there is nothing basically wrong in having such a healthy mix of economic activity. But, of course, there were underlying flaws in this model. Banks in Ireland, even more than in other EU countries, entered a race for improved profitability by lending for property development and property purchase on criteria that were obviously too generous. When the property bubble burst many developers just went out of business, while personal home borrowers found themselves in negative equity territory.
We all know what happened to the financial services sector in the last year or so. While foreign banks in Ireland were not deeply affected, the local banks had to be rescued by the Irish government to avoid the inevitable contagion in the rest of the economy.
Irish manufacturing industry was also hit at the same time. A fall in demand for Irish products meant that manufacturing capacity had to be reduced. But this process was also accelerated by the fact that Irish labour has become too expensive. As the IMF report pointed out, "Ireland has become the most expensive place to do business in the eurozone." The average wage in Ireland went up from €22,000 in 1997 to €35,000 in 2007.
The lessons to be learned from this experience are important for us too. Governments should tighten fiscal policy at times when the economy is overheating, especially in a scenario where interest rates are low. Low interest rates were the worst thing that could have happened to Ireland in the last five years.
Dazzling growth in government income resulting from frothy property-related taxes and corporate tax on financial services profits should be invested in the country's productive infrastructure. Unfortunately, most governments emulate the Irish government by using windfall revenues in good times as a political carrot to lure the electorate by lowering income tax and increasing social benefits that then become unaffordable in a time of economic crisis.
Yet another lesson is to keep labour costs under control. Despite the highly qualified workforce, Ireland is no longer attractive to foreign investors who would rather go to Eastern European countries that offer better value for money and equally qualified workers. The Irish government is now facing reality. A reduction in social benefits, a cull of civil servants, a freeze on infrastructural projects and an increase in taxation are now inevitable. This is bitter medicine, but the disease it is meant to cure is equally serious.
johncassarwhite@yahoo.com