George Kerevan: Irish economic woe, put in perspective, seems bearable

Published on Tuesday 14 April 2009 21:40

IN THIS column, on 29 March, 2006, I wrote: "Regular readers will know that I'm a fan of small, independent economies… But there is also a time to take off the rose-coloured spectacles.

Not everything is sound in the Icelandic and Irish economies, which also provide negative lessons for Scotland and may portend dark clouds for the whole North Atlantic economy."

On Ireland, I worried that the Irish were moving away from their proven export-led economic model based on attracting inward investment through low corporate taxes. Instead they became fixated with an unsustainable domestic housing boom financed through cheap local bank loans. I warned: "A record 12 per cent of the Irish workforce is employed by the construction industry: any slowdown in house-building would trigger a serious rise in unemployment as well as a collapse in consumer spending. The Irish house boom is based precariously on the fact that interest rates have been kept artificially low till now because they are set in remote Frankfurt to suit the lacklustre German economy."

A year later, world interest rates started rising on the back of inflationary fears. This triggered the US subprime meltdown. But it also shattered the Irish housing boom, taking with it the main Irish banks whose profits were generated through the local mortgages. Last week, the Irish government tabled its third emergency budget in a year in a bid to stabilise finances.

So is Ireland a basket case? True, GDP will contract by 7.7 per cent this year and will not show growth until 2011. But remember that, in the decade to 2007, Ireland boasted an average growth rate of more than 7 per cent a year – nearly four times the Scottish performance. This year's drop in GDP, while serious, only reverses roughly one year's earlier growth.

Ireland's GDP per capita, if 100 is the EU average, will still be 135 even after this year's fall. That is more than the UK (114) or Germany (117). While I always thought the property boom was bound to blow up in their faces, at least the Irish have been left with a regenerated housing stock. All we got were lots of imported Chinese plasma screens. The real question is: what is the Irish Plan B? In last week's budget, the Irish finance minister, Brian Lenihan, correctly, decided to go back to basics. "Our economy must return to being driven by sustainable export-led growth, rather than by domestic demand," he said. "Our price and cost structure must fall relative to our trading partners."

In fact, the core of the Irish economy is in good condition. Exports will take a hit because foreign customers are also in recession, declining by a predicted 5.9 per cent this year. But German exports are headed for a 16.5 per cent drop and British by 9.8 per cent. Ireland is strong in precisely the sectors that should do well in the recovery, including pharmaceuticals and IT.

Lenihan has chosen to take the medicine quickly, hoping the voters will prefer that to wallowing in uncertainty. He has upped personal taxes significantly in order to narrow the deficit and give the markets confidence. Those on 16,000 a year will pay 2 per cent extra in income tax, those on 45,000 4 per cent more and anyone on 273,000 an additional 9 per cent. Public workers are also paying a hefty levy to fund their pensions. MPs will have their expenses cut by 10 per cent.

Most commentators recommended that public spending be cut rather than taxes increased during a recession. Instead, Lenihan opted for a 55:45 split in favour of tax rises. His calculation is that the fall in consumer prices (down 2.6 per cent) will compensate for the cut in living standards. But he is gambling on creating a sense of shared sacrifice. The public-sector pension levy is designed to make private-sector workers feel they are not shouldering the burden alone.

Lenihan also wants to switch resources away from consumption towards exports. By raising personal taxes, his budget was able to fund a series of initiatives for the long term. Core infrastructure investment was retained and there are incentives to boost R&D spending to 2.5 per cent of GNP by 2013 – in Scotland it's less than 1 per cent.

The Irish made their own errors. But they just may be nimble enough to correct them.