The Celtic Tiger Returns

In my Money Week column this week, I've been arguing that the Irish economy will come back a lot faster than people imagine. Here's a taster....

What’s the difference between Iceland and Ireland, ran the joke in the City a few months back. One letter, and about six months.
Last week, it seemed as if that cruel jibe had more than touch of truth to it.
The Irish economy, the Celtic Tiger which for the last decade had been on a miraculous, giddy ascent to the top of the global prosperity leagues, has come crashing spectacularly down to earth. With its banks turned to toast in the credit crunch, and its property prices in freefall, the Government was last week forced to introduce one of the most savage budgets seen anywhere in the developed world, including cuts of at least 10% in the pay of all public sector workers, and reductions in welfare benefits.
But, in truth, the Irish aren’t about to go back to potato farming quite yet. Almost alone in the developed world, the Irish Government has crafted completely the right response to the credit crunch. It has allowed house prices to fall drastically, cut back a bloated state, and kept taxes low and steady. It is, in short, pushing for an enterprise recovery, accepting short term pain in exchange for medium-term gain.
Over the next decade, the Celtic Tiger will come roaring back. And it will give the rest of the world – and in particular its larger neighbour on the other side of the Irish Sea – another lesson in how to successfully run a modern, flexible, business-friendly economy.
In recent years, the Irish have certainly learnt the meaning of the phrase ‘boom and bust’. Over the last thirty years, it has transformed itself from a relatively poor backwater into one of the world’s most dynamic economies. Through the 1990s, it was regularly clocking up annual growth rates of close on 10% a year. Irish companies such as Ryanair expanded around the world. Migrants, once an Irish export, became an import instead, as Eastern Europeans flocked to Dublin in even greater numbers than they did to London. By 2005, the Organisation for Economic Co-operation and Development ranked it as one of the five wealthiest nations in the world, alongside the US, Switzerland, Norway and Luxembourg: a remarkable achievement, given that it is not a global super-power, a tax haven, or sitting on oil wells.
The British tended to be snooty about their neighbours achievement, presuming it was riding on a tide of EU subsidies. But so was Portugal, and indeed France, and they weren’t nearly as rich. In fact, the Irish had done it their own way, with radically low corporate taxes, and a state that was one of the smallest in the developed world.
But the credit crunch hit it hard. Its banks were wildly over-extended, particularly in their dabbling in the British buy-to-let and self-cert markets. In the last few months, the extent of the recession has become plain. The economy shrank by a terrifying 7.5% this year, and is forecast to contract by another 1.25%in 2010. House prices have fallen 45% from their 2007 peak, and are still going down. Unemployment is rising. The banks have had to be bailed out.
But just take a look at the response.
While Britain, along with many other countries, is racking up huge debts, printing money like crazy, and raising taxes, the Irish, just as they did thirty years ago, are taking a radically different path.
The Budget last week was a bold step. As a member of the euro, Ireland doesn’t have the luxury of devaluing its currency. Nor can it just print money. Only the European Central Bank can do that. Instead it had to put its own house in order. Last week’s budget set out plans to reduce the deficit from more than 11% of GDP now to less than 3% of GDP by 2014. Public sector pay is to be cut by 10%, and cabinet ministers will see their salaries reduced by at least 15%. Welfare payments for the unemployed were reduced, along with child benefit. Just as importantly, the government took the pain on the spending side of the balance sheet, refusing to raise taxes overall. Crucially, the 12.5% corporation tax rate that had made Ireland a magnet for foreign investment, remains in place.
There is no doubt that a tough couple of years lie ahead. The budget cuts are not going to turn around the economy any time soon. There isn’t going to be any lift from the housing market, nor will there be a sudden boom in speculative bank lending. There is going to be a lot of knuckling down and hard-work.
Even so, lift your eyes to the medium-term horizon, and the outlook is surprisingly good. By 2012, Ireland will have its budget deficit under control. It will have house prices that are back to levels where people can actually afford to buy them. It will not be threatened by constantly rising taxes. It will have a strong currency, not threatened by constant devaluation, or vulnerable to speculative attacks in the markets. And it will have some of the lowest tax rates in Europe, along with the certainty that there will be no real need for the government to raise taxes in the future. Along with that, it will still have one of the youngest, best-educated workforces in the developed world. Plus, of course, the English language.
It sounds like pretty good mix. And indeed, it is a pretty good mix.
In effect, Ireland is taking the pain in one short-sharp shock. It is purging the excesses of the bubble, and putting its economy on a sounder footing.
It will work. The Celtic Tiger will come roaring back. The policies it is pushing through now will lay the basis for a strong recovery in the next decade, just at the time while much of the rest of the world is scratching its head, and wondering why the strategy of piling debts upon debt isn’t actually working. Not for the first time, the Irish will have given the rest of the world a lesson in sound economics.