The luck of the Irish has run out: After 20 years of spectacular success, Ireland has fallen on very hard times. Some analysts believe Irish gross domestic product will contract by nearly 10 per cent in 2009, with further contraction possible in 2010. The job losses will be huge, and without drastic action, the fiscal deficit could balloon to over 12 per cent of GDP. The Conference Board of Canada's own benchmarking of the economic performance of major OECD countries has seen Ireland plunge to last place from its No. 1 ranking in 2007.
Why is this happening? Certainly the U.S. economic recession has meant a sharp reduction in flows of foreign direct investment, which was a key factor in the rise of the Celtic tiger during the 1990s. But the collapse of foreign investment was not the only factor - and probably not even the main factor - in Ireland's sharp recession.
Ireland experienced a huge property bubble over the past decade, similar to the housing bubbles in the United States, Britain and Spain. This created the illusion of more wealth in the country than actually existed. The Irish bubble, in both new investment and in prices, was driven principally by profligate lending behaviour by certain Irish banks, allowing developers to build housing estates across the country. Domestic tax advantages to builders also drove the bubble. In far too many cases, and in all corners of the country, the new housing estates are sitting empty, or are rented only for the short summer tourist season.
The Irish economy was further inflated by huge nominal wage gains throughout the economy. Irish minimum wages are the second highest in Europe, nearly $14 an hour - much higher than its closest neighbour, Britain, which has the added advantage of a pound that has fallen in value against the euro over the past year. As a further sign of wage inflation (plus a lack of realism in politics), the Irish prime minister makes more money than the U.S. president!
There is yet another complicating factor: There is no independent Irish monetary policy to address local financial and economic conditions. A member of the European Union since 1973, Ireland eagerly adopted the euro as its currency when it was launched in 1999. The euro was initially a source of strength and stability in attracting foreign investment to Ireland, but has now become a significant drag on the country's competitiveness. Membership in the euro zone has meant Ireland was unable to raise domestic interest rates to slow the housing bubble, and it is now unable to slash interest rates more aggressively than other euro members. Moreover, a still-strong euro makes Ireland an expensive place to visit and it impairs Ireland's international competitiveness for its exports.
Can Ireland rebound? Many of the underlying reasons for the 20-year foreign investment boom are still there - low corporate tax rates, membership within the EU's trade rules, a well-educated, youthful and highly articulate English-speaking work force. Once America's global corporations begin to recover and expand, Ireland should once again attract new foreign investment.
But significant domestic reform is also needed. The Irish banking system will have to deal with the huge stock of non-performing mortgages, requiring significant additional government support. The Irish government's budget needs to be brought under control through spending cuts and increased taxation, and domestic prices for labour and for property are going to have to fall much further before the country restores its international competitiveness. The Celtic tiger can crawl out of the pit, but some tough and unpopular policy decisions will be needed, too.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.