7 Reasons Why Ireland Will Be Left Behind


IRELAND POST-RECESSION:As the first signs of economic recovery are seen in the US, Ireland faces a glut of problems that could see the country left behind while the rest of the developed world returns to fiscal prosperity

LAST JUNE when Ben Bernanke thought he spied some green shoots of recovery in the US economy, another American economist, Nouriel Roubini, referred to them as yellow weeds, while Warren Buffet claimed not to have seen anything, even though he had just had cataracts removed from his eyes.

In recent weeks there is more reason for optimism in the US and most commentators would be of the view that the US economy may show some modest growth in 2010, though the unemployment rate might be slow to come down. Because America is a relatively closed economy the robust fiscal stimulus and quantitative easing were bound to pay dividends. American recessions usually don't last much longer than a year.

Some recovery in the same timeframe is probably also on the cards for the euro area.

So what does all this mean for Ireland?

If the world economy is beginning to grow again, it might be expected that Ireland, because of its openness, would benefit quickly through stronger exports, foreign direct investment, increased tourism and so forth. There are signs the pace of decline in Ireland is moderating but we still don't know when the floor will be reached or how long the economy will remain on the floor. There are reasons to believe recovery in Ireland will take longer than in other developed economies and they are listed below.

1 Lack of competitiveness

It is by no means certain we have restored competitiveness. Wages and other costs have been reduced in the recession, especially in the exposed sector, but this has also happened in other countries with which we trade. We may not have improved our competitiveness, relatively speaking, by very much, if at all. Maintaining our high minimum wage rate, while admirable in terms of equity, is not conducive to protecting market share. The lack of public-sector reform is also an adverse factor since it reduces overall productivity in the economy and adds to unit costs.

Because of a legacy of uncompetitiveness, the rising tide of international trade may not lift our boat until all the bilge water has been pumped out. Resumption of inward flows of foreign direct investment may also be delayed for much the same reason. In addition, US multinationals may be reluctant to go against Barack Obama's stated desire not to "ship American jobs overseas". At present, there are affiliates of almost all of the important high-tech US multinational companies established in Ireland. This could imply a sort of natural limit to further investment from the US.

We are powerless to influence the exchange rate at which we export and import. If the US dollar were to fall further in relation to the euro, we would suffer another loss of competitiveness. If China, for example, were to switch some of its savings from dollars to euros, this problem would be thrown into stark relief. Ireland should ask the IMF to revisit the 'substitution account', ie the creation of a new international currency in which countries like China could invest without causing exchange-rate volatility.

2 Dormant construction industry

It is certain one sector of the economy will not make any contribution to growth for some years to come. Because of years of overbuilding, the construction sector will remain dormant for a long time. This is particularly troubling because it is a labour-intensive part of the economy. It also has a high multiplier effect on other sectors.

3 Uncertainty about taxes

Nama and the process of fiscal adjustment have caused major uncertainties, especially in the minds of taxpayers. No one knows for sure how much additional taxes will be imposed as a result of bailing out the banks. The tax commission report also creates uncertainty.

Even though it appears as if the government may long-finger some of the tax proposals, the public don't know this for certain. In these circumstances it is likely people will save as much as they can now to cope with future tax liabilities. Although consumer spending may not fall a great deal further, it is not likely to recover any time soon.

The government is dealing with the various issues one by one and it does not see the interconnections, eg between Nama and consumer behaviour. This reflects the fact there is no overall economic plan. Another example is the effect of the property-tax proposal on Nama and indeed the entire budget. As long as the prospect of a property tax is hanging over people, the property market will remain moribund. It would be madness to trade-up in such a climate. Thus the recovery in property values needed to make Nama profitable and to safeguard taxpayers probably won't occur. This is another huge inconsistency that arises because there is no overall strategic plan.

4 Limited access to credit

Because of sluggish consumption and a moribund property market, business investment will be slow to recover. Nama will have the effect of providing liquidity to the banks but there is no guarantee that this will increase the flow of credit for business investment. Traditionally, Irish banks have not lent much for investment in plant and equipment and it is most unlikely that they will start now. Nor do they have much understanding of the investment needs of high-tech sectors of the economy.

To date the Irish banks have been investing their liquid surpluses in government paper. This is likely to continue. In other words they will get funds from the ECB (on foot of the Nama IOUs) and will invest them in Irish government bonds. This will of course help finance the government's fiscal deficit but it won't do much for the private productive sector.

In essence the ECB will be financing the government's fiscal deficit. This would be illegal under EU rules if it were done directly. But if the funds are provided first to the Irish banks who then pass them on to the government, that is not illegal. A cynic might well argue that this will make it easy for the government to avoid important decisions like public sector reform, pay cuts, and so on.

We can now, at last, understand the main reason why the government set its face against nationalising the banks. If they had done that the ECB funds could not end up in the government (NTMA) coffers. This is because the banks would be owned by the government and the ECB would not be permitted to lend to them. Nama, in other words, has all the hallmarks of a stroke. One wonders if the Greens are even aware of this.

But strokes do not help the economy. The entire exercise can be seen as a weird form of 'crowding out' - sidelining the private sector in favour of government. It is likely the private business sector will remain short of credit, especially for medium- to long-term investment which is so crucial for continuing development.

It is also likely that public investment in infrastructure will be cut. This kind of expenditure is easier to cut from a political point of view than social welfare spending or public servants' pay. But, unfortunately, it will reduce the productive capacity of the economy.

5 Unrest among the social partners

The destructive bickering of the social partners as they seek to impress their respective constituencies, is a complete turn-off to potential investors. The social partners spent the last 15 years dividing up the national cake among themselves, but did nothing to enlarge it. The big decisions about social welfare, public sector reform and additional taxation have still to be taken and no constructive proposals are coming from the social partners. Instead there are warning shots and threats of civil unrest similar to those which bedevilled the country in the 1980s.

6 Hoarding labour

Many companies are trying their best to avoid redundancies in the hope a recovery will begin sooner rather than later. But labour-hoarding cannot last indefinitely. The longer recovery is delayed, the greater the risk that many more workers will be let go.

7 Lack of confidence

The confidence built up in the Celtic Tiger period has now been lost and the polls show there is little confidence in government to lead the way out of recession. The 'fire in the belly' which is required to get business investment going again is not in evidence.

There are, of course, some positive factors such as the goal of becoming a smart economy, networking with the Irish diaspora and the developing stock of Irish entrepreneurs, especially in the field of technology. But these factors have a fairly long gestation period and, although they will benefit the economy in the long run, it is unlikely they will be significant in helping the economy recover over the next few years.