Ireland vulnerable to Bush policies

COMMENT: Barely a month after President George W. Bush's re-election, political and financial market events are proving the recent comments by the Taoiseach that the election of Senator John Kerry would have been bad for the Irish economy - and the corollary that a Bush Administration will be good for the Irish economy - wrong.

It is telling that we have to return to the first Reagan presidency to find a period when, on the basis of real GNP over the four-year presidential term, the Irish economy was weaker than over the last four years of the Bush presidency.

To be fair to the Bush Administration, it has had the consequences of the dotcom bubble, 9/11 and deep-seated corporate governance failures to contend with, though it still seems in denial of the economic problems facing the US.

In turn, the problem for a globalised economy like Ireland's is that it is the natural bearer of the consequences of these problems.

The structural weaknesses in the US economy were recently highlighted in an important speech by Mr Alan Greenspan, the chairman of the Federal Reserve Board, where he underlined the dangers that growing fiscal and trade deficits pose for the US economy. If the new Bush government behaves as the last one has, then rising military spending, tax cuts aimed at the richer end of society and a weak labour market are just some factors that point to the expansion of these deficits.

President Bush seems ready to spend political capital at the expense of economic capital.

As Mr Greenspan pointed out, in the absence of serious fiscal changes from the White House to address the twin deficits, the dollar will weaken further, and interest rates may rise if foreign investors (mostly Japan and China) are no longer willing to fund the US economy.

Taking the dollar first, currency markets have already delivered their verdict on the US election, with the dollar falling beyond the 1.33 mark against the euro this week. To date most of the weakness of the dollar has been absorbed by the euro, which makes life even more difficult for Irish exporters and contributes to the increasingly uncompetitive nature of the Irish economy.

Another implication of higher deficits is rising interest rates. Though the cost of capital for Irish companies is set in Frankfurt, the cost of capital for US companies investing in Ireland is set by the Federal Reserve and the US treasury market. A rising cost of capital in the US is unambiguously negative for the Irish economy as it deters foreign investment and slows growth.

It is no coincidence that investment in Ireland and its economic performance took off once Democrat treasury secretaries like Mr Robert Rubin and Mr Larry Summers mastered deficits in the 1990s and lowered the cost of investment.

Alternatively, should the White House slow the US economy in order to rein in the deficits, this too will be bad for small open economies like Ireland's. As the most globalised country in the world, Ireland and the Taoiseach have the right to be worried about the general health of the US economy and the rise of economic nationalism and protectionism.

These forces stifled the wave of globalisation that stretched from 1870 to 1913 and created a difficult international economic climate into which the Irish state was born.

As then, wars, profound structural financial imbalances and rising protectionism are threatening open societies and economies now. Though these forces are found in both the US and the euro zone, the Irish economy is currently more sensitive to the fault lines emanating from Washington than from Brussels.

The "miracle" of economic growth in Ireland over the past 15 years owes much to the successful importation of the Washington Consensus.

Ireland is an unusual case in international economics in that it has on balance made a success of this policy mix. The facets of globalisation that anti-globalisers complain most about, such as large US multinationals, the Anglo-Saxon economic model and offshore tax havens, are among the most prominent reasons cited for the success of the Irish economy over the last 15 years.

US multinationals are important to the Irish economy partly because they pay more, and invest and research more, than domestic companies. Their productivity levels make the domestic sector look pedestrian.

The Taoiseach's concerns are well founded. Ireland has yet to really experience the down-side of the Anglo-Saxon model of economics that it has embraced over the past 15 years. The policies of the new Bush Administration look likely to test this.

Michael O'Sullivan is head of global equity strategy at State Street Global Markets, but writes here in a personal capacity.