Irish economy faces severe challenges, says Trichet

"Hard decisions" will have to be taken to overcome the "severe challenges" facing the Irish economy, the president of the European Central Bank (ECB), Jean-Claude Trichet, said in Dublin today.

Mr Trichet told members of the Institute of International and European Affairs (IIEA) that he was "optimistic" about the prospects for the Irish economy, but he cautioned that the Government must adopt an economic policy that "convincingly reduces future public deficits" and recovers lost competitiveness.

The Irish economy will be "well placed" to benefit from the eventual recovery in the global economy because of its open nature, he said.

Repeating his call for wage restraint, Mr Trichet said it was vital that euro zone governments and social partners take account of competitiveness and labour market conditions when setting wages "in a responsible and timely manner", while national authorities should "pursue courageous policies of spending restraint" in order to minimise job losses.

"We surely do not want to lose human capital or scar a large proportion of the people of working age," he said.

The ECB president also called on governments to resist introducing measures that hinder free competition, cross-border trade and protectionist measures.

He said reforms under the Lisbon agenda must be implemented to improve the euro zone's long-term growth prospects.

In a speech concentrating on both the external and internal competitiveness of the euro zone, Mr Trichet said "competitiveness" was a disconcerting word to many people as it suggested pressures to change that could have personal and social costs.

But he added that countries in which highly productive firms can thrive were likely to do better in terms of their overall export performance: "In general, these are countries with more intense domestic market competition, better technology and greater openness to foreign competitors."

Observers who in the past said that European integration would lead to the continent closing off trade avenues to the rest of the world have been proved to be "utterly wrong", Mr Trichet said.

In the mid-1990s, exports of goods and services from the euro area to the rest of the world came to around 30 per cent of the area's total gross domestic product (GDP); now they are closer to 44 per cent of GDP. This makes the European economy more open than the US and Japan, he noted.

Mr Trichet said the main source of difference in increases in unit labour costs throughout Europe stemmed from differences in wage growth and not differences in productivity growth.

The ECB President said some countries had seen their labour costs increase as a result of strong growth in domestic demand that was "related to expectations of consumers or firms about future income and profit prospects, which, it is now clear, were overly optimistic".

This situation was "often accompanied or intensified by an insufficiently tight fiscal stance, even if headline fiscal numbers such as the deficit and the debt ratio still suggested a healthy fiscal situation", he said.

"In some cases sizeable wage increases in the public sector during normal or good times may have provided the wrong signals for wage bargaining in other sectors," he added, resulting in losses in competitiveness and the build-up of "domestic imbalances".

Turning directly to Ireland, Mr Trichet said advantages such as the Irish economy's openness to trade, a high degree of flexibility, a business-friendly regulatory environment and a skilled workforce had not been lost as a result of the global financial crisis, but the unprecedented international economic shock had come at the same time as the Irish economy's necessary rebalancing.

"Some things will of course have to change. But none of the positive characteristics are lost nor should they be lost in the crisis," he concluded.

The IIEA welcomed remarks made by Mr Trichet in Paris last week that to speak of any particular country as a weak link in the euro zone would be an error of judgement.

In a statement, the IIEA Working Group said the cost of Government borrowing could be "mitigated by a positive gesture" from the ECB.

"Solidarity in the European Union as a whole and within the Euro-system has never been more urgent," they said.

The governing council of the ECB meets in Frankfurt next Thursday to decide on interest rate policy. After keeping its key lending rate steady at 2 per cent earlier this month, the ECB is widely expected to announce a further cut in interest rates, which would take euro zone interest rates down to a historic low.