Government must let property bubble burst

 

The property crash is not an economic disaster but a coming of age, writes Michael O'Sullivan.

TOO MUCH of the commentary on Ireland's economic downturn is focused on the short term, on trying to prevent the necessary unwinding of the bubble in our property sector. Only when all of the illusions we hold about Ireland's economic performance over the past seven years are broken can we move onto the next phase in its economic development.

Ireland's economy has grown in two broad stages in the last 20 years. The first one was a coupling of the country to the very powerful forces of globalisation (eg US multinationals), while the second saw the flourishing of the domestic economy with the tailwind of low interest rates.

Where the first phase saw Ireland grow in confidence, the second, arguably, saw it become complacent, uncompetitive and dazzled by its own unexpected success. This is standard behaviour in economies in the full throes of an economic bubble.

The catharsis of a recession should help to bring expectations back to more normal levels and, it is to be hoped, make Irish people more appreciative of their long economic history and their policymakers more focused on the long-run economic and social future.

Instead of panicking in the face of the contraction in growth, we should see the bursting of Ireland's economic bubble as a necessary coming of age and an opportunity for reflection. Ireland is a developed country with an adolescent economy; awkward and sometimes ugly growing pains are to be expected.

As countless historic examples have shown (eg the Asian Tigers in the 1990s) and studies from the International Monetary Fund illustrate, economic bubbles are even harder to stop on the way down than on the way up.

The biggest mistake policymakers and politicians could make at this stage is to try to prop up the asset bubble in the property market.

However, the apparent bewilderment of some politicians in the face of the downturn, and the desire of many of our oligarchs (as expressed in these pages) to see their industries supported by the State, suggests that the short-term crisis and not the long-term future dominates attention spans.

The sooner we except that the Irish economy has been over-cooked and needs to adjust, the better, not least because mapping out the future requires an understanding of what has happened.

This is only likely to happen when a number of illusions have been shattered.

The first is that Irish policy-making genius and not global economic forces have been largely responsible for the successful globalisation of Ireland.

There is plenty of self-congratulation (some of it deserved) for the policy measures that have helped Ireland become an economic success, but no serious debate on how a small country with an open economy can manage the effects of globalisation.

Secondly, the property boom needs to be recognised as the alchemic combination of high expectations and cheap money. One positive aspect of a correction in the property market is that housing is likely to approach affordable levels.

At the same time capital should move back towards more productive sectors and away from speculative ones. Bail-outs should be avoided, save perhaps for where the poorest and more disadvantaged elements of society may find themselves financially impaired by the downturn, and where long-term social problems could arise as a result.

A third, related illusion is that the Irish economy will continue to achieve the rates of growth seen over the past 20 years. Unless the domestic industrial sector can muster sustained higher rates of revenue growth, a more pedestrian progression for our economy is more likely.

This in turn should have serious implications for expectations of wage growth, wealth and inflation.

Many of the other certainties underlying the Irish economy are also being whittled away - some multinationals are relocating and in key areas like education (especially maths and physics) attainment levels are slipping. Other articles of faith are also falling asunder, such as the assumption that Ireland is socially, culturally and politically, a European nation.

The unmasking of our economic miracle is also likely to uncover many social changes and problems that had received scant attention in more prosperous times: as the investor Warren Buffet remarked, it is only when the tide goes out that we see who's been swimming naked.

Despite the many pitfalls that could befall it, Ireland has a potentially bright economic future. Many other countries still regard it as a model to be copied. However, the real test of this model is now, in the face of a sharp correction, and how we invest for the next phase of development.

Yet, delaying a close, strategic examination of what Ireland's engagement with globalisation means could squander the country's recent successes. Inventive policy will be the key determinant of Ireland's continued economic success. Irish politicians need to accept the bursting of the property bubble as an economic coming of age and play their part in adjusting downwards expectations of wealth, wage and inflation rises. They must begin to focus on where we would like to be in 10 years, and not just in 10 months.

Michael O'Sullivan is the author ofIreland and the Global Question (published by Cork University Press).