ANALYSIS:With recent events on Wall Street in mind, the Government here may need to help Irish banks and talk down public expectations of never-ending growth, writes Michael O'Sullivan
Last night's rejection of the US treasury's assets relief plan underlines the deep tensions facing the world economy and heightens the need for small countries such as Ireland to face up to the implications of the credit crisis. Under the so-far unsuccessful plan, liquidity from the treasury would have helped to undo the critical blockage in the plumbing of the global banking system that has so far prevented money flowing through to the real economy.
The proposed treasury plan took place against a background of tectonic level changes in the global financial services industry and a shift in economic power globally, from leveraged countries (ie the US and the UK) towards less leveraged ones (ie China, the Gulf states and Brazil).
The plan also marked the first time during the credit crisis that policymakers had begun to tackle the underlying causes of the credit problem rather than its symptoms.
More importantly, in the context of Ireland's drop into recession, the Tarp and the manner in which it was put together has much to teach a small globalised country such as Ireland.
The first lesson is that we should not imagine that the dramatic actions taken by Ben Bernanke and Henry Paulson in the past two weeks are sufficient to reduce significantly the economic risks facing the world economy in general and Europe in particular. Their actions were necessary to prevent a profoundly serious dislocation in financial markets becoming a grave economic threat, but the launch of the treasury plan does not itself eliminate the economic risks.
What is worrying here is the apparent glee of politicians in Ireland and across Europe at the results of short selling restrictions last week. Such short-term steps do very little to address the underlying economic fault lines facing Ireland and its neighbours.
This approach also masks the absence of any serious debate of the economic risks facing Ireland and of the ways globalisation affects it in the longer term.
Similar to the debate on the Lisbon Treaty, there has been plenty of alarm in the press about the possible extreme scenarios that could transpire (ie bank runs, soaring unemployment and the like), but very little careful analysis of what is probable. In short, this is a time when there is a premium on cool heads and leadership. The innovative policy approach of Fed Reserve chairman Ben Bernanke and the "stand-up and fight" attitude of treasury secretary Henry Paulson are good examples to follow in this regard.
Another trend that has become clearer is that market prices will rise or fall until they inflict such pain on authorities and consumers that they change their behaviour.
Bankers and policymakers in Europe, Asia and the US have so far largely reacted to seizures in the global financial system as opposed to getting ahead of the underlying problems. The lesson here is that policymaking must not be crisis-led and that authorities need to make policy changes before these are forced upon them.
In this regard, two areas of the Irish economy that need urgent attention are the banking system and public expectations of growth. Firstly, the authorities need to shepherd the Irish banks through a potentially difficult period of refunding of balance sheets, while also insisting on the managed unwind of leverage in their loan portfolios.
Secondly, public expectations of the kind of lifestyles, wage, wealth and economic growth people can enjoy are too high and need to be talked down. This is a critical, though likely politically unrewarding, exercise and will require considerable leadership to see it through. A final lesson for us is that the Tarp plan and the massive upheaval in the financial system that preceded it should break any denial of the fact that the credit crisis is the offshoot of a very significant asset price bubble.
People in Ireland need to accept that much of the strong growth in the economy over the past five years resulted from a bubble in the property/construction sector and that this bubble now needs to be allowed to deflate.
No attempt should be made to prop up the property sector, save perhaps at the lower end of the market where a steep and prolonged fall in house prices could sow the seeds of future social problems. Infrastructure such as public transport and schools needs to be built around new housing estates and conurbations, where developers' zeal has previously led planners' aptitude.
The bursting of the bubble should mark a coming of age in the Irish economy and we will be much better off focusing on the potential of the next 10 years rather than the uncertainty of the next 10 months.
Overall, the US treasury plan would have been a welcome development, especially for financial markets, but its implications also are sobering, especially for small open economies like Ireland's that have ridden on the coat-tails of Anglo-Saxon style globalisation in the past 20 years.
If we acknowledge these implications and act upon them quickly, then our economic future remains potentially bright; if we don't then we may well sleepwalk through the next decade in the same way the Japanese economy trudged through the 1990s.
• Michael O'Sullivan is the author of Ireland and the Global Questionpublished by Cork University Press.