“What’s the difference between Iceland and Ireland? One letter, and about six months.” That was the big joke around the City a few months back.
Last week, it seemed as if the cruel jibe had more than a touch of truth to it. Ireland, the Celtic Tiger that for the last decade had been on a giddy ascent to the top of the global prosperity leagues, has come crashing down to earth. With its banks turned to toast in the credit crunch, and property prices in freefall, the government has been forced to introduce one of the most savage budgets seen anywhere in the developed world. It included cuts of at least 10% in the pay of all public-sector workers, and reduced welfare benefits.
Yet almost alone in the developed world, the Irish government has crafted the right response to the credit crunch. It has allowed house prices to fall drastically, cut back a bloated state, and kept taxes low and steady. It is, in short, pushing for an enterprise recovery, accepting short-term pain in exchange for medium-term gain. Over the next decade, the Celtic Tiger will come roaring back. And it will give the rest of the world – particularly its larger neighbour on the other side of the Irish Sea – another lesson in how to run a modern, flexible, business-friendly economy successfully.
Ireland has certainly learnt the meaning of the phrase ‘boom and bust’. Over the last 30 years, it has transformed itself from a relatively poor backwater into one of the world’s most dynamic economies. During the 1990s, it regularly clocked up annual growth rates of close on 10% a year. Irish companies such as Ryanair expanded around the world. Migrants, once an Irish export, became an import instead, as eastern Europeans flocked to Dublin in even greater numbers than they did to London. By 2005, the Organisation for Economic Co-operation and Development ranked Ireland as one of the five wealthiest nations in the world, alongside America, Switzerland, Norway and Luxembourg. That’s a remarkable achievement, given that it is neither a global super-power, nor a tax haven, nor is it sitting on oil wells.
The British tended to be snooty about Ireland’s achievement, assuming it was riding on a tide of EU subsidies. But so was Portugal, and indeed France, and they weren’t nearly as rich. In fact, the Irish had done it their own way, with low corporate taxes and a state that was one of the smallest in the developed world.
The credit crunch hit Ireland hard. Its banks were wildly over-extended, particularly in the British buy-to-let and self-certification markets. In the last few months, the extent of the recession has become plain. The economy shrank by 7.5% this year and is forecast to contract by another 1.25% in 2010. House prices are 45% below their 2007 peak, and are still falling. Unemployment is rising. The banks have had to be bailed out.
But just look at the response. Britain, along with many other countries, is racking up huge debts, printing money like crazy, and raising taxes. Ireland, just as it did 30 years ago, is taking a very different path. As a member of the euro, it doesn’t have the luxury of devaluing its currency. Nor can it just print money. Only the European Central Bank can do that. So it had to put its own house in order. Last week’s budget set out plans to cut the deficit from more than 11% of GDP now to less than 3% of GDP by 2014. Public-sector pay is to be cut by 5% and cabinet ministers will see their salaries fall by at least 15%. Welfare payments for the unemployed were reduced, along with child benefit. Just as importantly, the government took the pain on the spending side of the balance sheet, refusing to raise taxes overall. Crucially, the 12.5% corporation tax rate that has made Ireland a magnet for foreign investment remains in place.
There is no doubt that a tough couple of years lie ahead. The budget cuts won’t turn the economy around anytime soon. There won’t be any lift from the housing market, nor will there be a sudden boom in speculative bank lending. There will be a lot of knuckling down and hard work.
But lift your eyes to the medium-term horizon and the outlook is surprisingly good. By 2012, Ireland will have its budget deficit under control. House prices will be back to levels where people can actually afford to buy. It will not be threatened by constantly rising taxes. It will have a strong currency, not threatened by constant devaluation, or vulnerable to speculative attacks in the markets. And it will have some of the lowest tax rates in Europe, along with the certainty that there will be no real need for the government to raise taxes in the future. And it will still have one of the youngest, best-educated, English-speaking workforces in the developed world. That’s a pretty good mix.
In effect, Ireland is taking the pain in one short blast. It is purging the excesses of the bubble, and putting its economy on a sounder footing. It will work. The Celtic Tiger will be back. The policies it is pushing through now will lay the basis for a strong recovery in the next decade, just as much of the rest of the world is scratching its head and wondering why the strategy of piling debt upon debt isn’t working. Not for the first time, the Irish will have given the rest of the world a lesson in sound economics.