The Irish hangover

Ireland is now experiencing a nasty hangover, after a ten-year economic party based on low company taxes and a debt-led property boom.

The emerald isle’s gross domestic product will contract by a whacking 10% this year, say OECD forecasts.

Unemployment is over 12% having risen even faster than in America. This is from effectively full employment 2 years ago.

House prices are reported to have fallen by as much as by 50%, although the average fall is about 9% and not that different from many other countries.

Some bank shares have fallen in value by as much as 90%. The Government had to nationalise the worst performer, Anglo Irish Bank.

The famous Celtic Tiger had a long way to fall though. Recently the property market went crazy. House prices had more than doubled in the past decade and billions of dollars are expected to be lost as loans to property developers turn bad.

Adopting the Euro currency also had a hidden problem. People could borrow money at effectively German interest rates.

The Irish Reserve Bank lost the power to raise interest rates as part of the deal, so the property bubble probably got bigger than it otherwise might have.

Fortunately Irish banks didn’t get tied up with American toxic loans. But they did lend too much to their own wild boys. The bad loans, largely to developers, could amount to as much as 10% of the whole economy.

Regular Irish have also been hit hard. Queues for the benefit have been long and those with work are taking pay cuts. It’s similar to most countries but more severe.

Many have mortgages to pay on houses whose value is less than that of the loan. This is the price they pay for grabbing 100% mortgages in the belief that house prices will always go up.

The Government is also suffering, running a significant budget deficit after a large drop in revenue. Public servants’ wages were too high and have been cut along with other spending.

Despite the low company taxes of 12.5%, the Government made plenty of money during the long boom, when migrant workers moved to Ireland.

They bought houses, prices went up and everyone was happy. Now they are leaving, as the property developers, whose debts paid their wages, go broke.

Even so, 17 years of economic growth, at an average rate of 6.5% cannot be dismissed. Within two generations, Ireland has become a different country.

Even 30 years back, many Irish homes lacked electricity and had outside privies, rather than proper toilets.

Ireland's dispersing population - estimated at 70 million - helped populate the New World. Even now, the rate of unemployment is much lower than in the bad old days when it was over 17%.

Ireland’s growth was not initially based on property speculation, but on exports and the arrival of overseas companies attracted by low taxes, access to the EU market and a young, educated, English-speaking low-cost workforce.

The hangover cure

As the Finance Minister argues, the key is in turning the economy back to genuine export-led growth. As part of the European Union, there should still be demand for both Ireland’s high-tech electronic goods and its traditional farm products.

A reduction in wages and a rise in taxes will also help, according to The Economist. Both appear likely. At 12% unemployment, wage reduction is inevitable.

As for taxes, the government relied too heavily on revenue from property-related taxes.

Now that this has diminished, revenue will have to come from elsewhere – most likely an increase in income tax, as they are reluctant to change their attractively low corporate rate.

Large companies, like Dell computers set up factories in Ireland, although today the trend is to assemble even the top brands in China. Ireland is hoping a reduction in wages and the low corporate tax rate will encourage companies like them to stay.

Yesterday the Irish Parliament sat down to ponder the ominous prospect of buying €90 billion of bad loans off the country’s banks.

These loans are currently clogging up the lending system and small businesses can’t find cash to pay their expenses, squeezing each other’s revenue and creating more unemployment.

The debate on the street is whether it’s worth locking in a future of government debt at taxpayers’ expense.

The government firmly, and rightly, believes it is – because compared with further economic stagnation, it is the lesser of two evils.

The key is how much of a discount they will demand for the loans, with some saying around 30%.

The country also needs to cuddle up to Europe. This is looking iffy. Ireland is the only country in the EU that has still yet to approve the Lisbon Treaty, which increases the powers of the European Parliament.

The second-chance vote is on October 2 and the EU has given binding guarantees that it won’t change Ireland’s military neutrality, abortion and taxation policies.

Many Irish people are still undecided or downright suspicious. But as they account for only 1% of Europe’s population, other countries may feel the tail is wagging the dog. And Ireland certainly isn’t in a position to bargain.

By Lawrence Watt