Compared with the euro zone's expected growth of just 0.6% in 2002, Ireland still looks robust. But the country faces a peculiar dilemma: After years of extraordinary growth, wages have been rising 8% or 9% annually in the past few years, especially in key service industries. That has kicked off a stubbornly high rate of inflation, double the European Union average. And though the economy is cooling off, it's not doing so fast enough to create the needed slack in the labor market. Higher interest rates would curb this inflation. But Irish rates are now set by the European Central Bank, which shows no sign of tightening. "There is growing concern from Irish businesses that wage costs are accelerating too rapidly," says Brian Geoghegan, director of economic affairs at the Irish Business & Employers Confederation in Dublin. "We have lost some competitiveness."
Now, the Irish are fuming, and the fear in Dublin--and in Brussels--is that voters will vent their frustrations at the polls on Oct. 19. That's when Ireland holds its second referendum on the Nice Treaty, the EU accord that opens the way for its expansion to the East. Plenty of Irish don't like the idea of expansion to begin with, but they're also upset that Prime Minister Bertie Ahern--a big Nice backer--has mismanaged the economy. A "no" vote on Nice would be a good way to slam Ahern for his performance.
To be fair, Ahern makes a compelling argument that Ireland's export-driven economy--the country ships out 73% of what it produces--has much to gain from an expanded EU. This nation already has reaped enormous benefits from EU membership, primarily in the form of development grants, generous farm subsidies, and privileged access to the world's largest market.
But a win for the government on Nice will do little for the economy immediately, although it might help Ireland in the long run. It won't do much for Ahern, either. The government's approval ratings have plummeted, to 34% from more than 53% in May, when voters extended the ruling coalition's five-year mandate. "The public feels it was conned," says Alan McQuaid, chief economist for Bloxham Stockbrokers in Dublin. "At the time of the election, economists said things were getting worse, but the politicians insisted the economy was doing just fine."
It is now clear that the slowdown was obscured by massive government spending in the runup to the May poll. A generous five-year savings plan launched before the election chips in $1 from the government for every $4 a citizen contributes. The scheme will cost the state $500 million a year through 2007. Meanwhile, income taxes were cut to their lowest levels in years, with the top rate falling to 40%. With tax revenue further crimped by the slow economy, the Irish treasury is facing a $750 million shortfall for the current fiscal year--its first since 1997. The deficit is set to balloon to $3 billion by 2003, unless the government acts.
To help plug the gap, officials are considering boosting excise taxes on booze, gasoline, and cigarettes. A proposed 30% hike in cigarette taxes would price a pack at $7. Yet economists warn that the higher levies would stoke inflation.
Irish taxpayers are enduring a hangover from the boom in other ways. Housing prices have tripled in the past decade, and many families find themselves priced out of the market. Roads are congested, public transportation is poor, and the health service is underfunded. High wages are already driving some companies to seek out lower-cost locales in Asia and Eastern Europe. Foreign investment fell to $9.8 billion in 2001 from $24 billion the previous year. If policymakers don't act quickly to bolster competitiveness, the Celtic Tiger's roar may turn into a whimper. By Kerry Capell in London