Global Economics

Ireland's Luck Is Running Out


The island nation's decline goes beyond the credit crunch and bear markets: It's emblematic of the perils of competing in the global economy

Once the envy of Europe, Ireland's economy is set to grow this year at it slowest rate in two decades. The collapse of a housing bubble coupled with the strong euro is raising unemployment and slowing growth, reducing the Celtic Tiger's roar to a whimper. And the news keeps getting worse. More than $5.5 billion was wiped off the value of Irish stocks on Mar. 17, in what commentators have dubbed the "St. Patrick's Day massacre."

"The Irish economy is heading into recession," says Alan Ahearne, an economist at the National University of Ireland, Galway, and a former senior economist at the U.S. Federal Reserve.

Ireland's slump is, in many respects, a microcosm of the challenges facing countries such as the U.S., Britain, and Spain. It's not just about the global credit crunch, weak banks, or bearish stock markets. Rather, Ireland is at the tail end of a housing- and consumer-fueled boom—similar to that of the U.S.—and finds itself at the mercy of global trends such as inflation, wage-scale gaps, and increased competition from emerging economies.

Rising Prices, Eroding Exports

The former highflier's troubles began in the housing market, but they predate the global credit crunch by nearly a year. Ireland enjoyed the biggest property boom ever recorded, Ahearne says, with average house prices up more than 300% in the past decade, to more than $490,000 at the beginning of last year. Since then, though, both home prices and residential construction have fallen off sharply. The building slump has led many construction firms, which are among the country's biggest employers, to slash jobs. Ireland's housing sector as a percentage of gross domestic product is three times bigger than that of the U.S., so the downturn, Ahearne says, is having a much bigger impact on the broader economy.

At the same time, the cost of living and doing business is soaring. The headline inflation rate is hovering near 5%, while basic consumer inflation is 3.5% vs. 3.3% for the euro zone as a whole. And the euro's rise against the dollar and the pound sterling has made Ireland much less competitive in its two main export markets. That, in turn, has led many manufacturers, both Irish and foreign, to eliminate local positions. Over the last year, big multinationals such as Pfizer (PFE), Procter & Gamble (PG), Motorola (MOT), Vodafone (VOD), and Allergan (AGN) have cut scores of Irish jobs. Irish unemployment topped 5.2% in February, up from 4.5% a year ago.

The upshot, says Jim Power, chief economist at the Dublin-based financial-services group Friends First, is that Ireland's global competitiveness has markedly deteriorated. That's a view also shared by the European Central Bank, which recently issued a report showing that for the second year in a row, Ireland suffered the biggest decline in competitiveness of the 15 countries in the euro zone.

Multinationals Pull Back

Now Power and others fear that Ireland's decline, coupled with increased competition from lower-cost, emerging markets, is threatening the very foreign direct investment that made its economy so successful in the past two decades. The country hosts nearly 1,000 foreign multinational companies that employ more than 150,000 workers. Led by technology giants such as Intel (INTC) and Microsoft (MSFT) and pharmaceutical firms such as Wyeth (WYE) and Amgen (AMGN), these companies were attracted by Ireland's low, 12.5% corporate tax rate, skilled workforce, and business-friendly environment.

There are already signs that the pace of foreign investment is slowing. A recent report from consultancy OCO Global showed that the amount of direct foreign investment into Ireland fell by 5% last year, to $2 billion. At the same time, the number of Irish jobs created as a result of foreign direct investment fell by 40%. Case in point: Last October, Amgen, the world's biggest biotech company, announced it was shelving plans to build a billion-dollar manufacturing plant in County Cork. Mark Sawyer, the company's general manager in Ireland, said in a statement that the decision was "in no way reflective of the business environment in Ireland."

That may be, but there are real fears that if the European Commission succeeds at harmonizing corporate tax rates across Europe, Ireland's competitiveness would be further eroded. "It would remove significant competitive advantages from economies such as Ireland that have used a competitive corporate tax rate as a sweetener for multinationals to locate here," Power says.

"The Emperor Has No Clothes"

In truth, Ireland's competitiveness has been eroding for the past five years. But it was disguised, Ahearne says, by the housing boom, which fed the domestic economy and kept the jobs machine going. At the same time, Irish exports, underpinned by a booming global economy, kept growing.

With the U.S. heading toward recession, the situation has changed, and Ireland can no longer rely on those twin engines of growth—housing and exports. "We are now seeing the emperor has no clothes," says Ahearne. "It is slowly dawning on policymakers and others that the Irish export sector is in far worse shape and more vulnerable than they imagined."

The problem for Ireland is that, as part of the euro zone, it has no control over either interest rates or exchange rates. That leaves the country no room to maneuver its way out of recession via monetary policy. Yet fiscal policy poses its own dilemmas. Experts say the best way for Ireland to regain its competitiveness isn't to flood the economy with public spending but rather to rein it in. The Economic & Social Research Institute, a Dublin think tank, forecasts that the country's $3.6 billion surplus in 2006 could turn into a deficit of nearly $12 billion by 2009 if the government doesn't curb public spending.

At the same time, economists believe that rising wages also must be capped. Roughly every three years, Ireland reaches a national pay agreement, in which unions and employers organizations work together to set national wage increases. "The way we'll regain our competitiveness in the short term is to ensure we don't pay ourselves too much," Ahearne says. "We want to convince multinationals considering investment that Ireland is not a chronically high-inflation country." And that its boom times aren't a thing of the past.


Tim Cook's Reboot
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus