Then the Irish story unraveled with remarkable swiftness. Ireland was the first country in the euro-zone to slide into recession in 2008, with its gross domestic product (GDP) declining more than 14% in two years by the end of 2009. Ireland also is an ongoing case study of what it means to pursue a path of austerity in response to economic crisis, in contrast to the relentless onslaught of Keynesian stimulus packages being implemented by governments ranging from the United States to China.
During the boom, Ireland’s economic transformation ranked up there with the best of the Asian Tigers. Twenty years ago, Irish GDP per person was about two-thirds of the EU average. Between 1993 and 1998, Ireland’s GDP increased by 45%, with annual rates of growth approaching 10%. House prices soared as shopping malls appeared on the outskirts of Ireland’s newly vibrant cities. By 2003, Ireland’s GDP was a third higher than the EU average. Unemployment fell from 17% in 1987 to 4%. Government debt shrank from 112% of GDP to 33%.
Thanks to a low corporate tax rate of 12.5%, Ireland attracted a huge amount of foreign direct investment (FDI). At its peak, Ireland boasted 1,100 multinational companies, which exported goods worth some $60 billion, accounting for a whopping 87% of Ireland’s total exports. Nine of the world’s top ten drug companies operated in Ireland. One-third of all personal computers sold in Europe were manufactured in Ireland. Ireland also was the world’s biggest software exporter, ahead of the United States. Ireland had become a European country that Americans could relate to: English-speaking, entrepreneurial and successful.
Thanks to a deadly cocktail of a world-beating property boom, combined with unrestrained government spending, the boom veered out of control. The price of an average house soared by more than 350% between 1997 and 2006. The price of an acre of un-zoned land rose from 5,000 to 35,000 euros in rural Ireland in seven years. Between 2004 and 2008, banks in Ireland issued $50 billion in mortgages — the equivalent of banks in a country the size of the United States issuing mortgages of $2.8 trillion.
Flush with cash, the government went on a spending binge. From 1997 to 2008, investment in Ireland’s health service went up five-fold. Public-sector employment soared, even as pay doubled. Infrastructure projects were started across the country, but invariably completed spectacularly over budget.
The Irish economy unraveled with remarkable swiftness. Soaring labor costs forced Dell to pull up stakes and move 1,900 jobs to Poland. The collapse of the iconic Waterford Crystal brand quickly followed. Anglo Irish, the most aggressive lender of the past 20 years, was nationalized as property values halved. Tax revenues in 2008 were the worst on record as the economy collapsed. The government’s budget went from surpluses in 2006 and 2007 to a staggering deficit of 14.3% of its GDP last year — worse than Greece.
The Bitter Taste of Austerity Medicine
The Irish government’s response was both swift and harsh. Irish Premier Brian Cowen launched what many called the biggest assault ever seen on the public services of a modern Western state. The government raised taxes, even as it cut salaries in the public sector by up to 20%. But public finances are hardly flush. The government plans to cut its deficit to less than 3% of GDP by the end of 2014. But for now, the OECD forecasts Ireland’s deficit at 11.7% of GDP in 2010 and 10.8% in 2011.
Ireland is a living, breathing test case of the austerity measures that are causing taxpayers and workers to take to the streets with pitchforks across the globe. Keynesian acolyte Paul Krugman argues that Ireland’s current woes offer a glimpse into the consequences of fiscal austerity in the United States. On its face, it’s a sad irony that rather than being rewarded for swallowing the bitter cod-liver oil medicine of austerity, Ireland is grouped right alongside the other PIGS — Portugal, Greece and Spain. The Irish government’s heroic efforts notwithstanding, Ireland still pays three percentage points more than Germany on its benchmark bonds.
Ireland’s downturn has been almost certainly sharper and its recovery has been delayed compared to what it would have been had its government gone on a U.S.-style spending spree. That said, Ireland’s economy already may have turned the corner. Ireland’s economy expanded for the first time in more than two years in the first quarter by 2.7%, and is expected to grow as much as 1.5% this year. This is an improvement over an earlier prediction of 0.5% and marks the first full-year expansion since 2007. Ireland’s unemployment rate today stands at 13.4%, the highest since September 1994. But this is substantially less than the 16% projected for 2010 last year. Overall, Ireland is quietly starting to outperform the most pessimistic projections.
While Keynesians like Krugman argue against the dangers of the United States becoming the “next Ireland,” the reality is that Ireland’s austerity efforts have kept it from becoming the “next Greece.” And the markets now seem to agree. While Ireland pays three percentage points more than Germany for its bonds, for Greece, that number is closer to seven percentage points higher.
Harvard economist Ken Rogoff, co-author of the bestseller “This Time Is Different” points out: “If you want to escape default, the Irish path is the only way to go. But the Ireland experience points to the profound challenges that the current strategy implies.” The lesson? After a boom, the economic pied piper must be paid somehow.
And it’s better to pay him today than tomorrow.