Opinion Piece about Ireland in todays WSJ.
http://online.wsj.com/article/SB123301620834517715.html
http://online.wsj.com/article/SB123301620834517715.html
The Sickly Tiger
Ireland is in for a nasty deflationary spiral.
By MICHAEL J. O'SULLIVAN | From today's Wall Street Journal Europe
Economic luck has deserted the Irish. House prices are collapsing, economic growth is turning sharply negative, and unemployment is on the rise. The only thing making Ireland's shocking fall from financial grace a little less conspicuous is the fact that so many other countries, from the U.S. to Singapore to the U.K., are experiencing similar difficulties.
What is upsetting about Ireland's case is that only six months ago most of its economic problems could have been managed and treated as the growing pains of an adolescent economy, by forcing banks to write down asset values, for example.
Instead, Ireland's policy makers are on course for a painful deflationary spiral, largely by focusing on problems that are only tangential to the real economy, such as the commercial property sector, and by avoiding those that merit full attention, namely small and medium-size businesses.
To highlight some of Dublin's most blatant policy slip-ups: Politicians on both sides are still in denial about the country's severe property bubble, refusing even to call it one. They still appear to believe that the downturn in property values is cyclical, and not structural. The government also continues to ignore the economy's deteriorating competitiveness, gave a strategically unwise guarantee of the debt and deposits of all Irish banks and, most recently, nationalized Anglo-Irish Bank.
Anglo-Irish was an important cog in Ireland's credit machine and helped to fuel the property bubble. Beset with corporate governance issues, its books were never properly scrutinized by finance officials and regulators, it now appears. By nationalizing Anglo-Irish, the Irish government simply softened the financial blow for many members of its oligarch class rather than averting a material risk to the real economy.
Nationalizing Anglo has further damaged consumer confidence and egged on a fear in financial markets that the poor quality of banking assets may lead to a long-term and hefty increase in the country's debt. Fitch estimates that the combined amount of Irish bank debt and deposits totals around 180% of Ireland's GDP.
Dublin's efforts to save Ireland's banking system have sown deeper and more widespread fears about the whole European project, and in particular about a possible breakup of the euro zone, than Ireland's rejection of the EU Treaty ever did. Sovereign bond spreads between German government debt, which is the euro-zone benchmark, and debt issued by the Irish and other smaller euro-zone governments are now much higher than following the Treaty vote last June.
Moreover, this unnecessary bailout has further increased the financial toll on shareholders, pensioners, savers and small businesses as growth will slow and taxes will have to rise. As in many other countries, the relative economic and psychological damage of the credit crisis is being felt hardest by the man in the street as opposed to those at the epicenter of the problem.
So what can be done? Ireland faces three economic fault lines: the downturn in the global economic cycle about which it can do very little; an ugly property market bubble about which its political class remains in denial; and a severe lack of competitiveness about which something drastic needs to be done.
The bursting of Ireland's property bubble has left the public and private finances in disarray and there is a risk that the bond market may turn its back on an auction of Irish debt. If this happened, the ECB may step in and buy or guarantee the government debt. Euro-zone countries will likely help to bail out the likes of Ireland, Greece and Spain rather than seeing them default, which could have devastating ripple effects throughout the common currency zone.
In the near term, Ireland's politicians need to end economically inefficient bailouts. To avoid social problems in new residential conurbations as a result of the collapsed housing market, the government must embark on a serious spending package to improve neighborhood infrastructure, including schools, telecommunications and health care. Dublin must reinvigorate Ireland's education system and financial services industry. The banking problem and resulting financial burden on the state can only be eased if the Irish banks write down, restructure and correctly value large-scale commercial property assets. Then, a "bad bank" could take on these toxic assets and help unclog the blockage in the banking system.
In turn, this would help allow policy makers to focus on Ireland's competitiveness problem. The economic pain of the credit crisis and the corresponding economic adjustment are likely to be felt through falling asset prices and wages. This in turn may well result in a nasty period of deflation, something that is likely to become more complicated as the rest of the world eventually begins to reflate, which would further damage Ireland's purchasing power.
Deflation of asset prices and wages will be unavoidable, but it must be accompanied by a managed structural shift in the Irish economy from banking, property and some retail sectors toward domestic industries with higher earnings growth rates, such as software. In order to do so, the government must upgrade the country's math, science and research capabilities.
There has been some talk in Ireland of calling in the IMF to help rebalance Dublin's finances. In the long term, though, Ireland needs to re-establish its competitiveness and rediscover the importance of factors like education, a quality labor market and innovation as drivers of growth. Only then can the country regain its title as Celtic Tiger.
Mr. O'Sullivan is the author of "Ireland and the Global Question" (Cork University Press, 2006).