More positivity for the Irish economy - why am I worried?

Now I'm worried. So many international pundits have been rushing recently to extol the virtues of the Irish economic recovery that one has to start remembering that we've been here before – and it didn’t work out well.

Think about it. In the mid nineties the term “Celtic Tiger” was coined to describe what appeared to be a runaway success in terms of becoming a prosperous nation in the shortest possible time. We could do no wrong. Retired Irish politicians and business leaders toured the global lecture circuit telling the rest of the world how it should be done. The Irish bought anything that came up for sale, whether it was Polish banks or Chicago real-estate.

The truth of the matter is revealed in this video clip by Alan Mattich of Dow Jones Newswires. Ireland is a small, very open economy. We depend on international trade, much of it carried out by non-indigenous Multi-national corporations that have been attracted here by our corporate tax rate, combined it must be said by the very real facts that we have a sharp, young, well educated workforce, are the only English speaking state in the Euro zone (Memo to government: don’t even think about leaving the Euro or doing anything that might endanger it as a unit of currency) and enjoy the benefits of having one of the most professional and effective development agencies, IDA Ireland, in the world.

But it is so, so easy to lose the run of oneself. Will we be more circumspect this time around? And if so, for how long?

Fiscal Union

In economics, fiscal matters relate to revenues and expenditures, as opposed to monetary matters, which have to do with the relative value of the currency and all that it depends on, such as interest rates and money supply.

In the Euro zone, which comprises of the 17 EU member states that use the Euro as their unit of exchange, the European Central Bank (ECB) has responsibility for monetary matters. It has declared its primary objective in managing monetary policy to be the control of inflation or, to be more precise, inflation expectations. Each individual Euro zone member state is responsible for its own fiscal policy.

If fiscal policy is about revenues and expenditures, then the most important aspect of this has to be decisions about how taxes are raised, which in turn include questions about the activities that should be taxed and at what rates. The other important element of fiscal policy is how money is spent, which means how national budgets are prepared and executed.

At the extreme, full fiscal union would mean that fiscal strategy in the EU would be centralised, just as monetary policy is at present.

For Ireland, under the current bailout agreement with the ECB and the IMF, there is already an element of what might be called fiscal cooperation in place, as both these bodies now have oversight of Irish budgetary provisions. This, however, falls well short of full fiscal union. The most serious block to fiscal union is the determination of the Irish government to hold on to its favourable corporation tax rate of 12.5%, which has been a significant factor in motivating Multi-national Corporations to locate, and in many cases establish their European headquarters, in Ireland. There are well founded fears that fiscal union would result in a rise of the Irish corporation tax rate to a standard, Euro zone wide, percentage. Many other EU states maintain that the relatively low Irish rate confers an unfair advantage in the attraction of Foreign Direct Investment (FDI).

In addition to the above there are many commentators in Ireland who maintain that fiscal union would mean an effective loss of sovereignty for the Irish state. This is surprising, as we have already, and long since, effectively ceded sovereignty by accepting EU directives under legally binding treaties, by convention named after the cities in which they were formulated such as Rome, Maastricht, Nice, Lisbon and even Dublin, in areas of social policy, anti-discrimination measures, consumer legislation and the penal code, to name but some.

Has Ireland's economy turned the corner?

More and more international observers are making positive comments about the Irish economy. At the end of July 2011 an article appeared in Reuters’ US edition under the heading “Billionaire Ross bets on v-shaped Irish recovery”. It was a report on the comments made by the man who has just invested €300 million of his own money, as part of an overall foreign injection of €1.1 billion, in Bank of Ireland. Wilbur Ross is quoted as saying that the deal was fueled by positive news from Ireland that indicates it is breaking away from “its troubled peers in southern Europe” and embarking on a solid recovery.

Then, on August 17th 2011, the Financial Times published an article from two economists, David Vines, professor of economics at Oxford University, and Max Watson, fellow of Wolfson College at Oxford, who is also a member of the Central Bank of Ireland Commission.

The academics argue that Ireland is swiftly restoring its competitive edge. We’re moving towards a sizeable current account surplus. Our public debt will peak at 110 per cent of GDP, which while large is not unmanageable (Belgium’s debt to GDP ratio was 98.6 % in 2010 and had been much higher than that for many years – since well before the latest recession).

The major challenge facing Ireland, according to the authors, is the situation with the banks. They claim that the corner has been turned here too, due to recapitalisation, a sharp division between core and non-core assets, and regular and rigorous stress tests. They might also have mentioned the new broom, no-nonsense Financial Regulator. The investment by Wilbur Ross and his consortium in Bank of Ireland, reported in the Reuters article mentioned at the outset, feeds nicely into this assessment.

Then there is the much vaunted cost of insuring Ireland’s debt, calculated by reference to the spread on credit default swaps (CDSs). While CDS spreads have fallen for all of the EU states, including countries that have been the focus of much comment such as Greece, Portugal and Spain, those for Ireland were the first in that group to show a marked decrease. No doubt these instruments will wax and wane as always but, in any event, Ireland does not have to re-enter the sovereign debt market until 2014 because of the bailout arrangement with the ECB and IMF.

The quiet man of the Irish economy, agriculture, has seen significant buoyancy over the last year as so-called "soft" commodities, which go into food production, have been subject to sharp rises on world markets. Tourism figures too are well up on previous years and this is despite the relative high value of the Euro against other currencies, most notably the US Dollar. Both of these developments are all the more welcome because they involve indigenous, some might say traditional, sectors of the economy.

All in all, this is a positive picture. It’s certainly not one to get complacent about, but satisfactory none the less, and hopefully just what is needed to encourage the redoubling of official efforts into the future to consolidate and build on what has been achieved.