Ireland Stakes Own Recovery Path

The government says things are improving because the rate of deterioration in the jobs market is slowing. Opposition Fine Gael's enterprise spokesman disagrees: "No amount of George Bush-style declarations of victory can disguise the fact that Ireland is still mired deep in recession," he told the press. Poor George W. Bush seems to be dragged into every unpleasantness, even Ireland's economic woes.

Both sides are right. The Irish economy is in bad shape, but the decline has been slowing in recent months. The real issue is what to do now. Ireland has models galore. It could follow Greece, whose Prime Minister George Papandreou stunned observers by responding to the downgrading of his nation's sovereign debt with a plan to increase public-sector pay. It could follow the British model: soak the rich, who are already eyeing more welcoming tax jurisdictions, and continue to increase spending despite an unsustainable fiscal deficit that has produced an unveiled warning from the rating agencies that its triple-A credit rating is under review. It could follow the U.S., where a fiscal deficit of around 12% that shows no signs of destroying the administration's appetite for new spending programs.

But it has staked out a different course, designed to retain the nation's attraction to inward investors, and to restore Ireland's international competitiveness by cutting labor costs, while at the same time jettisoning those policies that threaten to turn it into another Greece. In short, it has to decide whether to sign on with those who believe fiscal probity must wait until a recovery has taken hold, lest austerity abort that recovery. Or whether it can cut its deficit by controlling public spending, while avoiding tax increases that might scare off its very mobile wealth creators and international investors.

It seems to have opted for the latter course. In the budget announced a few weeks ago, finance minister Brian Lenihan takes an axe to public spending, which Angel Gurria, secretary general of the Organization for Economic Cooperation and Development points out was 50% higher in real terms last year then five years ago. Public-sector pay is to be cut 5% for the lower-paid, 15% in the upper reaches, and 20% for the Taoiseach, Brian Cowen. Child benefit is to be reduced. Payments to doctors, lawyers and other professionals working on state contracts are to be reduced.

Most significantly from the point of view of those who argue that an economy can't tax its way out of recession, the 12.5% corporate tax remains in place. It will not be raised, despite complaints from other euro-zone members that this in some way constitutes unfair competition for inward investment.

There is some disagreement over whether these spending cuts will enable Ireland to reach its goal of reducing the deficit to 3% of GDP in three-to-four years. Economists at Goodbody Stockbrokers do not believe the government will reach its targets. If they are right, Moody's, which has already downgraded Irish debt from triple-A to Aa1, might just take the rating down another notch. Moody's says it will "closely monitor" the situation.

Economists at Goldman Sachs are more optimistic. Ireland's plan, they say, benefits from wide political support, and "is based on broadly sound assumptions". But even the pessimists at Goodbody agree that "a recovery is underway", and expect the Irish economy to grow at an annual rate of 2.4% in 2011. The official government forecast is for growth at a 3% rate or slightly higher, on the back of a surge in exports.

Difficulties remain, especially in the banking sector, where the leading banks — Allied Irish Bank PLC and Bank of Ireland PLC —need new capital in addition to the €3.5 billion the government has already injected in return for 25% stakes in each. Patrick Honohan, governor of the central bank, deems it "quite possible" that the government will have to take its stakes to 50% before the crisis is over.

That said, the worst of Ireland's woes are probably behind it —a tribute to the political will lacking in one of its neighbors.