Reykjavik-on-Liffey

The Irish economy Reykjavik-on-Liffey
Feb 5th 2009 DUBLIN

From The Economist print edition

The Irish government struggles with the effects of a deep recession
THE difference between Ireland and Iceland, so the current joke goes, is one letter and six months. A Dublin economist responds that the real difference lies in a four-letter word: euro. Ireland is in, and Iceland is not. A former European commissioner from Ireland, Peter Sutherland, thinks that Europe’s single currency has kept Ireland afloat. Even so, GDP is expected to contract by 5% and the unemployment rate to rise to over 9% this year. And Ireland is bracing itself for a credit downgrade on its sovereign debt.

Much will depend on how the rating agencies judge the latest efforts by the prime minister, Brian Cowen, to stabilise the public finances. On February 3rd he made a poor start, before recovering. After weeks of talks, he failed to win trade union support for his budget cuts. Yet hours later he imposed the measures the unions had rejected, including a pension levy on public-service workers. His unilateral action signalled the end of two decades of social partnership, based on a consensus approach to wage bargaining between government, employers and unions.

Mr Cowen’s cuts are the first steps in a five-year austerity programme meant to close a huge budget deficit. But they come at a hard time. The economy has been hit by the global credit crunch, a burst property bubble and collapsing tax revenues. This year’s estimated budget deficit will be some 10% of GDP, even after the latest cuts. The government hopes to restore balance by 2013, but that will take spending cuts and tax increases worth €16 billion (equivalent to 8% of GDP).

The rapid deterioration in the public finances has unnerved bond markets and raised Ireland’s borrowing costs. In recent weeks Irish bond spreads over German bonds have widened by over two percentage points. Yet Mr Cowen’s political problem is that he is ill-placed to sell acceptance of five years of austerity. His government has struggled with its banking crisis. Morale has been dented by a succession of economic shocks. Last month Waterford Wedgwood, a maker of luxury glassware and china, went into receivership; and Dell, a computer maker, announced it was closing its manufacturing plant in Limerick, with the loss of 1,900 jobs, and moving to Poland.

The government’s public standing could hardly be lower. In a recent poll three out of four respondents said its handling of the economy had been poor. Fianna Fail, which leads the coalition and has been in power since 1997, is trailing in the polls. Mr Cowen’s only consolation is a favourable shift in views of the European Union’s Lisbon treaty. There is expected to be a second referendum on this in the autumn, and recent polls show a two-to-one majority in favour. Ireland’s euro membership during the recession may make all the difference at the ballot box.