The Irish Economy - Essay Example

The Irish Economy The Irish economy has been an ideal case of a country which roller-costered from being a country labelled as “Poorest of Rich” to being saluted as “Europe’s shining light”, in a period of 10 years (Murphy, 2000, “The ‘Celtic Tiger’ – An Analysis of Ireland’s Economic Growth Performance”). During the period of mid nineteen nineties till 2007, the country had an exceptional run, with near perfect economic indicators. It was believed that an era of low-tax (Independent, 2004, “Low-tax policies created the Tiger”) coupled with the positive influence of globalization spurred the growth which many countries are now trying to replicate. The spectacular growth in GDP from $81.214 billion in 1997 to $260.08 billion in 2007 (Economy Watch, n.d., “2007 Economic Statistics and Indicators”), coupled with favourable employment figures and increased investment activities made Ireland truly worthy of being named as Celtic Tiger. However, this dream run was halted abruptly since 2008. With the financial crisis gripping the world, Ireland was no exception. The Irish economy was in a boom, and there was an increased transaction in the real estate markets. As everywhere else, analysts believed that too much dependence on housing sector triggered this crisis for the Celtic Tiger. A statistical report by Republics Economic and Social Research Institute (ESRI) indicates that about 75000 housing units were constructed in 2007, in comparison to 30000 in 2008 (Sharrock, 2008, “Ireland teetering towards recession as bubble bursts”). In addition to this, the average prices of the housing sector have dwindled by a massive 15%, with industry analysts still trying to predict the bottom of the trough. A faulty valuation system resulted in an overvaluation of assets by 12.5% in 2007. Prices are feared to fall by 6.3% in 2008 and 1.5% more in 2009. ESRI estimates predict that the total fall in inflation adjusted prices would be around 24%. Ireland had mainly been an export oriented economy. Although Ireland had exhibited average yearly increases of fifteen per cent (equivalent to five percentage points) in its otherwise nominal house prices during 1995-2007, the scenario had underwent drastic changes since the first quarter of the 2007 fiscal. McCarthy and McQuinn had given a brief picture of the macroeconomic phenomena by saying that “this rapid turnaround in house prices over a relatively short period of time, coupled with the significant volume of mortgages taken out by a young population during a period of heightened price levels, raises a number of worrying macroeconomic issues” (McCarthy & McQuinn, February 2010, “Introduction”). Responding to these problems, the Irish government came forward in order to provide a guarantee to the nation’s banking system during September 2008. Though this measure had come as a relief, another factor that troubled the Celtic Tiger was the increasing financial anguish that the mortgage holders had been going through. Scholarly sources reveal that approximately 340000 mortgages had been approved during 2004-2006 – the period that witnessed the highest house prices. It was during the same period that the economy of Ireland was basking in the financial glory characterised by noteworthy improvements in standards of living and hence, “the general ability within the economy to sustain such mortgages was quite high” (McCarthy & McQuinn, February 2010, “Introduction”). During the subsequent period, the drastic changes in the state of affairs gave rise to the perception that “the severe decline in the performance of the Irish property sector allied to the post 2007 global economic downturn has had a distinctly harsh impact on the Irish economy with unemployment rates, in particular, experiencing a swift increase from 4.5 per cent in mid 2006 to over 12 per cent in mid 2009 (McCarthy & McQuinn, February 2010, “Introduction”). Based on these observations it might be suggested that a lot of households in Ireland are stifled by difficulties with the repayment of their mortgages. Such a situation naturally calls for the intervention by the Irish Government as well as the European Central Bank. Gallagher and Komito (2010), while drawing attention to the involvement of national politicians, have suggested that “if the voters then use them as a conduit for getting all sorts of jobs done, this may not be anything to do with the electoral system itself, and more to do with voter expectations, with the weaknesses of local government, with the bureaucratic difficulties of getting welfare entitlements or making government responsive to local concerns” (Hardiman, 2009, “Political accountability and policy capabilities”). Political jargon apart, it has been found that the need of the hour for Ireland is an improved infrastructure that “will enhance Ireland’s competitiveness and attractiveness as a location for foreign direct investment” (Anonymous, n.d., “An investment economy”). Owing to the criticality of the situation, the economy has been facing major obstacles that the Central Bank’s Governor had summed up as “I think it’s fair to say – and what data we have seems to bear this out – that banks in Ireland reacted to their own difficulties and to the downturn by greatly reducing their risk appetite. Some of this was a necessary adjustment, but the result has been limited availability of credit for start-up firms and SMEs. Indeed, I have the impression that, during the years of property-based lending, the banks have lost their edge in small business lending” (Anonymous, n.d., “An investment economy”). Chances are bleak that the position will improve even as banks try to curtail their lending. The factors that add to this as key constraints are “Ireland’s fiscal position and the restrictions imposed by the Stability and Growth Pact (SGP)” (Anonymous, n.d., “An investment economy”). In this particular scenario there had been substantial efforts from the Irish Financial Regulator (IRF) in “encouraging Irish banks to help one another with liquidity loans where possible” (Honohan, 2009, “The bubble bursts”), although it had ended up in shaking the market confidence that was already rendered vulnerable by ineffective measures against previous credit expansion. Among the drastic steps that the government has taken in order to reinforce the economy the one that is worth a mention was the nationalisation of the Anglo-Irish Bank (AIB). For the purpose of manifesting complete refurbishment of the existing system, the previous board of directors (BOD) had also been replaced. The overall scenario had been quite bleak in Ireland through the period between Q1 of 2008 and Q2 of 2009. It was during this period that the seasonally-adjusted real GNP has slipped by 13.5 per cent, and as Honohan (2009) reports, “the Central Bank governor argued that Irish macro policy needs to focus, not just on the correction of the fiscal deficit, but on a broader re-balancing of the macro economy, acknowledging the nature and causes of the economic downturn from which recovery must somehow be managed” (McCarthy, 2009, “A Macroeconomic and Banking Collapse”). The attempts that the Irish government has taken to rejuvenate the macroeconomic aspects of the nation can be broadly classified as fiscal consolidations to enhance government revenue and to reduce government spending, measures to bring about a macroeconomic equilibrium, and reconstructing the nation’s banking system. It has been observed that the budgetary actions that the government had adopted in 2009 “achieved no more than a containment of the GGB deficit to 12% of GDP next year” (McCarthy, 2009, “Fiscal Consolidation – Enhancing Government Revenue”). Although the tax policy of Ireland experiences a lot of constraints and is defined to a great extent by those of neighbouring economies, “Most indirect taxes do not display sizeable ‘headroom’ against the UK rates, and direct taxes on earned income have already been increased significantly” (McCarthy, 2009, “Fiscal Consolidation – Enhancing Government Revenue”). McCarthy has also argued that “The Exchequer is now suffering from negative fiscal drag, and those below the income tax threshold in late 2009 include people whose real income has risen over the past year. The rising price level was regularly invoked over the last decade as support for increases in tax credits and allowances, and the there is no logical case for ignoring the fall in prices in this connection when it is relied upon to support expenditure reductions” (McCarthy, 2009, “Fiscal Consolidation – Enhancing Government Revenue”). Apart from the tax credits as well as allowances, there has been a regular disposal of assets held by the nation, in order to increase revenues. Among the range of government activities that have aimed at revitalising the national economy, the second one is to undertake fiscal consolidations to reduce government spending. In order to manifest this, the Irish government has taken a couple of expenditure policies into consideration although they are beyond its remit, and McCarthy (2009) reports that “The first concerns rates of pay in the public service and the second the capital spending programme” (McCarthy, 2009, “Fiscal consolidation – Reducing Government Spending”). The first expenditure policy comprises Public Service Pensions as well as the National Pension Reserve Fund (NPRF). The problems associated with the Public Service Pensions had been emphasised in the 2009 Comptroller and Auditor-General (CAG) report as “Unfunded accrued liabilities stood at €108 billion at end 2008, and the annual cash cost is expected to approximately quadruple as a % of GNP over the next fifty years” (McCarthy, 2009, “Public Service Pensions and the NPRF”). While responding to these problems the Irish government should remodel the existing pension schemes while simultaneously shifting towards a well defined structure. This is deemed necessary in order to standardise public finances, to manifest better mobility among private and public sectors, and to bring about reintegration of the Irish labour market. In contrast to the Public Service Pensions, the NPRF “is a long-short hedge fund, short bonds and long equities, notwithstanding relentless assertions to the contrary” (McCarthy, 2009, “Public Service Pensions and the NPRF”), whose assets are meant to compensate for pension liabilities of the state. In the backdrop of the current situation, “The government does not plan to borrow any further money to invest in equities, and the Fund should now be wound down: the carrying cost of the Fund has risen substantially in the last two years in line with the premium on Irish government debt, and to persist with it adds gratuitously to the volatility of the government’s net financial position” (McCarthy, 2009, “Public Service Pensions and the NPRF”), and this holds considerable prospect to reduce the government’s spending and bolstering the national economy. While the Irish government have been working diligently to clean up a huge mess that it was stuck in it has been found that “Some projects in the National Development Plan are backlog-elimination, some are capacity-enhancing, while some are Bubble left-over which never made sense” (McCarthy, 2009, “The Capital Programme”). This finding leads to the recommendations that the projects addressing to backlog-elimination should be continued only if the finances permit, whereas, those that aim at enhancing capacities must be kept on hold owing to the fact that the national economy has not fully recovered yet. The Irish government has to be more proactive in bringing about dynamic changes in the macroeconomic aspects of the nation in order to revive its status to that of the Celtic Tiger. Though the nation is trying hard to come out from the economic haze left behind by the financial crisis, certain drastic steps has been taken by Brian Lenihan, Minister for Finance while proposing the national budget for 2010. The minister has said “In the Renewed Programme for Government we have accepted the recommendations of the Commission on Taxation on the need for a property tax” (Lenihan, 2009, “Broadening the Tax Base”), and he has substantially reformed income tax in order to broaden the national tax base. The government has been trying to bring about transparency by making high earners pay proportionally high taxes. It has also introduced carbon tax. The Irish government has also been aiming at refurbishing the national economy in a holistic fashion in order to bring about all-round changes – in nearly all macroeconomic elements, ranging from the tax kitty to child benefit. Thus, the prospects are quite promising for the erstwhile Celtic Tiger to roar again in the near future. References 1. Anonymous. An investment economy. No Date. Strategic Investment Bank Financing Ireland’s Investment Economy. April 22, 2010 . 2. Economy Watch. 2007 Economic Statistics and Indicators. No Date. Economic Statistics by Year. April 22, 2010 . 3. Hardiman, N. Political accountability and policy capabilities. November 26, 2009. The Impact of the Crisis on the Irish Political System. April 22, 2010 . 4. Honohan, P. The bubble bursts. June 24 - June 27, 2009. Euro Membership and Bank Stability Friends or Foes? Lessons from Ireland. April 22, 2010 . 5. Independent. Low-tax policies created the Tiger. October 24, 2004. Editorial. April 22, 2010 . 6. Lenihan, B. Broadening the Tax Base. December 9, 2009. Financial Statement of the Minister for Finance. April 23, 2010 . 7. McCarthy, C. A Macroeconomic and Banking Collapse. November 26, 2009. Fiscal Adjustment and Re-balancing the Irish Economy. April 23, 2010 . 8. McCarthy, C. Fiscal Consolidation – Enhancing Government Revenue. November 26, 2009. Fiscal Adjustment and Re-balancing the Irish Economy. April 23, 2010 . 9. McCarthy, C. Fiscal consolidation – Reducing Government Spending. November 26, 2009. Fiscal Adjustment and Re-balancing the Irish Economy. April 23, 2010 . 10. McCarthy, C. Public Service Pensions and the NPRF. November 26, 2009. Fiscal Adjustment and Re-balancing the Irish Economy. April 23, 2010 . 11. McCarthy, C. The Capital Programme. November 26, 2009. Fiscal Adjustment and Re-balancing the Irish Economy. April 23, 2010 . 12. McCarthy, Y. & McQuinn, K. Introduction. February 2010. How are Irish households coping with their mortgage repayments? Information from the SILC Survey. April 22, 2010 . 13. Murphy, A. E. The ‘Celtic Tiger’ – An Analysis of Ireland’s Economic Growth Performance. April 2000. EU Working Papers. April 22, 2010 . 14. Sharrock, D. Ireland teetering towards recession as bubble bursts. June 30, 2008. Times Online. April 22, 2010 . Read More