The Economics behind the Irish Elections

By: Marc Coleman, Economics Editor, Irish Times

“Better the Devil you know than the Devil you don’t know”. If you want to sum up the result of last Thursday’s election in Ireland, that old Irish phrase does the trick. For three elections in a row the Fianna Fail party (an Irish phrase meaning the Soldiers of Destiny) and their liberal Progressive Democrat allies triumphed over the opposition Fine Gael (Tribe of Gaels) and Labour party. Automatically, the Irish names of Ireland’s two largest parties tell you something important about Ireland’s political economy: it doesn’t split along left-right lines. Derived from the Celtic cultural revival that led to Ireland’s independence, and the civil war which followed it, the Fianna Fail and Fine Gael parties have created a pragmatic model of parliamentary politics where one party keeps check on the other without having any fundamental differences in outlook: Fine Gael’s instincts are more liberal on economic issues than Fianna Fail but for reasons of practical politics – namely to get into government - it usually allies itself with the left-leaning Labour party.

That doesn’t mean that ideology doesn’t count at all. The present government won the 1997 and 2002 elections arguing for cuts in income tax (the opposition emphasized the need to index Ireland’s un-indexed income tax bands). This time Fine Gael got the message and moved to the right on the issue of cutting not just income tax rates, but stamp duty on property as well. Sensing a growing unease about public services, Fianna Fail moved slightly to the left on other issues such as investment in public infrastructure and the environment. The result: Fine Gael decimated the Progressive Democrats, a party that not only competes with it for more liberal voters but sides with the Fianna Fail party. Fianna Fail correspondingly halted the growth of the Labour party, the Greens and Sinn Fein.

At face value, the economy’s performance seemed to justify the government’s re-election. At 6 per cent, Ireland’s GDP growth last year beat most other countries in the EU. In the closing days of the campaign the OECD was quoted as ‘warning’ Ireland that growth would slow to 4 per cent by 2008, over a percentage point higher than the OECD average. Ireland’s unemployment is one of the lowest in the world while in terms of openness to trade, the Irish economy compares well with Singapore and Hong Kong.

What lies behind these figures is less impressive. If Ireland had its own central bank and Jean Claude Trichet were its President, he would have died of a heart attack about two years ago. From €180 billion three years ago, the country’s stock of private sector credit has almost doubled to €320 billion as of last March. According to a study by the country’s leading research organization, the Economic and Social Research Institute (ESRI), two thirds of borrowers feel their debts are now putting a squeeze on their finances.

Many of these are younger borrowers who have entered mortgage market in the last few years when ECB interest rates were at historic lows. But although Ireland belongs to the euro zone, it has a UK style approach to home ownership. To satisfy an intense desire to own rather than rent property, Irish borrowers saddle themselves with huge mortgages at variable rates at a relatively early age. Having risen to the point where people felt it could go no higher, house prices began accelerating in the autumn of 2005

Fiscal policy has been just as frantic. In the two years leading up to the election, public expenditure rose by a whopping 25 per cent. Finance Minister Brian Cowen justified this as making up for lost ground. In terms of GDP, Ireland’s public expenditure had been amongst the lowest in Europe and increases in public spending seemed to be consistent with the idea that Ireland should converge with the rest of the EU in terms of public service provision.

But as in most of Europe, increases in public spending have not led to better public service provision. Instead of cutting public service numbers by 5,000 as promised, the outgoing government increased them by some 50,000. The benefits of the change to the economy are unclear, but the impact on the unemployment rate is of the order of 2 percentage points.
Another thing holding unemployment down has been a construction boom – it has to be said – of unprecedented scale. Out of a Labour Force of just over 2 million, some 290,000 persons now work in construction, or one in eight of the workforce.

This is twice the EU average and as the election got going, economists from all political backgrounds were asking one question: What will happen to the IRISH economy when construction employment normalizes?
Everyone agrees that housebuilding, a main motor of recent employment growth, has now peaked and is set to decline and this makes the question increasingly urgent: The government provided an answer to it in the form of the National Development Plan (NDP). The NDP is a series of renewable plans designed to take Ireland’s infrastructure up to EU standards. The latest one, which starts this year, will TAKE public capital investment in Ireland to places that it has never been before: Between a quarter and a third of GDP will be spent on hard infrastructure over the next term of government. That, says the government, will cushion the economy from any downturn affecting house-building.

Despite high spending growth, fiscal metrics are accommodative. With one exception, 2002, the government has run budgetary surpluses in each of the last ten years. Public debt has sunk dramatically to about a quarter of GDP.  
What is not accommodative, at least according to the ESRI, is the economy’s capacity to absorb that kind of spend. Citing flaws in previous plans, the ESRI warns that the next one will drive up inflation. Many disagree with it: If congestion and high prices are to be avoided, more infrastructure is a must (Ireland is a country still without a proper motorway system and with no rail line between the city centre of its capital and its main airport).
If the ESRI does have a point, then it isn’t the point it think it has. Interest rates aside, the government’s appetite for spending money has been a significant contributor to what, in the long run, is Ireland’s most challenging economic problem: The cost of living. Once the poorest of countries in Europe, everything from clothing to real estate is now more expensive than most other places in the world, never mind Europe. For a modest family home in a suburb of Ireland’s capital city, expect to pay at least €700,000. Poor spatial planning and land use, combined with a credit boom, have driven Irish real estate prices to the point where reasonably paid professionals can no longer afford city accommodation.
 
The cost of everything has risen in tandem. Commercial rents are so high that Dublin’s Grafton street is now among the tenth most expensive streets in the world to shop in the world. For many years the US Chamber of Commerce only had good things to say about Ireland’s investment-friendly climate. Now it has warned that Ireland’s low tax rates are not enough to save it from the impact of rising costs. It is a crucial message from an important friend: Sticking with what you know is no longer enough to preserve Ireland’s prosperity. If they are going to redesign the economy’s cost base and achieve its full, startling, potential then Ireland’s policy makers will have to take new and untested directions and, above all, think at a higher level then ever before.

Marc Coleman is Economics Editor with the Irish Times newspaper.

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