Saturday, March 28, 2009

Irish Economy Adjusting In A Painful Way

Ireland had the biggest boom of all Western European countries (many countries hardly boomed at all), a boom that had both sound and unsound elements. The sound elements included the very low corporate income tax and a favorable demographic structure, while the unsound element of course consisted in massive monetary inflation fueled by the ECB's low interest rate policy.

The sound elements are still there, but these positive factors are now overwhelmed by the cyclical slump caused by the end of the monetary boom and the global economic downturn.

The bad news for Ireland is that it is suffering a very deep slump-much worse than the recession in the rest of the euro area. GDP fell by a full 7.5% in the year to Q4 2008. The alternative GNP measure (used because Ireland's GDP number is strongly influenced by corporate tax planning transactions) fell less, but only slightly so (6.7%).

Looking at the specific components, government consumption was basically flat while consumer spending fell 4.1%. The driving factor behind the slump however was the drop in fixed investments by 31.4%.

On the plus side however, net exports improved dramatically. Indeed, the current account deficit almost disappeared during Q4 2008 and was only €133 million (roughly 0.3% of GNP), down from €2.73 billion in Q4 2007 (roughly 6.5% of GNP).

Preliminary numbers for January trade shows that this trend continues, as exports fell a mere 1% while imports fell 28%. It seems likely that the current account deficit will be turned into a surplus during 2009.

At the same time, price inflation has dropped much faster than in the overall euro area, from 3.5% in the year to February 2008 to 0.1% in the year to February 2009. In the euro area as a whole, the drop was more modest, from 3.3% to 1.2%. Ireland will probably see that number fall below zero in the coming months.

Thus, while conditions are again turning inflationary elsewhere, Ireland is indeed experiencing a deflationary downturn. The downside for Ireland is that this will in the short-term imply a deeper downturn, as the GDP/GNP numbers illustrate. But as the current account numbers illustrate, Ireland is at the same time adjusting much faster than elsewhere. The fact that the previously very large current account deficit (previously as large as America's peak levels relative to the size of the economy) is turning into a surplus is in part the result of improved competitiveness through lower inflation, but mostly a result of the fact that the Irish are no longer borrowing from abroad to finance malinvestments.


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