Ireland shows UK the way to euroland

ACCORDING TO Francis Maude, the shadow Chancellor, the Irish experience shows the perils of Britain joining the euro. This has become a repeated refrain among the euro-sceptics.

Sir Stanley Kalms of Dixons - the UK company which might find it embarrassing if its customers could easily compare much cheaper personal computer prices in Germany with its own - warned a City audience of this Irish problem recently. Mr Maude, in full flow at the Adam Smith Institute in June, said: "We can already see that a rigid supra-national structure leads to economic compromise. While Germany stagnates, Ireland overheats."

Mr Maude had better watch out, as this may prove to be an embarrassingly premature judgement on both counts. Even the International Monetary Fund, on whose report Mr Maude was commenting on Saturday, and which is an organisation paid to worry about possible problems, does not say that the Irish economy is overheating.

It highlights the potential risks given that interest rates have fallen by 3.5 percentage points since the beginning of 1998 as Ireland aligned with economic and monetary union (Emu) interest rates, but that is not its central case. It projects a slowdown in domestic demand, and says that "the outlook is for output growth to slow in 1999".

Moreover, "rapid output growth per se need not signal a concern given Ireland's low inflation rate and current account surplus". Certainly, Ireland is still growing at a fearsome rate - 8.9 per cent last year - having handsomely outstripped British output per head in 1997.

This is the "Celtic tiger", an economic success built on a commitment to education and therefore to a skilled workforce, and on a business-friendly set of policies which has attracted direct foreign investment. In the past five years, the average annual growth rate of output in Ireland was a staggering 8.5 per cent, the best performance of any developed country in the world and some five-times the rate achieved by Britain.

The risk of demand outpacing supply - overheating - is difficult to judge because most people do not believe that Ireland can go on growing at its recent rates. After all, Ireland's GDP per head is 5 per cent above the EU average (and above the UK average) and it becomes more difficult to grow when you are no longer just catching up with the leaders.

But there is a debate about how much Ireland's potential or trend growth will slow. The Government thinks long-run growth should be 4 to 5 per cent a year, while the International Monetary Fund is more optimistic at 6 to 6.5 per cent a year. It could even be higher.

Productivity - output per head - is still growing like Topsy; even after allowing for increases in labour and capital, output is growing over time by about 3 per cent a year. Ireland has also been able to draw on the unemployed at home, returning emigrants, and increased female participation in the labour force. Astonishingly, Irish employment rose by 6 per cent last year, and the labour force expanded by 3.4 per cent. So this is an economy with a highly flexible and successful supply-side.

So how should we judge over-heating? The usual test is the inflation rate, because prices rise when demand outstrips supply. But on this basis, the Irish economy is cooling down. The inflation figures published on Tuesday - the second set since the IMF report was finalised - showed that the rise in consumer prices over the year to July was just 1.2 per cent. Last year's peak figure - recorded in August - was nearly three times as high at 3.2 per cent.

Irish inflation has been steadily falling, as the graph shows. This consumer price measure of inflation includes housing costs (like the headline UK Retail Price Index) and has therefore been flattered by the fall in interest rates, as the IMF points out. But that drop accounts for only part of the improvement, as we can see by looking at Irish inflation as measured by the Harmonised Index of Consumer Prices (HICP) used by the European Central Bank to assess price stability. This excludes housing costs and therefore the influence of mortgage rate declines, but it has also fallen back from a peak of 3 per cent last August to just 1.9 per cent in July.

This decline in price inflation is likely to have taken some of the edge off Ireland's earnings growth, which is perhaps the best test of overheating in a small, open economy. The risk is that Irish wage bargainers go for wage increases which are too high to be sustainable, despite the impressive performance of productivity, and that this eventually prices employees out of work.

Overall, the IMF judges that the economy can afford to pay 5 per cent a year increases: given that manufacturing earnings increases rose from 2.9 per cent in 1997 to 5.6 per cent in 1998, the labour market is at the edge of sustainable pay rises. (We will not know this year's trend for a while, since there is a six-month time lag in the earnings figures).

Another big questionmark is over the housing market. Ireland's house prices rose by 30 per cent in 1998. Although price rises had slowed to an annualised 15 per cent in the first five months of this year, lending is still strong, and it is certainly too early to say that the boom is over. However, there are fundamental reasons for the rise: prices had been stable for many years, and real incomes, employment and the population are all rising. The Government is sensibly encouraging supply, and the Governor of the Central Bank has been raising his eyebrows at mortgage lenders to ensure careful lending criteria. If necessary, the Central Bank could insist on the banks putting aside higher capital against the possibility of bad loans, which would make new lending less attractive.

It is important, though, not to see Ireland's house price boom through a British prism. Because Ireland no longer has a separate interest rate or exchange rate from that of the euro-zone as a whole, it cannot raise interest rates (and the exchange rate) to tackle the problem.

Nor does it need to do so to the same extent that Britain would - if domestic demand surges because of a "feelgood" factor, Ireland's current account may go into deficit, but so what? In Britain, this would set the alarm bells ringing, as it could be a harbinger of a sterling crisis. But in Ireland, there will be no effect on the euro or interest rates. There will be no downside unless the boom spills over into earnings growth.

This means that Ireland's exporters and other borrowers are partially protected from the consequences - if they prove to be such - of Irish homeowners' excessive enthusiasm, in a way that does not happen in Britain.

It also means that Cork businesses need not suffer because of Dublin booms (Midlands manufacturers nervously looking at South- eastern house prices please note). If there is a house-price bubble, the problems will fall mainly on those who have been rash enough to lend and borrow to invest in houses. The consequences will ultimately surface in their negative equity when house prices fall.

Whatever happens, Ireland's problems will also work themselves out more gradually because the foreign exchange markets cannot press Irish policy makers to take rapid action. Therefore the cycle is likely to be a gentler one, as it has been with local booms in the United States (for example, Massachusetts). On balance, the Irish economy is likely to go on having the luck of the leprechauns. Ireland has the sort of economic problems the British should die for.

Christopher Huhne is a Liberal Democrat member of the European Parliament's economic and monetary affairs committee, and author of "Both sides of the coin: the case for the euro and European monetary union" in which James Forder wrote the case against.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40k: SThree: SThree are a global FTSE 250 busi...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: SThree are a global FTSE 250 ...

Recruitment Genius: Mortgage Administrator

£20000 - £25000 per annum: Recruitment Genius: We are a vibrant and establishe...

Day In a Page

Migrant crisis: UN official Philippe Douste-Blazy reveals the harrowing sights he encountered among refugees arriving on Lampedusa

‘Can we really just turn away?’

Dead bodies, men drowning, women miscarrying – a senior UN figure on the horrors he has witnessed among migrants arriving on Lampedusa, and urges politicians not to underestimate our caring nature
Nine of Syria and Iraq's 10 world heritage sites are in danger as Isis ravages centuries of history

Nine of Syria and Iraq's 10 world heritage sites are in danger...

... and not just because of Isis vandalism
Girl on a Plane: An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack

Girl on a Plane

An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack
Why Frederick Forsyth's spying days could spell disaster for today's journalists

Why Frederick Forsyth's spying days could spell disaster for today's journalists

The author of 'The Day of the Jackal' has revealed he spied for MI6 while a foreign correspondent
Markus Persson: If being that rich is so bad, why not just give it all away?

That's a bit rich

The billionaire inventor of computer game Minecraft says he is bored, lonely and isolated by his vast wealth. If it’s that bad, says Simon Kelner, why not just give it all away?
Euro 2016: Chris Coleman on course to end half a century of hurt for Wales

Coleman on course to end half a century of hurt for Wales

Wales last qualified for major tournament in 1958 but after several near misses the current crop can book place at Euro 2016 and end all the indifference
Rugby World Cup 2015: The tournament's forgotten XV

Forgotten XV of the rugby World Cup

Now the squads are out, Chris Hewett picks a side of stars who missed the cut
A groundbreaking study of 'Britain's Atlantis' long buried at the bottom of the North Sea could revolutionise how we see our prehistoric past

Britain's Atlantis

Scientific study beneath North Sea could revolutionise how we see the past
The Queen has 'done and said nothing that anybody will remember,' says Starkey

The Queen has 'done and said nothing that anybody will remember'

David Starkey's assessment
Oliver Sacks said his life has been 'an enormous privilege and adventure'

'An enormous privilege and adventure'

Oliver Sacks writing about his life
'Gibraltar is British, and it is going to stay British forever'

'Gibraltar is British, and it is going to stay British forever'

The Rock's Chief Minister hits back at Spanish government's 'lies'
Britain is still addicted to 'dirty coal'

Britain still addicted to 'dirty' coal

Biggest energy suppliers are more dependent on fossil fuel than a decade ago
Orthorexia nervosa: How becoming obsessed with healthy eating can lead to malnutrition

Orthorexia nervosa

How becoming obsessed with healthy eating can lead to malnutrition
Lady Chatterley is not obscene, says TV director

Lady Chatterley’s Lover

Director Jed Mercurio on why DH Lawrence's novel 'is not an obscene story'
Farmers in tropical forests are training ants to kill off bigger pests

Set a pest to catch a pest

Farmers in tropical forests are training ants to kill off bigger pests