Ireland's economic mess nobody's fault but our own

For some time now the Irish government and, indeed, a lot of Irish people, have been clinging to the belief that the mess the Irish economy has got itself into is mainly the fault of the international financial crisis. The explanation for our catastrophic collapse is that since we are the most open economy in Europe, we have been hit much harder than other countries by the international crisis.  

That argument was well and truly buried last week by the International Monetary Fund (IMF), which published a report on Ireland that was so critical of our behavior during the latter stages of the Celtic Tiger boom that the only word for it is scathing. We behaved stupidly and recklessly and did not listen to warnings (including warnings from the IMF) that we were heading for big trouble.   

The meltdown in the Irish economy is our own fault, according to the IMF. Yes, we have been hit by the international crisis like everyone else.

But the much deeper, faster slump here is down to us, not the global financial crisis.  The recession is worse here than anywhere else in Europe and it's our fault, the IMF makes clear.  

In summary, what the IMF report says is that during the boom we let our cost base (wages, services, in fact just about everything that businesses have to pay for) increase so fast that we got ourselves into a totally uncompetitive position.  The result is that we are now the most expensive country in Europe, after tiny, wealthy Luxembourg.  Companies have been lining up to get out of Ireland to go to cheaper locations.  

What the IMF report also makes clear is that this trend was evident over the last few years of the boom.  Manufacturing jobs were vanishing.  Even high tech jobs were shifting.

But what was happening was masked by our property boom, which the government continued to stoke up long after it was clear that it was not sustainable.  At the height of the madness we were building homes at five or six times the rate in the U.K. where they had a boom of their own.  Construction became not only the most important driver of the economy but also the bedrock of the government's tax revenue, underpinning lavish state spending.  

So when the property bubble burst, we were screwed.  By then the decline in the manufacturing and services economy -- the real economy -- had reached a crisis point. 

We were losing jobs so fast it was terrifying (and that is still happening).  Tax revenues from the property sector collapsed and tax revenues from business, sales and incomes all shrunk. 

We shifted from being a country where there were big budget surpluses to one in which a yawning budget deficit opened up.  And as more people lost their jobs (we are now heading for half a million out of work), the cost to the state in welfare soared. 

This made the bad economic situation even worse.  The bad situation was created during the boom when government spending grew at a dizzying rate, with the numbers on the state payroll shooting up and the levels of pay they were getting surpassing pay in the private sector. 

Now the boom is over, tax revenues are in freefall and we can't pay for our inflated state sector without huge borrowing.  And it's made worse because on top of that we have the added cost of an army of unemployed people who have lost their jobs in the private sector.  

All this is very embarrassing for Taoiseach (Prime Minister) Brian Cowen because he was minister for finance when the decisions were taken that resulted in the present mess.  Of course he was not the only one to blame.

The real culprit was the then Taoiseach Bertie Ahern, who leaned on his young minister for finance at the time to keep the property boom going and to keep spending state money like there was no tomorrow. 

While Ahern was taoiseach the cost of the public sector pay bill actually doubled.  There was supposed to be a payback in terms of increased efficiency in state services, but this never happened.  If anything, even with the extra numbers, the services became more shambolic and unreliable.

We are now in a very difficult situation, with the cost of public service pay and the cost of welfare together far exceeding the total tax take.  The result is that we have to borrow €25 billion this year and at least €22 billion next year just to keep going.  

We can't do that for more than a few years without the country going bankrupt.  So urgent and determined measures are necessary, the IMF says. 

In the last budget, the government increased taxes and made only minimal reductions in some services (although even this led to public protests), but that was only the beginning of a program of cuts that will continue for a few years. The IMF report recognizes that there is limited room for further tax increases and that in future there will have to be major cutbacks in state spending.  

What we have to do is cut state spending by a few billion a year in each of the next few years, something that becomes progressively harder to do as the cuts bite into services. 

The government knows this, but as the IMF suggests, there can be a long way between knowing what you have to do and actually doing it. "The task ahead is formidable and determined execution of these initiatives will be needed," the IMF report says.  

What they are really saying is that while the government's plan to make cutbacks is correct, the political will is weak.

The IMF says that there could be some increase in taxes by pushing income taxes higher and introducing a wide reaching annual property tax (at present there are no property taxes here unless a property is sold).  But the scope on taxation is limited. 

The big adjustment must come on the spending side.  So the state needs to radically cut the cost of services and the pay of state workers.   The difficulty will be to achieve that without reducing frontline services (schools, hospitals, etc., etc.).  

To give just one example of how difficult this is going to be, consider the question of child benefit, the monthly payments made to the parents of all children here, regardless of family income. In families with three kids this is over €500 a month. 

These payments cost huge amounts of state money each year, and the system needs to be reformed so that only families in need will get the payments.  At present many middle class families let the money accumulate and then use it to change the car, book a holiday or they save it for college costs.  

Indications from the government that this system is going to be changed radically in the next budget has already led to warnings that any changes may be unworkable or even unconstitutional.      

This unwillingness to make any sacrifices underlines the challenge facing the government.  What people here don't realize yet is that there has to be a reduction of at least 20 percent in total state spending over the next few years if we are to get out of this mess.  

The alternative is that instead of just offering advice, the IMF will be back a few years from now when the markets will not loan us any more money and Ireland goes belly up.  There will then be an IMF slash and burn attack on state spending here that will make current proposals look like a holiday.

The IMF says the government's plan for the next few years to reduce our Budget deficit is on the right track. It urges us to improve our competitiveness by reducing our costs, particularly wage costs. 

It also backs the government's National Asset Management Agency (our version of a national bad bank) to take the toxic loans out of the existing banks and get them lending again.  But it does say that temporary nationalization of all the main banks here would make it easier to value the toxic assets than the government's present policy of avoiding nationalization.  

One way or the other, the IMF makes it clear that the behavior of the Irish banks was highly irresponsible and that we must not let them off the hook by paying too much for the assets they lent billions on. 

The IMF report on Ireland is easy to find on line and is worth reading in full.  And next week we will have the report of the independent expert tasked by the government at identifying where billions in state spending can be saved in the coming years.   Now that will really be worth reading!