‘The 1938 political framework is no longer fit for purpose’
Wrong policy choices and inaction by Irish Governments led to lost decades in the 1950s, and in the 1980s, and policy failures during the boom years of this decade are ensuring that the coming recession will be deeper and longer in Ireland than elsewhere. ‘To have endured three periods of chronic economic underperformance in half a century as a result of policy mistakes must make it abundantly clear to all thinking people who care about the future of the country that the 1937 political framework is no longer fit for purpose’, writes Dan O’Brien, Ireland editor of the Economist Intelligence Unit in this extract from his forthcoming book, ‘Ireland, Europe and the World: Writings on a new Century’, to be published in the Autumn by Gill & Macmillan
In times as grim as these, there is a danger that pessimism can turn to defeatism; uncertainty to despondency; and fear to capitulation. Just as hubris during the boom allowed one excessively positive view of Irish economic performance to dominate, now negativity is in the ascendant. But situations are rarely as good as the Panglossians would claim or as bad as the gloom-mongers would have it. Balance is always needed. It is needed now more than ever.
Dan O'Brien
Dan O'Brien

There can be little doubt that the Irish economy will endure a deeper and longer recession than most other high-income economies. Seeing to this will be the magnitude of the banking and fiscal crises, the destruction of wealth as a result of the collapse in asset prices and the radical down-sizing of the construction industry. But while the medium term outlook is bleak, Ireland retains important and enduring strengths, of which three stand out. First, a workforce that is one of the most educated in the world toiling in a labour market that functions flexibly. Second, a good business environment for international companies and a proven track record in attracting them to locate in the country. And, third, a highly successful internationally traded services sector.

The quality of the labour force and the way it is configured is central to any economy. Human capital is one of the bases of prosperity: the more an economy has, the more potential it has. Human capital survives even the deepest recessions - what is learnt is not unlearnt, expertise does not evaporate and degrees conferred are not taken back by universities. Ireland has a highly skilled workforce, and its quality continues to improve. Of young people entering the Irish jobs market today, the proportion with a third level qualification is exceeded by only four other countries globally.

In the immediate future, the focus on qualifications can, if anything, be expected to become greater with the less ready availability of employment - some young people who may have decided during the boom years to work rather than study will do the latter during the depression years. Thus, the Irish economy will retain high levels of human capital, even if at least some of this will leak out through emigration (the longer Ireland’s recession lasts compared to the rest of the world, the greater these leakages will be, which is one of the many reasons why front-loading all necessary reforms is imperative).

Having good human resources is one thing. Allocating them efficiently is another. Ireland’s flexible labour market allowed the economy to grow strongly when demand conditions were good, drawing in an infusion of foreign talent that gave new dimensions, dynamism and skills to the workforce. Although supply does not always create its own demand, the same flexibility should ensure that jobs are created quickly and in large numbers once the recovery takes hold.

The quality and flexibility of the workforce provides one of the explanations for Ireland’s second real and fundamental strength - its extraordinary success in attracting many of the world’s best companies to operate in the country and create employment on a comparatively massive scale. The international explosion of mobile investment in the 1990s came at the perfect time for Ireland, allowing it to become a global success story in the amount and quality of foreign direct investment (FDI) it attracted. There were many reasons for this, including the country’s European Union involvement, combined with domestic factors, such as a good business environment and those abundant and flexible skills.

Remarkably, and despite the competitiveness problems that have arisen in recent years, inflows of new investment have remained strong. The best measure of the sort of jobs-rich foreign investment that is vital for Ireland comes from the UN. Folks there measure the number of new foreign investment projects in each country each year. In the 2003-07 period, Ireland averaged 144 a year without any discernable trend decline. In comparative terms, Ireland attracted the second highest number of projects in the EU-27 in per capita terms. IDA Ireland figures for 2008, from which the UN numbers are sourced, show that inward investment continued to flow strongly last year.

Success was no fluke. Ireland has been, and remains, a good place to do business relative to most other countries. In addition, the increase in the cost base during the boom years is now being reversed, albeit in the most brutal way possible. Commercial property prices are plummeting and wages are falling. Although government-influenced aspects of competitiveness have been long neglected, the market is considerably more important in determining overall competitiveness. This should ensure that the sharp, on-going decline in the cost base helps maintain Ireland’s attractiveness as a location for foreign companies.

There are, however, many things that could undermine continued success. Some are external, such as changes to the US tax code, but many are domestically determined, such as poor management of the public finances, any weakening of ties to the EU, the appearance of cronyism in dealing with the financial crisis and complacency in addressing specific cost issues affecting key sectors. Failure quickly to get to grips with these issues risks pushing Ireland off the all-important short-lists that companies draw up when deciding where to locate their foreign operations. Since the 1990s at least, Ireland has been on those lists. Success breeds success - everyone wanted to be associated with a winner. Companies piled in. But failure repels. If Ireland does not deal expeditiously with its domestic weaknesses, companies already in situ will divest - gradually or at a stroke - and new companies will be much harder to attract.

A third real strength of the Irish economy is its development of a world-beating traded services sector. From a virtual standing start 20 years ago, it is now the largest per capita exporter of services in the world. More than $1 of every $40 spent globally on services imports accrues to companies in Ireland. When one considers that only one in every 1,500 inhabitants of the planet resides in Ireland, it is very clear just how disproportionate is its world market share. For a high-wage, geographically peripheral, island economy this is exactly where it should be.

Among the most encouraging aspects of the sector’s development has been the success of home-grown companies. Over the course of the current decade to 2007, their foreign sales more than doubled, to over €3bn. Although this is only a fraction of foreign-owned companies’ services exports, the rate of growth was more rapid. It is one of the very few examples where Irish companies have been more dynamic than their foreign-owned counterparts based in the country (one of the least discussed weaknesses of the Irish economy during the boom years was indigenous companies’ aggregate loss of world market share and their very low levels of innovation by the standards of peer countries).

But there is no reason for complacency. The internationally traded services sector is dominated by foreign companies. As stated above, maintaining attractiveness is essential, and perhaps even more essential in the case of services companies than those in manufacturing as the former are more footloose than the latter (manufacturers have greater sunk costs, such as factories and machinery, which make them less mobile).

There are real underlying strengths in the Irish economy. They can reassert themselves once the world economy returns to solid growth, however long that takes. But whether they are allowed to generate the prosperity that they have the potential to create will depend to a considerable extent on policy choices. Policy choices, in turn, will be determined by the quality of the policy-making mechanism. And this gives cause for real concern because Ireland‘s political system is not up to task of formulating and implementing the sort of difficult and pro-active policies that are needed.

The wrong policy choices in the 1950s led Ireland to miss out on the post-War boom enjoyed by the rest of Europe and North America. Policy errors and inaction caused another lost decade in the 1980s. The coming recession will be deeper and longer than elsewhere because of failures during the boom years to manage the public finances prudently, to regulate the banking system effectively and to work on maintaining competitiveness as doggedly and determinedly as that task requires.

Without the constitutional, institutional and administrative reform of the kind advocated in this book, Ireland is destined - at best - to return to the mediocrity and underperformance of most of the post-independence era. Such reform would require the embracing of change to a degree we have not managed before. The last two inflection points in Irish history came in the late 1910s and the late 1950s. Perhaps, a half century on from the last, the current crisis will produce another. It is up to the Irish people. Many other peoples have little or no means of influencing their future. We are fortunate to have more than most. If we do not rise to the challenge, we will have nobody but ourselves to blame.
Dan O'Brien is senior economist/editor at the Economist Intelligence Unit.