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Ireland's tiger economy - wit' or wit'out the euro

ONE of my fondest memories is of Bertie Ahern at a debate at Trinity College in Dublin shortly after the pound had left the European exchange rate mechanism in September 1992; Ireland was struggling with a punt that had stayed in while the pound had devalued by some 20pc.

Mr Ahern, then finance minister, had a mantra for the evening: "I will not devalue t'e punt". Of course within a few months he had done just that. Why? Because in those days when Ireland controlled its own interest rates and currency it would have been madness to be a fifth overvalued against the country of which you are virtually a part.

Those days are far away but the logic remains, in reverse. Today, the pound has soared by about a fifth against the euro to which the hapless Mr Ahern, now Taoiseach, is tied without recourse. In a continent of huge divergence, Ireland stands out as the most divergent of all - growing at 8pc while Germany and Italy may with luck be shocked by this huge devaluation into 3pc growth. In Frankfurt, the ECB council smile indulgently: Ireland is too small to worry about - it and the rest of the "periphery" can take its chance.

And what will that be? Since the reforms started by Mr Haughey back in the mid-1980s and which re-modelled the country on the new Thatcherite Britain, Ireland has been a fast-growing economy with low labour costs and general deregulation. It has attracted huge amounts of mainly American investment, much of it in the computer and software business.

The big countries of the EU have never felt threatened by the "Irish model" with its under 4m souls. So, like many of the EU's small countries, the name of its game has been to say "yes" to Germany and France, collect the agricultural and regional largesse, and get on with competitive deregulation on the quiet.

So, with or without the euro, Ireland was always going to grow fast. What the euro has done is to take away the restraint that would have been exercised by monetary policy. Consider a sample of the latest figures. Car registrations in January-February were up 49pc on a year earlier; house prices were up 31pc in 1998 and another 22pc in the year to the third quarter of 1999, with latest figures thought to be running at over 25pc, with thousands of expatriate Irish being lured back to the homeland. January's retail sales volumes were 17pc up on a year before.

So far inflation has been held back in spite of this runaway boom coming on top of already-strong growth (Ireland grew by an average of over 8pc per annum from 1994 to 1998). Its underlying retail price index (excluding mortgage rates, held down by the euro) rose 5.2pc in the year to March - much of it, though, due to tobacco tax and oil. Average earnings are rising by around 5.5pc, which, with productivity growth strong, is not yet a problem.

But this relative restraint of prices and wages is built on an incomes policy, buttressed up to now by high levels of immigration which has kept the supply of labour not so far behind ever-growing demand. Experience with incomes policies shows that they do not last against the pressure of supply and demand; in Ireland, it can only be a matter of time before the dam breaks.

There are two main possibilities. Either the Government encourages yet more thousands of immigrants and allows house prices to be driven up to the stratosphere, in which case union demands will be fuelled by housing costs. Or the flood of immigrants is stemmed, in which case the wage demands will be fuelled by severe labour shortage.

Already there has been a transport workers' strike over wage demands of 20pc; other public sector workers are said to be planning similar demands. So far, the incomes policy has held but the whiff of a summer or winter of discontent is in the air.

Where will this end? Ireland is a "tiger economy" whose emerging-market dynamism was in any case bound to bring rising real (inflation-adjusted) wages and prices relative to other countries. As an economy modernises and acquires new industries its rising productivity allows real wages to rise and the new industries can charge higher prices in world markets. As growth spills over into humdrum local services like transport and schooling whose productivity cannot grow so fast, their relative prices will be pushed up by rising real wage costs, by the scarcity of land and by sheer demand pressure.

This can happen in two ways. With the exchange rate fixed and monetary policy set somewhere else, it will happen through rising prices and money wages. With the exchange rate free to move and monetary policy set to keep prices under control it will be the exchange rate that rises to raise the real value of wages and the relative prices in world markets; so it has been for the UK and so it would have been for Ireland had it stayed out of the euro (with the pound and the dollar).

By joining the euro, therefore, Ireland chose systematically higher inflation to accompany the heady growth it would have in or out of the euro. But there is a further element in its euro brew: loss of control over its business cycle. Ireland is "enjoying" a huge boom that would never have been permitted under a floating punt when interest rates would have already been up to seven per cent or above.

Of course, it is this boom that has got such admiring and naive reports from the BBC; but a hard landing cannot be far away. Its most likely form would be a collapse of the incomes policy, wage costs escalation, and spending cut-backs by investors and consumers as the Government takes emergency action - perhaps huge tax increases or a floating tax on buying punts (a backdoor floating exchange rate).

The ensuing slump will be far worse than it would have been had the boom been kept under control. Higher inflation and reinforced boom-and-slump is an unattractive recipe for UK citizens and businesses. That's the lesson of Ireland and the euro.

Patrick Minford is professor of economics at Cardiff Business School  

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