Former Celtic Tiger Faces Deep Budget Cuts

Ireland must enact painful spending cuts in order to restore confidence in its economy.

With a budget deficit approaching 30 percent and investor confidence in its sovereign bonds falling, pressure on Ireland to either rein in spending or seek help from its fellow European Union member states has been mounting. Some even wonder if it might have to brace for a disaster similar to Greece’s.

In the wake of April’s financial meltdown in Greece, European leaders agreed to an unprecedented rescue effort to save not only Greece from sovereign default but protect the future of the euro itself. With a €750 billion stabilization package, the European Commission, individual member states as well as the International Monetary Fund sought to restore confidence in the common currency.

Ireland has so far refused to take aid from its European neighbors with Dublin insisting that it is not engaged in any bailout talks. The Irish government believes that it can present a credible austerity budget next month to satisfy investors. A rescue effort, by contrast, would only undermine investors’ confidence in the state’s ability to repay its loans. For a country that is extremely dependent on foreign investment, which represent two-thirds of GDP, that is a risk it can ill-afford to take.

A crisis in Ireland, moreover, would likely spill over to the continent where countries like Portugal and Spain are mired in recession.

Unlike Greece, Ireland entered recession with a budget surplus and after several years of strong economic growth. It did witness a massive housing boom in the years preceding the crisis which severely weakened its financial sector.

At A Fistful of Euros, P.O. Neill summarizes the roots of Ireland’s current predicament:

First, there were massive explicit and implicit subsidies to the banking and property sectors, the implicit subsidies now becoming explicit during the cleanup phase.

Second, there was a distortion in the perceived cost of public services, as the revenue windfall from the property boom made it seem that more resources could be poured into public services without having to raise taxes.

Third, there was (and is) a political economy that emphasizes pie-sharing and co-option rather than questions of efficiency and distribution, which in turn led to a don’t-rock-the-boat reaction to critics.

And fourth, there was a naive trade union sector (referring in particular to unions for lower paid workers) that didn’t see how their demands for closer alignment of public- and private-sector pay, national wage bargaining, and final salary pension schemes would interact with each other to produce massive pay and benefit differentials.

The result, according to Neill, was a banking sector that grew too large and a public sector that grew larger at an underestimated cost.

Despite high levels of government spending, especially in recent months, Ireland remains economically one of the freest nations in the world with a strong protection of property rights, a near lack of corruption, efficient business regulations and competitive tax rates. “These strengths,” notes the 2010 Index of Economic Freedom compiled by the conservative Heritage Foundation and The Wall Street Journal, “provide solid foundations on which to build recovery and curb long-term unemployment.”