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Celtic Tiger chained by Europe

As Ireland faces its worst recession in a quarter-century, policies that bind the European Union now represent obstacles to recovery.
/ Source: a href="http://www.washingtonpost.com/wp-srv/front.htm" linktype="External" resizable="true" status="true" scrollbars="true">The Washington Post</a

When Ireland entered the world's most ambitious economic alliance -- the European Union -- the Celtic Tiger roared to life. Membership in Europe's private club, along with the subsequent adoption of the euro, lured scores of multinational companies to this country and ushered in an unprecedented era of growth.

But as Ireland faces its worst recession in a quarter-century, the policies and institutions that bind the European Union now represent some of the country's biggest obstacles to recovery.

The global credit crunch has silenced the construction cranes that transformed Dublin from a sleepy backwater to a major financial center. Yet the Irish are finding they have fewer and fewer ways to get them started again.

In surrendering monetary policy to the European Central Bank and agreeing to meet specific budget targets, Ireland and other E.U. countries are now handicapped in their ability to craft responses to specific economic challenges. As a result, economists say, the recession in Europe is likely to be even deeper, and last longer, than the one in the United States, making it more difficult for the global economy to bounce back quickly.

"The structural problems in the United States are on an order of magnitude less than in Europe," said Constantin Gurdgiev, an economist and research director of NCB Stockbrokers in Dublin. "Ireland is now the litmus test for the European model -- a test of whether it will work or whether it won't."

Fast-deteriorating picture
Seeking solutions, European leaders will converge in Washington on Saturday for a global economic summit, pushing sweeping reforms of the world financial system. Pressing for everything from global guidelines on executive pay to universal accounting standards, they are calling on the United States and other major nations to sign on to their plan within 100 days.

Their urgency stems from the fast-deteriorating economic picture at home. While the United States is set to shrink by 1 percent in 2009, the 27 E.U. nations may contract by an average of 1.4 percent, according to Tom Mayer, chief economist for Deutsche Bank in London. The former dynamos of the region, including Ireland and Spain, appear likely to be hit hardest, with unemployment in Ireland already at an 11-year high and, analysts predict, likely to get much worse.

Before the global downturn, the country had emerged as a beacon for foreign companies -- particularly those in the United States -- eager to tap rich European consumers. Ireland benefited from being the only English-speaking nation in the euro zone. But it also greased the wheels of growth by offering companies lucrative incentives and among of the lowest corporate tax rates in the world. From 1995 to 2007, the Irish economy grew at a blistering average of 7.5 percent a year.

That growth was most visible on the Dublin riverfront, where a new breed of developers transformed this city of cozy pubs with a slew of new luxury condos, wine bars and grade-A office space. Fueled by low interest rates on euro loans and a flood of Eastern European immigrants who came to work in the sprouting restaurants and factories of Dublin, Cork and Shannon, house prices in some areas of Ireland jumped as much as 500 percent in a decade.

"The problem, you see, is that things got out of hand," said Mike Wallace, a developer who sports white rock-star hair and an earring. "The money was too cheap, and incentives to build too great. The effect was the opposite of European integration. We became more like America and less like Europe. That has got to change."

Today, Wallace has three prime parcels of land that he'd like to build on. Despite a national housing glut, the properties are in highly coveted areas, but most banks are refusing to lend. Banks that are willing to do so are charging interest rates -- once so low as to promote overbuilding -- that are too high to make any building project worthwhile. "We can't seem to get it just right," he said.

Euro works against a quick recovery
Part of the problem is that European monetary policy, which once worked in favor of fast growth in Ireland, is now working against it. Over the past decade, analysts say, European Central Bank interest rates were probably too low for the likes of Ireland, contributing to a massive credit bubble here that has all but collapsed in recent months.

Now that Ireland needs aggressively low interest rates to stimulate the ailing economy, it is not getting them. This summer, when the economy here became the first in the industrialized world to fall into recession since the credit crisis began, the European Central Bank actually raised interest rates, worried more about the rise of inflation across the euro zone. Although the ECB has since cut rates twice, it has kept them higher than the Federal Reserve's benchmark rate and the Bank of England's. That strategy, economists say, makes sense for euro zone countries such as France, which is not in recession, but not for Ireland.

To be sure, few in Ireland are talking about abandoning the euro, credited with preventing the runs seen in recent weeks in nations including Iceland and Denmark, which have kept their own currencies. But many here concede that the euro is also working against a quick recovery. The relatively expensive currency has driven up the cost of doing business in Ireland, worsening woes here as Dell and the other multinationals that planted their flags in Ireland years ago shift jobs to countries with lower labor costs.

"It's great to be part of the club when everything is going well," said Mark Doyle, marketing director for Green Isle Foods. A frozen-food exporter with a focus on the English market, the company has been stung by the euro's recent strengthening against the British pound. "There is no other way for us to prosper other than inside the European Union, but we have to make sure that we are looking out for Irish interests, even when they might diverge from Europe's."

Delicate dance with the EU
As Ireland struggles to contain the crisis, it is locked in a delicate dance with the European Union. The alliance's leadership in Brussels, for example, is demanding that Ireland cut public spending to meet E.U. standards for budget deficits. But the Irish government -- facing diminished tax revenue and a deficit as high as 6.5 percent this year -- is struggling to comply.

While nations around the world are cutting taxes to stimulate their economies, Ireland is adding an income levy as high as 2 percent. Protests have already forced the government to roll back at least one controversial plan that would have made Irish people older than 70 pay for medical care, which became free to seniors in the late 1990s.

Still, the government is moving ahead with a slew of other unpopular measures, including cuts in education that will mean a reduction in the number of teachers nationwide. It is also scrapping plans to give inoculations to girls to prevent cervical cancer. There is talk now of public employees taking a voluntary 10 percent pay cut.

Ireland's one independent financial move in recent weeks -- a measure to guarantee all banking deposits in October -- brought a sharp rebuke from European leaders. Dublin should not, they said, act alone.

Nervous investors have driven up the cost of borrowing on world markets, even for European nations like Ireland, Spain and Austria that were once considered surefire bets. To avoid paying higher and higher borrowing costs, analysts say, the government here may need to risk the future of its retirees by dipping into the national pension fund if Irish banks need help.

Though no national polls have yet been released, some analysts say the Irish may be growing increasingly resistant to the more centralized Europe envisioned by many of its leaders. Earlier this year, the Irish cast a vote against the Lisbon Treaty, rejecting what many described as a European Constitution that would have given more power in E.U. officials in Brussels.

The crisis is also zapping Irish confidence and presenting this proud nation with a hard reality check. The seemingly endless years of riches after so many of struggle seem, for the time being, to have come to an end.

"We're very scared," said Siobhan Tobin, 23, a public kindergarten teacher in the town of Naas, 20 miles south of Dublin, and one of hundreds of teachers across Ireland who may lose her job in the coming months. The budget cuts would have the newest teachers -- like Tobin -- ousted first.

"I think there is a concern that Ireland is a small country that could be bullied by Europe, but I also think we are looking at ourselves and our society," Tobin said. "Was the Irish miracle for real? What will the future be like? We don't know anymore."