Bill Riley: Ireland suffers from US recession

Of all euro-zone countries, Ireland is uniquely vulnerable to the economic slowdown in the US. As a highly open economy, exporting 78 per cent of its gross domestic product last year, it is heavily dependent on world markets. But as a euro-zone member that accounts for just 1 per cent of the area's GDP, Dublin has little influence over monetary policy, set by the European Central Bank, or exchange rate policy, set by the currency markets.

"For the past five years of the boom we have been saying, 'when is it going to end?' " says Patrick Honohan, a Dublin-based fellow of the Centre for Economic Policy Research, a European think-tank. "We thought it might come with an outbreak of foot-and-mouth, something that damages tourism, a high-tech downturn, or a change to the tax regime. Well, now we have got three out of four."

The threat of foot-and-mouth has led to severe movement restrictions, and tourism has been hit by overseas perceptions that Ireland is somehow dangerously infected. But there has been only one case of the disease in the Republic, and it seems to have been successfully contained.

The bigger threat is from the US-led slowdown in the world economy. Ireland accounts for one-third of all US electronics investment in Europe. US-owned companies provide 5 per cent of total employment, and half of all exports. Thirteen per cent of Irish GDP depends on exports to the US - a figure five times the euro-zone average. In hitting technology businesses and the US the hardest, the slowdown is hurting an industry and a market that has underpinned Ireland's recent prosperity. Besides electronics, the E20bn ($17.6bn) chemicals and bulk pharmaceuticals sector, which depends on the US market, may also be vulnerable.

On the surface, there appears as yet to be little cause for concern. First, the reaction of US investors has been only modest. The Industrial Development Agency, the government body that promotes Ireland as a location for foreign investment, estimates that multinational companies have cut fewer than 700 jobs since the start of the year.

Intel, for example, despite postponing its new plant, is to maintain its core Irish workforce of 3,500, as well as 1,400 subcontractors.

The IDA also expects about 15,000 jobs to be cre ated by inward investment this year, compared with 24,000 in 2000, a record year. Officials say that job losses are nothing new in the foreign-owned sector, where 5-6 per cent of workers are shed every year. Even last year there were almost 9,000 job losses, as old plants were closed or relocated.

Second, monetary policy - the other motor of the Irish economy in recent years - remains loose, even after the ECB's refusal to cut interest rates. Indeed, based on the reported headline inflation rate of 5.4 per cent for

March, real interest rates are still negative. Last year the huge expansion in construction created 23,000 jobs. This is almost as many as were created by inward investment.

Even so, some indicators do point to worse times ahead. The property market appears to be slowing, reflecting weaker demand from multinational executives and returning Irish emigrants seeking jobs at foreign-owned companies. There is evidence of higher car repossessions. Irish newspapers report falling recruitment advertising. And consumer confidence has dipped.

The Irish Central Bank predicts that growth will fall from 9.75 per cent last year to 7 per cent this year. Julian Callow of Credit Suisse First Boston in London expects an even sharper slowdown, to 5 per cent growth this year and next. That is still high by most standards, but it would be Ireland's weakest performance since 1993.

Charlie McCreevy, Ireland's finance minister, believes the slowdown may be a blessing in disguise. He told the European Parliament last Wednesday that a combination of slower US consumption and the impact of the foot-and-mouth disease on Ireland's agricultural exports would reduce the risk of overheating.

Inflationary pressures have been a serious worry. According to the Organisation for Economic Co-operation and Development, increasing pay pressures will force unit labour costs to rise 4.2 per cent this year and next, compared with a euro-zone average of 1.4 per cent. Some say the global slowdown may provide just the right amount of shock to business and consumers to cool growth to a more sustainable pace.

To hope that the economy can adjust smoothly and painlessly may be optimistic, however. "For most people in employment, all they have seen is the economy growing at more than 5 per cent," says David Croughan, chief economist at the Irish Business and Employers Federation. "Consumer confidence could swing very dramatically."

One problem could emerge from increased borrowing. Private-sector debt has soared from E44bn in 1997 to E111bn at the end of last year. If the economy goes into reverse and house prices fall, that debt burden could lead to bankruptcies and a financial crisis.

The other great risk is in the exchange rate. If the US slowdown is severe and prolonged, the dollar could fall rapidly against the euro as capital flees to Europe as a safe haven. If that happens, Ireland could face a downturn in its second-largest market (after the UK) at the same time as a sharp loss of competitiveness.

By joining the euro, Ireland has taken away the risk of a currency crisis caused by a loss of confidence in its economy. But the threat of economic volatility may come from another direction. As Dan McLaughlin, chief economist at Bank of Ireland, warns: "It would be fanciful to think you could have a recession in the US and not have an impact in Ireland."