Present crisis aside, our economy was in trouble because of a damaging loss of competitiveness, writes Garret FitzGerald
THE SCALE and suddenness of both the global credit crunch and our own domestic housing bubble collapse has obscured the fact that long before these two crises hit us, our economy was already in serious trouble because of a most damaging loss of competitiveness, the origins of which go back to the end of the 1990s.
What caused this loss of competitiveness, and how much ground have we lost in world markets?
On the first point, there was a radical shift of government economic and financial policy about 1998, which reversed the wise and prudent policies pursued consistently by three successive governments in the eight years that followed the resolution of our last major financial crisis between 1981 and 1989.
Those three governments, led successively by Charles Haughey (after Ray MacSharry had persuaded him to emerge from his 1980-1987 mood of denial about that earlier financial crisis), Albert Reynolds and John Bruton, had held public spending growth to a modest and prudent 7.25 per cent a year, and had kept our inflation rate down to 2 per cent a year - slightly below inflation in the rest of the EU. But thereafter, between 1998 and 2002, our economy was seriously destabilised. The modest annual current spending increase of the years from 1989 to 1998 was accelerated, first in 1999 and 2000 to 9-10%, and then in 2001 to over 17 per cent, followed by a further 14 per cent in 2002. This process involved a cumulative 80 per cent increase in spending within five short years!
I should perhaps say that it was the scale and speed of the increase in current public spending at that time that was damaging, rather than the level to which public spending was thus raised - which was not, and is not, in itself excessive, if adequately funded by sustainable tax revenue.
This over-rapid boost to public spending happened at the worst possible moment for our country - for it was just then that, for the first time in our history, we were achieving full employment, which would inevitably create its own inflationary pressures, and were also approaching participation in a European single currency. The benefits of participation in the euro zone would be accompanied by our government losing the luxury it had enjoyed since 1979 of being able to devalue its way out of inflationary crises.
The huge and quite sudden public spending boost after 1998 sparked off a fatally damaging burst of price inflation. Between 1999 and 2003 that explosion in current public spending doubled our inflation to an annual average of 4.1 per cent a year - over twice the inflation rate of our EU partners during that period.
In turn, and perhaps inevitably, that price inflation contributed to wage inflation, which had the effect of seriously undermining our competitiveness. Between the years 2000 and 2006 earnings in Irish manufacturing increased by 43 per cent - almost twice the 23 per cent increase in such earnings that occurred in that period in the rest of the EU.
Between 1993 and 2002 world trade in goods and services had almost doubled - but during those years the volume of Irish exports of goods had increased three-and-a-half times, and exports of goods plus services had approximately quadrupled. So we had doubled our share of world trade within less than a decade: a quite extraordinary economic performance.
However, since 2002 our loss of competitiveness has cost us about one-quarter of that greatly increased share of world trade for, although the volume of world trade in goods and services increased between 2002 and 2007 by a further 50 per cent, the volume of Irish exports of goods rose during that period by only 10 per cent.
Moreover, because of falling export prices the contribution of goods exports to our overall external receipts is now much lower than it was eight years ago: it is down from almost 80 per cent to 55 per cent.
In the face of the stagnant earnings from exports of goods since 2002 our capacity to pay for increased import needs has been maintained only by virtue of a more than trebling of the value both of our exports of services, and also of investment income from outside the State - either or both of which could now be at risk in the present global crisis.
This persistence of a high rate of Irish economic growth until just 12 months ago owed little or nothing to merchandise export growth and almost everything to demand being artificially stimulated by an unsustainable credit boom, which the government of the day chose to encourage rather than to damp down.
Throughout 2005 to 2007 credit expansion artificially boosted the growth of Irish personal consumption to an unsustainable 6.25 per cent a year - a process that this year has gone drastically into reverse.
So, well before the start of the economic crisis - brought about by an oil price spike combined with a global credit crunch, which in our case were aggravated by the bursting of a domestic housing bubble - our economy had already been made extremely vulnerable by domestic fiscal mismanagement of the grossest kind.
You may well ask how, over such a long period of nine years, was it possible for policies to have been pursued that so undermined our economic viability?
Clearly our two post-1997 governments were primarily to blame - especially the first.
We were singularly unfortunate in having in the years after 1997 as minister for finance an ideologically driven politician, preoccupied with taxation issues, and apparently totally resistant to the advice he must have been receiving from his civil servants on the dangers of his spending policies - which, it seems, were based on the absurdist principle: "If we have it, we should spend it!"
Moreover, it appears that after 1997 neither the taoiseach of the day nor the cabinet seem ever to have intervened in the budgetary process to restrain these highly dangerous policies.
The question of why this disastrous policy was never effectively challenged from outside the government is a matter to which I may return.