Everywhere across Europe, one can these days find conference discussing the achievements in 10 years of EMU. This week-end, I had the opportunity to go to Dublin to Euroframe’s conference on that topic (see program here), presenting the latest findings of my joint research with Ulrich Fritsche and Ingrid Größl on divergences in EMU. As it turned out, Ireland has become one prime destination to visit the consequences of economic divergences in the euro-area.
Having not been to Ireland for 15 years, the changes I could observe were breath-taking. Dublin has become a sizzling city, full of boutiques, trendy bars, and expensive restaurants. Of course, I had been familiar with the statistics that per-capita-incomes in Ireland are now among the highest in Europe and actually have surpassed Swiss per-capita incomes in purchasing-power-terms. However, on the other hand, Dublin in a lot of parts still has the small-town feeling, mostly created by the fact that buildings are not very high in most parts of the city. Moreover, the streets are much too narrow to allow for the traffic of let’s say London or Paris. The narrow streets, however, did not prevent the Dubliners to stock up in cars and busses over the past decade, so moving along in Dublin’s street is a rather slow experience.
While for a long time, the Irish boom had relied on a competitive exchange rate and foreign direct investment, in the past years, it was powered by a real estate and building boom. At the end, Dublin real estate prices where among the highest in the world and the . Of course, I had read about it – but seeing all the consequences with my own eyes was a different experience.
Coming from Berlin, probably the industrialized world’s cheapest city to live in, Dublin is unbelievably expensive. Even though real estate prices have already fallen by roughly 10 percent over the past year, residential housing in Dublin seems still be sold for €8000 to €10,000 per square meter (while top locations in Berlin or an average apartment in Munich only fetch €4000). Having a pint of Guiness never was exactly cheap in Ireland, but now it approaches being a luxury, especially if you feel like adding some food to your drink. A Big Mac is sold at €3.60, almost 20 percent above the Economist’s value for EMU (see here).
While wage increases in Ireland for a long time were backed by productivity improvements, lately they weren’t anymore. According to the latest data from the EU commission, relative unit labour costs have outpaced those of the rest of EMU since the late 1990s, and especially strongly since 2004. Irish newspapers were reporting that the wages for the top civil servants lately have been increased – to €300,000 annually (just for comparison: German Chancellor Merkel earns about €270,000 and the highest ranking German pay scale for civil servants is about €130,000; with Germany having a population almost 20 times as big as Ireland).
This loss in competitiveness is now already felt by the export industry – and made worse by the dollar’s slide as Ireland trades a lot with the US. The current account deficit is projected to reach 5 percent of GDP this year even in the wake of a drastic slowdown in economic growth which is projected to reach only 1.5 percent this year (according to the latest OECD forecast, this is the second-lowest growth in the euro-area, after Italy).
So the interesting question (which is also pondered by Irish newspapers) is now: Is the Celtic Tiger only catching its breath or will Ireland experience a more serious downturn? Could it be possible that the growth story reverses just as it has happened in Portugal? Of course, only time will tell. My guess, however, would be that Ireland will experience a much more pronounced downturn than it is now envisioned in the OECD’s and the EU’s forecast.
As we know from our experience in Gemany, adjustments to overvaluation in EMU are painful and costly, especially when they are coupled with the need for a sharp correction in the construction sector. We will now see in the Irish case how much flexible wages might help to dampen the blow. However, in the meanwhile, the Irish government might just make things worse: Already tax revenue is falling significantly below what was projected. First commentators in the papers discuss tax increases. While a contractionary fiscal policy might shorten the adjustment period, it will sure make the pain worse.
This post has been co-posted at Eurozone Watch.