On Ireland’s superior economic performance

Earlier in the week, I wrote a post on Spain which explained why there is limited applicability of Latvia’s travails with austerity for larger economies in the euro zone like Spain. This is irrespective of whether one views Latvia as an austerity failure or a success. One place where Latvia does have applicability, however, is Ireland. In both cases you have an economy that was overheated and wracked by the excesses of a housing bubble. When these bubbles popped, it left a wake of bad private sector debt. In both cases, the response was austerity and asset writedowns, with the result being a huge economic contraction. But both of these economies have since begun to grow.

Ireland has been a standout within the euro zone, especially in the manufacturing sector. When the euro zone PMIs came out yesterday, Ireland showed growth in its manufacturing sector for the 11th straight month. Here’s how the Irish Independent covered the story:

Ireland’s manufacturing sector expanded for the 11th straight month although the flow of new orders contracted for the first time in a year, a survey signalled yesterday.

While the sector is still expanding, the NCB Manufacturing Purchasing Managers’ Index dropped to 50.3 in January from 51.4 a month earlier, a shade above the 50pc mark that separates expansion from contraction.

“While output remains in positive territory and new export orders grew for a fourth successive month, other areas showed signs of weakness,” said Philip O’Sullivan, chief economist at NCB Stockbrokers. “Tying it all together… today’s release points to a sluggish start to 2013 for the manufacturing sector,” he said.

Manufacturing contributes around one quarter of Ireland’s gross domestic product, according to World Bank figures.

New orders contracted for the first time in a year, falling to 49.5 from 50.9 in December while employment contracted for the first time in 11 months. Input prices grew sharply, while output prices contracted.

While the PMI figures are usually a good indicator for industrial production, the PMIs have continued to signal expansion while the Central Statistics Office figures suggest industrial production is under severe pressure thanks to some medicines going off patent.

Going back to what I wrote yesterday in the Spain and Portugal post, the Irish Independent article reinforces my contention that it was really only Germany that showed good numbers in the euro zone PMIs for January. The other important countries were below the 50 mark. And the one country that has consistently done well in manufacturing over the last year, Ireland, saw its numbers decline to near contraction levels. Also notice that Ireland’s new orders numbers were actually below 50 i.e. foretelling of a potential contraction.

My conclusion about Ireland is similar to what I wrote about Latvia, that its small size and dependence on external flows make Ireland more able to pull off an internal devaluation. Internal devaluation is a bigger boost due to the importance of trade and money flows. And Ireland’s small size makes the changes and the emigration abroad easer to absorb by its  trade partners. But note that Ireland has suffered mightily nonetheless. Unemployment is about 15%, deficits are large and government debt to GDP has ballooned from 25% to well over 100% because of the effect on the financial sector and its bailout by the state. Any setback in Ireland’s growth trajectory would be catastrophic.

So it’s important that Europe doesn’t get complacent. I believe European policy makers want to use Ireland as an example of success. And this makes them eager to cut deals which soften the blow for Ireland as it emerges from its bailout. I expect some sort of deal to be reached that cuts Ireland’s bailout debt interest rate, lengthens maturities or somehow unburdens the state of its financial sector-related obligations. The political calculus behind this will be to boost Ireland and help it to continue as an example of austerity’s success, irrespective of whether that so-called success is applicable to larger economies in the euro zone.