IRISH ECONOMY:Lack of economic expertise led us into this catastrophe. The best we can do now is make sure it never happens again, writes MICHAEL CASEY

IN RECENT ARTICLES Garret FitzGerald has pointed to a lack of economic expertise at the top echelons of government and the public sector, ever since the Whitaker era. That, combined with lack of patriotism and political cronyism at all levels, has indeed contributed to the present crisis. Imagine trying to run a health service with administrators but no medical specialists.

Our top policy-makers did not understand the implications of joining the euro zone – for example, how the sharp reduction in interest rates to European levels would boost borrowing in an artificial way, especially for property.

There was a failure to grasp the impact of foreign direct investment. Since Ireland was the only English-speaking country in the euro zone, we became even more attractive to US multinationals as a platform for exporting into the EU. This galvanised the supply side of the economy, but in a rather artificial way.

The high growth rates of the Celtic Tiger period, combined with low real interest rates, were literally too good to be true. Positive returns could be made on any kind of investment. Where public infrastructure was concerned, serious errors were made because there was little knowledge of cost-benefit techniques. There had to be a day of reckoning because the most inescapable economic law of all is that there is no free lunch.

Social partnership, combined with populist governments, resulted in excessive wage growth and increases in government spending, funded by unsustainable property-related taxes. Competitiveness was lost and the exchequer was extremely vulnerable to a slowdown in construction activity. Governments did not seem to worry about wage growth, probably because industrial productivity was growing well. They did not realise that the productivity of indigenous Irish firms was nowhere near that of the US multinationals. They seemed to have forgotten that devaluation was no longer an option.

No one at policy-making level had the expertise to see behind the good headline figures and address the deep-seated fragilities in the system. Maybe they didn’t want to know. They also ignored the possibility of all the risks occurring at the same time – covariance. A rudimentary knowledge of economic history should have alerted them to the probability of the virtuous circle turning into a vicious one. There was never going to be a soft landing.

With understanding in short supply, delusion was rampant. Politicians boasted about how they had brought the Celtic Tiger to life. Did they actually believe this? No journalist asked them what exactly they had done to bring about the miracle.

Lack of expertise hit us in another way too. The essence of good policy-making is to examine “what-if” scenarios, and to develop alternative strategies – plan Bs. What would happen if property prices fell? How would government revenue be affected if construction slowed down and unemployment rose? What if foreign direct investment eased off? Would Irish entrepreneurs be able to take up the slack?

The real tragedy is that this was not the first time we were caught out by inadequate expertise. It also happened in the early 1980s. We joined the Exchange Rate Mechanism (ERM) in 1979. This was the precursor to the euro – a hard currency regime dominated by the German deutschmark. Did we tighten fiscal policy to gear up for this tough new regime? No, we did the opposite, going on a spending spree that brought us perilously close to bankruptcy. To fail twice in much the same way is unforgivable. Over a 30-year period, nothing was done to close the knowledge deficit.

There was, however, a positive development at the beginning of the ERM period. The then governor of the Central Bank, Charlie Murray, very much in the Whitaker mould, was worried that, when we broke the link with sterling, the commercial banks would not have the expertise to deal in Irish pounds as a foreign currency and the market would be disorderly. The banks were lackadaisical about the matter; some saying their chief executives and chairmen were away on holiday. Murray dealt firmly with them and ensured the expertise was in place. One wonders if the banks were ever dealt with as firmly in subsequent years.

The Government now hopes that taking €15 billion out of the economy over the next few years will not have any deflationary impact. This may be based on the experience of the late 1980s, when fiscal adjustment did not seem to slow down the economy. The circumstances were, however, different then. World trade was growing, there were no zombie banks, and consumer confidence had been improved by the Tallaght Strategy. Inflation had also eroded the burden of the national debt.

In present circumstances it is going to be difficult for any government to achieve much more than damage limitation. In general, Irish governments have much more power to harm the economy than to help it. It is difficult to see how any government can create jobs. Spending on infrastructure might help a little – for as long as the projects last – but it is really the private sector that creates sustainable jobs.

Clearly, if foreign direct investment picks up, we might see a reduction in unemployment. Other than that, we will have to rely on the indigenous private sector. This sector, however, depends in turn on consumer demand, which is likely to remain sluggish. The austerity measures in the UK are also likely to reduce demand for exports from Irish firms.

Other problems facing the indigenous sector include the difficulty of accessing bank loans and a lower return on investment than in the good years. Nevertheless, there is spare capacity and it should be relatively easy to increase production without making substantial new investment. This may account in part for the recent growth in industrial output and exports, though most of this is due to the US multinationals, especially pharmaceutical firms.

There is another risk that doesn’t bear thinking about: the possibility that China might experience a property crash. This would severely affect US borrowing, world trade and foreign direct investment. In this event, the second dip could be worse than the first.

Looming over the Irish economy like a dark cloud is the banking crisis and the need for further recapitalisation. This adds to the uncertainty of consumers who have little knowledge of the implications for increased taxation in the future as debt servicing costs mount. The situation has not been helped by the high interest rate being charged on the “rescue” funds, or by the ECB’s insistence that senior bondholders in our banks be repaid in full.

This matter could be revisited if Portugal, Spain and perhaps Italy were to decide to negotiate with bondholders. The fact that Nama has not fulfilled its primary aim of helping the banks lend to productive businesses is extremely serious. Its role will have to be closely examined, as will the suggestion that banks have lied about the valuation of their assets.

The IMF/EU/ECB rescue plan does provide us with funds for three years. Consequently, pressure from the international bond markets should ease. If it does not, or if the fiscal adjustments prove to be too severe, we may have to restructure our debt. This is not the end of the world; other countries have been down this road before us and many will follow. We have already been shamed by our Government. Another dose of humble pie will not be lethal.

Even though the rescue package has not been a generous one and will actually add to our fiscal difficulties, we should remain loyal to the euro. Some commentators advocate leaving the euro or having a two-tier system. Neither is appealing. We would have to face a higher burden of debt if our “new” currency were weaker than the one in which the debt was denominated. We should work towards improving the architecture of the euro zone.

The face of Irish banking will change over the next few years, with asset sales, mergers and acquisitions. Ownership by foreigners doesn’t matter. It is possible that most of the existing shareholders in AIB and BoI are foreign institutions. As long as there is competition, Irish people should get a reasonable deal from banks located here – maybe even better than was provided by the “Irish” banks.

One of the benefits of foreign ownership would be that taxpayers would not be on the hazard in any future crisis. There is a case to be made for having one state-owned bank for strategic national reasons. It would, of course, have to compete on a level playing field.

Most important of all, we must acquire the expertise needed to manage the economy properly. We simply cannot afford to make such catastrophic mistakes again.

Michael Casey is former chief economist at the Central Bank and member of the Executive Board of the IMF in Washington DC. His book, Ireland's Malaise: The Troubled Personality of the Irish Economyis published by Liffey Press