OPINION:Evident wage flexibility and resilient exports mean Ireland is well-placed for recovery, writes PETER SUTHERLAND.

IN RECENT weeks there has been a great deal of commentary about the Irish economy and the challenges that it faces.

Understandably, much of it has focused on the grim details of Ireland’s budget deficit that, following last week’s Supplementary Budget, is forecast to rise to 10.75 per cent of gross domestic product this year. A deficit that size would likely be the largest in the euro zone although, on Goldman Sachs’ forecasts, it will be slightly less than that of the UK.

The reasons for the deficit are well known. Ireland’s growth and tax revenues, from about 2003, became overly dependent on housing. At the peak of the housing bubble in 2007, residential investment accounted for 13 per cent of Irish GDP (against 6 per cent in the UK) and capital gains tax and stamp duty accounted for 13 per cent of Irish tax revenues (against 4 per cent in the UK). So, when the property bubble burst, the economy slowed sharply and tax revenues plummeted. The problems of the Irish banks are related to this issue too (their exposure to US mortgage-backed securities and other non-domestic toxic assets is minimal).

While the housing slowdown and the associated budget deficit have created a major challenge, to focus exclusively on housing-related problems provides a distorted picture of the underlying health of the Irish economy. The economy has been a phenomenon since the late 1980s. From a relatively poor country on Europe’s periphery, Ireland has risen to become one of the richest economies in the world in 20 years. Even after an anticipated 8 per cent fall this year, its GDP per capita, in terms of purchasing power, will remain significantly higher than that of the UK or Germany. And, while unemployment has risen, there are still 80 per cent more jobs in Ireland today than 15 years ago. Much of its infrastructure has been transformed during this period.

During the housing investment boom, Ireland’s current account balance moved from a long-term surplus into deficit. That deficit peaked at 5 per cent of GDP in 2007, comparable to the UK and US at the peak (6 per cent and 4 per cent, respectively), and much less than economies such as Spain (10 per cent) and Greece (14 per cent). Since 2007, Ireland’s current account position has been rising and, at the current trajectory, it should return to surplus by the year-end. To the extent that Irish public sector borrowing has been rising, this is being more than offset by a rise in private sector saving.

The cause of these favourable statistics is export-led growth, led by inward investment in industries such as information technology, pharmaceuticals and private sector services.

The fact that Ireland’s economic success has been driven by exports in these areas has resulted in a far stronger basic Irish economy than the one that existed in the 1980s. Because of the nature of these exports, the drop in exports anticipated for this year, as a result of recession, is estimated to be only 5.9 per cent. The corresponding Organisation for Economic Co-operation and Development figure for Germany is 16.5 per cent, France, 11.4 per cent, and Great Britain, 9.8 per cent. Some others are considerably worse, such as Japan, forecast at 26.4 per cent.

Another issue on which there has been much comment is the alleged disadvantage to Ireland of being in the euro zone. In reality, Ireland may have been saved by its membership from the possibility of a run on its currency – however unwarranted such a run would have been. The UK, meanwhile, has seen its currency fall by 30 per cent against the euro, and this is likely to bring short-run benefits. This option is not, of course, available to Ireland; flexibility has had to come instead from an adjustment in real wages. But – and this is the most important positive for Ireland’s long-term prospects – there is clear evidence that it is dealing with the competitiveness issue in a sustainable manner and one I believe to be unprecedented in the OECD area.

The latest data suggests there has already been an 8 per cent drop in private sector wages and salaries and, via the “pension levy”, there has also been in effect a 7-8 per cent fall in public sector pay. It is hard to imagine wages in other economies displaying such flexibility. If these figures are maintained or even supplemented, the Irish economy should emerge from the recession in a highly competitive position. Meanwhile, the Minister of Finance has given an undertaking to maintain Ireland’s low corporation tax rate of 12.5 per cent.

It can be argued that the Budget last week will have deflationary effects, particularly in regard to tax increases, but the alternative might have been a major funding crisis. It has to be recognised that Ireland has a very open economy. Fiscal easing, even if it were possible, is less beneficial to Ireland and would be more costly in terms of driving up the cost of borrowing.

While I do not want to trivialise the difficulties that Ireland faces, its problems are acute in nature rather than chronic. Once Ireland overcomes this short-term panic – and I believe that last week’s Budget, whatever its alleged deficiencies, was a vital step in this process – the basic strengths of the Irish economy remain formidable.

If the Irish people continue to react constructively to the harsh measures necessary, Ireland will be in a very strong position to benefit from the eventual global recovery, and its healthy demographic profile will greatly help in this. – (Copyright The Financial Times Ltd 2009)

The writer is a former EU commissioner. He is chairman of BP and chairman of Goldman Sachs International