EU plots the path to EMU on Irish economic model

GROWTH will remain very sluggish this year, but conditions will improve dramatic economy in 1997. This is the central message form the European central message from the European Commission's latest assessment of the state of play on the Continent.

Luckily for all the champions of the single currency, the Commission reckons that growth will be sufficiently strong next year to allow the EU to proceed to monetary union. This is hardly a surprising conclusion, given Brussels's pivotal role in the EMU project.

This "jam tomorrow" promise is interesting for a variety of reasons not least because the "model" the Commission is unwittingly employing to back up its forecasts is the Irish experience of the late 1980s and its subsequent performance in the 1990s.

The EU contends that because of the Maastricht timetable the European economies, particularly Germany and France, will suffer under the twin impediments of deep reductions in government spending and increased taxes. These negative factors have been exacerbated by a significant deterioration in the employment outlook and, in the case of Germany, a collapse in the construction sector which had been booming since reunification. In short, what we are looking at is something similar to a semi recession on the continent.

However, by 1997 the picture will brighten significantly and, according to the EU, the reduction in government spending itself will be the main catalyst for the rebound. The Commission argues that reductions in government expenditure will "liberate" the private sector in France and Germany, boosting both economies. The story reads something along the following lines when the private sector (consumers and business) sees that the government has finally got its profligate act together, it will take this as a very positive sign and will immediately respond by bringing forward consumption and investment which had been postponed because of the government's financial delinquency.

This implies that in the past, the private sectors of France and Germany have been held back by rising budget spending and consequent tax increases. So, as individuals' tax bills rose progressively, they stopped spending and began to save instead, causing the growth rate in the economy to slow down. In a new environment where budget deficits are falling, the opposite will happen the more the deficit falls, the more people will dip into their savings and spend because they know that taxes will fall in the near future.

However, this logic runs totally counter to the traditional wisdom which asserts that any recession will be made even deeper if the government begins to cut spending by closing hospitals, slashing public sector wages and the like.

The economy that turned this traditional logic on its head is Ireland. In 1987, when the Fianna Fail administration started slashing spending, most conventional commentators screamed blast one out, turn off the lights. The prospect of cutting the budget deficit from 10 per cent to 3 per cent of GDP, appeared (a) impossible and (b) filled most with trepidation as many forecast that the economy would go into a tailspin, only recovering years after the initial shock.

In fact what transpired was nothing short of an economic miracle which laid the foundations for the impressive growth in the 1990s, leading to the "Celtic Tiger" label. Almost immediately as early as the second half of 1987 investment started to pick up on the back of a strong export performance. Interest rates fell swiftly and, amazingly, the property market which had been lifeless for the best part of a decade took off. Personal spending set tills ringing and the late 1980s saw the Irish economy out pace Europe.

The impressive performance continued into the 1990s, albeit with a slight let up in 1992/93. The last two years have seen bumper growth and the future, despite the grief being suffered at present by our EU partners, looks rosy.

So successful has this story been that the European Commission now regards Ireland as a role model for the rest of the Continent. The Commission's forecasts are predicated on domestic activity coming back strongly next year, combined with stronger growth in Asia and the US.

The key to domestic activity is that consumers and business will finally regard the new, slimmer government deficit as sustainable and, as the threat of higher taxes recedes in an environment of low interest rates, the domestic consumer will start spending again.

For the sake of European integration, the Irish model had better be exportable.