A bankrupt economy. Migrants queuing up at the docks. Houses being sold for a few euros a piece. Soup kitchens starting up in the centre of Dublin. Most of us assumed that Ireland's economy was sinking along with the other bailed-out peripheral nations of the eurozone, Greece and Portugal. It looked as though Ireland would be stuck in recession for a generation or more.
Yet, while everyone has been distracted by the grisly banking crisis in the eurozone, something very interesting has been happening on the other side of the Irish Sea. The economy has been steadily recovering. Bond yields are heading down again. Foreign money is even starting to flow back into the Irish banks.
There is an interesting lesson in that. Financial markets are fixating on questions such as whether governments are boosting spending or cutting it, and whether central banks are printing money or not. But what really counts is whether you have a strong basic economy low taxes, a small state, healthy demographics, and a skilled, competitive workforce. During the 1990s, the Irish gave the world a lesson in how low corporate taxes could boost growth. Now they are reminding us that, so long as you get the basics right, an economy can recover quickly from a crash even without governments or central banks helping.
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No single country experienced as extreme a boom and bust as Ireland. After decades of stagnation after the end of British rule, in the mid-1980s it discovered supply-side economics. It slashed corporate tax to just 12.5% and limited the state's size to only a little over 30% of GDP. The result was a flood of inward investment and a booming economy. By the start of the last decade, it was richer than Britain, and one of the five richest countries in the world, along with America, Switzerland, Luxembourg and Norway. The euro, however, took an economy that was already on fire and threw petrol on it. Absurdly low interest rates led to a crazy property and banking bubble. When that burst, Ireland was bankrupt. It was forced to go to the European Union and International Monetary Fund for a bail-out. The economy slipped into a deep recession. The housing market tanked.
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But while it is too early to say that Ireland is a Celtic Tiger once again, it has made some impressive progress in the last six months. In the second quarter of this year, Ireland grew by 1.6%, led by its exporters. It probably won't sustain that pace, but it also isn't in much danger of a double-dip recession, even as the rest of the world slows. The central bank expects 1.8% growth for 2012. Plenty of countries would happily settle for that.
The bond market is in better shape too. Last week, the yield on ten-year Irish government debt dropped all the way to 7.6%. At the height of the crisis, it hit 14%. Yields are far lower than for Greece or Portugal, and not much worse than for Spain or Italy. Foreigners are even starting to put money into Irish banks again. According to the Irish central bank, there is now €579bn on deposit in all banks located in Ireland, a rise of €2bn on July's total. The majority of that increase was accounted for by overseas depositors. It was a modest rise and may well say something about what eurozone savers think of French and German banks but it's a start. At least money isn't fleeing the country as it was three years ago.
In short, it looks like Ireland is pulling through. The economy has steadied, and while the bank losses will be a burden for years to come, it no longer seems to be disappearing down an economic plughole the way that Greece is. Most mainstream economists would have predicted otherwise. With sharp cuts in public spending, there were forecasts for a depression lasting for years. Without a functioning banking system to make loans, it would never recover. But the Keynesian analysis misses a key point. The fundamental strength of an economy is what matters: the rest is froth. And in Ireland, the fundamentals are pretty good.
It is a formidable export machine Irish exports are even higher as a percentage of GDP than German exports. That has held up well. Investment in industry has been rising steadily, even through the slump. Despite some pick up in emigration, Ireland has a relatively young, highly skilled workforce. And the government, despite intense pressure from the French as the bail-out was being negotiated, refused to raise taxes on business to the high levels seen throughout the eurozone. The result? It has recovered far faster than anyone thought possible.
There is a lesson in that for Britain. Forget quantitative easing and the cuts. What we should focus on is getting the basics right. In Britain, that means pushing corporate taxes down, reducing the burden of an over-mighty state sector, and upgrading our skills. Get those things right, and fairly soon the economy will come good.
This article was originally published in MoneyWeek magazine issue number 559 on 14 October 2011, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, subscribe to MoneyWeek magazine.
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