Ireland's new troubles (pg. 2)

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By Shawn Tully, senior editor at large

Another factor was that buying and flipping houses and condos became a national sport rivaling rugby and hurling. The sheer volume of construction was staggering: Ireland built 90,000 houses and condos in 2006, nearly half the number of those erected in Britain, whose population is 15 times larger. That year residential construction reached 16% of GDP, three times the figure in the U.S.

The signs of the glut are most vivid in rural areas, where developers blanketed former farms with houses, expecting jobs to follow. In central Ireland, Johnny Owens, a concrete supplier, joined the frenzy by building a 46-home subdivision and installing utilities for 39 more. Today all but five houses remain unsold. "The place isn't derelict at all, but it looks lonely and forlorn," says Owens.

Ireland's banks remain stricken by the real estate debacle. The country faces large expenditures to rescue its banks, but the numbers aren't nearly as scary as they appear. The government has a cache of savings to tide the banks over without further straining its budget.

After Lehman's fall spread fear that Ireland's big lenders would fail, the administration guaranteed the deposits and foreign borrowings at its leading banks. The size of that guarantee appears towering: $585 billion. But what really matters is the size of the potential losses the government must cover in a worst-case scenario. Those numbers seem manageable. Ireland has already pledged to give its two largest banks, Allied Irish and Bank of Ireland, $4.65 billion each in new capital, U.S.-style, in exchange for preferred stock. It will also buy portfolios of troubled real estate loans from the banks.

***

Put simply, if Ireland is to get back on track, it must lower labor costs and preserve its favorable tax regime. Already the nation is making progress on lowering wages. It has started to reinvent itself by attracting more jobs in highly sophisticated, often capital-intensive fields. It has been able to do so because Ireland follows the U.S. model: Employers are free to trim workforces without the onerous regulations and union rules that prevail in most European countries. In Ireland only about 20% of private employees are unionized, and foreign companies are rarely constrained by union contracts.

"We have good labor flexibility in Ireland that allows us to shift jobs from manufacturing to higher-value-added areas like research and services," says Paul Rellis, Microsoft's chief in Ireland. Adds Denis O'Brien, the billionaire cellphone entrepreneur who also owns a chain of radio stations in Ireland: "I'd be extremely reluctant to invest in France or Germany because of the labor laws. You have too many rules and negotiations. In Ireland we can cut labor costs very quickly."

Because of the flexibility of Ireland's economy, the flow of money from overseas remains strong: In 2008 Ireland's Investment and Development Agency helped lure $2.7 billion in foreign investments, 14% more than in 2007. The new arrivals fall into two main categories: pan-European services and high-tech manufacturing, especially in pharmaceuticals.

In services, PayPal recently announced a $19 million expansion of its operations center in Dublin, where 900 employees engage customers in 42 languages. IBM runs its treasury functions for Europe from Dublin and conducts research for super-high-speed cloud computing and for underwater sensors to detect changes in tides, currents, and water quality. Microsoft is building a $500 million data center in Dublin. Apple now runs its operations for Europe and the Middle East from Cork, employing more workers than it did in the days when it engaged in major manufacturing in Ireland.

This sector is already tasting the benefits of declining costs. "I just hired someone who was laid off from a U.S. company - and had been making $200,000 a year - for $133,000," says Slattery of State Street. "We're looking at no increase in labor costs for three to four years."

The falling costs are crucial. Just because these businesses are high-paying and capital-intensive doesn't mean that they aren't hawks on expenses. If Ireland's costs stayed high, the nation would risk losing top candidates to competitors such as Singapore, South Korea, and Puerto Rico.

***

The second broad category is upscale manufacturing of biotech drugs and medical devices. Boston Scientific makes cardiac stents in Galway. Cork is now one of the world's leading centers for biotech manufacturing; its prominent residents include J&J's Centocor, Gilead Sciences, and Schering-Plough.

In nearby Waterford, the story at Genzyme is a primer in the kinds of productivity increases, with minimal extra costs, that foreign manufacturers can achieve in Ireland. Genzyme makes, weighs, mixes, and packages extremely sophisticated biotech drugs at a 37-acre facility that once housed a Ray-Ban sunglasses plant. The work takes place in heavily robotized, sterile, temperature-controlled labs. The products are among the world's most expensive: A prescription for its enzyme-replacement therapy Cerezyme costs about $200,000 a year.

Today Genzyme (GENZ) employs 460 workers and produces drugs that bring more than $1 billion at retail. It just completed one new plant and is building another, for a total cost of $240 million. Its general manager in Waterford, Dominic Carolan, says that the sharp decline in construction costs will shave some 10% off the estimated budget.

Since his production is highly automated, Carolan reckons that he can triple it by adding just 150 workers, one-third of his current workforce. Result: His costs per vial and tablet will fall dramatically. "Ireland has a big advantage because of the skilled labor force and the high reliability of production," he says. "Now costs are falling too. The days of the pay increases are gone."

***

Will Ireland's future bring Joycean bleakness or a celebration out of Sean O'Casey? That will largely be up to the government. A shortfall in tax revenue or a surge in spending - if the government buckles to the public-sector unions - could put the country in harm's way. With the deficit zooming, Ireland would have to borrow even more money or raise taxes enormously. Either route would prove extremely damaging. Ireland's borrowing is already slated to drive its debt as a portion of GDP to 80% by 2012, close to the danger zone. That could raise its already lofty interest costs to unaffordable levels. Then Ireland would need an international bailout.

The most likely rescuer would be the European Central Bank. An ECB bailout would sink Ireland in a bog. Germany, along with France and other EU members, has long complained that Ireland's 12.5% corporate tax rate - less than half the average for the EU - gives it an unfair advantage in attracting foreign investment. It's highly likely that the rescuers would demand that Ireland substantially raise the corporate levy to lower its deficit. "If that happens, it would be the worst possible blow to Ireland," says O'Leary of Ryanair. "Our low corporate tax rate is the single most important factor in attracting foreign investment."

It would also undermine Ireland's crucial campaign to lower wages. "If taxes rise, employees will demand higher pay," says Alan Barrett, an economist at the Economic and Social Research Institute, a private think tank. "That would go in the opposite direction from our attempts to restore competitiveness."

On April 7 the government unveiled a plan to reduce the deficit from almost 11% to 3% of GDP by 2013. If Ireland can achieve its numbers, the fiscal crisis will pass, and the export machine will not just remain powerful but gain in strength. The rub is that it's only an even bet that the government can do it.

The most convincing solution - deep reductions to reverse years of reckless spending - is clearly off the table. The question is whether the government can deliver even on its own barely adequate projections. Ireland's leading party, Fianna Fil - in power for the past 15 years - takes moderate, centrist positions but often bends to the will of the powerful public-sector unions. It's disturbing that most of the spending cuts needed to meet the government's projections are being postponed until future years.

Prime Minister Cowen needs to lower headcounts and reduce public-sector pay far more than the modest reductions so far to meet his targets, and swears his government is willing to do both. Says deputy prime minister Mary Coughlan: "We're determined to make the difficult decisions. Excessive borrowing would undermine our credibility."

We'll leave the last word for O'Leary of Ryanair. For all his contempt for government policies, O'Leary is a huge fan of Irish ingenuity. He's an exemplar himself: He bought his own private Mercedes taxi so that he can ride in special commuter lanes and not have to sit in traffic. "Maybe we drink too much, but the Irish are brilliant people," he declares. And they'll need all their blarney and brilliance to get through this crisis.  To top of page

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