Ireland's Central Statistical Office reported on April 29 that the country's unemployment rate rose to 11.4 percent in April from 11 percent in March. The figures were released as Ireland's leading economic think tank, the Economic and Social Research Institute (ESRI) reported that the unemployment rate would rise to between 14 and 16.8 percent by 2010 and that the gross domestic product (GDP) would contract in 2009 by 8.3 percent. ESRI projects that the economy will contract by about 14 percent over the period of 2008-2010, the largest economic decline for an industrialized country since the Great Depression. The "Celtic Tiger," a moniker Ireland earned with its average annual economic growth of 7.5 percent between 1995 and 2007, is now facing possible extinction. The current economic crisis has gutted Ireland's financial sector, which was the engine for the real estate boom of the 2000s as development went into overdrive, fueled by cheap worldwide credit and the domestically low interest rate made possible by Ireland's accession to the euro in 1999. Most worrisome, however, is the potential for the effects of the current economic crisis to undermine the main sources of the recent Irish boom: the financial sector and an investment-friendly climate.

Birth of the Celtic Tiger

While Ireland's entry into the EU in 1973 is often seen as the key variable in the Irish miracle, it is Ireland's geography and demographics that gave it an upper hand in the technological revolution and globalized world economy. Ireland's location in the North Atlantic, between Europe and North America, gave it an excellent base for economic growth and a comparative advantage for attracting U.S. investors looking to do business in Europe. The five-hour time zone difference between Ireland and the U.S. East Coast, along with Ireland's English-speaking population of roughly 4.5 million, added to its attractiveness to U.S. investors. With so much interest from across the Atlantic, Ireland was in a position to benefit greatly from the advantages associated with EU entry: funding for infrastructure and education through various EU programs, and access to the wider European markets. By the end of the 1980s, Ireland boasted an educated and dynamic population, and in 1998 the Belfast Agreement eased tensions in Northern Ireland, which reduced the political instability that had plagued the island for centuries. Furthermore, Dublin's corporate tax rate of 12.5 percent (within the European Union, only very new members Cyprus and Bulgaria had lower corporate tax rates) gave Ireland the perfect combination of geography, an educated English-speaking populace and an investor-friendly climate unrivaled in the EU. Investors from the United States and Europe flooded the island with everything from call centers to law and accounting firm branch offices (using the five-hour time difference to have almost around-the-clock coverage for their business operations), scrambling to take advantage of the economic conditions in Ireland.

Trouble Ahead — the Banks

However, after 2003, the boom in Ireland relied less on attracting investment and parlaying its geographic location and more on overindulgence in the cheap credit that flooded the global capital markets at the time. Furthermore, Ireland's 1999 entry into the eurozone gave it — like other eurozone members — low euro interest rates that Irish consumers could have only dreamed of. This fueled an enormous real estate bubble rivaled only by Spain's. Ireland today leads the developed world in terms of the housing "price gap," which the International Monetary Fund (IMF) defines as the percent increase in housing prices above what can be explained by sound economic fundamentals, such as interest rates or increases in homeowner wealth. Understandably, property prices have been crashing since 2007, with a decline of 17.7 percent in house prices since January 2007, and a commercial property value drop of 37.2 percent in 2008. Crashing property values are now threatening to destroy not only the Irish construction industry (which accounts for 10 percent of the country's employment) but also the indebted banking system. Ireland's banking industry had grown exponentially since Ireland joined the eurozone in 1999, with bank assets standing at 940 percent of total Irish GDP (in the United States, total financial assets stand at roughly 400 percent of GDP, and total financial assets in the European Union as a whole are just under 400 percent). Irish banks have funded much of their credit expansion — which was used to fund Ireland's property development boom — through foreign borrowing, as their depositor base is fairly modest considering the relatively small population of the country. According to a Deutsche Bank analysis, the banking sector's foreign liabilities climbed to 39 percent of total assets in December 2008, or somewhere in the neighborhood of 400 percent of total Irish GDP. With foreign banking debt approaching Icelandic proportions and a housing market facing a downturn similar to that of Spain, Irish banks are between a rock and a hard place. The pressure is worsened by the fact that in 2009 alone the top three Irish banks — Anglo Irish Bank, Allied Irish Banks and Bank of Ireland — are facing more than $20 billion in bond maturities, with an additional $25 billion expected in 2010, according to Bloomberg. The Irish government has responded to the risk presented by the enormous bank debt by guaranteeing 440 billion euro ($587 billion) in bank deposits and debt as well as enacting two bank rescue packages — 10 billion euro ($13.4 billion) in December 2008 and 7 billion euro ($9.3 billion) in February. There are further calls to nationalize all the banks, with the Finance Ministry in favor of setting up the National Assets Management Agency which would buy up approximately 80-90 billion euro ($106-$120 billion) of toxic property assets.

The Burden on the Celtic Tiger

The problem with propping up Ireland's banks is that by doing so, the government is digging a deep hole. The Irish government's debt — which reached 109 percent of GDP in 1987 — had been reduced to a very manageable 38 percent of GDP in 2000 as the Celtic Tiger economy churned. Dublin's debt is set to rise astronomically due to various rescue packages; the IMF forecasts that the government debt could rise from 47.3 percent in 2008 to as much as 76.4 percent in 2012, higher than all but the most egregious spenders in Europe (Belgium, Greece and Italy). The budget deficit is projected to climb to 11 percent in 2009 and potentially 13 percent in 2010 — more than four times the 3 percent limit set by the eurozone (although the European Union, in a decision on April 27, has allowed Ireland to exceed the 3 percent limit until 2013). The high budget deficit and climbing public debt have already led to Ireland losing its AAA credit rating from Standard & Poor as well as Fitch, which lowered it to AA+. A lower credit rating means that Ireland will have to pay more to finance more debt in the international bond markets, which are already treating Irish debt with suspicion (Irish government bond spreads against the German bond yields, the standard measurement for risk of government bonds in Europe, have surpassed even those of Greece, which is considered one of the riskier government debts in the developed world). Since Ireland cannot print money on its own due to European Monetary Union rules, it will have to depend solely on spending cuts and tax increases to slowly bring down its debt and budget deficit. The brunt of the tax increases will be carried by the wealthy income earners, although the highest wealth threshold for taxation has been reduced from 100,100 euros ($133,500) to just over 75,000 euros ($100,000). However, even the minimum-wage earners will see taxes increased. Tax increases should contribute an extra 1.8 billion euros ($2.4 billion) to the government budget, according to the government — a welcome sum considering that tax receipts are down as economic performance slows. The combination of high unemployment, higher taxes and cuts in welfare spending could spell social unrest for Ireland in coming years. However, the corporate tax rate will remain unchanged, and high unemployment could depress wages, thus maintaining Ireland's status as a lucrative investment opportunity and business-basing locale. In fact, Dublin seems to be doing everything possible — even though some measures could create considerable social angst and unrest — in order to preserve the low corporate tax rate that allowed it to exploit its geographic and demographic advantages into a successful development model. This means that with careful management (which may include surviving a banking collapse the likes of which Europe has not seen since Iceland's implosion), Ireland could retain its status as an attractive investment destination, if not return to the Celtic Tiger days of its past — and all things considered, that is a very important ray of hope in these challenging times.