Ireland vs Iceland: Which will emerge from economic crisis first?

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Ireland’s referendum on the Lisbon treaty on Friday should in principle be about the treaty’s contents, not the state of the Irish economy. But the economy’s collapse over the past 12 months compels both pro-Lisbon and anti-Lisbon forces to confront the question of whether membership of the European Union – and, specifically, of the eurozone – has helped (even saved) Ireland, made things worse, or not made much difference one way or the other.

An interesting angle from which to approach this question is to ask whether Ireland has fared better than another island off the north-west coast of Europe that was thrown into turmoil at almost exactly the same moment last year – namely, Iceland. Iceland isn’t a EU member and doesn’t use the euro. Has this accelerated Iceland’s recovery or held it back?

In terms of headline gross domestic product figures, Iceland comes out narrowly ahead. Over the last four quarters, its economy has contracted by a cumulative 3.8 per cent, almost half Ireland’s 7.4 per cent, according to a Deutsche Bank study. But the inflation numbers paint a different picture: Iceland’s consumer price index is up 10.9 per cent since August, Ireland’s is down 2.4 per cent. Both countries, of course, have horrendously high budget deficits – 13.5 per cent of GDP predicted this year for Iceland, 12 per cent for Ireland.

Unquestionably, the main difference relates to each nation’s external exchange rate and, by extension, its international business competitiveness. The Icelandic krona all but collapsed after the crisis broke out, whereas Ireland, using the euro, could not devalue. The result is that Iceland’s unit labour costs have fallen by 29 per cent over the past 12 months and by an astonishing 45. 6 per cent from their peak in the fourth quarter of 2005.

By contrast, Irish unit labour costs have dropped by only 4.3 per cent over the past year – and this has occurred more because of painful adjustments in the real economy (unemployment, reduced working time, reduced bonuses and wage cuts) than because of exchange rate factors (a falling euro). Irish exports to the UK have been affected by the steep fall in the pound against the euro.

Of course, the geyser that is the Icelandic economy is still throwing up columns of noxious steam. Iceland remains vulnerable because of the unparalleled damage inflicted on its financial sector and sovereign debt position.

But the hard truth is that Ireland – like fellow eurozone members Italy, Greece and Spain – has a long and hard road ahead to claw back its competitiveness. And this is a lesson with even broader implications for Europe. For when the dust settles, it may well emerge that the financial crisis has served to accentuate the differences in competitive advantage in the eurozone between, on the one hand, Germany and other star performers such as Finland and the Netherlands and, on the other, Ireland and the Mediterranean countries.

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