Hamish McRae: We have a lot to learn from Ireland

The biggest lesson is that, if a country has to impose austerity, it should do so swiftly

Britain has a lot to learn about fiscal policy from Ireland. To Irish civil servants, property owners, taxpayers, the unemployed, indeed to almost anyone living there that might provoke a hollow laugh. Ireland has had an even more spectacular boom and bust cycle than the UK. Its banks are in even worse shape. The property slump is even deeper. And the fiscal deficit is pretty much as bad as ours.

So what should we learn? Ireland last week moved to correct its fiscal mistakes, whereas we are still in denial about them. Just as important, the austerity budget it brought in seems to have been largely accepted by the Irish people. And if past experience is any guide, this budget will start to lay the basis for a return to solid growth.

The Irish budget was announced on the same day as our pre-budget report and as a result received rather less attention here than it deserved. The bones of it were a cut in public sector pay ranging from 5 per cent at the bottom end to 15 per cent at the top (and a 20 per cent cut for the Taoiseach, Brian Cowen), a cut in other state benefits including, controversially, child benefit, and the introduction of a new carbon tax. Most other taxes, however, have remained broadly the same and the 12.5 per cent corporation tax, seen by many as one of the keys to Ireland's attractiveness as a destination for inward investment, is untouched.

There is something else. Ireland has started its austerity programme while the economy is still forecast to shrink. Unlike the UK it is not putting off cuts in spending until there is more evidence of growth, our government's argument for not cutting the deficit next year.

You might say that this is because Ireland has less leeway than the UK in increasing its borrowing. Its debt has been downgraded and, as part of the eurozone, it is unable to devalue its currency and reduce the debt burden that way. But it may well be that when a country reaches some level of indebtedness, further state borrowing becomes ineffective at boosting demand because everyone knows it is not sustainable. As a result, you are better to get on with it and hope that it is politically acceptable.

It seems to be so, for the budget has been generally well-received. The Greens are on board, thanks in part to the carbon tax. There is real and understandable concern about the cut in child benefit and the fact that even poorly-paid public service workers have to take a cut. But public reaction has not been so adverse, perhaps because many private sector workers have had to take pay cuts already and so in a way what is happening now to the public sector employees matches what has already happened to them. There was a one-day public-sector workers' strike but a second one was called off. Ireland has a long tradition of reasonable co-operation between the government and the unions and these wage cuts certainly are stress-testing that. But it has been tested several times before.

The scale of the challenge remains daunting. I had not realised quite what a catastrophe the collapse of the property market had brought to the Irish banks until I read a new best-seller in Ireland, The Bankers – How the Banks Brought Ireland to its Knees, by Shane Ross, a journalist and independent senator in Dublin. Irish bankers were paying themselves three or more times as much as their counterparts in the UK, while posting profits that can now be seen as non-existent or worse. There was a cosy collusion between the bankers and the property developers to lend more and hence show even higher banking returns.

The over-reliance on construction was singled out by the finance minister, Brian Lenihan, when he presented his budget. Because the Irish construction industry was so much bigger in relative terms than in the UK, the impact on the job market has been much more serious. Unemployment is already 12.5 per cent and forecast to rise to around 14.5 per cent next year. Within the Eurozone, only Spain is worse.

But Ireland, unlike the UK, has not damaged its attractiveness as a destination for inward investment. Irish taxpayers have just as much reason to be angry at the country's bankers as do British, indeed more so, but the country has not sought to bring in additional taxation on foreign bankers working in the country. It is extremely important, when seeking to attract foreign investment, that tax structures should be predictable. That is a test that Ireland has passed and Britain has failed.

If that is the first lesson, there are, I suggest several others. One is that the principal burden of austerity measures has to be on the spending side rather than the taxation side. Since so much of any state's costs are in terms of wages to its employees, tackling that must be a priority. Politically it appears difficult, but less so if it is perceived as fair by the electorate at large. One of the most notable features of the past year in both the UK and Ireland has been the way the hardship has fallen disproportionately on the private sector. Sharing the pain means bringing similar discipline to the public sector and the electorate in Ireland seems to accept that.

But the biggest lesson surely is that if a country has to impose austerity, it should do so swiftly. The economic case for this was noted above – that once deficits are seen as unsustainable they cease to boost demand – and while the economists' computer models don't spew out that result, the experience of many countries, including Ireland in 1987, does so. The austerity programme then, laid the basis for the 20-year boom that followed. It could happen again. Indeed I personally believe it will happen again – and that is not at all to do with the fact that this newspaper is owned by an Irish company or that I was mostly brought up there. In three years' time Ireland will again be a fast-growing economy, have its deficit under control, and will again be admired for its enterprise. As for the politics of it all, the comment of Brendan Keenan in the Irish Independent yesterday deserves a wider audience:

"The UK has postponed correction until growth comes. That is normal economics, but it may yet prove bad politics. Fianna Fail politicians were very doubtful that the Republic could stand another dose of the same medicine in 2011. There may yet be widespread industrial unrest, but a lot of the heavy lifting has been done."

h.mcrae@independent.co.uk