Last Wednesday, Ireland’s government announced a four-year austerity plan that would cut spending by about 20% and raise taxes over the same time span. That, in conjunction with a bailout package from the European Union (EU) and the International Monetary Fund (IMF), could restore confidence in the Irish economy. However, the prospect of higher taxes might induce some Irish citizens to seek more favorable tax jurisdictions. Complicating matters, Ireland’s Prime Minister Brian Cowan is under tremendous pressure after eliminating 24,750 public sector jobs and cutting pay for new public sector workers by 10%. Cowan has resisted calls for his resignation, but he may soon have to face a “no confidence” vote.
So far, Ireland has resisted pressure from France, Germany and other EU countries to raise its corporate tax rate above the current 12.5%. Due to this low rate, many giant U.S. technology and pharmaceutical firms — like Google (NASDAQ: GOOG), Intel (NASDAQ: INTC), Merck (NYSE: MRK), Microsoft (NASDAQ: MSFT) and Pfizer (NYSE: PFE) — use Ireland as their corporate base for European operations. Ironically, Ireland was the only country in the euro-zone where unit labor costs fell last year, thanks in large part to U.S. outsourcing of jobs to Ireland, due in part to its low corporate tax rates. According to Ernst & Young, over 600 American businesses have invested $165 billion so far in Ireland.
As the pressure on Ireland ebbed last week, European bond investors took a closer look at Portugal and Spain. Despite rising bond yields on their sovereign euro-bonds, European Council President Herman van Rompuy assured investors that Portugal won’t be “the next Ireland,” since “Portugal has not suffered from a housing-market bubble, its financial sector is not oversized and its banks are well capitalized.”
Meanwhile, Spanish Prime Minister Jose Luis Rodriguez Zapatero echoed those words, saying there was “absolutely no chance” that the euro-zone’s fourth-largest economy would seek a bailout from the EU. Alas, Zapatero’s attempt to calm the markets had little effect, since the euro tumbled to $1.32 on Friday (from $1.38 on Monday) and the selloff in Spanish and Portuguese sovereign bonds continued all week.
The leader of Europe’s strongest economy – Germany’s Chancellor Angela Merkel – said on Tuesday that the euro is facing “an extraordinarily serious situation” in the wake of Ireland’s debt problems, and Germany’s Finance Minister, Wolfgang Schauble, added that the fate of the euro is now “at stake.”
In the interim, thanks largely to Germany’s strong economy, the euro-zone purchasing managers’ index rose unexpectedly strongly to 55.4 in November, up from 53.8 in October, reversing a decline in previous months. Additionally, a record pace of job creation in German manufacturing could boost hopes of a more lasting pick-up in consumer spending in Europe’s largest economy. France also saw a significant pickup in economic activity, with its manufacturing purchasing managers’ index hitting a 10-year high of 57.5 last week, up from 55.2 in October. So overall, I expect that, despite sovereign debt fears, there is clear evidence that economic growth in the EU is picking up, which is good news for global economic growth.