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Why Ireland matters

The second round of the euro debt crisis is bad news for Britain's exporters.
September 26, 2011

A small country it may be, but Ireland is a more important economy than China - if you're a British exporter. Last year, the UK exported almost three times as many goods to Ireland as to China: £15.9bn against £5.4bn.

This is why Ireland's crisis matters to the UK. As its government cuts spending and raises taxes to support the banks - plans to do so will be announced next week and expanded upon in the Budget in early December - its weaker economy will hit UK exports.

This is not the only danger. Most euro zone nations will try to reduce borrowing next year. Economists at Barclays Capital estimate that the euro area as a whole will see a fiscal tightening of 1.2 per cent of GDP next year. If this weakens growth in the region, UK exports to the area - which account for 8.5 per cent of our GDP - will also suffer.

Yes, it's possible that this might produce an "expansionary fiscal tightening" of the sort described by Harvard economists Alberto Alesina and Silvia Ardagna. However, on the rare occasions when these have happened, it has often been because the exchange rate fell. But if this happens, UK exporters would suffer a loss of competitiveness.

Such a loss can happen in other ways. One is that the risk of a break-up of the euro has increased, which would leave holders of euros owning some weak punts and escudos. Although this is a small probability, the tiny chance of a big loss might be sufficient to depress the euro.

Also, in an effort to support the banks and mitigate the fiscal squeeze, the ECB might prolong its easy money policy, which would weaken the euro. The mix of weaker growth and a stronger pound against the euro is bad for UK exporters. Which adds to doubts about whether exports can fill the gap created by cuts in public spending.