We continue to watch with concern as Ireland’s economic condition worsens.  The country is undergoing a painful economic deflation as liquidity evaporates and their monstrous housing bubble collapses.  A report released last Thursday showed retail prices dropping 3.5% in April as consumer spending waned.  The current deflation in Ireland is the worst the country has seen since the 1930’s.

The AP reports:

“Consumer Prices in April, as measured by the Consumer Prices Index, decreased by 0.8 percent in the month. This compares to an increase of 0.1 percent recorded in April of last year,” the CSO said in a statement.

“As a result, prices on average, as measured by the CPI, were 3.5 percent lower in April compared with April 2008.”

In January, a 0.1-percent 12-month decline was the first time the country had experienced falling prices since the early 1960s. The annual rate of inflation stood at minus 1.7 percent in February and minus 2.6 percent in March.

To date the Irish government has embarked on a massive program of borrowing in an effort to stabilize the downward plunge.    The government has increased social spending a whopping 63% since 2003.   Now the devastated economy is decimating tax receipts leaving the government with an 11% budget deficit — making Ireland the weakest economy in western Europe.

Barron’s reports:

The risk is that Ireland will lose control of its destiny. Some believe that if the government doesn’t soon begin to cut costs, it may not be able to borrow enough to meet its needs and then will have to be rescued by its European neighbors. This could destroy Ireland’s allure for foreign investors such as Intel, HP, Microsoft , and Pfizer that helped make it a shooting star for almost two decades.

“An international bailout will wreck our competitiveness,” says the blue-jean-clad O’Leary, sipping vending machine espresso bought with a euro bummed from a flight attendant. “For a company the only reliable way to restore profits is to lower costs. The government needs to get off its backside and radically cut spending.”

As its troubles mount, Ireland also stands in danger of losing a rare gift: its image as a beacon for talent – and as the EU’s leading land of opportunity. Chefs from France, construction workers from Poland, and accountants from the Czech Republic are heading home. In 2007, 67,000 more people arrived than departed. This year 30,000 more workers are expected to leave than arrive, reversing 14 years of strong immigration and raising fears that the curse of the ’70s and ’80s – the steady exodus of the best workers – is again exerting its grip.

We see Ireland’s mandate quite simply at this point:   The country must reduce it’s private labor costs, and steer clear of raising taxes as its government deficit soars.  Crucial to the latter, and to maintaining Ireland’s low tax environment will be a lowering of wages for public-sector workers as well.  Fortunately, the nation isn’t bound by the same labor and union regulations as its neighbors on the continent — a flexibility which should in theory allow Ireland to reduce labor costs with greater ease than many other nations in the Eurozone.   While the cure for Ireland’s ills may be simple to describe, the treatment itself promises to be painful both socially and politically.