Ireland's economic boom: the true causes

A reply to the OECD Economic Survey on Ireland 

Sir, you are right in asserting that the Irish economy is no longer the sick man of Europe (Observer 217/218, 1999). Whereas Ireland’s national income per head grew by just 1.8% per year for most of the 20th century, during the last six years income per head has grown by over 6% annually. Although the transformation in economic performance is relatively recent, the Irish economy is an interesting case study into the link between economic policy and growth.

Your Economic Survey of Ireland 1998-1999 illustrates how difficult it is for even the most expert economists to explain Ireland’s turnaround. One reason for the confusion is that the boom reflects a confluence of several factors and to isolate the influence of any subset of them can be problematic. Another problem is the different time lags between policy and effect: changes in education policy, for example, will take years to feed through, whereas cuts in taxes will be felt more quickly.

The OECD’s view is that the most important causal influence has been inflows of direct foreign investment, particularly from the United States. Increased labour input is identified as another key component, followed by EU membership and structural funds. Incomes policy also figures on the list. Fiscal consolidation gets a mention, but we are warned that its contribution has not been as powerful “as some have claimed”.

This ordering of causal factors begs several questions. First, since 1989, the number of people at work in Ireland has increased by over 450,000. US subsidiaries in manufacturing and internationally traded services, including financial services, have accounted for at most 10% of this increase. Even if each of these US jobs generated one further job in the economy, that would still leave 80% of the Irish growth in employment unexplained. Hence US foreign investment was important, but the claim that it was the major factor is hard to sustain.

There is also a problem with the argument that the supply of well-qualified entrants to the labour market played a key role. To be sure, more young people graduated, more women entered the workforce and more emigrants returned home. But Ireland has never been short of labour inputs. In the 1980s a third of our emigrants were bright, English-speaking and motivated graduates. Why were there no jobs for them then, but plenty in the 1990s? Clearly, labour supply was a facilitating factor; it helped in an important way to sustain growth, but it did not ignite that growth.

An alternative view is that more people were hired after the late 1980s because business in Ireland became more profitable and confident. And fiscal policy played a central role in transforming the business environment. It began with a cross-party consensus on government spending cutbacks, which gave notice of the political will to restore order to the nation’s finances. That determination paved the way for interest rates to ease and for moderate pay deals and tax cuts. Higher consumption and business investment followed.

Another question: of the net 450,000 jobs created during the past decade, some 335,000 were in the services sector, mainly private market services – how did it happen that these jobs appeared on the scene in the short period of a decade? During the 1980s, the Irish services sector had generated fewer jobs in relation to its GNP by comparison with other OECD countries. This under-performance was related to high taxes, high labour costs, excessive regulation and anti-competitive practices. The change in fiscal policy was important in addressing these weaknesses.

Another aspect of Ireland’s transformation that is underestimated in the OECD analysis is the impact of de-regulation and competition policies. Competition in the airline industry, for instance, had a major impact on Irish tourism.

In short, the Ireland survey overestimates the role of foreign investment and labour supply, and underestimates the part played by fiscal and competition policy in the economic recovery. In a post-EMU context, fiscal policy will remain a powerful tool.

Dermot McAleese is Professor of Economics at Trinity College

University of Dublin, Ireland

©OECD Observer No 217/218, Summer 1999 




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