The Irish Economy: Recent Growth, European
Integration and Future Prospects
Dermot McAleese
Address at the Centro Informação Europeia Jacques Delors,
Lisbon, Friday 12 October 2001

The author is Whately Professor of Political Economy and Dean of the Faculty of Business, Economic and
Social Sciences, Trinity College, Dublin
INTRODUCTION
Writing a decade ago on Ireland's dismal economic performance, an eminent Irish
historian concluded that no other European country, east or west, north or south, has
recorded so slow a rate of growth of national income in the twentieth century. Professor
Lee's analysis of Ireland's economic ills had a time frame that lasted from Independence
in 1922 to 1985. During that period, national income per head had grown by an average
1.8% per year, about the same as the UK, but well below the growth rate experienced in
continental Europe. Membership of the European Community was generally seen as
having been helpful, but there was little sign of the catch up on European incomes that
had been hoped for at the time of accession. Ireland’s GDP per head languished at under
two-thirds of the EC average in 1985, up only slightly from 59% in 1973.
During the past decade, a profound change in economic performance has occurred. The
Irish economy has been transformed from the lame duck economy depicted in Lee's book
Ireland 1922-1985 (Cambridge University Press, 1989) to a shining exemplar of the
1990s. In 1994, its performance was likened by a Morgan Stanley economist in London
to that of the Asian Tiger economies; whence the birth of the Celtic Tiger.
Since 1994, Ireland’s GNP has grown at an unprecedented 8.6% per year. An amazing
turnaround was how the OECD described it.
The turnaround confounded the best
forecasters, native and foreign. In the early 1990s a growth rate of 3% would have
seemed highly satisfactory. Estimates of potential growth rates using standard estimation
techniques have been at least 3 to 4 percentage points below the growth rate actually
achieved (with substantial price stability) for the past decade.
Economic success arouses curiosity and demands explanation. The list of publications on
the Irish growth experience continues to lengthen.
The Irish economy became the
equivalent of a Hollywood starlet, with all the wondrous benefits and dangers of that
position. Its example has been frequently cited in the international literature. Ireland is
among a very select number of comparators in the IMF’s latest (November 2000) Country
Report on Portugal; and an insightful analysis of Ireland’s growth experience by Dr
1
Miguel de Freitas is included in a recent edition of the Bank of Portugal’s Economic
Bulletin.
Why this interest in such a small and relatively insignificant economy? One reason is that
Ireland’s experience constitutes a dramatic instance of convergence and catch up in the
context of European integration. The poor do not always have to get poorer. A second
reason is that the upsurge in growth was accompanied by a sharp shift in economic policy
orientation based on three pillars: a) increased reliance on the market system and
competition, b) macroeconomic stability and c) globalisation and integration.
This
coincidence seems like a striking vindication of the new consensus economic policies that
have swept through the world during the past two decades. Hence, as a case study,
Ireland has appeal for a wide range of specialists: regional economists, core-periphery
theorists and policy analysts.
This paper is divided into three sections. The first section comments on some key
features of the growth process.
The second section examines the extent to which
membership of the EU contributed to this growth. Third, we comment the implications
for Ireland of a) the change in status from below average to above average income, b) the
advent of the euro, c) the increasingly active role of Union institutions in fiscal policy and
d) Enlargement and the Nice Referendum. Fourth, we briefly examine the effects on the
Irish economy of the global economic downturn, and the worsening outlook following the
attack on the US on 11 September and the subsequent military action in Afghanistan.
CHARACTERISTICS OF IRISH GROWTH
Initially many economists thought the post 1993 growth rates were a statistical illusion.
There was talk of a soufflé economy, the product of transfer-pricing-inflated multinational
profits in high tech sectors rather than ‘real’ bread and butter economic activity.
Suspicions were strengthened by the slow reaction of employment to growth – ‘jobless
growth’ was another favourite description of the early process.
2
As tax revenues started to boom, these doubts evaporated. The government budget
deficit of 13% in 1987 was steadily transformed into an eventual budget surplus of 4% in
2000. The debt/GDP ratio, which had exceeded 120% in the late 1980s, declined to 47%
in 2000 and is expected to decline further to 34% by end 2001.1
Moreover, growth eventually did generate jobs, albeit after a certain time lag. Numbers
employed rose by 600,000 between 1992 and 2001, a rise of over 50%. This huge
expansion in job opportunities had three far reaching repercussions on the labour market
and on Irish society: a) unemployment fell from 16% to 3.6%, b) female labour
participation rose dramatically and c) Ireland changed from being a country of net
emigration to one of net immigration.
Ireland: Real Annual Average Growth Rates
GDP
GDP per capita
Employment
GDP per worker
1960-80
4.1
3.1
0.5
3.5
1980-93
3.3
2.9
0.0
3.3
1993-2000
8.3
7.4
4.7
3.5
Thus, from being one of Europe’s poorest countries in 1973, Irish GDP per capita at PPP
surpassed the UK level in 1996 and the EU average shortly afterwards. By 2000,
Ireland’s GDP per person had reached 119% of the EU average, compared with 59%
when Ireland joined the then Common Market in 1973.2 The impact of growth on living
standards was magnified by the accompanying fall in the dependency ratio. Whereas in
1
An indicator of the extent of the fiscal transformation is the recent award of an AAA rating from Standard
& Poors. The S&P rating, which takes account of the world economic downturn, commends the
government’s commitment to fiscal prudence, and describes Ireland as an increasingly diverse and resilient
economy (Irish Times, 4 October 2001).
2
The extent of catch up in terms of GNP per person is less impressive. Because of large net dividend and
royalty payments abroad by foreign (mostly US) multinationals established in Ireland, there is a 15
percentage-point gap between Ireland’s GDP and GNP.
3
1990, every 10 people at work had 21 dependants to support, a decade later the figure has
fallen to 14 (and it will decline further to 12 in the year 2006).
A crucial feature of the Irish experience has been the expansion of employment. From
1993 to 2000, employment increased by 4.7% per year. This compared with a situation of
zero increase for the previous three decades. With astonishing rapidity, Ireland was
transformed from a labour abundant economy with a chronic shortage of job
opportunities to a situation of full employment and labour scarcity.
As employment grew, many low productivity workers, who were previously either
unemployed or considered unemployable, were drawn into the labour market. In these
circumstances, a sharp fall in labour productivity growth might have been expected.
Most of the additional employment was generated in the services sector where
productivity growth has always tended to be lowest and this would be further reason for
anticipating a weakening productivity performance. In fact, no such decline occurred.
GDP per worker grew by 3.5% per annum 1993-2000 compared with 3.3% 1980-94.
Disaggregated figures suggest that this can be explained by a rise in productivity in the
services sector from 0.8% to 1.6% between the two periods. The combined force of
rising employment and maintained productivity growth ensured a major acceleration in
the rise in living standards.
De Freitas (2000) draws attention to one further twist in the productivity story. Total
output growth is determined by growth of inputs such as labour and capital, and also by
improvements in the way these inputs are deployed.
This is called total factor
productivity or the Solow residual. The Solow residual rose significantly during the
boom years. Kennedy estimates this as rising from 2.3% in 1980-93 to 3.6% per annum
1993-2000. These figures are consistent with de Freitas’ estimates for the shorter period
to 1998. This growth in TFP is highly significant in so far as it relates to the influence of
improved economic policies and stronger integration within Europe (see below).
4
Another remarkable feature of the decade has been the decline in labour’s share of total
value added. It fell from 57% at the start of the decade to 50% in 2000. The corollary is
a significant increase in the share of corporate profits and earnings of the self-employed.
Kennedy estimates an increase in the share of profits in industry’s net domestic product
from 47% in 1993 to 58% in 2000 and a rise from 25% to 38% in the services sector
during this period. This radical factor income shift from labour to capital needs careful
interpretation. (Lane 1998). It is not due to increased capital intensity of production. The
exceptional profitability of multinational subsidiaries has certainly had an impact. There
is abundant evidence of a quantum leap in profitability, which took place against a
background of pay restraint across the economy.
Pay restraint was organised through Social Partnership. Ireland adopted a unique model
of wage determination, involving extensive consultation and agreement between the
social partners. The key element was: wage restraint in return for income tax cuts and
ongoing participation in economic decision making through social partnership
committees. This policy is not favoured by economic orthodoxy but it has produced
tangible benefits for Irish employees and employers alike. Business received a boost to
profits, and employees got more jobs and better pay. Compensation per employee in the
business sector rose by 43% since 1993, compared with a cumulative consumer price
increase of 25%. National pay agreements kept the lid on pay claims during a period of
unprecedented output growth and thus enabled this growth to translate into higher
employment and lower unemployment. Reductions in income tax meant that take home
pay increases substantially exceeded nominal pay increases.3
THE EFFECTS OF EUROPEAN INTEGRATION
It is sometimes said that economists have been unable to explain the causes of Ireland’s
boom. This is only partly true. There is general agreement on the list of factors that
contributed to growth and that these contributory factors interacted positively with each
5
other -- in a Myrdalian process of cumulative and circular causation. The main subject
of contention concerns the weight to be attached to the different causal factors. Thus
while the OECD stresses foreign investment and Ireland’s education policy, others
emphasise the role of macroeconomic policy and the introduction of competition and
lower taxes. Another view stresses the role of Ireland’s social consensus model of wage
determination and policy formation. De Freitas considers the boom as the result of
transient, self-limiting factors and long run factors. Thus transient factors such as the
decline in unemployment and the rise in female labour participation made a big impact on
growth, but they can be sustained only up to the point. After this point (full employment
for instance), further improvement of living standards requires growth in long run
productivity. It will be some time before there will be sufficient data to determine which
of these various interpretations carries most weight.
What part did membership of the European Union play in delivering faster growth to
Ireland? This is a question of enduring interest to all countries and regions with living
standards below the EU average, and especially to the 12 new applicants. In Ireland, this
has been a comparatively neglected topic to date, but in the light of the NO vote in the
Nice Referendum and the Commission’s reprimand of the Irish government’s handling of
fiscal policy earlier this year, now might be a timely occasion to consider this issue.
In principle, economic integration can affect economic growth in several ways. First, it
ensures access to other members’ markets, an important advantage to countries with a
competitive cost structure.
Integration also enhances the attraction of a lower cost
country to foreign investors. Second, membership provides access to financial assistance
of various sorts from the centre to the less prosperous member states.
Third, new
members operate in the context of an agreed institutional framework and policy
guidelines. Fourth, membership can help growth by moderating extreme nationalist
sentiments and subsuming them in a broader “European” context. Each of these issues
will now be considered in turn.
3
The radical left interprets things differently; labour in their view was denied its proper participation in the
6
a) Trade and Foreign Direct Investment
Export growth contributed significantly to overall growth, as one would expect in a
highly open economy like Ireland’s. Export volume increased by 16.5% per annum 19932000 compared with 9.2% 1980-93. The contribution of total net exports to real GDP
growth averaged 3.8% p.a. 1991-99 compared with 1.4% in the previous decade (Arora
and Vamvakidis 2001). The EU economy was in the doldrums for most of the 1990s, so
there was limited direct stimulus from that source that differed from earlier periods.
OECD market share statistics indicated that Irish export growth owes slightly more to
increased market share, both in Europe and in the US, than to market growth.
The performance of the US economy proved to be of crucial importance. During the
1990s, American corporations enjoyed exceptional levels of profitability and as a result
were ready to invest abroad.
The level of US FDI flows into Ireland increased
significantly during the 1990s. Ireland’s share of US FDI within the EU doubled, from
3% to 7%. This FDI was concentrated on fast growing high tech industries with a
predominantly export orientation. For these industries, the single market reforms were of
crucial importance and came just at the right time.
Ireland’s favourable regime of corporate profits taxation (CPT) was an additional
investment incentive.
This took the form of a preferential tax rate of 10% on all
corporate profits earned in manufacturing and traded services industry. In 1998, under
pressure from the European Commission, a new CPT regime was negotiated. The CPT
rate was raised to 12.5%, applicable to all sectors, effective from 2003. The 10% rate
was ‘grandparented’ up to 2010 for companies already enjoying this preference. In
addition to tax incentives, financial grants are offered to new enterprises in respect of
capital spending, R&D and labour training, but these were being pared back during the
1990s. The European Commission showed considerable flexibility and helpfulness to
Celtic Tiger’s success.(see Allen 2000).
7
Ireland in these negotiations. Also, the Commission’s restrictions on state aids in the
more developed regions were necessary in order to make the Irish incentives effective.
The more developed member states would have been willing to match Irish incentives
had the Commission not prevented it and the inward investment boom would have been
halted in its tracks.
EU membership was also important to the development of the International Financial
Services Centre (IFSC) in Dublin. Contacts developed through EU institutions helped to
get the project started, and the common institutional framework within the EU made
Dublin a credible alternative to other financial centres (White, 2000). With over 8,000
people now at work in IFSC activities (strictly defined), the IFSC has turned out to be an
important employer and a source of significant tax revenue.4 In 2000, tax revenues were
estimated at £500 million or 0.5% of GDP.
FDI is important in explaining the Irish catch-up but it is not the whole story, no more
than FDI is just a tax incentives story. American subsidiaries accounted for only about
10% of the total economy-wide increase in employment since 1989. Even if each of these
jobs generated a multiplier effect of one further job elsewhere in the economy (as is often
assumed), this still leaves 80% of the employment growth unexplained. Besides the FDI
programmes had been operating successfully through much of the previous decades in
terms of attracting new industries to Ireland. As was often pointed out at the time, there
were no comparable successes in the domestic economy. During the 1990s something
dramatic was going on in the services sector, where 80% of the new jobs were being
generated, and in the entrepreneurial climate in the domestic economy generally. Without
explanation of what that something was, no account of the Celtic Tiger can be complete.
b) Financial Assistance
4
Certification of new activities at the IFSC ceased in 1999, but growth in existing activities has continued
to increase. Employment grew by over 1,400 jobs in 2000. The 8,000 figure refers to end 2000. IDA
Annual Report 2000
8
Integration agreements usually include provision for economic and technical co-operation
and modest financial transfers from the richer to the poorer members. The amount of
transfers provided by various EU development and convergence programmes over time
has been quite exceptional. While modest amounts of aid had been disbursed through the
ERDF and the ESF since the early 1970s, a major stimulus came with the launch of the
Structural Funds programme in 1989.5 These programmes were set up as "regional
counterbalancing" measures, designed to avoid any widening in regional inequalities,
especially in regions where innovative sectors were absent and scope for exploiting
economies of scale limited.
Irish Receipts from the European Union 1975-2000
1975
1986
1991
1997
2000
GROSS RECEIPTS
109
1147
2201
2504
2049
PAYMENTS TO EU
BUDGET
10
240
348
514
847
NET EU RECEIPTS
99
907
1853
1990
1202
(% GNP)
2.9
5.9
7.6
4.8
1.8
IR£m current prices
Source: Department of Finance, own estimates, figures for 2000 are provisional
During the decade 1989-99, Ireland's structural fund receipts have averaged about 2.6%
of GNP per annum. This scale of assistance can be compared with aid flows to middle
income developing countries of 1% of GNP (World Bank estimates). Aid to populous
poor countries such as India and China amounts to even less than this.
5
Structural Funds include the European Regional Development Fund (ERDF), European Social Fund (ESF)
and the Guidance Section of the Agricultural Fund (FEOGA). I also include Cohesion Funds. Barry (1999)
summarises these estimates with the conclusion that Structural Funds contributed only half of one
percentage point of the per annum growth of GNP during the 1990s, leading to a rise in GNP of 4
percentage points above what it would have been..
9
Although many continental Europeans firmly believe that Ireland has grown rich on the
back of the European taxpayer, the actual impact of the Structural Funds seems to be
considerably smaller than one would expect. Simulations by Bradley (1992) suggest that
Ireland's GNP would be 2.7 percentage points (and GNP per head only 0.8 percentage
points) higher by the year 2000 as result of the 1989-93 programme. Later, using a
similar methodology based on a large macro model, Honohan (1997) estimated that the
combined impact of the two EU structural aid programmes spanning the decade up to
1999 would add only 2 percentage points to GNP in the long run.6
Perhaps some specific areas of spending failed to yield the return they should have.
Tansey, for example, argues that while structural funds from 1989 greatly increased
participant numbers on active labour market programmes, "the evidence that they have
significantly improved the national training effort is at best mixed" (Tansey 1998 p. 133).
On the other hand, the Structural Funds programmes boosted confidence and enhanced
the acceptability of many of the EU 'level playing field' initiatives that might otherwise
have been considered unacceptable. Also the obligation to account to Brussels for the
spending of the funds has led to considerable improvements in the way public sector
investment is planned and monitored.
The adoption of multi-annual programming
encouraged national authorities to think beyond the single year planning horizon. As
Alan Gray observed, the contribution of the European Commission in influencing Irish
planning and evaluation methods "deserves more than a footnote in Irish economic
history" (Gray 1998 p 52). The structural funds framework also led to greater coordination in activities co-financed by the Community. Cynics will say that it was all
done merely in order to obtain the EU money, and in part they are right. But mind-sets
have also changed - for the better.
c) Policy guidelines
EU economic policy helped the Irish economy in two main ways. First, EU competition
and regulation policy helped the Irish government to open up the financial, transport and
6
The finding of only a slight macro-impact is consistent with the economic aid literature (World Bank
10
public utility sectors to competition. Opening up these sectors made the Irish economy
more cost competitive and helped to generate job opportunities directly and indirectly
(tourism for instance was a major beneficiary of lower air fares). Competition policy had
a profound effect in stimulating economic activity in the services sector. For a long time,
this sector was comparatively neglected in the mistaken belief that ‘real’ growth
happened only in manufacturing, and that if it grew rapidly, employment in services
would automatically follow.
The threat of competition restrained unions in public
utilities with consequent reduced costs of key inputs to business.
Second, the Maastricht criteria set down objectives that countries would have to attain in
order to qualify for admission to the common currency area and, in so doing, established
the parameters for Irish fiscal policy from the late 1980s onwards. The need for a
changed policy orientation had been signalled in a report of the National Economic and
Social Council in 1986 but the specific targets of Maastricht helped to legitimise and
reinforce the process. Reducing debt/GDP ratio to a sustainable level became a priority
objective of macro policy. The decision was made to focus attack on controlling public
spending and to use whatever leeway emerged to reduce taxes.
For a small open
economy, curbing public spending proved a productive way forward. It created room for
tax cuts while simultaneously lowering the debt ratio. Coming in the wake of penal
income tax rates and widespread tax evasion, two tax amnesties, involving legalisation of
income and exemption of tax penalties on declared income, were hugely successful
revenue earners.
Domestic interest rates fell steeply and investor confidence
strengthened. In the debate about expansionary fiscal contraction, the importance of
investment demand tends to be overlooked. A final item in the macroeconomic ‘story’:
lower taxes and a more stable macro background translated into a boom in the private
sector.
As noted earlier, virtually all of the increase in employment since 1993 was
generated by the private sector, and two thirds of this was in marketed services. Lower
taxes and confidence in the fiscal integrity of the government were key elements in this
process.
1998).
11
Change in fiscal policy in the late 1980s was a critical element in Ireland’s subsequent
economic success. It triggered economic growth by a) providing a firm underpinning to
Ireland’s low tax regime, b) improving business and consumer confidence and c) ensuring
cost competitiveness. Some of the impetus for change stemmed from internal factors but
the backdrop of support from Europe made a key difference. The Maastricht fiscal
criteria -- in particular the 3% budget deficit/GDP and 60% debt/GDP ratio limits – were
the driving force of fiscal policy and gave vital focus to it. The new fiscal parameters
coincided exactly with what the Irish economy needed at the time.7
d) Northern Ireland
Northern Ireland is rarely mentioned in the context of the Republic’s boom. Yet the
peace process, which began in 1994, helped to sustain the boom by giving Ireland a better
image abroad and by enabling government to shift focus from security matters to
economic development.
Meetings of EC committees and council gave frequent
opportunities for ministers of the UK and Irish governments to meet and discuss Northern
Ireland in an informal way. While it is often asserted that membership allowed Ireland to
step out of the shadow of British influence and to play a distinct role on a larger world
stage, far more important was the concept of a common European citizenship weaning
nationalists in particular away from excessive preoccupation with irredentist ambitions.
So far the emphasis has been on the positive impact of Europe on the Irish economy. A
recurrent theme of debate has been the possibility of integration membership leading to
cumulative economic decline. Drawing on the core-periphery school, the case was made
that integration would exacerbate regional disparities.
An Irish MEP argued that,
following the implementation of the Single Market, the poorer regions of Europe could
face collapse in the near future without continuous large scale transfers of funds from
7
Honohan (2001) argues the contrary on the basis that the deficit had been reduced considerably by 1989,
ahead of the ratification of the Maastricht Treaty. I would counter-argue first that the end 1980s figures
were favoured by the once-off effect of the tax amnesty and second that the Maastricht criteria were
crucially helpful in gaining public acceptance of the 3% target as a valid national objective, not just a bookkeeping exercise.
12
strong regions to weak (O'Malley 1988 p 10). This outcome would be brought about
because economies of scale would favour big firms in the large member states, and
because poorer regions would bear the brunt of adjustment costs following the
liberalisation of EC trade with third world countries. The Community’s labour market
policies were another source of concern.
unemployment and low employment growth.
These have been associated with high
As labour market inflexibilities were
imposed on Ireland by EU social legislation, some feared that the unemployment problem
would worsen.
While, the above arguments have been vigorously debated over the past 25 years, with
hindsight, we see that convergence, not divergence, has been the outcome of integration.
Specialisation has led more to higher incomes than to greater vulnerability. The wage
gap between white-collar and blue-collar employees has widened, but the relationship
between the wage gap and Ireland's imports from developing countries seems to have
been statistically insignificant (Figini and Görg 1998).
The evidence suggests that Ireland’s poor economic performance in the past originated as
much in bad policy as in objective external events. High taxes, high labour costs,
excessive regulation and anti-competitive practices would be prime culprits.
These
defects inhibited development in the potentially most employment-intensive sector of the
economy, the services sector. It is easy to forget how effectively the fiscal stabilisation
package dealt with these structural defects. Incomes policy, tax reductions, improved
competitiveness and spending cutbacks were part of a coherent policy initiative. The
introduction of new de-regulation and competition policies was also important. European
integration generated forces that in various ways directed the Irish economy onto a
superior growth trajectory.
13
NEW CHALLENGES
Long before 11 September, the consensus view in Ireland was that the economy would
not be able to sustain the Celtic Tiger growth rates much longer. The second annual
update of Ireland’s Stability Programme, published in December 2000, projected a fall in
real GNP growth rates from 8.6% in 2000 to 5% in 2002 and to just 2% from 2015
onwards. As Ireland reaches European living standards, high GDP growth will be less
needed and, as it happens, less attainable. The focus of policy should be on securing
sustainable growth rather than maximum growth, and on ensuring a soft landing to these
lower growth rates. Both the economic success of the recent past and the future trajectory
of the economy have implications for Ireland’s evolving relations with Europe. We
comment on some of them below.
a) The EU Budget: from Beneficiary to Donor
Ireland's status as a large net recipient of EU funds is now in process of rapid
transformation. As GNP increases, Ireland's annual contribution to the EU also rises. It
has increased from £283 million in 1990 to an estimated £847 million in 2000. In future,
CAP funding for Irish agriculture is likely to be increasingly restrained. As Table 2 above
shows, these have comprised around half of Ireland’s gross receipts from the EU for
many years. Even more significant, structural fund inflows will diminish. Net receipts
from the EU are projected to fall by half over the next few years, from £1,910 m in 1999
to £827million in 2006. The change in status to a net contributor, while entirely a
welcome development, will no doubt have a profound impact on how the Irish see
themselves and on how they view the EU.
b) Advent of the euro area (without the UK)
While the process of attaining eligibility for EMU has proved highly beneficial for the
economy, membership of the euro area will bring new challenges to the economy.
14
The standard benefits of a single currency apply with particular force to an open economy
such as Ireland. There will be a saving in transactions costs (a small gain), and increased
price transparency (possibly much larger gain). The elimination of exchange rate risk vis
a vis the euro area is expected to reduce Irish interest rates by somewhere between 1 and
2 percentage points over the long run. This will stimulate investment and generate faster
growth (Baker et al 1996, De Buitleir et al 1995).
Against this there are drawbacks.8 Irish firms will be vulnerable to changes in sterling
and the dollar, more so than other euro area countries since the proportion of total trade
with the euro area is the lowest of all members (30%) and fluctuations of output have
been very weakly correlated with other members also. Irish business was badly scarred
by the rise in the Irish pound relative to sterling during the 1992-93 currency crisis.
Similar unwarranted revaluations in an euro context will create adjustment problems but
they at least will not be accompanied by the short run interest rate hikes to defend the
currency that wreaked havoc in past currency crises.
Another problem is that the
European Central Bank’s monetary policy has to be determined by the needs of the euro
area, not those of the Irish economy. However, all members of the euro area are in the
same position in this respect. The argument that Ireland is especially vulnerable because
of its weak degree of synchronisation with core euro area economies may also have to be
revised in the light of recent history.9 The business cycle has become dramatically more
synchronised worldwide than in the past. Is there any European country in October 2001
that would want the ECB to raise interest rates? Needless to say, the net benefits of the
euro to Ireland would be greatly enhanced if the UK were to adopt the single currency.
As a member of the euro area, the most feared scenario is that a fall in the value of
sterling and the dollar will lead to an erosion of Ireland’s competitiveness just at a time
when exports are already being hit by a slowing world economy. Of course, opting out of
8
The case against Ireland joining EMU is made in Thom (1997), Thom and Neary (1997), Neary (1997).
The counter-factual implicit in this argument – of a high-octane Irish central bank, fine tuning the
economy from year to year and providing soft landings or quick recoveries a la carte, is not entirely
plausible. It relies on an exaggerated faith in the effectiveness of counter-cyclical monetary policy in a
small open economy such as Ireland.
9
15
the euro area would also have involved risks. Foreign investors might have interpreted
such action as evidence of a weakening commitment to Europe. Also there are intangible
benefits to being close to the centre of decision taking in European monetary policy.
Even more important, abstention from EMU might have weakened the government's
commitment to fiscal control and a lower debt/GDP ratio. Such an eventuality would
have been calamitous.
c) Fiscal policy and the Broad Economic Policy Guidelines
Over the long run, the hope is that EMU will consolidate the benefits of fiscal prudence,
low inflation and fast growth. There have been deviations from this expectation in the
recent past. Thus, the first two years of EMU have been associated with rising inflation
in Ireland, not price stability. Consumer prices rose by 5.5 % in 2000 and another 4% rise
is expected this year. The Department of Finance estimated that 2.5 percentage points of
inflation in 2000 was attributable to the impact of interest rates, energy prices and excise
taxes.
The remainder was due to a mixture of the Balassa-Samuelson effect and
overheating. There has been a rapid escalation of prices of services (7% in 2000), and in
construction costs (up 15% in the each of the past two years).
This rise in Ireland’s inflation has not gone unnoticed in Brussels. The 2000 Broad
Economic Policy Guidelines (BEPG) recommended that “given the extent of overheating
in the economy” the Irish Government should “gear the Budget for 2001 to ensuring
economic stability”.10
Even though the budget surplus exceeded 4% of GDP, the
implication of the Commission’s guidelines was that this surplus should be increased in
2001. Instead the government felt justified in reducing the surplus, thereby on its own
figures implementing an expansionary fiscal policy, arguing that it was obliged to
increase spending by the terms of the social partnership and that continuation of this
partnership was essential to avoid a wage explosion. Much was made of projections
indicating a reversion to more restrained budgets in subsequent years. The ensuing
reprimand from the Commission led to a much-hyped, unnecessary and unfortunate
10
Text in the Official Journal of the European Communities 12 February 2001
16
disagreement about who controlled budgetary policy. In the context of the slowdown in
recent months, both the Commission and the Central Bank of Ireland have expressed
concern about the extraordinary growth of public current spending, at a rate of 21% a year
according to the Revised Estimates, much of it accounted for by special public sector pay
increases and higher service prices.
In a deteriorating atmosphere relations were further aggravated by proposals for action
against harmful tax competition among member states, interpreted in Ireland as an
indirect attack on the low corporation tax regime. In an historical sense the tax regime
has been important to Ireland. Honohan (2001) uses estimates derived from a paper by
NBER to infer that Ireland’s FDI stock was 70% higher than it would have been had
Ireland’s effective corporate tax rate been the same as the next lowest tax rate in an EU
member state. Had he taken the average EU effective tax rate the effect would have been
all the more dramatic.
The competitive advantage to Ireland has however been
diminished in recent years as corporate and other taxes in Europe are falling rapidly, a
trend even more pronounced in East European.
Experience shows that periods of rapid growth can be brought to a halt by economic
policy mistakes. Governments are vulnerable to pressure for more spending from special
interest groups. While a reversal of the Irish government’s prudent approach seems
unlikely, not least because of the restraining influence of Brussels and Frankfurt, procyclical spending is hard to resist.
d) Enlargement and the Nice Treaty Referendum
It is paradoxical that in June 2001 the Irish electorate voted No to the Nice Treaty at the
peak of the economic boom, just at a time when one would have thought that the rewards
of EU membership were never more apparent. The outcome was determined not by a rise
in the number voting No but rather by the vertiginous decline in the number of voters
prepared to go out and vote Yes. What happened to these missing 600,000 voters?
17
35
V o te s C a s t I n F iv e I r i s h R e fe r e n d a O n E u r o p ea n
T r e a ti e s S i n c e 1 9 7 2
30
25
1 ,2 0 0 ,0 0 0
20
15
10
Food
1 ,0 0 0 ,0 0 0
Gas
8 0 0 ,0 0 0
Motel
Y e s
6 0 0 ,0 0 0
N o
4 0 0 ,0 0 0
5
2 0 0 ,0 0 0
0
0
1972
Jan
Feb
1987
Mar
1992
1998
Apr
May
2001
Jun
Studies of the economic impact of Enlargement concluded that there would be small net
gains to Ireland in trade in industrial goods, and some benefits from migration in easing
Ireland’s labour shortage since east European migrants would be relatively easy to
integrate and would bring needed skills. Effects on foreign investment would also be
mildly positive. Ireland might benefit from the larger FDI inflows attracted by the
enlarged market.
There is a lingering fear of displacement of Ireland’s FDI by
competition from low labour cost applicant countries, but the type of FDI being attracted
to Ireland in recent years consists of high value added areas of the knowledge economy
such as infomatics, digital media, eBusiness and healthsciences. The developed areas of
the EU (Scotland, Wales, Germany) are Ireland’s main competitors for these industries,
not low labour cost regions.
The net impact of enlargement on Irish agriculture is likely to be negative. Initial prices
on accession will stimulate production in the candidate countries, adding to surpluses and
putting downward pressure on future price increases. The budgetary implications under
the Common Agriculture Policy (CAP) will largely depend on decisions with respect to
direct payments to farmers. The impact on Structural Funds will also impose costs on
Ireland. Originally this effect was expected to be very considerable, on the assumption
that new members would receive the same per capita amount of structural funds as
18
Greece/Portugal. (400 euro per capita). However, the imposition of a 4% of GDP limit
on the amount receivable by the new members has reduced the overall budget impact
considerably, from an original estimate of 42 billion euro to a relatively modest 9 billion
euro.
In economic benefit-cost terms, therefore, the impact of Enlargement on the Irish
economy is likely to be broadly neutral, with probable downsides for agriculture and
budget (NESC 1997, Institute of European Affairs 1999). This feature distinguishes the
Nice referendum from previous ones where there were clear financial gains to large
sectors of the Irish electorate to the proposed change and which consequently produced
comfortable majority Yes results. (The Amsterdam Treaty vote in 1998 is an exception
but here the Yes vote already was showing signs of slippage.) This illustrates the
difficulty facing the government in securing a yes vote in a new referendum before the
end of 2002.
The case for Enlargement will have to be argued in political as well as in economic terms,
and latent fears about its consequences for migration will have to be frankly addressed.
But the economic consequences of Enlargement may not be the problem; most Irish
people interviewed in the polls claimed to support it. Underlying the no vote three major
non-economic issues have to be confronted: a) genuine concerns (however misplaced)
about neutrality, b) the sense among the electorate that they were being steamrolled into a
decision without adequate time for debate and reflection and c) a fear that the revised
institutional framework would weaken Ireland’s power in EU decision making.
The government has set up a National Forum on Europe to publicise and explore these
issues and we can expect a much more vigorous effort to persuade a majority to vote yes
on this occasion. There is no evidence as yet of a detailed strategy having been worked
through to confront difficult questions such as: what if any concessions can the
government win from its EU partners which might induce a higher ‘yes’ turnout? What
19
the implications of a second ‘no’ vote would be for Ireland, the EU and the candidate
countries is unclear, but certainly they would be not be trivial.
EFFECTS OF THE WORLD DOWNTURN
The September attack on New York came at a time when forecasts of global economic
growth were already being revised downwards very rapidly. The downturn was led by the
US economy which during the 1990s had played a major role in stimulating world
growth. The impact of reduced US growth on a country depends significantly on the
share of US trade in its total trade and its total GDP. On this basis, the Irish economy is
likely to be far more vulnerable than any other EU member state.
Allowance however must be made for the extent to which a fall in exports to the US may
be counterbalanced by a fall in imports from the US. This can be done by estimating the
contribution to real GDP growth rates of net exports to the US. An IMF study indicates
that during the period 1991-99, net exports to the US contributed on average 0.9
percentage points annually to Ireland’s growth, but virtually nothing to the EU generally
and a zero effect for Portugal and Spain (Arora and Vamvakidis, 2001). There are of
course many linkages between the US and the rest of the world in addition to
merchandise trade; foreign investment, services trade, stock markets and business
confidence.
Using a more comprehensive analysis the concludes of US growth is
correlated one to one with developing countries’ growth but shows a much weaker (0.20.4 percentage point) and less statistically significant linkage with industrial countries’
growth. These estimates are consistent with this year’s observed deterioration in Asia
and Latin America’s economies. They may underestimate the impact of the US on
industrial countries given the degree to which the interdependence of our economies has
increased in recent years. Europe is already feeling the contagion effects: on its stock
markets, exports and unemployment and business confidence.
Merchandise Trade with the US as % of GDP
1990
1999
20
Ireland
9.1
Portugal
2.6
Spain
1.7
UK
4.5
Germany
3.2
Netherlands
6.2
Singapore
49.4
Canada
30.4
Source: Arora and Vamvakidis (2001)
18.5
2.2
1.9
5.4
3.9
7.1
41.7
56.1
In Ireland, there is agreement that this year’s GDP will decline to around 6%. There are
different views on the outlook for 2002. The ESRI’s scenario on the basis of a “sharp
slowdown” in the US and EU economies projects a GNP growth of only 1.8%, and a
consequent rise in unemployment to 6.3% in 2002 and 7.6% in 2003. Official estimates
are less bleak. The Central Bank anticipates GDP growth of 4% in 2002 and private
sector economists generally favour the view that the downturn will be short-lived, rather
as in the case of the Gulf War. Experience teaches us the unhappy lesson that official
forecasts in these circumstances tend to be over-optimistic.
The economic downturn will have further implications for Ireland’s relations with the
EU. The first concerns the fiscal targets of the Stability and Growth pact. Estimates of
Ireland’s general government surplus were 3.3% of GDP prior to 11 September,
compared with a Budget target of 4.3%.
The outturn might well be around 2%.
According to the ESRI, we cannot rule out the possibility that this year’s surplus could
change into a “significant” deficit next year in a worst case scenario when tax revenues
fall, unemployment compensation rises, public pay commitments made in more
prosperous times have to be met and so on. Before this happens, however, it is likely that
some of EU partners will have breached the 3% deficit threshold. In such an eventuality,
we can expect a vigorous debate about the degree of flexibility to be applied, above and
beyond that already embodied in Pact.
A second issue relates to competition and state
aids. Already the Commission is involved in discussions about the amount and form of
financial assistance the Irish government can provide to the state owned Aer Lingus, a
highly charged, politically sensitive issue with national elections due to be held next year.
21
CONCLUSION
… the Irish success story of the last decade has been built on the basis of EU
membership and the completion of the single market. Enlargement of the EU will
provide an important opportunity for Ireland to expand into new markets. Within
the EU there will be a need to rethink our strategy and priorities. By the end of
the decade, as one of the wealthiest members of the EU, Ireland will have new
responsibilities and changing needs. Duffy et al (2001) p.xiii
The economic boom has brought major benefits to the Irish people and serious wealth to a
substantial minority. Inevitably, some have done better than others and a small minority
may not have seen much improvement in their living standards. In many ways, the
economic boom is a case study of the good consequences that follow from adopting
policies built around the three pillars of macroeconomic stability, globalisation and
competition in the market system to which the European Commission strongly
subscribes. The challenge now is to convince the electorate – in Ireland and throughout
the Union -- that the benefits from European integration are not past tense, but continue
into the future, while changing in form and substance as integration itself intensifies.
As we face into a sharp reduction in growth in 2002, the durability of the last decade’s
gains will be put to the test.
Economic history shows that countries that become
prosperous tend to stay prosperous.
Enough physical and human capital has been
accumulated in the good times to enable these countries to survive the stresses of
recession. This is encouraging for Ireland. Maintaining social consensus and reasonable
pay increases is proving difficult. The education system needs continuous upgrading.
There is need for ongoing focus on long run policy issues: traffic congestion, housing
supply, and provision for pensions – but these problems are partly the result of prosperity
and they seem more soluble from our present position than they did a decade ago.
22
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Acknowledgements: I am grateful to Colette Ging and Michael Sanfey for comments on
a first draft. They are of course not responsible for any remaining errors.
irish economy/lisbon1001rev
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