Is the celtic tiger a paper tiger?

By Cormac Grda

Paper presented at the Money, Macro, and Finance Group 2001 Conference,

Queen’s

University, Belfast, 5-7 September 2001. My thanks to Frank Barry, Joe

Durkan, John

Sheehan, and Kevin O’Rourke for comments and advice.

IS THE CELTIC TIGER A PAPER TIGER?

Cormac Grda

Last year Ireland’s GDP grew faster than anywhere else in the world. In

2001 Ireland remains at the top of the OECD growth league (Economist

Intelligence Unit, 2001: 10- 11; OECD, 2001: vi). Nonetheless, though the

Irish economy continues to attract the headlines, gone is the euphoric tone

of even a year or two ago. Now attention focuses more on plant closures by

(mainly U. S.) multinationals and the downward revision of growth forecasts.

Economists debate the prospects of a ‘ soft landing’ and the sustainability

of growth rates half or less those experienced in the 1990s. Nonetheless

the achievements of the last decade or so have been indeed notable. For

reasons noted below, they are better captured by GNP per head than by GDP

per head. Not only has GNP per head in the Republic moved far ahead of

Northern Ireland’s in the 1990s, but it has reached that of the UK as a

whole. Living standards have risen too, if not quite in tandem. Who would

have believed all this possible even a decade ago?

Just as there was no hint that a Celtic Tiger was about to roar in the

economic commentary of the early 1990s, there was little sense that the

experience might prove temporary in the commentary of the late 1990s (e. g.

Gray, 1997; Sweeney, 1998; ansey, 1999; Barry, 1999). Accounts of the Irish

economic miracle tended to be very presentcentred.

Reading them just a few years later, they seemed to imply that Ireland had

switched

definitively to a new, higher, steady state growth regime. So much so that

for a few years policy makers from far and near sought the key to achieving

rapid sustained economic growth from Ireland. 1 It became the turn of IDA

personnel and Irish economists to travel abroad offering rather seeking

advice.

A longer-term, more historical perspective suggests a less dramatic spin.

Measuring

the performance of the Irish economy against that of the OECD convergence

club (shorthand for the pattern reflected in Figures 1(a) and 1(b) below)

between mid-century and the mid-1980s implies serious under-achievement. In

this period only the 1960s offered a ray of hope.

The 1950s were a ‘ lost decade’ of virtual stagnation and mass emigration,

while between 1973 and the mid-1980s the record was one of initial growth

fuelled by reckless fiscal deficits and a bloated public sector, followed

by a painful fiscal correction. However, applying the same simple

convergence framework to the 1950-1998 period as a unit suggests that

Ireland was 2 ‘ on track’, in the sense that it grew as fast as an economy

with its 1950 income level might be expected to grow ( Grda and O’Rourke,

1996; 2000). The difference is clear from Figures 1(a) and 1(b). This, and

signs that the economy is now returning to more modest growth rates,

suggest that the Celtic Tiger’s main achievement was catching up with the

rest. Seen from this perspective, the signs that growth is slackening are

nothing to be concerned about.

Press commentary evokes a sense of disappointment, however, and public

policy, with its focus on the need for yet more and more imported capital

and imported labour seems hell-bent on the pursuit of continued rapid

growth.

pic

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The current slow-down suggests the following interpretation of the half

century. Before the late 1980s decades of protectionism followed by wrong-

headed fiscal policy widened the gap between Ireland and almost every other

economy in western Europe except Britain. At the same time the Republic had

developed some of the prerequisites for faster economic growth: an

underemployed labour force; a stock of emigrants willing to return, given

better job prospects; ample energy supplies; an underutilised transport

network; a competent and honest public service. An attractive tax package

for U. S. multinationals attracted by the prospect of the single European

market, and the conviction that Irish policymakers had learned from the

mistakes of the late 1970s and early 1980s, did the rest. There followed

the hectic Celtic Tiger interlude, and by the end of the 1990s Ireland had

made up the ground it had lost.

This record is summarised by the fact that Ireland, where GDP per head was

the same

as in Italy in 1950, fell far behind in the following three decades or so,

and then more than made up all the lost ground from the mid-1980s on (in

1998 Ireland’s GDP per head was eight per cent higher than Italy’s). So is

the bottom line that Ireland had caught up and that its new growth

trajectory would sweep it pass not just Italy but everybody else? Not so.

The present value of Irish GDP per head, discounted back to 1950, would

have been 28. 9 per cent higher had it experienced Italian growth rates over

the period as a whole, with the slightly lower Italian average growth over

the period, but concentrated at the beginning rather than at the end (

Grda and O’Rourke, 1997; 2000; see Figure 2). Moreover, the spectacular

output growth rates of recent years tend to make us forget that

productivity performance was not so spectacular relative to the record

before 1987. The growth in output per worker between 1971

and 1987 was almost as fast as that in the decade that followed. Whence

Brendan Walsh’s comment that ‘ if attention had been focused on output per

worker rather than total output the phrase ‘ Celtic Tiger’ would never have

become popular’ (Walsh, 1999: 3).

pic

So what produced the Tiger? One of Ireland’s leading macroeconomists has

argued that

several factors played a role, and that ‘ we cannot establish the relative

importance of each’ (Walsh, 2000: 671). Still, it is hardly surprising that

a recent acclaimed account by an ex politician and an ex-head of the

Industrial Development Authority would give pride of place to politicians

‘ who took a long-term strategic view on a number of specific issues’, and

the ‘ rifle-shot, rather than the scatter-gun, approach’ to seeking out

multinationals adopted by the IDA since the 1980s (McSharry and White,

2000: 363-4, 368, and passim). Other factors often highlighted in the

literature include fiscal restraint, generous tax incentives to

multinationals, EU largesse, plentiful human capital, a pliable labour

force, and social partnership. It is the contention of this paper that some

elements in this package of factors have been oversold, and that others

were geared to delivering catch-up, but not limitless growth at the rates

achieved in the 1990s.

Human Capital:

Government spokesmen and the IDA frequently stress the part played by

Ireland’s

human capital. The argument has been overdone, for two reasons. The first

hinges on the distinction between the social and the private return on

education, too often neglected in this context. Indeed in the 1970s and

1980s analysis focused on the gap between the two, due the emigration of so

many of those with third-level qualifications (e. g. NESC, 1991). In the

circumstances, investing more instead in infrastructure such as roads and

telecommunications might have yielded a better return. The claim that

schooling has boosted growth tends to rest on a growth accounting approach

to human capital’s contribution, which in effect assumes that it had no

opportunity cost (Durkan, Harmon, and Fitzgerald, 1999; Tansey, 1998: 250).

Ireland’s investment in education is now undoubtedly producing high private

and social

returns, quite apart from ‘ new growth theory’ gains, but who is to say that

less investment in schooling at times in the past would have been the more

sensible option?

The second reason why the case for investment in human capital has been

oversold is

that, for all the hype about Ireland’s highly educated workforce, recent

international

comparisons show it in a less than stellar light. Ireland passes muster

when measured by the Third International Mathematics and Science Study

(TIMMS), which tested samples of schoolchildren in their early teens in 39

countries in 1995: in these tests Irish schoolchildren came fourth out of

the thirteen EU countries included. However, the much-cited International

Adult Literacy Test (IALS), which focuses on those old enough to be in the

labour force, is more relevant. IALS, which measured adult literacy skills

across OECD member-states in 1995, returns a less impressive verdict. By

this measure Ireland came ahead of only Portugal of the ten EU economies

included (see Table 1).

pic

True, Irish educational standards have improved significantly in recent

decades, especially due to the introduction of free second-level education

in 1967, but correcting for cohort effects does not make much difference

(Barro and Lee, 2001; Steedman and McIntosh, 2001).

This suggests that commentary in the 1990s exaggerated the quality of the

Irish labour force. Perhaps fluent English meant more to U. S.

multinationals than high IALS scores. That, however, is hardly a function

of policy, nor specific to the 1980s or 1990s.

Fiscal Policy:

Ireland’s efforts at setting its public finances right in the 1980s

attracted a good deal of

attention abroad. In 1989 Rudiger Dornbusch scorned at a ‘ failed

stabilization’, which a few years later would spawn the concept of an

expansionary fiscal contraction (EFC). An EFC occurs when the deflationary

effects of budgetary surpluses on aggregate demand are outweighed by their

positive impacts on private expectations, investment and consumption. For a

time the role of EFC in jump-starting Irish recovery was the subject of

much debate. The latest consensus is against it. Of course, this does not

rule out a role for stabilization policy. McSharry and White deem fiscal

stabilisation ‘ the main precondition for a sustained economic recovery’,

and the case is more formally stated by Patrick Honohan (1999).

Unquestionably without the dramatic, unequally-borne fiscal corrections of

the 1982-7 period, DFI would gone elsewhere and the Tiger would not have

roared. However, had the economy not almost self-destructed from the late

1970s the corrections would have not been necessary in the first place. In

other words fiscal stabilization was about making up lost ground, not

achieving a new steady state.

The transfer of about IR9 billion at 1994 prices to the Irish exchequer

between 1989

and 1999 through the EU’s Community Support Frameworks (Delors I and Delors

II) arguably eased the challenge of fiscal stabilization, as Marshall Aid

did for other European economies in an earlier generation. But

macroeconomic simulations suggest that in accounting for the Celtic Tiger

the transfer was an ‘ also ran’. 2 Frank Barry, John Bradley, and Aoife

Hannan (1999; see too Honohan, 1997) found that without it GDP would have

been 3 to 4 percentage points less in the late 1990s. This must be set

against the doubling of real GDP between 1990 and 2001.

Since 1987, when the Tiger was born, and today the ratio of government

revenue to

GDP has dropped from 40. 3 to 33. 2 per cent, and the ratio of public

expenditure to GDP from 7 48. 5 to 27. 7 per cent. The Irish public sector is

now the smallest in the EU in relative terms. Over the same period the

ratio of national debt to GDP has fallen from over 100 per cent in 1987 to

38 per cent by the end of 2000. The timing suggests that Ireland’s current

status as a low tax, low public debt economy is a product of the Celtic

Tiger, however, not its cause.

Social Partnership:

A similar argument can be made about social partnership, introduced in

1987. Irish

economists were initially very sceptical of it (e. g. Durkan, 1992), but the

scepticism soon gave way to a conviction that social partnership was a

distinctively Irish contribution to economic success. Some now even argue

for social partnership as a recipe for long-run growth in a full employment

context. Here too history has something to say. This ‘ Irish solution to an

Irish problem’ bears a close resemblance to the tripartite contract between

labour, capital and the state developed in many other European economies in

the early 1950s. In those cases organised labour made a commitment to wage

moderation in return for a capitalist commitment to re-invest profits and

the state’s commitment to the welfare state. The particularly Irish feature

of social partnership in the 1980s and 1990s, in an era when the welfare

state was under threat in any case, was the state’s undertaking to reduce

personal taxation instead.

Social partnership worked well in the mess left behind by governments in

the late 1970s and early 1980s. The commitment to wage moderation made

sense when unemployment was high, and contributed to the share of wages and

salaries in GDP plunging from 57. 5 percent in 1987 to 46. 3 per cent twelve

years later. Wage moderation in the heavily unionised public sector was a

boon to the public finances. Social partnership also kept down the number

of industrial disputes and workdays lost. The system has persisted, its

most recent embodiment being the Programme for Competitiveness and

Fairness. However, in an economy like Ireland’s in 2001, where unemployment

is three per cent, the scope for social partnership 1980s and 1990s-style

is less compelling. Wage moderation simply leads to excess demand for

labour and loss of credibility for the trade union movement. Ironically,

key features of social partnership – centralised bargaining, wage

moderation, low wage dispersion – were identified by some labour economists

as reasons for the poor performance of some European economies in the 1980s

(e. g. Calmfors and Driffil, 1988; Freeman, 1989). For social partnership to

continue working it needs to re-invent itself.

‘ Free Trade’:

In the 1960s Ireland scrapped much of the protectionist apparatus built up

since the 1930s. Tariffs were reduced unilaterally, and the Industrial

Development Authority, originally an arm of protectionist policy, was

transformed into an agency to attract foreign capital. But what emerged was

hardly free trade. Instead Ireland shifted from one form of trade

distortion to another: export-subsidizing industrialization (ESI) replaced

import-substituting industrialisation (ISI). A trade sector bloated by DFI

replaced one shrunk by ISI. However, while ISI resulted in small and mainly

indigenous factories, short production runs, and high costs, ESI relied on

foreign capital and a global (though mainly European) market, and so was

more likely to involve firms and industries subject to increasing returns

to scale; it was also more likely to generate productivity enhancing

agglomeration effects. There is some evidence

to support this (Barry et al. 2001).

Perhaps it is too soon to ask whether this new, more sophisticated form of

protectionism has produced any grown-up infants. Can subsidies to export-

oriented

multinationals generate dynamic gains that ISI-oriented protection cannot

deliver? The first generation of multinationals, those introduced in the

1960s and 1970s, certainly failed to deliver on this score. Some

researchers, like NUI Galway’s Roy Green, are more optimistic about the

current generation: according to Green, the policy of concentrating on high

technology sectors and forging linkages with the local economy ‘ has proved

to be a winning formula in the development and sustainability of Ireland’s

extraordinary economic metamorphosis’ (Green, 2000).

It bears noting, however, that public policy has led to Ireland being one

of the only

countries in the OECD in which manufacturing’s share in output has

continued to rise. The rest of western Europe has been experiencing de-

industrialization since the 1970s. While manufacturing’s share in the

Republic’s GDP has risen from barely one-fifth in the 1950s to 35. 4 per

cent in 1970 and 38. 4 per cent today (1999), its share in the UK has

plummeted from 35 per cent in 1979 to 23. 9 per cent in 1999. 3 Some of the

rise in the Republic is the product of DFI-induced transfer pricing, but

employment data corroborate Irish distinctiveness in this respect. The

proportion of total civilian employment accounted for by industry has

fallen throughout Europe in recent decades, but in Ireland it has held its

own (Figure 3). It is striking that the shift in Ireland’s occupational

structure is so different to that of the rest of northwestern Europe. Is it

because Ireland has bucked the European de-industrialization trend that it

has done so well? Is this a reflection of Ireland’s true comparative

advantage, or is it merely a distortion produced by the corporate tax

regime? One argument on the side of optimism might be that the ‘ rust-belt’

de-industrialisation responsible for the decline in the industrial labour

force elsewhere (as in Northern Ireland) is the product of an earlier

industrial phase that largely passed the Republic by.

Figure 3

pic

Corporation Tax:

For a long time Ireland paid a high price for how it exercised its economic

sovereignty.

Today it is reaping the benefits of independence. While the gaps between

poor and wealthy regions of the United Kingdom are slow to narrow, and in

some cases are widening, Ireland has overtaken the UK in terms of output,

if not quite in living standards. 4 The main economic benefit of sovereignty

has been control of fiscal policy. Ireland can get away with its low

corporate tax regime because it is a small economy, producing about one

percent of EU GDP, and because it was the first to offer foreign investors

such tax concessions. Size matters: if Germany or France decided

unilaterally to reduce its corporate taxation level to the 12. 5 per cent

across the board rate being introduced by Ireland in 2003, it would risk

breaking up the EU. Being first matters: Ireland’s position in this near-to-

zero sum game depends on others 10 – or too many others – not following

suit. Whether aspirant EU member states from Eastern Europe are likely to

compete on this front remains to be seen. That certainly would not be in

Ireland’s interest.

It has been argued that the taxation argument has been oversold, since in

recent years

Ireland’s share of US DFI in Europe has risen despite some narrowing in tax

differentials. The findings of a recent paper by Rosanne Altshuler, Harry

Grubert, and Scott Newton (1998) are interesting in this context. Altshuler

and her colleagues have produced evidence of an increasing sensitivity of

US DFI to tax rates, finding that the elasticity of real capital to after-

tax rates of return doubled from 1. 5 in 1984 to almost three in 1992. They

attribute the rise to the increasing mobility of capital and globalization.

Has the elasticity risen further since the early 1990s? If so, this could

explain why Ireland has managed to increase its share, but also how

vulnerable it would be to tax harmonisation (Altshuler et al., 1998;

Grubert and Mutti, 2001). The issue is

worth urgent attention. In a similar vein Reint Gropp and Kristina Kostial

have simulated the effect tax harmonisation would have had on European

economies in the 1990s. They find that it would have cost the Republic FDI

worth over 1. 3 per cent of GDP annually between 1990 and 1997 (Gropp and

Kostial, 2001).

Some sense of the impact of the tax regime on industrial structure may be

obtained from Table 2. There we first compare the share of wages and

salaries to net output in a range of sectors in both Ireland the UK in the

late 1990s. In Ireland most of the enterprises in the first four sectors

are indigenous, whereas the second four are dominated by US multinationals.

The UK data operate as rough controls. The most striking feature is the

small share of net output going on wages and salaries in Ireland’s

multinational sectors. Labour’s small share in Ireland’s NACE 21-22 is

explained by the presence of a subsidiary of Microsoft in that sector.

These differences, and the concentration of US multinationals in these

sectors, underline the importance of transfer

pricing for US DFI in Ireland (and the distortions in both Irish GDP and

industrial production data). The same goes for much of Ireland’s

internationally traded services sector, since 1987 also beneficiaries of

low corporation profits tax. More systematic comparisons of sectoral data,

embracing all NACE categories and perhaps a few more economies, might help

reveal the ‘ real’ size of Ireland’s industrial sector. Be that as it may,

so far Ireland has not been a loser by its distorted, though perhaps also

somewhat vulnerable, foreign trade regime.

Finally, referring back to our earlier remarks about infant firms growing

up, Table 2 also compares the percentages of employees described as

‘ operatives’ (Ireland) or ‘ industrial workers’ (UK) in the same sectors.

The high-tech sectors dominated by DFI are of particular interest, given

the prevailing belief in Ireland that they attract highly skilled and

highly educated workers. The strength of white collar occupations in these

sectors in both countries is confirmed. Also worth noting, though, is how

Ireland lags behind the UK in this respect in all cases (though US FDI also

bulks large in the UK).

TABLE 2: LABOUR SHARE AND RATIO OF OPERATIVES TO OTHER WORKERS IN SELECTED

INDUSTRIES, IRELAND (1998) AND THE UNITED KINGDOM (1997)picConclusion:

In the mid-1980s, with massive reserves of unemployed labour and more to

draw on

abroad, a grave fiscal situation recently brought under control, a generous

corporation tax regime, and the prospects of wage moderation, industrial

peace, and a single European market, the conditions for an economic

recovery in Ireland were right. The Tiger’s achievement was to capitalise

on this situation. The Irish economy – now healthy, rich, and relatively

well run – is no Paper Tiger.

Yet this is no time for smugness. Small open economies, no matter how

successful, get buffeted by exogenous shocks. Ireland now faces the double

threat of the US recession in short run and of competition from Eastern

Europe diverting FDI in the longer run. It may grow faster than the OECD

norm for a few more years, but to think that it can do so in the long run

is wishful thinking. Most likely, soon the Tiger years will be remembered

as the interlude when Ireland made up all the ground it had lost and became

a ‘ normal’ European economy.

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ENDNOTES:

1. The seminar held in conjunction with the launch of Frank Barry’s

Understanding

Ireland’s Economic Growth in May 1999 attracted embassy officials from

three

continents (including those of Poland, Hungary, Denmark, Estonia, Israel,

Mexico, and

Finland). Even Silvio Berlusconi took a fleeting interest in il tigre

irlandese (Irish Times,

24 October 1996; c. 3-6 June 2000).

2. The transfer was also tiny compared to that from Whitehall to Northern

Ireland, estimated

at about one quarter of personal expenditure in the 1990s. See Grda,

2000: 278, 282.

3. For comparability construction has been added to industry in the UK.

Compare Grda,

1997: 122-124.

4. For example, since the 1960s Welsh domestic product per head has fallen

behind that of

the UK as a whole. In 1968 it was 86. 1 per cent; in 1990 83. 2 per cent, in

1998 it was

just short of four-fifths.