Ireland: the return of the “Celtic tiger”?

This article was published on the 11th of September, 2016, by the Beerderbeg magazine. The article was published originally in Spanish language. 

In only five years Ireland has progressed from being the second rescued country of the Eurozone (the first one was Greece in May 2010) to lead the economic growth of the 19 countries in the Eurozone. This recovery (Figure 1) looks like a miracle if we take into account that Ireland was considered a “GIIPS” member, a name used by the British press to identify the countries in the peripheries of the Eurozone that had serious deficit problems and public debt: Portugal, Italy, Ireland, Greece and Spain.

FIgura 1_Irlanda

Figure 1: Evolution of the quarterly variation index of the GDP at market prices (1st quarter 2012 – 1st quarter 2016). Source: Eurostat. Own elaboration.

How has Ireland managed to overcome the crisis so quickly? Why the same measures that have worked for Ireland have not worked that well for the other bailed out countries? Can we affirm that the “Celt tiger” (name given to the Irish economy during the last 90’s) is back?

The long path of the Celtic tiger

To understand the characteristics of the current Irish economy it’s necessary to go back in time. The country didn’t become an independent Republic until 1922; before that date Ireland was part of the United Kingdom, but unlike the British metropolis, the Emerald Isle was a poor and underdeveloped country. During the XIX century, millions of Irishmen abandoned their homeland heading to London or to the other side of the Atlantic, running away from misery and hunger. The dreadful 1845 Potato Famine (or Great Hunger) is still a latent trauma in the Irish memory. Even when the country freed itself from the English yoke, it couldn’t develop like its neighbours; between 1913 and 1950, Ireland grew at a moderate pace and its per capita income levels were light years away from the ones from countries like the UK, France or Germany. Even before 1950, during the so-called “Post-World War II economic expansion”, the Celt country was considered a straggler.

The fundamental issues faced by the Irish economy hadn’t changed much since the XIX century: a small and protectionist economy, focused on self-sufficient rural activities and fragmented properties incapable of leveraging mass production, the increase in the use of technology nor the economies of scale [1]. One should add up to these characteristics the status quo’s reticence against the liberalization and modernization of the economy; a similar situation to that of countries like Spain or Greece, also left behind in the socioeconomic development from the mid XX century.

It wasn’t until the late 50’s, due to the Whitaker Report, that the Irish government and the country’s elites admitted that the path towards growth based on exportations and a progressive integration into the European market (back then the European Economic Community, EEC) was unavoidable. This shift progressively attracted foreign capital (Foreign Direct Investment, FDI) eager to invest in a country with so much yet to be built, and enabled Ireland to start the necessary reforms to enter the EEC in 1973.

These foundations – economy based on exportats, a high level of FDI and integration to the European market – allowed Ireland to earn the name of “Celtic tiger” in the mid 90’s. From the beginning of this decade to the 2007 financial crisis, Ireland was the European country that experienced the biggest economic growth, multiplying by four its GDP. Besides, from the late 90’s, the government kept the corporate income taxes under 30%, lowering it progressively and leaving it at 12,5% from 2003 onwards [2].

This tax advantage is key to explain why big multinational companies, especially North American high-techs, settled their headquarters in the Emerald Isle at the end of the previous century. To this day, 29 of the 30 world’s biggest technological enterprises have their headquarters in Ireland. In fact, the low taxation of these companies and their alleged fiscal advantages are generating some conflicts; see the recent case of Apple, in which the European Commission (EC) accuses the North American enterprise of receiving state aid, a practice especially prohibited in the Treaty on the Functioning of the European Union (TFEU), so the EU demands to the Irish government to retroactively levy the 13.000 millions of euro of Apple’s unpaid taxes (*).

However, the success of the Celtic tiger cannot be understood only as a matter of fiscal bonus and discounts, but as a sum of a variety of factors whose application generated a virtuous circle that allowed the country to progress at an accelerated pace. The European integration had a major role because, due to its relative underdevelopment, Ireland was a net receiver of the European funds from 1973 to 2011 (in total, the net contribution of the EU in this period was 42.000 million euro [3]). In Ireland, these investments found a high return, though they progressively lost importance in relation to the Irish GDP. On the other hand, the role of the government is also key to understand the economic development of Ireland because, from the beginning of the 90s, active policies were carried out to attract foreign investment (key role of Industrial Development Authority, IDA state agency) and to promote certain industries, especially the information and communication technologies sector (ICT), the biotechnological, the pharmaceutical and, until 2008, the construction one.

The construction crisis

Ireland lived a similar episode to the real estate bubble that took place in Spain and the United States during the 2000s decade. The rise of the available income per capita during the years of the housing bubble led to a growth of purchased properties, whose prices soared. According to the Department of Housing, Planning and Local Government, the average price of property went from 87.202€ in 1996 to 322.634€ in 2007, a 270% rise. As a consequence, the banking sector specialized in mortgages, though its exposure to the so-called subprime or toxic mortgages was minimal; therefore, we should not understand the Irish crisis as a direct consequence to the North American crisis [4].

The collapse of the bubble happened in a dramatic way in 2008, with the sudden drop of property prices. The international crisis strongly struck the Irish economy, traditionally open, increasing the unemployment and, consequently, complicating and even making impossible the payment of the mortgage’s fees. The mortgage crisis derived into a banking crisis, to which the Irish government, like many others in Europe, responded with a big injection of public funds into the main banks (in total, the net cost of rescuing the banks cost Ireland 43.000 million euro). These desperate measures triggered the public deficit to an unsustainable 32% of the GDP (in 2009 Spain reached a maximum of 11%). It was then, at the end of 2010, that the Irish government finally recognized the need to be bailed out by the European authorities (through the recently created European Financial Stability Facility), the International Monetary Fund (IMF) together with bilateral loans from the United Kingdom, Sweden and Denmark. The total cost of the Irish rescue was 85.000 million euro.

The bailed out GIPS and the crisis

As metnioned at the beginning of the article, Ireland was the second country to be bailed out, but also the first one to abandon the 2013 bailout plan. The official version, specially defended by the European Commission, is that the correct application of the reforms brought by the bailout plan –restructuring of the banking sector (increasing the regulation and applying good practices, in line with the reforms proposed at European level), budgetary adjustment (deficit reduction) and internal devaluation (reduction of labour costs to gain competitiveness) – brought positive results. If these measures did not work that well in Greece, Portugal and Spain is because these countries did not apply them correctly (or not that adequately). This is a half-truth. The impact of the crisis and the adjustment measures over the bailed out PIGS (Italy will be omitted from the analysis because it was not bailed out and because it deserves a whole new chapter) was not the same because the institutional and productive framework of these countries has not been the same for decades. Neither the four started with the same income level, public debt or unemployment when the crisis began.

In the mid 90s, Ireland had already dissociated from the other three GIPS in terms of per capita income, whether if calculated with the GDP per capita (PIB, in Spanish) or with the gross national income (GNI; RNB, in Spanish) per capita (discontinuous line):

Figure 2: Evolution of per capita income in the GIPS (1990-2015). Source: World Bank. Own elaboration.

Figure 2: Evolution of per capita income in the GIPS (1990-2015). Source: World Bank. Own elaboration.

It is important, especially in the Irish case, not to consider only the GDP per capita to calculate the income of each individual. The GDP takes into consideration the value of products and services produced in a country during a year, regardless of whether this wealth ends up or not in the pockets of the Irish people. However, the GNI also takes into consideration the difference between the income received from foreign countries minus the payments made to them (net income from abroad). For instance, there’s a high amount of benefits made by big multinationals settled in Ireland that end up being repatriated to the United States. For this reason, we observe in Image 2 that the Irish GNI per capita is lower than its GDP per capita.

In 2008 this difference was huge; the national income per capita was only a 62% of the GDP per capita; since then, however, the evolution of the national income has ended up converging with the gross national product. In the case of the other GIPS it happens exactly the opposite: the gross national income exceeds the GDP per capita. Why? Because in these countries the foreign flows (income generated abroad repatriated to Spain, Greece or Portugal) exceed the payments made abroad. This can be a symptom of a variety of factors, among them a low FDI level, a bigger number of internationalized enterprises that repatriate their benefits, or a bigger number of emigrants working outside the country.

Before the crisis, the unemployment level was also considerably lower in Ireland than in the rest of the compared countries:

Figure 3: Evolution of the unemployment rate in the GIPS (1990-2015). Source: IMF: World Economic Outlook, April 2016. Own elaboration.

Figure 3: Evolution of the unemployment rate in the GIPS (1990-2015). Source: IMF: World Economic Outlook, April 2016. Own elaboration.

As a consequence of the crisis, the unemployment in Ireland shot up like in the rest of the analyzed countries, but in 2012 it reached the 14,7% of the labour force. In 2015 it was the bailed out country with the lowest unemployment level.

Finally, though in Greece and Portugal the government debt was relatively high in relation to the GDP and already rising before the crisis, in Spain and Ireland (the two countries with the highest economic growth until 2007) the debt levels were relatively low. From 2008 they shot up due to diverse cyclic factors: reduction of the government revenue and rise of the expenditure (increase of the government debt), plus the debt generated by the rescue of the banks.

Figure 4: Evolution of public debt as a percentage of GDP in the PIGS (1995-2015). Source: IMF, World Economic Outlook April 2016. Own elaboration.

Figure 4: Evolution of public debt as a percentage of GDP in the GIPS (1995-2015). Source: IMF, World Economic Outlook April 2016. Own elaboration.

In 2012, in the midst of the bailout, Ireland reached a relatively alarming 120% of debt to GDP, but has managed to reduce this ratio to a 100% in 2015. Spain, though, despite the adjustments, has not managed to reduce the debt, which is still on the rise year after year.

But, once they were bailed out, what country had to apply the most severe financial adjustment? We can analyze it through two variables: variation of the GDP and variation of the amount of government expenditure. As we see in Images 5 and 6 Greece is, by far, the bailed out country that has applied the biggest adjustment in its public finances, both in terms of GDP adjustment and of expenditure reduction. Of the three other countries, Ireland is the one that has reduced more substantially its public expenditure during the period of 2011-2015 (we must remember that it went from a 120% of public debt to GDP to a 100%). However, unlike Spain and Portugal, the Irish GDP had a very positive evolution in the same period. Does that mean the evolution of the Irish GDP was more favourable because its expenditure adjustment was tighter? If that’s the logic, the Greek GDP would have risen but, instead, its evolution is still negative nowadays. Greece is in the midst of a recession despite having applied the highest adjustment of all the bailed out countries. Therefore, we can deduce that there is no direct relation between applying a tighter financial adjustment and the GDP growth.

 

Figure 5: GDP variation at constant prices in the GIPS for the periods 2008-2011 and 2011-2015. Source: IMF, World Economic Outlook Database April 2016. Own elaboration.

Figure 5: GDP variation at constant prices in the GIPS for the periods 2008-2011 and 2011-2015. Source: IMF, World Economic Outlook Database April 2016. Own elaboration.

Figure 6: Percentage variation of public expenditure in the GIPS for the periods 2008-2011 and 2011-2015. Source: IMF, World Economic Outlook Database April 2016. Own elaboration.

Figure 6: Percentage variation of public expenditure in the GIPS for the periods 2008-2011 and 2011-2015. Source: IMF, World Economic Outlook Database April 2016. Own elaboration.

This does not imply that Ireland “has not done the homework” (in the Troika’s argot). The reduction of the government expenditure was drastic, and the internal devaluation a reality: between 2008 and 2015 the labour costs in Ireland were reduced to a 10%, according to official data provided by Central Statistics Office (CSO). However, this devaluation hasn’t equally affected all the sectors, and in fact there are sectors that haven’t neither cut the salaries nor destroyed employment. We can see in the following graph what has been the variation of labour costs in Ireland per each sector:

Figure 7: Evolution of labor costs in Ireland per sector (data for 2008, 2011 and 2015). Source: CSO. Own elaboration.

Figure 7: Evolution of labor costs in Ireland per sector (data for 2008, 2011 and 2015). Source: CSO. Own elaboration.

As we see in Figure 7, the clearly highest adjustment takes place in the construction sector, followed by the hotel/catering sector and the public administration. But notice that the key sectors of the Irish economy –biotechnological-pharmaceutical (health) and ICT – haven’t experienced cuts in the labour costs, but an expansion. These sectors do not compete in neither salaries nor prices, but have their foundations in specific human capital and its capacity for innovation. Therefore, a reduction of labour costs not only would not make them more competitive internationally, but also would harm them. These sectors have increased their labour costs, but they have also generated employment during the 2008-2015 period, as we see in the graph below:

Figure 8: Evolution of employment in Ireland per sector (data for 2008, 2011 and 2015). Source: CSO. Own elaboration.

Figure 8: Evolution of employment in Ireland per sector (data for 2008, 2011 and 2015). Source: CSO. Own elaboration.

We can affirm, then, that neither the crisis nor the adjustments derived from the bailout have affected the key sectors of the Irish economy; sectors that, on the other side, are closely linked to the FDI and the exportations, two elements that, we must remember, were the foundations of the Celtic tiger.

In the following charts we can see that neither the exportations nor the foreign investment have been affected by the crisis nor the adjustments derived from the bailout, rather the contrary:

Figure 9: Evolution of exports as a percentage of GDP in the GIPS and in Germany (2000-2015). Source: IMF World Economic Outlook Database April 2016. Own elaboration.

Figure 9: Evolution of exports as a percentage of GDP in the GIPS and in Germany (2000-2015). Source: IMF World Economic Outlook Database April 2016. Own elaboration.

As we can see in Image 9, Ireland’s export-based economy has remained intact even during the recession. The level of exportations as ratio to the GDP in Ireland is not only way higher than in the rest of the PIGS, but also surpasses export-based economies like Germany (DE).

Concerning the foreign direct investment, it has risen in Ireland since 2011; exactly the opposite to Spain, Greece and Portugal.

Figure 10: Evolution of foreign direct investment (FDI) in the GIPS (2000-2015). Source: World Bank. Own elaboration.

Figure 10: Evolution of foreign direct investment (FDI) in the GIPS (2000-2015). Source: World Bank. Own elaboration.

Other important sectors to the Irish economy that do compete in prices and salaries, like hotel/catering and tourism, were benefited by a VAT reduction from 13,5% to 9% that was applied on July 1rst 2011, right a few months after the bailout, as a measure to sustain the unemployment levels in these sectors. As we see in Image 8, in 2015 the employment in the hotel/catering sector had already surpassed its 2008 level.

To sum it up, in Ireland, the effects of the crisis and the adjustments derived from the rescue have not been as harmful for the economy as in the rest of PIGS because of the following reasons:

  • Ireland had higher income levels and income levels per capita and a lower unemployment level and government debt than the other PIGS.
  • The internal devaluation affected the sectors that compete in prices and that do not provide significant added value to the Irish economy (construction, public administrations)
  • The key sectors to the Irish economy (biotechnological, pharmaceutical and ICT) have increased jobs and salaries during 2008-2015.
  • The exports level and the FDI have never stopped growing since 2011.
  • The VAT for the tourism and for the hotel/catering sector remained at 9% since 2011. The corporate tax has remained in the 12,5% and the big multinationals have been benefiting from tax advantages.

These factors not only have softened the crisis effects, but have also permitted the Irish economy to walk again in the path towards growth in a much more accelerated pace than the rest of the bailed out countries. The biggest achievement of the Irish government that has managed the country during the baileout has not been only “doing the homework”, but mostly keeping the Celt tiger basis safe: exportations, FDI and high added value sectors.

Despite the housing bubble and the bank crisis, Ireland had and has an institutional and productive framework that encourages the structural and sustainable growth of the economy, able to resist with notable success to the worst recession after the Second World War. We cannot say the same of Spain, Greece and Portugal, where the institutions have encouraged low added value sectors, or have directly been taking money from the citizenship. Following Daron Acemoglu and James A. Robinson’s theory, captured in their greatest work “Why nations fail?”, we can affirm that the Irish institutions have managed to construct a “virtuous circle” that encourages economic growth, employment creation and wealth distribution within society and not only within the economic elites and the over-protected sectors, like the shipping industry in Greece, or the financial and construction industries in Spain. This virtuous circle is the one and only “Celt tiger”.

(*) AN: At the closure date of this article (08/31/2016), it’s not clear yet if Apple has really received an advantageous treatment from the Irish government, as determined by the EC. Both the Irish government and Apple are willing to lodge an appeal at the European Courts.

REFERENCES

[1] Eichengreen, Barry (2008): The European Economy since 1945. Princeton University Press.

[2] European Commission (2015): Taxation trends in the European Union. Enlace: http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_structures/2015/report.pdf

[3] Official webpage of the Irish Presidency of the Council of the European Union (2013): How the EU is financed. Link:

http://m.eu2013.ie/ireland-and-the-presidency/abouttheeu/theeuexplained/howtheeuisfinanced/

[4] Connor, Gregory; Flavin, Thomas; O’Kelly, Brian (2010): The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features. Federal Reserve Bank of Atlanta.

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