Thursday, 4 December 2003

How sovereignty is key to Ireland's tiger success


THERE is broad agreement among econo-mists about what gave rise to the spectacular rate of growth of the Irish economy since 1987. This saw Ireland overtake both the UK and the OECD average in terms of real GDP per head. This success is down to six major influences over the past 40 years, for the origins of the story are to be found in events as far back as 1959.

The Irish economy was then in a dreadful condition, the result of 25 years of high tariffs and restrictions on inward investment. While the Cosgrave government elected in June 1922 had maintained a large measure of free trade, Eamonn de Valera’s government from 1932 was highly protectionist.

The economic consequences were catastrophic. The ratio of Irish exports to GDP fell from 29 per cent in 1929 to 15 per cent in 1938, and to 12 per cent in 1944. Tariffs and quotas remained high right up to the late 1950s. Under this policy of import substitution, Irish business produced a wide range of products with small production runs: cars were assembled from imported kits and imported corn flakes stuffed into packets.

Productivity and living standards declined. There were jobs for those willing to accept what De Valera described as “a frugal comfort for our people”. But many were not, and sailed to Liverpool and Holyhead.

In 1959, Sean Lemass succeeded De Valera as prime minister and initiated a reversal of economic policy. The new policy of openness to trade and the attraction of inward investment is one that all governments have since followed. It was laid out in a white paper entitled A Programme for Economic Development drawn up by the then secretary of the department of finance, TK Whittaker.

He saw that the only way forward was through increasing employment in manufacturing for export. Since Ireland had no tradition of manufacturing, this meant attracting foreign direct investment. So began a policy which, sustained over four decades, delivered its full fruits in the 1990s. This is the first factor accounting for Irish success.

The key features of Irish industrial policy have been consistency, focus, realism and the tax structure. Consistency means that policy has evolved without abrupt shifts when governments have changed. Long-term commitments on taxation and profit expatriation have been honoured. The policy has been focused on attracting firms in specific sectors such as electronics hardware, components and software, healthcare, financial and tele-services.

Inward investment in electronics in the 1970s produced domestic spin-offs in the 1990s. The policy exploited the strengths of the Irish economy, namely language, education, the good telecoms infrastructure and the attractive environment, and avoided the weaknesses – a tiny domestic market, a sparse population and high transport costs.

The principal tax incentive of a low, sometimes zero, rate of corporation tax was originally offered, together with capital grants, to selected foreign investors. Now, a uniform 10 per cent rate applies to foreign and indigenous firms alike.

With the new industrial policy went a reversal of the inward-looking trade policies of the 1930s, 40s and 50s. Landmark events in the re-opening of the Irish economy were the British-Irish Free Trade agreement of 1965, joining the Common Market in 1973, and participation in the Single European Market from 1992. Today Ireland is exceptionally open in terms of trade, capital flows and movements of labour. This is the second factor in its success.

Government policy played a big part in shaping the Irish economy in two other ways. Macroeconomic management had been indifferent for much of the 1960s and 70s, and was disastrous between 1978 and 1982. From then until 1986 it was merely ineffective. From 1987, however, sound macro-economic management was one of the keys unlocking the benefits of long-term industrial and educational policies.

The fourth factor was the consensus orchestrated by the government in 1987 between the political parties, the trade unions and the employers. This saw moderate pay increases being rewarded by reduced rates of personal taxation. These pay deals, accompanied by a rapid growth of labour productivity, secured Irish competitiveness. From the mid-1980s until the late-1990s unit labour costs in manufacturing fell by more than 40 per cent relative to the eurozone and by more than half against the UK.

The fifth major factor was the continuing investment in infrastructure. Heavy public investment in the 1970s and 1980s provided a first-class telecoms network and excess electric supply capacity, but by the end of the 1980s roads, ports and the sewerage system had become increasingly outdated. Ten years of European Structural Funds made a further contribution to infrastructure renewal.

The final factor was the improvement in the quantity and quality of the labour force. The natural increase in the population of working age and the increased female participation resulted in an annual increase of 2 per cent in the supply of labour throughout the 1990s.

The benefits of increased public investment in education and training, which began in the 1960s, came on-stream in the 1980s in the shape of markedly increased average skill levels in the workforce.

The mutual interaction of these six factors, coupled with a favourable external environment, helped foster a climate of social and business confidence in which enterprise flourished.

What lessons can Scotland learn? The particular set of historical circumstances that made Ireland’s experience can never be replicated in the future of that country, let alone in Scotland. But institutional arrangements associated with successful outcomes can be identified and copied.

One is an openness to foreign trade. Another is the power that can be exercised by a sovereign government. When one considers the extent of the influence which Irish government policy had upon the events of the past 40 years – in the conception and execution of its industrial policy, in the freedom to deploy varying rates of taxation, tariffs and quotas, in implementation of pay agreements, and in negotiation of international treaties – it is clear these measures could have been carried out only by a sovereign government.

A small European country hoping to succeed in today’s global markets without the policy instruments available to a sovereign government is like a golfer hoping out to win a competition with some of the best clubs missing from his bag.

David Simpson

• Professor Simpson is former economic adviser to Standard Life and once worked for the Economic and Social Research Institute in Dublin.

This article first appeared on Scotsman.com.