Economic freedom and growth: the case of the Celtic tiger.

• Author: Powell, Benjamin

Ireland was one of Europe's poorest countries for more than two centuries. Yet, during the 1990s, Ireland achieved a remarkable rate of economic growth. By the end of the decade, its GDP per capita stood at $25,500 (in terms of purchasing power parity), higher than both the United Kingdom at $22,300, and Germany at $23,500 (Economist Intelligence Unit [EIU] 2000: 25). In 1987, Ireland's GDP per capita was only 63 percent of the United Kingdom's (The Economist 1997). As Figure 1 shows, almost all of the catching up occurred in a little over a decade. From 1990 through 1995, Ireland's GDP increased at an average rate of 5.14 percent per year, and from 1996 through 2000, GDP increased at an average rate of 9.66 percent (International Monetary Fund 2001).

[FIGURE 1 OMITTED]

Most theories of economic growth can be dismissed as an explanation for the rapid growth of the Irish economy. The thesis of this paper is that no one particular policy is responsible for Ireland's dramatic economic growth. Rather, a general tendency of many policies to increase economic freedom has caused Ireland's economy to grow rapidly.

The first section of this paper looks at general policies and economic growth in Ireland from 1950 to 1973. The second section examines Ireland's experience with Keynesian policies and a fiscal crisis in the 1973-87 period. The third section considers the policies used to correct the fiscal crisis and achieve the dynamic growth that occurred from 1987 through 2000. The policies in the above periods are explained more broadly in the context of economic freedom and its relationship to economic growth in the fourth section. Other possible explanations of Irish economic growth are briefly explored. The paper ends with conclusions that can be drawn from Ireland's experience.

Early Prospects for Growth, 1950-73

The Irish Republic had a dismal record of economic growth before 1960. At the dawn of the 20th century Ireland had a relatively high GDP per capita, but it declined markedly vis-a-vis the rest of northwestern Europe up until 1960. During the 1950s, the policy stance of successive governments was that of protectionism. Exports as a proportion of GDP were only 39. percent, with more than 75 percent of those exports going to the United Kingdom (Considine and O'Leary 1999: 117). The high level of government interference in trade and the other parts of the economy caused dismal economic performance. In the 1950s, average growth rates were only 2 percent, far below the postwar European average (EIU 2000: 5). That dismal performance was reflected in massive emigration that reduced Ireland's population by one-seventh in the 1950s (Jacobsen 1994: 68).

The Irish government slowly shifted away from highly protectionist policies in the 1960s and began to pursue a strategy of export-led growth (Considine and O'Leary 1999: 117). Unilateral tariff cuts in 1964 and again in 1965, as well as the Anglo-Irish Trade Agreement in 1965 that swapped duty-free access of Irish manufactures to Britain for progressive annual 10 percent reductions in Irish tariffs, were particularly beneficial policies that helped make Ireland more attractive to foreign investors (Jacobsen 1994: 81).

Trade liberalization during the 1960s fueled Ireland's economic growth. Output expanded at an average annual rate of 4.2 percent, nearly double that achieved in the 1950s (EIU 2000: 5). Still, there was a great deal of state intervention in the economy during this time, and while the growth was much higher than the 1950s, it is not nearly as remarkable as the growth Ireland has experienced since 1990. During the decade of the 1960s, the rest of Europe was also experiencing about 4 percent GDP growth. Ireland's freer trade policies merely allowed it to cash in on the generally good growth rates the rest of Europe was experiencing. Ireland made no progress converging to the rest of Europe's standard of living; in fact, it actually fell slightly, from 66 percent of the EU 12 average in 1960 to 64 percent in 1973 (Considine and O'Leary 1999: 117).

Keynesian Policies and Fiscal Mismanagement, 1973-86

In the early 1970s, Ireland made further advances in trade liberalization and joined the European Economic Community in 1973. For the most part, however, the period from 1973 until 1986 was characterized by Keynesian policies that led to a fiscal crisis. Following the first oil shock in 1973 and continuing through the second oil shock in 1979, Ireland tried to boost aggregate demand through increased government expenditures--a policy that failed to revive the Irish economy.

The expansionary fiscal policies had the effect of putting the government in poor fiscal condition. The government had run substantial deficits, associated with the first oil shock, mostly for the purpose of financing capital accumulation up until 1977, which caused a ballooning current-account deficit (Honohan 1999:76). After 1977, the government engaged in an even more unsustainable fiscal expansion causing public-sector borrowing to rise from 10 percent of GNP to 17 percent, despite increased taxation. All categories of government spending increased between 1977 and 1981: wages and salaries increased due to national pay agreements; public bodies took on more staff to try to reduce unemployment; transfer payments increased; and an ambitious program of public infrastructure expansion caused capital spending to increase (Honohan 1999: 76). Interest payments also increased during this time. International interest rates were at an all-time high, and lenders required Ireland to pay a high risk premium. Interest rates in Ireland were 15 percent higher than in Germany (Considine and O'Leary 1999: 118).

The government reacted, in the early 1980s, by increasing taxes on labor and consumption to try to reduce the budget deficit. Although the primary deficit was cut in half, the debt-to-GDP ratio continued to climb, and by 1984 further tax increases were not seen as a viable solution to Ireland's fiscal situation (Lane 2000). The level of accumulated debt was 116 percent of GDP by 1986 (Considine and O'Leary 1999: 119). High levels of government debt, interest payments, and expenditures put the Irish government in a precarious fiscal position.

Ireland's economic growth during this time period was as dismal as its fiscal condition. Ireland averaged 1.9 percent expansion of GDP per year between 1973 and 1986 (Considine and O'Leary 1999: 111). Although that low growth rate was the same as during the 1950s, the difference was that the rest of Europe also grew slowly. Consequently, Ireland remained at about two-thirds the level of GDP per capita of the European Union. There was one sector of the Irish economy that did do relatively well during the 1973-86 period. Because of Ireland's increasing openness to trade, foreign-owned firms continued to expand, increasing their employment by 25 percent (Considine and O'Leary 1999: 119).

Unleashing the Tiger, 1987-2000

A radical policy shift was needed because of Ireland's fiscal crisis. The newly elected prime minister, Charles Haughey, had not followed a policy of limited government while previously in office (1979-82). In fact, his big spending policies played a part in creating the crisis (The Economist 1988). Prior to the 1987 reforms, Haughey and the incoming Fianna Fail government had campaigned on a populist platform against cutting public spending. It was the urgency of the fiscal crisis, not an ideological shift, that caused policy to change in Ireland. As Lane (2000: 317) notes, "The fiscal adjustment program was broadly based and non-ideological. Rather, there was a wide consensus that drastic action was the only option, with the alternative being a full-scale debt crisis requiring external intervention from the IMF or EU." Haughey himself said, "The policies which we have adopted are dictated entirely by the fiscal and economic realities, I wish to state categorically that they are not being undertaken for any ideological reason or political motives" but because they are "dictated by the sheer necessity of economic survival" (Jacobsen 1994: 177). Even the main opposition party supported Haughey's reforms (Lane 2000).

Since Ireland was a member of the European Monetary System (EMS), and had just successfully cut back its rate of inflation from 19.6 percent in 1981 to 4.6 percent in 1986, monetizing the debt through inflation was not a viable option (Lane 2000). Tax increases had already failed to resolve the crisis in the early 1980s. With both inflation and tax increases ruled out, reducing government expenditures was Ireland's only option to resolve its...