Close call for Irish economy on three occasions in short history

When the policy settings are right, the natural growth potential of the economy is impressive

The 1960s saw a change in direction of economic policy under Sean Lemass from that of his predecessor  Eamon de Valera

The 1960s saw a change in direction of economic policy under Sean Lemass from that of his predecessor Eamon de Valera

Wed, Nov 13, 2013, 13:28

In 1963 the independent Irish State was just over 40 years old and, over that period, its economic performance had, to say the least, been poor. Apart from the obvious difficulties of the second World War, the 1950s was a very disappointing decade.

While other economies were expanding strongly in a postwar reconstruction boom, the Irish economy performed poorly. Net outward migration averaged 40,000 a year and the population continued to decline. The population peaked at over 6.5 million in 1841 but had fallen to just 2.8 million by 1961.

Much of this reflected the failed policy of the De Valera governments in attempting to build a sustainable industrial base behind a wall of very high import tariffs. It was never likely that the small Irish market, in itself, would provide the size to enable industries to reap the natural benefits of economies of scale.

However, the seeds of a more successful period had already been sown before the start of the 1960s. In 1958 TK Whitaker, secretary of the Department of Finance, produced a seminal document, Economic Development. It argued that the Irish economy would only flourish by embracing the notion of free trade, ending protectionism and building an industrial base which was firmly focused on export markets.

The change in direction of policy, led by Whitaker and Seán Lemass, produced a relatively quick change of fortune. Net outward migration fell sharply in the 1960s and, for the first time, there was net inward migration during the 1970s. In spite of two oil crises at either end of that decade, the Irish economy managed an average GDP growth rate of almost 4.5 per cent a year during the 1970s.

Fiscal excesses of the Haughey era

However, just as we were getting it right, policymakers failed the economy again. The 1977 general election was fought, and won, promising very generous tax reductions. By the early 1980s, both the exchequer and balance of payments deficits amounted to mid-teen percentages of GNP, inflation and short-term interest rates exceeded 20 per cent, and government debt interest absorbed 30 per cent of tax revenue. The subsequent adjustment had, as expected, significant negative impacts on the economy. Annual GDP growth slowed to not much more than 1 per cent a year, the unemployment rate soared to more than 17 per cent and there was a resumption of net outward migration.

The Celtic Tiger

However, once these fiscal difficulties were behind us, many of the supply- side policies put in place during the 1960s and 1970s began to bear fruit: the focus on exports as a source of industrial growth, the benefits of the education reforms of the 1960s and the impact of the turnaround in migration flows in 1970s, as the increased birth rate of that decade was reflected in a strong flow of young, well-educated entrants into the labour force. A virtuous circle of positive feedback loops was now in place.

Most observers date the beginning of the so-called “Celtic Tiger” to about 1994, and many would divide the subsequent period up to 2007 into two distinct phases: the period 1994 to 2000 (“the good phase”) when growth was driven primarily by exports. Exports expanded by almost 20 per cent per annum over those seven years and the balance of payments remained in surplus each year.

In contrast, in the period between 2000 and 2007, export growth slowed and domestic demand, particularly construction, became the much more significant driver of economic performance. By 2007, the balance of payments was in deficit to the tune of more than 6 per cent of GNP.

Ireland was, of course, not alone in allowing significant excesses to accumulate in property and financial markets over this period but the appreciation of property prices and the growth in credit was far greater in Ireland than elsewhere. Not surprisingly the correction in the Irish economy, when the bubble burst, was far greater as a result. Real GNP fell by more than 9 per cent in 2009 and the cumulative fall from peak trough in nominal GNP was more than 20 per cent. Total employment fell by almost 330,000 and more than half of those losses (over 175,000) were in the construction sector.

In the process most of the banking system went bust. Total injections into the banking by the State, and the parent companies of foreign-owned banks, eventually came to some 75 per cent of GDP, one of the largest bank busts in global history. Inevitably the State itself had to enter a support programme financed by the International Monetary Fund, the European Union and the European Central Bank.

Longer term characteristics
for Ireland still intact

The good news is that over the past year or so there has been encouraging evidence that Ireland is finally emerging from one of its deepest ever recessions and we look set to exit the bailout programme on schedule at the end of this year.

Given the continued overhang of public and private sector debt, as well as the slow recovery in the global economy, it is likely that growth rates in the Irish economy in the next number of years will remain muted. Nevertheless the Irish economy looks to have better long-term growth potential than many others and, in some respects, this longer-term growth potential has improved in recent years. Theses include:

A significant improvement in competitiveness. Both price and wage inflation in Ireland in recent years has been exceptionally low. Other costs in the economy have also been reduced.

Favourable demographics. Although the pace of population growth in Ireland in recent years has slowed very considerably, this mainly reflects the impact of net outward migration. If net migration were to fall to zero, population growth would exceed 1 per cent a year, leaving Ireland as one of the few countries in Europe with a significant growth rate in its population.

There are also other “softer”, but no less important, characteristics. The proportion of the population which enters third-level education is one of the highest in the world and the education system is seen as one which is focused on the needs of a competitive economy. The labour force is English-speaking and is ranked number one in many surveys in terms of flexibility and adaptability. In addition, of course, we continue to maintain our very competitive corporation tax rate of 12.5 per cent .

Learning the lessons of the past

However, if we are to fully exploit this long-term potential for the Irish economy we need to, at least, avoid the major policy mistakes of the past. In our relatively short history we have almost blown up the economy on three separate occasions.

The public finances must never be allowed to get out of control again. An underlying deterioration in the public finances, and an over-reliance on what proved to be temporary revenue streams, was a key factor in the extent of the most recent downturn in the economy. It was the sole driver of the crisis of the early 1980s.

However, we have shown, when the policy settings are appropriate, the natural growth potential of the Irish economy is impressive. During the successful periods of the 1960s and 1970s and, again, in the 1990s, there was a combination of prudent fiscal policies and successful supply-side initiatives.

Hopefully, we are now within touching distance of restoring balance to the public finances and can supplement this progress with a continued focus on export markets, an attractive tax regime, labour market reforms, an improved education system, more efficient public services and better public and private sector policy analysis.

Robbie Kelleher is head of global investment strategy with Davy

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