Patrick Honohan June 1007

Ireland’s economic miracle: A story of delayed catch-up

Patrick HonohanTrinity College Dublin

Dublin, 12th June, 2007

Ireland: before & after the “Celtic Tiger”

• The Celtic Tiger period is explained as a belated catch-up to the leaders after a deep recession

• Some numbers mislead – it was a marvel of employment…not of productivity

• Since about 2000, the Celtic Tiger has matured…the current boom is an old-fashioned property bubble, fuelled by EMU, immigration and (latterly) credit financed by foreign borrowing of the banks

1: A hare not a tiger

1973: Ireland on the brink of modernization

• Too little of the population at work in the “modern” sector

• But the policy response to the oil-shock generated a deep 15-year recession and balance of payments crisis– Back to macro equilibrium only by late 1990s

• (Government spending triggers inflation, soaring debt…parallels with UK pre-Thatcher but more severe)

Non-agricultural employment as % of population,

1973

05

101520253035404550

UK Ireland

%

Labour productivity in UK and Ireland, 1973

£0

£500

£1,000

£1,500

£2,000

£2,500

£3,000

Agriculture Rest of economy

UKIreland

The hare goes to sleep.. then wakes up

• Was long-deferred– Convergence to UK share of population at work in modern

sector not accomplished until c. 2000– Agricultural employment did decline steadily– But a surge in unemployment ……and delayed/discouraged female participation…kept living standards down

• When the turnaround came, availability of – young, educated workforce, – returning migrants – and (eventually) immigrants from W. and E. Europe, China,

Nigeria • became a fuel not an obstacle

Non-agricultural employment as share of population

20

25

30

35

40

45

60 65 70 75 80 85 90 95 00

Non-agricultural employment as share of population

20

25

30

35

40

45

60 65 70 75 80 85 90 95 00

Non-agricultural employment as share of population

20

25

30

35

40

45

60 65 70 75 80 85 90 95 00

The 25-year business cycle delays the catch-up

2006 2000

1997

1993

1990

1987

1974

1975

1961

1979

1981

0

2

4

6

8

10

12

14

16

18

-6 -3 0 3 6 9 12 15 18

BOP Current a/c deficit as % GNP

Une

mpl

oym

ent r

ate

% (I

LO b

asis

)

2. Fiscal crisis: Struggling with the debt escalator

• Fiscal sea-saw in the 1970s leaves debt high

• Delayed adjustment with rising tax rates (and adverse UK and other external factors)…

…Sends economy into deep recession 1982-86

• Decisive fiscal correction and more favorable external environment after 1987 restores balance

Government surplus 1970-2001

-20

-15

-10

-5

0

5

10

70 75 80 85 90 95 00

% G

NP

SavingSurplusPrimary

Government Debt

0

20

40

60

80

100

120

140

70 75 80 85 90 95 00

% G

NP

Balancing the Budget: Taxes and Current Expenditure

20

25

30

35

40

45

50

55

70 75 80 85 90 95 00

as %

GN

P

TaxesCurrent Expenditure

Escalators: Interest and Transfers

0

2

4

6

8

10

12

14

16

18

20

22

70 75 80 85 90 95 00

as %

GN

P

InterestTransfers

3. Why did the employment ratio recover so well after the demand recession of the 1980s?

• Union weakness

• Moderate wage settlements negotiated centrally

• Personal tax reductions cemented the deals

• Migration increases as full employment is reached

• Deeper factors: organization of production, computerization, expectations of new cohort?

Distribution of population change by economic status

-60-40-20

020406080

100

61-71 71-86 86-91 91-01 01-06

thou

sand

s per

annu

m

non-agemploymentag. employment

unemployed

non-active

Over 64

Under 15

Components of population change

-40

-20

0

20

40

60

80

61-71 71-86 86-91 91-01 01-06

thou

sand

s (an

nuak

ave

rage

)

Net migration

Natural increase

Union Density (non-agricultural)

38

40

42

44

46

48

50

60 65 70 75 80 85 90 95

95

100

105

110

115

120

75 80 85 90 95 001000

1100

1200

1300

1400

1500

1600

1700

1800Wage competitiveness

Total employment (rhs)

Income tax rates (incl. social contribution)Single person on average earnings

0%

10%

20%

30%

40%

50%

60%

70%

1979 1984 1995 2002

AverageMarginal

4. The role of FDI and productivity

• Was it introduction of low corporation tax rate that created the inflow of FDI? (No)

• How much of the MNC value added stayed in Ireland? (Less than you think)

• Beware of crude numbers: because of exceptionally high profit component, much of GDP, exports, “productivity” distorted.

Convergence of per capita GDP

20

40

60

80

100

120

1970 1975 1980 1985 1990 1995 2000

Per

cent

of U

S (P

PP

s)ARG

AUS

AUT

BEL

CAN

DNK

FIN

FRA

GER

HKG

ISL

IRL

ISR

ITA

JPN

NLD

NZL

NOR

SGP

ESP

SWE

CHE

GBR

USA

IRL-GNP

IRL-GNP

Aggregate productivity growth

0

1

2

3

4

5

75/70 80/75 85/80 90/85 95/90 00/95 05/00

GDP/Empl GDP less MNC profits/Empl

0

1

2

3

70 75 80 85 90 950

2

4

6

Assets (lhs) FDI stock (rhs)

Ireland’s share in the stock of US Manufacturing FDI in the EU

5. Construction: the EMU interest rate shock

• As convergence achieved, the economy’s motor switched from exports to construction…

…boosted by the EMU-related fall in interest rates…and by immigration

• After 2004, a credit-fuelled second wave of property price increases and construction activity

• All models of underlying housing demand underpredict current housing prices– Residential property prices are now falling slightly

EMU

Real interest rates 1983-2007 deflated by 4-quarter future inflation

-5

0

5

10

15

20

83 85 87 89 91 93 95 97 99 01 03 05 07

Irish Real New House Prices 1970-2006

0.5

11.5

22.5

33.5

4

1970 1975 1980 1985 1990 1995 2000 2005

Inde

x, 1

970=

1

Real domestic credit & house pricesrolling 3-month growth rate 1997-2007

-4

-2

0

2

4

6

8

10

12

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

credithouse prices

Net position of credit institutions in Irelandvis-a-vis Irish residents

05

101520253035404550

1999 2000 2001 2002 2003 2004 2005 2006

% o

f GD

P

Employment in building as % of total employment, 1990-2006

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

90 95 00 05