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1 Rise and Fall of the Celtic Tiger See BPEA by Honahan and Walsh – commentary/journals/ bpea_macro/papers/ 200204_honohan.pdf

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1 1 Rise and Fall of the Celtic Tiger See BPEA by Honahan and Walsh – commentary/journals/ bpea_macro/papers/ 200204_honohan.pdf commentary/journals/ Short-loan PC 18940 Chapter 24 of Walsh and Leddin

2 2 Outline The nature of the Irish economic boom Not a productivity ‘miracle’ –But the growth of employment was ‘miraculous’ The rising employment/population ratio the key to understanding the speed with which we caught up with the leaders No ‘magic bullet’ Several factors – including luck – came together in the 1990s

3 3 Belated real convergence When Ireland began to catch up, it moved very rapidly like a hare Rapid spurt in 1990s By the end of the 1990s we had gone ahead of the average and, by some measures, were one of the richest countries in the world –See the graphs

4 4

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6 6 6 Ireland closed the gap with rest of EU in the 1990s Ireland Spain Greece Portugal EU15 GDP per person at PPS=100

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9 9 Basic Idea Convergence postponed –By policy errors prior to 1987 Convergence achieved –By return to traditional, sound policies –By removal of obstacles –By rapid rise in ratio of non-agricultural employment to population –No productivity miracle No magic bullet Alternative Q: –Why did it take so long?

10 10 Two Questions 1.Where did the growth come from? Accounting Question 2.Why did we grow? Lessons for the future Lessons for other countries

11 11 Real convergence Note that “real convergence” usually refers to the level of GDP per person, that is GDP/Population We can see that this is made of two elements, (GDP/person at work) x (Persons at work/population)

12 12 Sources of growth in GDP/person GDP/person at work = productivity Persons at work/population = employment rate Rate of growth of GDP per person  Rate of growth of productivity + rate of growth of employment rate

13 13 Where did the economic growth come from in the 1990s?

14 14 Where did the employment growth come from in the 1990s?

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16 16 Answer to Q of Where Growth came from Convergence due to 1.Rapid rise in ratio of non-agricultural employment to population This in turn due –Demographic factors Decline in proportion aged under 15 –Exceptional growth in numbers at work outside agriculture 2.Reasonable growth in productivity High by some standards But no miracle

17 17 Sources of growth in GDP/person, 1985-2000 The employment/population ratio rose from 24% to 41% With no change in the level of productivity this alone would have raised GDP/Person by over 60%

18 18

19 19 What actually happened was much less smooth Drastic set-backs between 1973 and mid-1980s –Shrinking productive base –Growing burden of dependency 224 dependants per 100 employed in 1986 Rapid recovery and catch up from late 1980s –124 dependants per 100 employed in 2001

20 20 Summary Prior to 1987: depression (negative growth), high unemployment (18%), high inflation (16%), public finances in crisis (deficit of 15.1%), balance of payments deficit (14.6% of GNP) and depreciating exchange rate. Mass emigration, rising poverty. “Basket Case” economy. 1994 to 2001: 7 years of spectacular growth (average 9%), low unemployment (3.6%), low inflation (1.4%), surpluses on fiscal budget (3.5%) and balance of payments (3.7%). The “Celtic Tiger” economy. 2001+: Return to more normal economic performance See Economist covers  Leddin and Walsh Macroeconomy of the Eurozone, 2003

21 21 From 1960 to 2000 One huge macroeconomic loop in terms of unemployment –We ended up in 2000 much where we started from in 1961 Path was not smooth –Policy errors after1973 –Led to enormous fiscal and balance of payment deficits –Painful correction during 1980s –Steady rise in the tax burden until 1986 –This trend reversed as spending was brought under control The correction became self-reinforcing by the late 1980s –Virtuous circle of declining burden of debt and taxation

22 22 Why Did We Grow? Why did employment grow? 1.Demographic factors –Sharp fall in birth rate after 1980 –led to fall in proportion of young dependents in population 2.Economic Policy –We saw some of this in the fiscal policy section

23 23 Demographics The fall in birth rate after 1980 could be regarded as –Ireland’s belated convergence to the demographic norm for a developed country Facilitated by rising female educational levels and Changes in attitudes and laws concerning contraception Triggered by rise in unemployment in early 1980s?

24 24 Economic Policy in the Tiger Distinguish between pre-boom factors: 1.Foreign direct investment (Industrial policy). 2.External assistance. 3.Investment in education. Factors that combined to ignite the boom: 4.Centralised wage bargaining. 5.Fiscal policy. 6.Upturn in World (US) economy. 7.Achieving EMU entry criteria. 8.Exchange rate policy. 9.Small is beautiful.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

25 25 1. Industrial Policy Success of IDA in attracting high-tech foreign multinational companies (MNCs): microelectronics, pharmaceuticals, medical instrumentation, computer software, financial services, telemarketing. However, the contribution of MNC’s can easily be exaggerated. Need to take into account their high level of imports (including payments for patents and royalties) and repatriated profits. Contribution to GNP in 1998 was only €4.8 billion. Considerably less than the sales figure.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

26 26 2. External Assistance 1973-2001: Total net receipts = €33,853.5 million. Annual average of €1,167.4 million or 3.9 % of GNP. The peak was 6.6% of GNP in 1991. Paid under a variety of headings: agriculture, social, regional and cohesion funds. Money mostly spent on roads, railways, telecommunications. Greatly improved the country’s productive capacity.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

27 27 3. Investment in Education The importance of “human capital formation” in the growth process. 2000:Primary€1,068 m Secondary€1,243 m Third level€838 m Well educated labour force acts as a magnet to foreign multinationals. Much of this investment took place in the 1970s and early 1980s. Note: Factors 1 to 3 were in place in the 1980s and do not explain the spurt in growth in the 1990s. Considered to be essential pre-conditions.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

28 28 4. Wage Bargaining Wage moderation following a return to centralised wage bargaining. National wage agreements involving the trade unions, employers and government. In return for moderate increases in nominal wages, the government promised tax cuts at budget time. For a number of years, inflation was greater than the basic wage awards resulting in a fall in real earnings. Improved Ireland’s competitive advantage. Only applies to workforce of 500,000 out of total employment of 1.7 million. May or may not have facilitated the IDA’s industrial policy.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

29 29 5. Fiscal Policy Restoring oder to the public finances in late 1980s was a pre- condition for a resumption of economic growth. Improved investor confidence and reduced the outflow of capital. Tax rates cut from 35% and 58% in 1988 to 20% and 42% in 2002. Difficult to disentangle cause and effect. Tax cuts in recent budgets increased the supply of labour and stimulated aggregate demand. Government expenditure under the 1994 and 2000 National Development Plans was €28 billion and €51 billion respectively. Expenditure went into improving infrastructure (road conjestion), environmental pollution, education and training, and housing.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

30 30 6. World Economy Ireland is very open to trade. Non-EMU countries account for 80.4 % of Irish trade. Very dependent on the US economy. Exports of €1.6 billion in 2001. Economic performance in USA has been major factor behind the growth in Ireland. Current slowdown in Ireland is due in large part to slowdown in US, terrorist attack 11 th September and the foot and mouth disease. Tourism increased by 8% per annum throughout the 1990s.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

31 31 7. EMU Entry Criteria To join EMU, Irish inflation had to drop to below 2.7 %. Hence, EMU forced the government to adopt an anti- inflationary stance. EMU membership also entailed a fall in Irish interest rates down to the low German rates. By the late 1990s, negative real interest rates stimulated the demand-side of the economy and fulled house price inflation.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

32 32 8. Exchange Rate Policy Over-valued exchange rate combined with high interest rates can seriously curtail a country’s growth potential. Devaluations in August 1986 (8%) and January 1993 (10%) prevented over-valuation. Central Bank followed a policy of stabilising the effective exchange rate. Involved playing off the strength of sterling against the weakness of the DM. Middle ground. From August 1997, the DM rate was allowed to drift down to the EMU entry rate of 2.4834.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

33 33 9. Small is Beautiful Obviously a lot easier to turn around a small country like Ireland than a very large country. The same level of foreign direct investment would have much less of an impact on, say, the Spanish economy. Factor number 10 was “luck”. Most of the above mentioned factors complemented each other in moving in the right direction at the right time.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

34 34 How Did these Factors Influence Output? Examine how factors 1 to 9 impact on the demand-side (AD) and the supply-side (AS) of the economy. This analysis is subjective because: 1. Some factors impact on both AS and AD. 2. The factors interact with each other. 3. It is virtually impossible to quantify the effect of each factor on economic growth, unemployment and inflation.

35 35 LRAS Long-run (natural real GNP) and short-run AS curves are determined by: –A. The size of the labour force. –B. Physical and human capital. –C. Advances in technology. Some of the Policies affect AS 1.Foreign direct investment  Affects B and C. 2. External assistance  Affects B. 3.Investment in education  Affects B and C. 4.Centralised wage bargaining  Short-run AS curve. 5. Fiscal policy  Affects A, B and C. 6. World economy  Affects B and C. Result: the long-run and short-run AS curves shift to the right.

36 36 AD AD curve is determined by: Consumer expenditure (C), Investment (I), Government expenditure (G) and Net exports (NX). 5.Fiscal policy  affects C, I and G. 6.World economy  I and NX. 7.EMU entry criteria  C, I and NX. 8.Exchange rate policy  NX. Result is a shift of the AD curve to the right.

37 37 Overall Equal movement of the AS and AD curves resulted in very fast real growth rates with little or no effect on inflation. 1994 – 2000. Average real growth rate = 8% Average inflation rate = 2% If the shift in AD > shift in AS, inflation would have increased by considerably more. Employment increased from 1,118,300 in 1993 to 1,745,000 in 2002. Unemployment rate fell from 14.5% to 3.6%.  Leddin and Walsh Macroeconomy of the Eurozone, 2003

38 38  AS 1 11 Graphical Representation  AD 1  AS 2  AD 2 Inflation Real growth rate Natural real GNP  Leddin and Walsh Macroeconomy of the Eurozone, 2003

39 39 After 2000, the real growth rate fell significantly. –The era of the Celtic Tiger ended in 2000. Ireland suffered periodic adverse shocks: 1. Downturn in the US and European economies. 2. Fall in equity markets due to unrealistic profit expectations and corporate accounting scandals. 3. Foot and mouth crisis in 2001. 4. September 11 th terrorist attack in 2001. 5.Subdued domestic demand. The End of the Celtic Tiger Era  Leddin and Walsh Macroeconomy of the Eurozone, 2003

40 40 The business cycle

41 41 Slowing employment growth

42 42 Explanations for slow-down Growth at the pace reached in the late 1990s not sustainable –Catch-up phase must come to an end –By 2000 full employment had been reached –Capacity constraints Especially infrastructure, housing –Inflationary pressures Loss of “super competitiveness” Relatively high inflation could be seen as an inevitable part of the adjustment process under a fixed exchnage rate

43 43 External factors The US economy entered a recession early in 2001 –Bursting of the great technology bubble –Followed by 9/11 The flow of FDI from the US slowed sharply The decline of the euro was reversed –Ireland loses competitiveness vis a vis UK, US Foot and Mouth Disease in 2001 –Impact on Tourism

44 44 Composition of employment growth Since 2001 the numbers at work in Industry have fallen by about 10% –Over half of this fall was in the “high tech” Electronics sector Forecasts of labour shortages a thing of the past! Illustrates hazards of “manpower forecasting”

45 45 Importance of service employment Service employment has continued to grow –But recently most of this growth has been in public sector services Health In modern, wealthy economies the service sector is the growth sector Breakdown of total employment –Services 66% Agriculture 6%, Industry 28% –Manufacturing 17%

46 46 Most of this period unemployment did not rise by much –Not much evidence of rise in hidden unemployment, such as a fall in participation rates or an increase in the numbers of “discouraged workers” May be changing now

47 47 Medium-term prospects Remember that the growth of an economy in the long term is determined by two factors The rate of growth of employment The rate of growth of productivity – output person at work

48 48 The rate of growth of employment Negative in 2008/9 But in medium term (2012?) likely to be fairly high for some year to come –Due to demographic factors –Some further increases in participation –Immigration? Maybe 1% to 1.5% over the medium term

49 49 Productivity growth Remember, there was no productivity miracle in the 1990s But we should be able to maintain a 2% to 2.5% growth in output per person employed

50 50 Total growth Labour force 1% - 1.5% Productivity 2% - 2.5% Total growth 3% - 4% Remember we’re talking about real GNP

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