Patrick Honohan June 1007

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

Patrick Honohan Trinity 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 50 45 40 35 30 % 25 20 15 10 5 0 UK

Ireland

Labour productivity in UK and Ireland, 1973 £3,000 £2,500 £2,000 UK Ireland

£1,500 £1,000 £500 £0 Agriculture

Rest of economy

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 45

40

35

30

25

20 60

65

70

75

80

85

90

95

00

Non-agricultural employment as share of population 45

40

35

30

25

20 60

65

70

75

80

85

90

95

00

Non-agricultural employment as share of population 45

40

35

30

25

20 60

65

70

75

80

85

90

95

00

The 25-year business cycle delays the catch-up 18 1987 16

1993

Unemployment rate % (ILO basis)

14 12

1990

10 1997

1981

8 1975

6

1979

4

2006

2000

1974

1961 2 0 -6

-3

0

3

6

9

BOP Current a/c deficit as % GNP

12

15

18

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

10

Saving Surplus

5

Primary

% GNP

0

-5

-10

-15

-20 70

75

80

85

90

95

00

Government Debt 140 120

% GNP

100 80 60 40 20 0 70

75

80

85

90

95

00

Balancing the Budget: Taxes and Current Expenditure

55

50

as % GNP

45

40

35 Taxes Current Expenditure

30

25

20 70

75

80

85

90

95

00

Escalators: Interest and Transfers

22 20 18 16

as % GNP

14 12 10 8 Interest

6

Transfers 4 2 0 70

75

80

85

90

95

00

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

100 thousands per annum

80

non-ag employment ag. employment

60 40

unemployed

20 0

non-active

-20

Over 64

-40

Under 15

-60 61-71

71-86

86-91

91-01

01-06

Components of population change Net migration

thousands (annuak average)

80

Natural increase

60 40 20 0 -20 -40 61-71

71-86

86-91

91-01

01-06

Union Density (non-agricultural)

50

48

46

44

42

40

38 60

65

70

75

80

85

90

95

120

1800 Wage competitiveness Total employment (rhs)

1700

115 1600 1500

110

1400 105

1300 1200

100 1100 95

1000 75

80

85

90

95

00

Income tax rates (incl. social contribution) Single person on average earnings 70% 60% 50% 40%

Average

30%

Marginal

20% 10% 0% 1979

1984

1995

2002

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

ARG AUS AUT BEL

120

CAN DNK FIN FRA

Percent of US (PPPs)

100

GER HKG ISL IRL

80

ISR ITA JPN NLD

60

NZL NOR

IRL-GNP

SGP ESP

40

SWE CHE GBR USA

20 1970

1975

1980

1985

1990

1995

2000

IRL-GNP

Aggregate productivity growth 5 4 3 2 1 0 75/70

80/75

85/80

GDP/Empl

90/85

95/90

00/95

GDP less MNC profits/Empl

05/00

Ireland’s share in the stock of US Manufacturing FDI in the EU 3

6

2

4

1

2

0

0 70

75

80

Assets (lhs)

85

90

FDI stock (rhs)

95

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

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

20

15

EMU

10

5

0

-5 83

85

87

89

91

93

95

97

99

01

03

05

07

Irish Real New House Prices 1970-2006 4 Index, 1970=1

3.5 3 2.5 2 1.5 1 0.5 1970 1975 1980 1985 1990 1995 2000 2005

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

12 10

credit house prices

8 6 4 2 0 -2 -4 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Net position of credit institutions in Ireland

% of GDP

vis-a-vis Irish residents 50 45 40 35 30 25 20 15 10 5 0 1999

2000

2001

2002

2003

2004

2005

2006

Employment in building as % of total employment, 1990-2006 14.0 13.0 12.0 11.0 10.0 9.0 8.0 7.0 6.0 5.0 90

95

00

05