Hausarbeit - Causes For The Celtic Tiger

Universität Potsdam Philosophische Fakultät Institut für Anglistik und Amerikanistik

Dr. Wolfgang Petschan

Hauptseminar Éire: The Emergence into the XXI Century Sommersemester 2007

Causes for the Celtic Tiger

Hans Müller Stahnsdorfer Str. 152b 14482 Potsdam [email protected] Matrikelnummer 717348 8. Fachsemester Betriebswirtschaftslehre

Potsdam, den 26.07.2007

Contents 1. The Celtic Tiger ................................................................................................................... 1 2. External Factors ................................................................................................................... 2 2.1. US Boom and Investments in the Republic of Ireland ................................................ 2 2.2. Technological Advances .............................................................................................. 3 2.3. European Union ........................................................................................................... 3 2.4. Introduction of the Euro ............................................................................................... 4 3. Internal Factors .................................................................................................................... 4 3.1. Labour Pool.................................................................................................................. 4 3.2. Social Partnership Agreements .................................................................................... 5 3.3. Tax Policy and Promotion by the Irish Government ................................................... 6 3.4. Stability in Northern Ireland (Good Friday Agreement) ............................................. 7 3.5. High Demand of Private Households .......................................................................... 7 4. After the Celtic Tiger ........................................................................................................... 7 References .................................................................................................................................. 9 Bibliography ............................................................................................................................... 9

List of Figures Figure 1: External and Internal Factors causing the Celtic Tiger .............................................. 2

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Causes for the Celtic Tiger Executive Summary Before the 1990s, Ireland had living standards and gross domestic product (GDP) growth rates more or less stagnating compared to its European neighbours. The era between about 1994 and 2001 called “The Celtic Tiger” changed the situation in Ireland significantly. GDP growth rates averaged a staggering 10% between 1995 and 2000. This paper uncovers the causes for this unprecedented growth. The principal factors are of external nature and include a booming US economy, which sent multinational high-tech and pharmaceutical companies searching for a European base which they found in Ireland. Further external factors were the advancing technology especially in the IT sector and EU-funds as well as the introduction of the Euro all of which served Ireland’s economy well. Internal Irish factors include a well educated, English speaking, computer literate and highly flexible workforce and lowtax policies. The latter was used by multinational companies for shifting profits from other countries into Ireland which causes the Irish GDP growth to appear exaggerated.

1. The Celtic Tiger Until the early 1990s, Ireland was a country that suffered from high unemployment and emigration waves. It was economically highly dependent on the UK, its industry was poorly developed and the living standards were low – compared to the rest of the European Union, which it had entered in 1973. In the mid 1990s, multinational companies predominantly from the United States began to invest in Ireland which caused the economy to grow substantially. Today, Ireland is one of the biggest producers of hardware and software for Europe. Its GDP grew as fast as in no other EU-country between 1995 and 2001 which is comparable only to the growth of the “Asian Tigers” and China (Clinch, Convery, & Walsh, 2002, p. 25-28). Unemployment virtually disappeared and incomes as well as the living standard rose and surpassed that of most European countries. Public debt has been falling and allowed public bodies to invest into infrastructure without rising taxes. Ireland became one of Europe’s richest countries. The questions that arise are: What caused this remarkable economic success story? What were reasons for growing foreign investments? Most findings in literature only take the reasons for the Celtic Tiger e.g. low taxes as more or less given and do not support them with arguments. Thus the main motivation of this paper is to uncover the relevant reasons for the Celtic Tiger which are based on an argumentative foundation. The hypothesis is, that low taxes as well as other factors alone are not cause enough for such an economic success. EU-transfers alone for instance could not have caused such a -1-

Causes for the Celtic Tiger growth because countries like Spain, Portugal and Greece received them as well but didn’t grow as fast as Ireland (Clinch et al., 2002, p. 29). Though conservative analysts see internal causes – causes over which Irish policy-makers had control or influence – as most important, many authors as Paul Sweeney regard external causes as more important. Figure 1 gives the reader an overview of the causes for the Celtic Tiger, which this paper deals with.

The Celtic Tiger External Factors • US boom and US investments in the Republic of Ireland • Technological advances, especially IT and communications • European Union funds • European Union single market • Introduction of the Euro

Internal Factors • Well educated, English speaking, computer literate labour pool • Social partnership agreements • Low taxes
“Transfer Pricing” • Irish government promotion • Good Friday Agreement • Demand of private households

Figure 1: External and Internal Factors causing the Celtic Tiger

2. External Factors External causes are those over which the government and people had little or no influence. They are amongst the most important economic factors. Examples are the economic situation in countries on which Ireland’s economy is heavily dependent upon such as the USA, the UK and countries within continental Europe. But also technological factors, the EU-membership and the introduction of the Euro play a decisive role. Each external factor came into play approximately at the same time in Ireland, developing a benign conjuncture (Sweeney, 1998, p. 91). Additionally a strong interaction between the level of foreign investment as external factor and government policy as an internal factor attracted a lot of investment. This chapter examines the external causes for the Celtic Tiger which are widely recognised as most important. 2.1. US Boom and Investments in the Republic of Ireland During the early 1990s, most Irish exports were in the fastest growing sectors, where goods and services were bought in spite of recession. Ireland boomed while the rest of Europe and the US did not (Sweeney, 1998, p. 83-84). Later on, during the mid 1990s, Irish economic growth was due to a unique set of (mostly exogenous) circumstances, centred on a massive -2-

Causes for the Celtic Tiger inflow of US corporate subsidiaries, which cannot be replicated in other countries and according to Coulter & Coleman could not have been sustained in Ireland. (Coulter & Coleman, 2003, p. 34). The authors were proven wrong though because the Irish economy picked up again into the phase of the so-called “Celtic Tiger 2”. None of the internal factors could have turned around the Irish economy was it not for a single factor: the sustained US boom in the 1990s particularly in computers and health related industries. The boom sent US corporations looking for new markets (of which the EU was most important) and tax shelters where they could shift unprecedented profits (Coulter & Coleman, 2003, p. 37). The success story of the Celtic Tiger is therefore intimately linked to the way the US economy itself has grown (Allen, 2000, p. 28). It emerged from a historic expansion in the United States that was centred on the information technology (IT) industry (Coulter & Coleman, 2003, p. 34). 2.2. Technological Advances The impact of new IT technology on productivity was enormous in Ireland (Clinch et al., 2002, p. 30). Concerning communications technology, a revolution took place. The disadvantaged state in peripheral areas was overcome by massive investments in state-of-the-art telephone system in the 1970s and early 1980s by new technologies and by the privatisation of Telecom Éireann. Fair competition became possible even in remote areas. A modern communication technology as a precondition for development in IT-industry was established and was made available for an acceptable price to everyone. Also innovative airlines reduced airfares dramatically and caused an influx of passengers using Irish airports (Sweeney, 1998, p. 90). Low energy prices and reductions in the cost of access to Ireland were favourable for direct foreign investments (DFI) as well (Clinch et al., 2002, p. 30). 2.3. European Union The Republic of Ireland benefited profoundly from EU-membership – this did not show very much so in the early membership years but especially in the late 1980s and early 1990s. EU funds were substantial and were invested in infrastructure such as ports, roads, airports, telecommunications, universities and other areas and had a multiplier effect on the economy. Thus, infrastructure was modernised and the productive capacity grew which was attractive to high-tech businesses from abroad. Large sums were invested in human capital through training (Sweeney, 1998, p. 86).

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Causes for the Celtic Tiger Since its independence in 1922, Ireland was heavily dependent on its trading relations with the UK. The EU-membership allowed Ireland to access Europe’s other large markets. Today, Germany is one of the Republics most important trading partners. According to a EU Commission study about its effects, the single market was even more important than the EU funds. Ireland was a net beneficiary of the Single Market, particularly in its manufacturing sector (Clinch et al., 2002, p. 30). Both funds and Single Market helped Ireland significantly to lay the foundation for the sustained economic growth (Sweeney, 1998, p. 87). 2.4. Introduction of the Euro The introduction of the Euro also had very positive effects on the Irish economy. Advantageous exchange rates against sterling and the US dollar gave the economy a boost (Clinch et al., 2002, p. 30). Economic growth was an immediate impact of a reduction of interest rates necessary for Economic and Monetary Union (EMU) membership. Without EMU, interest rates probably would have been much higher in order to dampen the strong growth in Ireland (Sweeney, 1999, p. 71).

3. Internal Factors The reform of the education system and the reform of labour relations as well as low taxes are frequently identified as measures that created the conditions that made economic prosperity possible and sustainable (Coulter & Coleman, 2003, p. 18). In this chapter the reader will find that those measures were not the only ones Irish society produced in order to strengthen their economy. Also, many of the domestic factors took a long time to bear fruit (Sweeney, 1998, p. 92). This could be a lesson for other countries: Long-term investments into education and an economic policy that is dedicated to investments without increasing public debt will eventually pay off. 3.1. Labour Pool Irish economy had lagged behind for a long time. That is why it was the last elastic source of relatively large, low wage labour pool remaining in Western Europe. The wages stood at the bottom of the European league (Allen, 2000, p. 25). This was an important factor why the labour market was so interesting for US companies. Increased investments in education took place from the 1960s (Clinch et al., 2002, p. 29). The introduction of formally free schooling in the late 1960s is also often identified as a measure that would ultimately serve to alter the economic fortunes of the Irish Republic. Suc-4-

Causes for the Celtic Tiger cessive Irish governments had persisted with a policy of educating workers in IT skills even during the bleak years when the local economy had insufficient need for them (Coulter & Coleman, 2003, p. 36). A highly educated workforce resulted (Coulter & Coleman, 2003, p. 11). Another opinion is, that praise coming from corporations that were attracted to the Republic principally by the prospect of dealing with a highly educated workforce have rarely managed to convince, because of a nowadays under-funded education system which emerges poorly out of international comparisons (Coulter & Coleman, 2003, p. 19). Thus it is not entirely clear, if the education in Ireland really is that much better than in competing countries. It is clear though that the English language in most parts of Ireland is used as everyday language except in the Gaeltachtaí (regions where Irish is the everyday language). This is an important advantage for multinational companies from the United States. Their employees do not have a problem communicating with the Irish. Ireland has an extremely flexible workforce compared to other European countries such as Germany, which is very attractive to many foreign companies who want to get manufacturing plants inside fortress “Europe” (Sweeney, 1999, p. 67). 3.2. Social Partnership Agreements National economic programmes designed to curb inflation, ease tax burdens, reduce government spending as a percentage of the GDP, increase labour force skills and promote foreign investment were an important factor. Social partnership agreements assured pay restraint and flexible labour, which were important to the multinational companies (Coulter & Coleman, 2003, p. 36). The Irish state was able to forge a consensus for cutting back on public spending and limiting wage rises. Fiscal stability and social partnership were critical pillars in transforming the economy (Allen, 2000, p. 12). Examples for this are cuts in the health care system. The first consensus deal was the Programme of National Recovery (PNR) 1988-1990, agreed between the Fianna Fáil1 government and the social partners in 1987. In return for placing limits on wage demands, the trade unions were offered certain assurances about the future conduct of government policy. The Programme for Economic and Social Progress (PESP) 1991-1993 and Programme for Competitiveness and Work (PCW) 1994-1997 were both similar to the PNR, with agreed pay increases and agreements on many policy areas, such as tax reform and social equality. In 1997 Partnership 2000 (P2K) was agreed by all the interest groups, includ-

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Fianna Fáil is the dominating centrist party in the Republic of Ireland

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Causes for the Celtic Tiger ing voluntary groups. Partnership at enterprise level was a key part of P2K (Sweeney, 1998, p. 101). It is held that the voluntary restraints that have been placed upon wages have been essential in creating conditions that have allowed indigenous and foreign businesses to flourish. The enormous cuts in public expenditure that marked the late 1980s are held to have established a desirable, stable macroeconomic environment that, in time, induced investments by some of the largest and most dynamic multinational corporations in the world. (Coulter & Coleman, 2003, p. 11). 3.3. Tax Policy and Promotion by the Irish Government The rate of taxation in the Irish Republic has for some time been by far the lowest in the EU. This state of affairs has encouraged multinationals not only to invest in the twenty-six counties but also to engage in some distinctive creative accounting practices as well. The relatively lenient fiscal regime that faces multinational corporations operating in the Irish Republic offers an enormous incentive to maximise the profits they declare within the state. (Coulter & Coleman, 2003, p. 19). Computer companies such as Intel and Apple needed a European base because the continent was one of the key battlegrounds between the global giants. They found it in the Republic of Ireland, which offered spectacularly low rate of taxation on corporate profits (Allen, 2000, p. 23). Additionally the Irish and US state cooperated to promote a pro-business agenda. An agreement between both governments allowed US companies to gain credits on higher taxes paid elsewhere and to use these credits to offset charges that could be made against the low tax rate paid in Ireland (Allen, 2000, p. 25). This resulted in a huge influx of US capital because Ireland offered a cheap platform for the export of goods into Europe. The US companies investing in Ireland are highly concentrated in electronics, software, health care and pharmaceuticals, services (telesales and financial services) (Allen, 2000, p. 26). Low tax rates not only meant that multinational companies could retain more of the profits they received from their activities in Ireland – they also enabled them to shift profits into Ireland by manipulating transfer prices (prices for intra-firm sales), so that they could reduce their overall global tax liabilities (Coulter & Coleman, 2003, p. 36-37). The low rate of company tax does induce them to declare additional profits in Ireland, which they do not really make here. This inflates GDP und makes Ireland look richer than it really is (Sweeney, 1998, p. 51). Thus the growth of GDP and GDP per capita in Ireland is probably exaggerated. In other words: Due to transfer pricing, Ireland is really not growing as fast as the numbers show, because profits from other countries are included in the GDP of Ireland. -6-

Causes for the Celtic Tiger If a single event can point to the birth of the Celtic Tiger, it was the Irish state’s success in attracting Intel to the country in 1990, at a historically high cost to the Irish state. A significant number of IT companies had already located in Ireland during the 1970s and 1980s. But after Intel located its European site for the production of computer chips near Dublin, nearly every major player in the computer industry followed. A similar agglomeration of foreign pharmaceutical companies also located in Ireland. Ireland became highly dependent on the US-economy (Coulter & Coleman, 2003, p. 38). 3.4. Stability in Northern Ireland (Good Friday Agreement) Since psychological factors as the mood of a society play a big role in economics, the stability in Northern Ireland certainly contributed to a positive mood in Ireland. This positive mood originating from the Good Friday Agreement further strengthened the trust of society and economic actors into the economy and led them (even if only subconsciously) to a higher demand and more investments. 3.5. High Demand of Private Households The myth of the Celtic Tiger altered people’s rational expectations as if it somehow allows and abrogation of personal financial responsibility. As the phase of unemployment was over, there developed an increased demand for credits, which also boosted growth (Sweeney, 1999, p. 60). Borrowing money had expanded from almost every single source. According to Sweeney, the reduction in interest rates had driven borrowing wild (Sweeney, 1999, p. 71).

4. After the Celtic Tiger Ireland did not achieve its economic transformation by following the prescriptions of neoclassical economists, which include privatisation, cuts in public spending and shrinking the state and its services. In many ways, it took the opposite direction. It has social partnership, not “free” determination of labour costs, and there was little privatisation, though the private and public owned enterprises changed radically in the period under review (Sweeney, 1998, p. 107). It achieved the economic transformation with the help of many positive external factors combined and arising more or less at the same time, supporting each other such as a booming US economy with multinational IT-companies looking for a suitable European base, technological advances, EU funds and the introduction of the Euro. Internal factors should not be underestimated, though they do not seem as indispensable as the external factors: A well educated, English speaking, computer literate and highly flexible workforce, partnership agree-7-

Causes for the Celtic Tiger ments and low-tax policies. Other countries can learn from Ireland, that long-term investments into education and infrastructure without increasing debts sooner or later will pay-off. One has to bear in mind though, that due to “transfer-pricing” GDP growth really is not as high as statistics show in the Republic of Ireland. After a recession everywhere else in 2001 and 2002 when the Irish economy still kept growing though not as fast as before, the Irish economy picked up speed again. Many analysts would have thought it impossible, but Ireland entered the era of the “Celtic Tiger 2”. It remains to be seen how long the economy can grow with such speed.

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Causes for the Celtic Tiger

References Allen, K. (2000). The Celtic Tiger: The Myth of social partnership in Ireland. Manchester: Blackhall Publishing. Clinch, J. P., & Convery, F., & Walsh, B. (2002). After the Celtic Tiger: Challenges Ahead. Dublin: The O’Brien Press. Coulter, C., & Coleman, S. (2003). The end of Irish history?: Critical reflections on the Celtic Tiger. Manchester: Manchester University Press. Sweeney, A. (1999). Irrational Exuberance: The Myth of the Celtic Tiger. Dublin: Blackhall Publishing. Sweeney, P. (1998). The Celtic Tiger: Ireland’s Continuing Economic Miracle. Dublin: Oak Tree Press.

Bibliography Bradley, J., & Birnie, E. (2001). Can the Celtic Tiger cross the Irish Border? Cork: Cork University Press. Breathnach, P. (1998). Exploring the ‘Celtic Tiger’ Phenomenon: Causes and Consequences of Ireland’s Economic Miracle. European Urban and Regional Studies, 5 (4), 305-316. Gottheil, F. (2003). Ireland: what’s Celtic about the Celtic Tiger? The Quarterly Review of Economics and Finance, 43 (5), 720-737. Kirby, P. (2002). The Celtic Tiger in Distress: Growth with Inequality in Ireland. Basingstoke: Palgrave. Mortell, M. P. (2002). The Celtic Tiger: A View from the Trenches of Academia. The Irish Economy in Transition: Successes, Problems and Prospects, 85, 249-257. Murphy, A. E. (2000). The ‘Celtic Tiger’: An Analysis of Ireland’s Economic Growth Performance. San Domenico: European University Institute. O’Hearn, D. (1998). Inside the Celtic Tiger: The Irish Economy and the Asian Model. London: Pluto Press. Powell, B. (2003). Economic Freedom and Growth: The Case of the Celtic Tiger. Cato Journal, 22 (3), 431-448. Whelan, C. T., & Maître, B. (2007). Levels and Patterns of Material Deprivation in Ireland: After the ‘Celtic Tiger’. European Sociological Review, 23 (2), 139-154.

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