Celtic Tiger Irelands Growth Economics Essay

Celtic tiger Irelands process Economics EssayThe Harrod-Domar (CITE) baffle poseed in the 1940s was to begin with intended to analyse business cycles, tho has since been adapted to scotch levyth. In the model, harvest-time is hooked on the levels of push and great. As developing countries typically crap a plentiful supply of labor movement, their issue is to a greater extent dependent on physical not bad(p) and nest egg to ca-ca gain. Growth is striked with net investment which volitioning go past to capital appreciation on that pointfrom producing elevateder(prenominal) levels of popput and income with loftyer levels of income there go away be broad(prenominal)er levels of saving. Thus, frugal fruit is dependent on policies and practices that leave promote savings and/or create scientific advancements that will decrease the capital-output ratio. However, this does not set aside a complete picture and as a result, further models mystify since bee n developed.The traditional classic branch model as developed by So disordered (1956) and other(a)s builds on the Harrod-Domar model by including labour as a divisor of production. However, the model allows little room to explain any touch on other outside factors, such as foreign consider investment, may energize on stinting increment. In the model there atomic number 18 lessen returns to capital and long run growth will be obstinate through exogenous factors such as technological advancement or world growth. Growth alone lasts for a transitional phase until the scrimping reaches its immature steady state level of output and employment. The model in addition states that growth pass judgment ar inversely related to a countrys income per capita a woeful country with standardised endowments to a richer country will grow faster and stilltually converge to the income per capita level of the richer one. Exogenous factors will only touch on growth in the short term a nd the only charge they can have lasting effects is via permanent technological shocks. However, Romer (1986), Lucas (1988) and Barro and Sala-i-Martin (1995) among others argon credited with the development of the endogenous growth model which considers technological advancements as endogenous to the model.In his seminal paper on growth, Romer (1986) pr hold outs an alternative model for long term stintingal growth. He states that income per capita among developed countries does not ineluctably converge with that of developed countries and that in fact there may be differing levels of growth. In particular, less developed countries can exhibit low levels of growth or may not grow at all. The factors that do target to growth be not dependent on exogenous technological ad bonnyments or differences in the midst of countries, but rather technology is endogenous to the model. unconstipated holding technology, population and other factors ceaseless, the roughly important idea is to prune the traditional assumption of diminishing returns. Thus, long run growth will come from the accumulation of knowledge. Knowledge can demonstrate increasing returns and marginal product and can have limitless, constant growth. New knowledge will be transferred between unwaverings and have positive externalities thereof go bading to change magnitude growth. Romer (1986) contests that these positive externalities be able to explain growth and argon necessary for an equilibrium state to exist.Similar to Romer, Lucas (1988) adds technology or human organisms capital to the neoclassical growth model. The model in his paper in any wooing considers development by doing as a way of capital accumulation. Population growth is held constant and both physical and human capital argon overwhelmd. strong-arm capital is taken from the traditional neoclassical growth model and human capital boosts productiveness, where a fixed effort level will lead to stable growth rank i n productivity. For a closed rescue, poorer countries will exsert to stay poor, but will actually have the resembling growth rates as richer countries. Therefore, there will be constant growth rates and a steady distribution of income. For the open sparing with on the loose(p) labour mobility and free trade of capital inputs, externalities and spillovers will lead to higher takings and higher skill levels, thus increasing the wealth of a country. Lucas besides states that diverse growth rates amongst countries can be due(p) to different levels of human capital growth associated with different unattackables. Accordingly, it is apparent that the same levels of technology and human capital are not in stock(predicate) in every country as the neoclassical model assumes.Barro (1991) learnd 98 countries to test the neoclassical idea that poorer countries will grow faster than richer countries. range of school enrolment were used to step levels of human capital. The results unwrap that gross domestic product per capita growth rates are importantly positively related to sign endowments of human capital and based on these initial levels, growth is negatively related to the initial level of gross domestic product per capita. These findings promisem to software documentation the neoclassical model that poorer countries will eventually converge with richer countries. However, this only holds for the poorer countries that have relatively high levels of human capital, compresseding that the human capital level is preceding(prenominal) what would be expected given the relatively low level of gross domestic product per capita. The paper too takes into account other factors, such as birth rate rates, government expenditure, political instability and corruption, and price distortions. contempt these preconditions, Barro concedes that the results are ineffective to explain the poor growth rates for countries in Latin American and Sub-Saharan Africa and send words that other factors must be involved. crossing or kingdomal Boom?From the surmisal, it is evident that lap of less developed countries is not robotlike and that many factors are responsible for economical growth. For the case of Ireland, there is overturn as to whether or not it was simply a matter of slow convergence or as a result of a regional miraculous food. There are several papers arguing both sides, which will now be examined. Grda (2002) argues that the economic transaction of Ireland in the nineties is importantly a matter of delayed convergence and making up for many decades of under executing. He finds that Ireland underachieved compared to other westerly europiuman countries from the end of military personnel War II until the late 1980s. Throughout that period, the mid-sixties provided a coup doeil at possible future economic growth. If the period is extended to 1998, Grda states that Ireland performed as expected given the low initial level of income per capita in the 1950s in order to achieve convergence. Thus, the economic slowdown manifest at the time of writing, 2002, seems to be in line with convergence possible action and to be expected as Ireland had reached its new steady state level. However, if the Celtic Tiger is simply a matter of delayed convergence, hence wherefore it took so long similarly need to be examined. Grda attributes this to poor fiscal polity practices and protectionism during the 1970s and early 1980s. Grda and ORourke (1996) examine in detail why Ireland underperformed in previous decades relative to other Western European countries. Ireland carry outd oft lower rates of GDP growth as evidenced in Figure 1. The richest countries in 1950, Switzerland (CH), UK and Denmark are compared with the poo backup man countries, Greece and Spain. Ireland is the capable outlier and exhibits much lazy growth than would be expected. They attribute the weak performance to a variety of factors parti cularly trade protectionist policies, heavy reliance on agricultural merchandises, and rent- desire behaviour. In particular, Ireland failed to participate in the economic recovery of the balance wheel of post WWII Europe by maintaining barriers to trade and waiting to open up the sparing until the 1960s. However, they do not find that low levels of investment in human and physical capital to have been significant factors. Grda and ORourke also suggest that Irelands proximity and reliance on the UK could have led to slower growth rates since the UK, while not underperforming, was not experiencing particularly high levels of growth.Figure 1 Average annual growth rates, 1950-1988, for Western EuropeSource Grda and ORourke (1996)Honohan and Walsh (2002) also take the view that Irelands economic performance can be attributed to delayed convergence. They argue that there was no productivity miracle but instead the crucify was mainly due to a change in fiscal and monetary policies a nd an improvement in the labour foodstuff, which allowed productivity to finally catch up to the levels of the rest of Europe. While an increase in the population employed and demographic trends are contradictoryly to be repeated, Honohan and Walsh argue that if the insurance changes had been make earlier, Ireland would have achieved convergence earlier. The argument that the change magnitude growth was due to a regional boom is also considered. However, it is immediately discounted when Irelands population and economic growth is compared to that of individual states of the U.S., ranking 23rd out of 50 (Honohan and Walsh, 2002).Barry (2000) examines if Irish growth can be attributed to changes in policy and to what extent, which would support the convergence hypothesis. The more(prenominal) or less important factor is correct microeconomic and industrial policy, which Barry argues is the main reason for the delay in development. However, he finds that there are other certain characteristics necessary for convergence to be achieved, including a stable sparing, an effective labour market, a developed market for exports, and sufficient levels of education. Thus, Barry seems to provide mixed support for the convergence surmise.The delayed convergence hypothesis suggests that Irelands economic growth was simply a matter of catching up with the rest of the developed world. However, it has some shortcomings including not satisfactorily explaining why Ireland failed to converge rather like the other peripheral EU countries of Spain, Portugal and Greece. Delayed convergence also does not give a role to the large increase in foreign direct investment as the theory does not suggest that anything other than threatening economic and industrial policies are necessary. The theory also suggests that since convergence has been achieved, all that is required to maintain it is to ensure the same sound policies are reviewed. The regional boom theory, on the other hand , does take into consideration other non-traditional factors such as FDI and the boom of the US frugality. It particularly thinkes on an economys export base as key for economic growth. This theory also leaves room for unexpected shocks, such as a decrease in FDI or downturn in the US economy to have an impact on the economy, which in light of fresh events, would seem to be much accurate. The regional boom theory will now be examined in much detail.A regional economy differs from a commonwealthal economy in that there is free movement of labour in and out of the region (Barry 2002a). Krugman (1997) has suggested that Ireland be treated as such a regional economy due to the fact that it exhibits many of the features of a small(a) region of a larger economy rather than a larger free nation. Ireland is a small, extremely open economy and before the adoption of the Euro, had a currency that was mostly pegged to some other. With the free movement of labour, wages are placed by those of the larger region, rather than within the country itself and tune verse are based on labour demand rather than labour supply determining job creation based on wages (Krugman, 1997). Also, adjustment to exogenous shocks will be dealt with differently by a country in a regional economy versus a crowned head country. If a shock occurs to the labour market in an open economy, labour will simply leave, rather than a wage adjustment occurring and new industries arising, as in a closed economy. Krugman argues in favour of the regional boom hypothesis because of the large increase in the export economy and the increase in jobs in the operate sector as a result. The majority of the increase in exports during the Celtic Tiger was in foreign-owned companies.Barry (2002b) examines Irelands economic performance and the factors that lead to convergence compared to the other peripheral EU countries of Spain, Portugal and Greece. Ireland, unlike the other countries, failed to reach EU a verage levels of growth until much later. contradictory previously argued by Grda and ORourke, Barry finds that this was not in fact due to macroeconomic policies, as all four countries had similar practices and in fact, Ireland was the most export oriented country of the group, as bear witnessn in Table 1. Barry finds the main difference between Ireland and the rest is actually in labour market operations. Ireland experienced high unemployment, high emigration and increased wages from the 1960s to the late 1980s. The relatively high wages meant domestically owned labour-intensive firms were unable to compete with foreign-owned firms as high levels of FDI, particularly in the manufacturing sector, started to attain the economy. Thus, Barrys findings seem to support the regional boom hypothesis with exports and FDI playing a key role in explaining Irish growth.Table 1 Exports of goods and services as a percentage of GDPBarry (1999) argues that in order to achieve high levels of growth in a regional economy, a nation unavoidably to be inter casely competitive in the non-agricultural sector, as increased capital in an agriculturally based economy will lead to more(prenominal) than emigration. He argues that industrialisation policy is crucial, whereas proponents of the convergence theory, including Grda consider this a distortion with Ireland merely switching from import-substitution industrialisation to export-substitution industrialisation ( Grda, 2002, p. 8). However, others, such as Barros and Cabral (2000) and Fumagalli (1999) suggest that in order to industrialise, such a distortion is necessary. mound et al (2005) consider both theories and come to the conclusion that perhaps it cannot be explained solely by one theory, but rather a conspiracy of the two. They argue that the necessary conditions for convergence were in place by the 1970s, but that Ireland suffered as a result of poor policy practices from 1973-1986 and spherical economic downtur n. However, this is not sufficient to explain the economic growth fully and thus, cumulus et al also incorporate the regional perspective. Labour and capital inflows were as equally important as sound policies in Irelands growth. Ireland was able to attract foreign investment, create more and higher quality jobs and as a result, the levels of labour force participation increased. They cite increases in employment and job creation as extremely important in the Irish case, which implies a larger role for government than in convergence theory. authorities needs to do more than just maintain proper fiscal policy and must ensure there is a competitive environment for business. Grda (2002) also considers the regional boom hypothesis, but finds it overly optimistic for proposing that high growth rates could be sustained without sustained increases in labour. However, both Barry (2002c) and Dascher (2000) develop a model of a regional boom economy with Irelands circumstantialations and find that labour inflows will decline as infrastructure and trapping become more congested. Yet, growth can still continue without more labour if sufficient stocks are maintained and there are no negative exogenous shocks to the larger regional economy. The regional boom theory also suggests that just because Ireland has caught up to average EU levels, it does not mean that further growth cannot be achieved as convergence theory would suggest. Indeed, if Ireland could continue attracting FDI and supplying labour, growth should still be able to continue, despite convergence already being attained.Blanchard (2002) comments on Honohan and Walshs 2002 paper and argues that convergence theory is not the abstract model to describe Irelands growth, but rather endogenous growth theory is. Instead of the Solow model which has diminishing returns to capital, he suggests the AK model of economic growth is more detach, where output and capital accumulation move unitedly because of consisten tly increasing employment levels. Thus, the economy will move towards producing more capital intensive goods. This is similar to the regional boom perspective where increases in labour and capital will stimulate each other to create more growth than would be possible in a national economy.The regional boom theory, unlike convergence theory, allows for negative exogenous shocks to affect growth. For guinea pig, a downturn in the global economy or a withdrawal of FDI in favour of cardinal and Eastern European countries, would significantly impact the Irish economy. However, convergence theory would consider these to be passing shocks and since no policy changes have been made, they should not affect growth. Conversely, the regional boom theory allows for the possibility that these could be permanent shocks with tremendous negative effects, including even a return to pre-Celtic Tiger levels of unemployment and emigration and the undoing of the catch-up.Overall, both perspectives off er valid reasons to explain Irelands economic growth however, in view of the recent financial crisis and Irelands sharp economic decline, it may be more appropriate to view the draw close of the 1990s in terms of a regional boom. While Ireland had relatively similar policies to Greece, Spain and Portugal, it did not catch up with European averages in the 1960s like the others did. Thus it seems perhaps more satisfactory to view Ireland in terms of part of a regional economy tied to the UK for that time period and again connected to the US during its boom years starting in the late 1980s. This theory also suggests that industrialisation strategy, creating an export-based economy and attracting FDI are the key factors for growth, rather than just appropriate macroeconomic policies. Both of these theories can provide useful lessons for other developing countries seeking to follow in Irelands footsteps of rapid economic growth.Lessons from Ireland for other countriesThere are many pa pers discussing the Irish economic boom, its causes and what lessons can be well-educated for other countries seeking to achieve such rapid economic growth. Acs, et al (2007) examine whether the Irish miracle could be duplicated in Hungary. The paper focalisees specifically on the impact of FDI and how it affects entrepreneurial activity. While they find significant differences between the two, the results do suggest several policy outcomes based on the Irish experience that Hungary could fulfil, including boosting human capital, improving the quality of FDI and encouraging more enterprise development.Andreosso-OCallaghan and Lenihan (2005) focus on economic policy and whether Ireland can provide a good example of economic development for NMS, with particular regard to developing small and medium sized enterprises (SMEs). They find that Ireland does indeed supply a useful model for others to follow. Developing the growth of SMEs is important for overall economic growth and it was a key focus of Irish industrial policy, particularly later on 1993. Andreosso-OCallaghan and Lenihan suggest that adopting Irish policies, such as dedicated development agencies, and proactively evaluating industrial policies, would help SMEs grow in NMS. However, they also warn of the dangers of relying too heavily on FDI as some would suggest Ireland has done.Hill et al (2005) examine the Irish experience in great detail, beginning with considering whether convergence theory or regional boom is more appropriate. They then recognize that for a small, open economy to develop and create quality jobs, the country needs to be competitive in the following four areas context for firm strategy and rivalry, demand conditions, factor (input) conditions and related and supporting industries (Hill et al, 2005, 5). There are also corresponding policy initiatives for each of the four areas measure policy, educational system, regional economy and institutions and consumer protection laws. Th ey then analyse these four areas for Ireland and how policymakers have performed. The economic conditions and performance of Arizona in the United States is then compared to Ireland, to see what lessons Arizona could learn and if they could replicate Irelands growth. The results show that Arizona shares some similar characteristics with Ireland and thus has some opportunities for similar growth.Bailey et al (2009) examine industrial policy in both the Celtic Tiger and East Asiatic Tiger countries to see what probable lessons African nations could learn. They focus primarily on the Irish experience and provide several reasons why Ireland is a better example for Africa, including that most African countries, like Ireland are small and open, Ireland had a more corporatist experience than in East Asia, and that in some East Asian countries the rights of trade unions were suppressed. Bailey et al take a holistic turn up to analysing Irish industrial policy, instead of focusing solely on policies that promote just FDI, or developing SMEs or Research and Development (RD), and then go through it to Africa. They find that Africa can learn from the policy examples and mistakes of Ireland and East Asia.In another paper, Bailey et al (2008) examine and compare the Irish and Hungarian experience, with particular focus on industrial policy and then determine what lessons other Central and Eastern European nations could learn. Hungary is selected as a comparison because it has closely followed the Irish model and has been cited by others, including the World Bank and the OECD, as a potential example for other developing countries (Fink, 2006). Like previously mentioned, Bailey et al implement a holistic approach to industrial policy. They assess both countries policies and find that attracting FDI has had the most significant impact on growth. However, they find that there are limitations to FDI based growth and thus emphasize the need to also develop domestic industry.F ortin (2000) discusses and analyses the characteristics and causes of the Irish economic boom. It is divided into two main sections, a long-term productivity boom and a short-term employment boom. get wind lessons as well as appropriate policies for other countries, particularly Canada, are identified based on the Irish experience. These include encouraging free trade and investment, industrial and task policy causative to business and ensuring high levels of education. Fortin examines Canadas recent economic performance and discusses what changes Canada can implement based on these lessons from Ireland. Although not all Irish policy is applicable, Canada can emulate the policies of fiscal discipline, openness and free trade.Hansen (2006) examines the Irish determinants of growth individually and assesses whether Latvia could repeat Irish success. The approach is more holistic and based on the methodology of Mancur Olson (1996) and Hansen states that this approach could be applie d to any of the other New Member States of the EU. The results show that Latvia has already implemented many of the same policies that contributed to the Irish boom. Other factors are considered to be specific to Ireland, and consequently unable to be replicated. Overall, Hansen suggests that Latvia cannot adopt much more from Ireland and goes so far as to suggest the Irish case is no miracle as others have proposed, but rather a crew of sound policy, timing and a bit of luck (2006, 13).With the exception of Hansen (2006) and Fortin (2000), most of the literature on Irish growth and lessons for other countries focuses on specific determinants or policies rather than taking a holistic approach. Therefore, this paper seeks to follow this example and examine the Irish boom in detail and then apply it to country.The individual determinants of Irish growth will now be examined in more detail.The Irish ExperienceMacroeconomic StabilityConvergence theory cites effective policy as an instr umental part of economic growth and indeed Irelands failure to catch up until recently has been attributed to this. In the immediate post-War period, much of Western Europe began to recover and experienced economic growth. However, in the 1950s, Ireland still relied heavily on agriculture, had high levels of emigration and protectionist policies. In the 1960s, the economic conditions began to turn around, with better macroeconomic policies being adopted. As Honohan and Walsh (2002) state, these include pegging the exchange rates to the British pound, managing a reasonable balance of payments deficit, nonprogressive fiscal policy of borrowing only to finance public capital investment and relatively low appraise rates. Previous protectionism was dropped and foreign direct investment was encouraged through grants and tax exemptions. Ireland entered into the Anglo-Irish Free Trade field of view Agreement in 1965 and also decided to apply for membership in the European Economic Commu nity (EEC), hence opening itself up for more trade. It would seem that during the 1960s Ireland was poised to catch up with the rest. However, in the 1970s, with the global oil crisis and inappropriate policy response, Ireland was unable to capitalise on the progress made in the previous decade.In an attempt to recover from the crisis quickly, expansionary practices were pursued, which caused truly wages to escalate and crowded out productive growth. Consequently, in 1987 there was public debt in excess of 130%, an unemployment rate of about 16%, inflation level around 9.5%, high interest rates and there was an average growth rate of 3.2% during the 1980s (Hansen, 2006). All of these elements were not conducive to economic growth and as a result, Ireland faced a implike recession. Accordingly, it became evident that economic policy changes needed to be made and the commonplace election of 1987 heralded the beginning of a more stable macroeconomic policy. The new government, emplo yers and trade unions developed a social partnership know as the Programme for National Recovery to reach an agreement on wages, taxes, and other social welfare improvements. The government offered lower income tax rates in exchange for wage moderation by the trade unions. As a result, the labour market became more competitive and effective and more employment opportunities were created in both the services and manufacturing sectors. financial PolicyFiscal policy from the 1970s to late 1980s was quite varied and went from being expansionary in 1977, to taxing and spending in 1981 and then to cost- penetrative in 1987. These changes coincided with different governments in power and corresponding different policy goals. It was not until 1987 that appropriate fiscal policy was adopted for the economic situation and as a result, stabilisation began to occur. The government focused on reducing the budget deficit, which had reached levels between 6.1% and 8.2% of gross national product be tween 1978-1987 and the debt to GNP ratio was a massive 131.4% in 1987 (Leddin and OLeary, 1991). By the end of 2001, the debt to GNP ratio was only 38% (Honohan and Walsh, 2002). Government spending also decreased from about 46% of GNP in 1987 to 37.2% already in 1991 (Leddin and OLeary, 1991). (For graphs see H and W).In addition to cutting spending and reducing the debt, the government cut tax rates. Comparing 2001 and 1985, the twinge income tax rates decreased from 65% to 42%, corporate tax rates fell from 50% to 16%, capital gains tax was bring down from 60% to 20% and capital acquisitions tax fell from 55% to 20% (Honohan and Walsh, 2002). From the 1960s until 1981, Ireland has a 0% tax rate on export dough. However, such low tax rates drew complaints from other EU members and, as a result, Ireland was forced to raise it to 10% in 1981. This discriminative corporate tax rate was put in place for profits in the manufacturing sector, internationally traded services, and act ivities in the Dublin based International pecuniary Services Centre (IFSC). Again, due to complaints, Ireland agreed to raise rates to 12.5% in 2003 for manufacturing and internationally traded services and in 2005 for IFSC activities. It is generally recognized that such low corporate tax rates were instrumental in attracting international companies to broadcast business in Ireland. Gropp and Kostial (2000) estimated that if Ireland had increased corporate tax rates to the EU average from 1990-1997, there would have been a loss of more than 1.3% of GDP per year in net FDI and a 0.8% loss of GDP in revenue. As a result of Irelands success, lowering of corporate tax rates has also been adopted by other countries, perhaps most significantly, Germany, who cut their tax rate from 40% in 2000 to 25% in 2001 (Walsh, 2000).Despite this, it is also important to note that the effect of low corporate tax rates on attracting FDI may be distorted as a result of transfer pricing. This means t hat foreign-owned companies may use pricing adjustments to share a larger share of their profits to their Irish operations and thus pay less taxes. This may be responsible for the large infract between GDP and GNP in Ireland during the 1990s. In 1998, GDP surpassed GNP by 14.3%, well higher than any other country in the OECD (Walsh, 2000). However, Walsh also states that the effects of transfer pricing on the measurement of economic growth should not be exaggerated (2000 225). Generally, GNP is used to measure the performance of the Irish economic boom because of the high levels of FDI. Overall, corporate tax rates have played an important role in attracting FDI, which in turn has been a significant factor in Irelands growth and will be examined more fully below.Monetary PolicyIreland decided to critical point the European Monetary System (EMS) and an adjustable peg system in 1978 and end its parity with the pound sterling in 1979. Although the decision was made more for politica l rather than economic reasons, there were definite economic implications. Throughout the period of EMS, many exchange rate readjustments occurred and for most of them the Irish pound was devalued against the German Deutschmark, which allowed Ireland to gain wage competitiveness. Overall, though, Irish membership in the EMS was not as successful as hoped and served to increase unbelief and discourage anti-inflationary practices. However, joining EMS laid the groundwork for signing the Maastricht Treaty in 1992 and thus the agreement to join the European Monetary Union (EMU). As a result of joining EMU and giving up their indie currency, Ireland experienced a onetime decrease in interest rates.