The secret of Ireland’s economic growth

The economic performance of Europe is nothing to get excited about. Yet there is one European member state that seems to defy the law of economic gravity: Ireland – the Celtic Tiger.

A recent report from an independent European think tank, based in Belgium, has compared the economic performance of several European economies, particularly Belgium and Ireland, over the period 1984 – 2002. They found that there were a surprising amount of large differences in economic growth and GNP per capita. Belgian real growth over this 18 year period amounted to 42%, while Ireland achieved an incredible 167%! Consequently, the Celtic Tiger has moved to the top of the European league: from one of the poorest to one of the most prosperous countries. What is the secret of its success?

The authors of the study have performed a multi-regression analysis, trying to establish the relative weights of 25 possible causes of growth differences, including age structures, education levels, inflation, number of annual working hours, interest rates, the ratio between direct and indirect taxes, the size of the public deficit, the impact of the accession to the EU, etc. The most striking conclusion was that 93% of the differences between growth performances could be explained by government spending and tax levels.

In 1985, the economy of Ireland was in shambles. It faced excessive budget deficits and minimal growth. Its GNP per capita amounted to only 65% of the Belgian level. Additionally, Irish unemployment stood at 17% against 10% for Belgium. Until 1985 both countries followed similar Keynesian policies of deficit spending. In 1983 Belgian public spending exceeded 50% of GNP.

Excessive spending triggered a vicious circle of a continuing rise in the tax burden and public debt. However, in 1985 Ireland made a complete turnaround. It drastically lowered the tax burden, and all wasteful government spending was eliminated. In a little, over three years public spending was reduced by 20%. The result was that Ireland entered a period of explosive GNP growth, averaging 5.6% from 1985 to 2002. This is roughly three times the Belgian growth rate. The boom went hand in hand with the creation of new jobs, which was far in excess of that in Belgium.

Because of its awe-inspiring rise in prosperity, Ireland has now more resources available for all sorts of social, cultural and environmental initiatives than Belgium does.

Contrary to the basic tenets of Keynesianism, the study showed that deficit spending and lowering interest rates had no positive effect on economic growth. More generally, the authors venture the thought that a 1% reduction in government spending will lead to additional annual growth of 0.6%. This figure, by and large, confirms the outcome of similar IMF studies.

But can the Irish model be emulated by other (European) countries? What about the fallacy of composition? One could argue that some formulas which perform well on a small scale, are not successful on a larger one. For instance, the theatre visitor whose view is hampered by the hat of the lady before him will be able to gain a better view by getting up and moving. But if all people followed his example, his initial advantage will vanish. But this cannot be believed to be true in this particular case. In any event, it is not what Adam Smith taught us: economic exchange is a positive-sum game.

Because Ireland belongs to the Anglo-Saxon world with English as its main language and its shared values, such as economic freedom. These assets give it an edge over many continental European countries regarding direct foreign investments. But it seems to be that these extra advantages do not detract from the central conclusion of the study: reduction of taxes is conducive to growth.

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