The Irish Economy: Lessons for New Zealand?

Box, Sarah Working Paper The Irish Economy: Lessons for New Zealand? New Zealand Treasury Working Paper, No. 98/01 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Box, Sarah (1998) : The Irish Economy: Lessons for New Zealand?, New Zealand Treasury Working Paper, No. 98/01, New Zealand Government, The Treasury, Wellington This Version is available at: https://hdl.handle.net/10419/205395 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ TREASURY WORKING PAPER 98/1 The Irish Economy: Lessons for New Zealand? Sarah Box ABSTRACT This paper compares and contrasts the economies of Ireland and New Zealand. It attempts to identify important factors behind Ireland’s recent strong growth, and seeks to derive ‘lessons’ for New Zealand. It is suggested that Ireland has benefited from its location, openness, macroeconomic stability, favourable demographics, educated population, wage moderation, foreign investment, European Union transfers, and luck! From a New Zealand viewpoint, the Irish experience reiterates the significance of quality investment, education and human capital, and macroeconomic stability and openness. But given the differences between the two countries, caution should be exercised in applying specific Irish policies in New Zealand. Disclaimer: The views expressed are those of the author(s) and do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. Summary Motivation Since the mid-1980’s Ireland has undergone a transformation. The economy is now one of the top performers in the OECD. GDP growth averaged 5.4% pa between 1987-96, with particularly high growth after 1993. Earlier, Ireland had spent its way into severe economic difficulties, with low growth, huge debt, and large and growing government and current account deficits. The scenario seems very familiar; indeed, New Zealand and Ireland do share some important characteristics regarding their experiences with economic crisis and subsequent reform. Not only this, but Ireland and New Zealand also have very similar country characteristics such as size, population, and an agricultural background. Despite the similarities though, New Zealand has experienced somewhat different results from the reform process. Even though reforming more intensely New Zealand only managed to average around 2% GDP growth between 1987-96. The differing growth rates meant that while Ireland’s GDP per capita was only 65% of New Zealand’s in 1985, by 1995 it had risen to 108% according to OECD statistics. The motivation for this study is quite clear  given the similarities between Ireland and New Zealand, can we learn anything from their performance that could help us achieve higher growth rates? This summary outlines the main sections of the paper. A table of main economic indicators can be found on page 13. Contributions to Growth Before looking at particular areas of the economy and the government’s policy stances, Ireland’s actual growth is decomposed into contributions from labour, capital and total factor productivity in the context of growth accounting. The decomposition suggests that Ireland’s TFP contribution to growth equaled 59% over the period 1970-96, which is above average compared with studies of other countries. Ireland experienced average annual TFP growth of 2.4% over the period, with labour growth of 0.55% and capital growth of 1.16%. These figures contrast sharply with New Zealand, where average annual TFP growth was 0.83%, labour growth was 1.23% and capital growth was 0.22%. While Ireland was converging to OECD levels at a slower than expected rate between 1945-88, it seems certain that it is now converging at a faster rate as its growth has accelerated. The question is whether this convergence may have been assisted by policy. There is also a question as to how much growth was assisted by the use of previously unemployed resources. 2 Sectoral Growth As would be expected in a modernising economy the agricultural sector has experienced a decline, both in terms of output and exports as percentages of total output and exports. Even so, employment is still at relatively high levels as compared to New Zealand, as employment has been artificially sustained by EU transfers. It is notable that New Zealand exports still comprise a large amount of agricultural products, while Ireland has moved away from this reliance. Industry has assumed a greater role in Ireland, accounting for nearly 40% of GDP and over 75% of exports. The activities of foreign firms have been the driving force behind this manufacturing growth, with the Irish government being most encouraging. Monetary Policy Ireland seems to have a number of goals for monetary policy which have luckily remained collectively feasible, meaning that Ireland has not had to make too many tough decisions in the monetary policy arena recently. Inflation is the stated main objective of the Irish Central Bank, and they have succeeded in bringing inflation down, to hover within a stable band of around 2-4% since the mid-1980’s. Membership of the ERM and the fiscal consolidation in the 1980’s assisted in achieving this. The Central Bank also seeks to smooth temporary and predictable fluctuations in interest rates. Long term interest rates are converging to German levels as would be expected under the EMS regime. New Zealand too has low and stable inflation, but the experience with interest rates has been much more volatile. In addition, the behaviour of real exchange rates differs markedly between the two countries. While Ireland has had a rather stable real exchange rate, with movement since 1984 being within a 16 percentage point band, New Zealand has had much wilder fluctuations, with a similarly measured band being about 36 percentage points wide. Ireland may be extracting this stability from EMS membership, but there are benefits of a stable exchange rate for investment. New Zealand has not been so fortunate. Fiscal Policy Reducing Ireland’s net debt was a priority for the government, and the figure is now falling as a percentage of GDP. However, this seems to be mainly because of the strong growth in GDP, rather than dedicated fiscal prudence and repayment. The government has generally run a deficit, although there was a small surplus in the last financial year. Maastricht will restrict their ability to let any deficits widen at any point in time. Tax and spending as a percentage of GDP are quite high  generally over 40%. This contrasts with New Zealand, which has kept below 40% and is trying to achieve 30% for expenditure. There are suggestions that Ireland has cut expenditure by just enough to meet the 3 Maastricht criteria, and that underlying structural issues have yet to be addressed. New Zealand on the other hand, has made significant changes at the structural level. Perhaps strong growth has enabled Ireland to put off making hard decisions with regard to further reforms. Most of the categories of revenue and expenditure are fairly similar between Ireland and New Zealand, except for Ireland’s higher expenditure on debt financing costs and New Zealand’s higher expenditure on social security and welfare. Ireland also has a large source of revenue in their Supply Services Receipts (social security levies). It is interesting that Ireland has a higher level of government involvement in the economy and is growing at such high rates  as suggested, perhaps high growth is masking the need to cut back government expenditure. Tax policy is complicated, and distortionary due to the systems of allowances and selective taxation. There is also a complex system for pay-related social insurance. In general, personal average and marginal tax rates are high; in 1996 Ireland’s average tax rate was 28.6% and its highest marginal rate was 55.8%. In contrast, New Zealand’s average tax rate was 19.14%, with the top marginal tax rate being 33%. In Ireland though, there are substantial clawbacks which effectively reduce the marginal tax rate, although these are highly distortionary. Reforms are underway, with the 1998 Irish Budget announcing tax cuts for most classes. Notably the 10% tax rate for specific trading activities, predominantly manufacturing, will not be altered until 2010 when the current legislation expires. At that point the rate will increase slightly to 12.5%, although they may face pressure from the EU to align with other member countries. Asset sales have not featured as prominently in Ireland’s history as they have in New Zealand’s, with sales of state-owned firms representing 0.3% of Ireland’s GDP between 1988-92, compared with 3.6% for New Zealand. The effect of the system of wage moderation, brought about by the national pay agreements, is unclear. It seemed to work, at least in the public sector, from 1987 to the early 1990’s. However, there is now increasing pressure on the agreements as workers demand higher settlements while at the same time the Government is being urged to restrain overall spending and wages. Foreign Direct Investment There has been a reasonably long history of openness in Ireland. Since the late 1950’s FDI has been actively attracted into the country, with a special agency (the IDA) set up and charged with drawing it in. The incentives for FDI are large, diverse, and it would seem, effective. It is worth noting however, that this policy’s success has only been apparent in the last decade or so. This possibly reflects some sort of virtuous circle, with other policy areas lending their support. 4 FDI has reached levels of around 3% of GDP in recent years, and there have been generally steady inflows. The majority of the investment is greenfield and export-oriented, with around half of the flows stemming from the USA. Other European countries also invest, suggesting that EU market penetration is not the overriding reason for investment in Ireland. Half of the employment and over 75% of the output of the industrial sector is attributable to foreign firms. Workers in foreign firms are generally more highly skilled, and are paid more. Real earnings have been rising, and the average manufacturing wage now exceeds that in New Zealand. The IDA targets industries to attract to Ireland, including electronics, engineering, healthcare, consumer products, financial services, and international services. These industries are targeted for their potential for transferring skills and technology, and for their job creation effects. Additionally there is an International Financial Services Centre and a special export zone (Shannon Free Airport). While Irish firms have received more encouragement recently, the incentives for FDI are still enormous. These include: • tax incentives  the tax rate on profits is only 10% (to be converted to 12.5% by 2003); • grants  including cash for capital, training, employment, research and development, and feasibility studies; and • provision of office and building sites, and the construction of factories and offices. There is evidence to suggest though, that FDI is squeezing out domestic entrepreneurship, with people finding it more profitable to work for a foreign firm than to start up a business of their own. The contrast between the Irish Government policies and the New Zealand Government policies is fairly stark. While Ireland has an interventionist stance, New Zealand maintains a ‘hands-off’ policy. In addition, the type of investment in New Zealand is quite different, with direct investment mainly involving the purchase of firms which are domestic market oriented. Savings and Investment For the total economy in Ireland the balance between savings and investment has turned from negative to positive since 1987-88, reflected in the movement to a current account surplus. This was by virtue of falling investment levels with relatively stable savings. New Zealand’s investment figures have generally been above those of Ireland, in recent years by around 5 percentage points. Savings does not differ a lot between the two countries, although at present Ireland exceeds New Zealand by about 2 percentage points. Despite the decline in Irish investment there has still been economic growth, to the astonishment of some Irish academics. The reason for this, it has been 5 suggested, it that inefficient public sector investment has fallen while foreign direct investment has risen. This FDI generates substantial flows of high valueadded exports. This raises important questions about the quality of investment. Current Account As stated, the current account in Ireland is now in surplus, due to the huge improvement in trade performance stemming mainly from foreign sector activities. As FDI is export-oriented trade flows have been large, with exports representing 69.5% of GDP in 1995. This has lifted merchandise trade well into surplus, with the trade balance as a percentage of GDP in 1995 equaling 21.3%. However, FDI has also led to a large factor income deficit. The level of EU transfers is also quite large, and their removal from the calculation of the current account balance would result in a small current account deficit. The fact that Ireland’s FDI has been concentrated in the tradeable sector theoretically means that foreigners are the main beneficiaries of the product of the investment. And theoretically New Zealand’s FDI, concentrated mainly in the non-tradeable sector, benefits New Zealanders. But the positive byproducts of FDI have been important for Ireland  reduced unemployment, transfer of skills, knowledge and technology, and exposure to international competitive practises and pressures. These factors mean that Ireland has benefited greatly from FDI. Unemployment Ireland experienced the fastest rate of expansion of employment in Europe between 1985-95, but the unemployment rate is still high at around 10%. The problem is with long-term unemployment (60% of total unemployment in 1995), which tends to be structural in nature. Older, less educated workers are losing their positions within the downsizing traditional sectors, and are unable to find work in the rapidly growing modern sector. Their lack of education means they make up a large group of people that are difficult to employ. Young uneducated people also make up a distinct group in the long-term unemployment statistics. It seems then that education is becoming increasingly important for job-seekers. Also, the high population growth rates in Ireland have meant that there have been large inflows into the ranks of job-seekers. Education Emphasis has been put on the education system in Ireland, in recognition of its importance. New Zealand still has a greater proportion of students attaining higher levels of education, but there is a larger emphasis on technical and scientific disciplines in Ireland. There is also anecdotal evidence of a far higher private contribution to education in Ireland in the form of private tutoring and so 6 forth. Education has traditionally been a passport to greater opportunities for the Irish, and as such there is an entrenched attitude towards education that is very positive. This perhaps constitutes an important cultural difference between Ireland and New Zealand. Future Prospects In the short-term Ireland is in danger of overheating. The economy showing signs of producing beyond sustainable capacity, and options for addressing the problem are limited, given the constraints of the imminent currency union. There will have to be moves by the Irish government to dampen down the economy if they wish to avoid ‘bubbling over’. Looking to the medium term, there are concerns about the marginalisation of Ireland in EU policy once the currency union commences operation. Peripheral countries such as Ireland are worried that policy decisions will reflect the needs of the core EU countries, and will not deal with shocks hitting other economies. Another concern is that the labour market will be under more pressure as shortages of labour, both skilled and unskilled, emerge. This is due to the slowing of labour force growth. Finally, Ireland may have to undertake some serious microeconomic reform in the future. There is a need to enhance flexibility within the economy in order to cope with asymmetric shocks, since the currency union will restrict Ireland’s options. Despite these concerns though, forecasts of growth are strong by New Zealand’s standards. Growth rates of over 4% are predicted until at least 2010  a drop from current highs, but still very respectable. This continued faith in the growth performance of Ireland reflects the underlying strong fundamentals of Ireland, such as its location and open stance. Conclusions Ireland’s growth is due to a number of factors. First of all Ireland is an English speaking nation on the edge of a large unified market, of which they are a member. They have actively encouraged foreign investment, which has been directed into high-tech exporting sectors. This created job opportunities for skilled labour and increased productivity. The macroeconomy was relatively stable, with low inflation and a steady exchange rate. Membership of the ERM helped to achieve this. In addition, fiscal moderation was followed with the aim of meeting the fiscal terms of the Maastricht Treaty. Ireland has had a favourable demographic structure, with a young population supplemented by increased female participation and higher levels of immigration. Workers are well educated and skilled, and wage levels are relatively low. This has enabled the growth of high-tech sectors within the economy. Ireland was also fortunate to receive structural grants from the EU, 7 which may have been useful in easing the transition from agriculture to manufacturing. It is unlikely that these grants had a large growth-enhancing effect though. It may be too that Ireland is just lucky! There are issues that Ireland faces in the future, the nearest being the danger of overheating. Further down the track Ireland may have cause for concern over the operation of the currency union, its competitiveness, and the process of structural change. Despite this though, growth forecasts are bright by New Zealand standards, with growth predicted to be over 4% until at least 2010. What can New Zealand take from Ireland’s growth experience? Our location and demographic structure are given, so perhaps New Zealand has to be twice as smart as other countries to achieve the same gains. We already have low inflation, and have been through extensive reforms. But while Ireland has not undertaken microeconomic reform to the extent New Zealand has, our position in the world may mean we have to address rigidities faster and more rigorously to remain in the game. Ireland’s stable macroeconomic environment may be something New Zealand can learn from. Are there different ways of running monetary policy that would yield a more stable exchange rate, and would this be beneficial for growth? Also, Ireland has attracted high quality investment, and has high quality workers. Is New Zealand’s FDI policy growth maximising? Should we consider the merits of a competitive tax regime? What can we do to improve the quality of our labourforce? According to the OECD, New Zealand will fall further and further behind the OECD average if our current performance is maintained. If anything, this study of Ireland has suggested that our potential may be much smaller given our location. Therefore New Zealand must put extra energy into improving the environment for growth and getting our policies right. 14 Investment - public and private (% of GDP)1980-85 1986-90 1991-95 Ireland 27.1 20.7 17.6 New Zealand 23.3 24.1 19.1 Government Government deficit/surplus (% of GDP) 1980 1990 1994 1995 1996 Ireland -6.3 -2.6 -2.0 -2.4 -1.1 New Zealand 0.1* -4.6* 0.9 3.1 3.6 * Note: The Crown moved to an accrual accounting framework in 1991/92. The closest proxy to the operating balance (shown for 1994-96) is the series adjusted financial balance (shown for 1980 and 1990). The two series are not directly comparable. Tax (% of GDP) 1980 1990 1994 1995 1996 Ireland 34.4 39.8 42.0 40.4 40.9 New Zealand 30.6 36.9 34.0 35.5 35.8 Labour Unemployment Rate 1980-85 1986-90 1991-95 1996 1997 Ireland 12.15 15.68 14.46 11.94 10.34 New Zealand 3.79 5.71 8.91 6.12 6.65 Participation Rates 1990 1991 1992 1993 1994 1995 1996 Ireland 61.9 60.9 60.2 59.7 60.2 60.9 62.3 New Zealand 63.8 63.8 63.4 63.3 64.6 65.3 65.5 Working Age Population (% of total population) 1980-85 1986-90 1991-94 Ireland 59.34 60.71 62.70 New Zealand 65.93 67.04 67.08 Employment Structures (% of total civilian employment) Agriculture Industry Services 15 Ireland 12 27.6 60.5 New Zealand 10.4 24.9 64.6 Given some of the similarities between the two economies, for example, their peripheral nature, near-identical populations, similar employment structures and open approaches to international trade; and combining this with their similar encounter with, and disparate results of, economic reforms, it seems most worthwhile to examine Ireland’s experience. Of course, there are differences between the two economies as well, the most prominent being location, as the maps below show. 16 The circles on the maps have a radius of around 2200 km. It is obvious that Ireland has much greater proximity to a collection of developed countries, while New Zealand’s circle only just touches the Australian coast. Nevertheless, if Ireland’s growth could be linked to various policy initiatives then there may be lessons to be learnt for New Zealand. 17 2. SITUATION LEADING TO REFORM IN IRELAND The Early Days... Having followed protectionist policies for a number of years, the Irish government decided in 1958 to pursue an export-oriented trade policy with foreign direct investment occupying the central role. The aim was to establish an extensive and sophisticated industrial base with a high export focus, by using imported private capital and technology. It was hoped this would cut unemployment, enable more efficient resource use, and stimulate growth and modernisation in the economy2. Growth rates were reasonably varied in the period 1960-75, but predominantly remained above 2% per year. Real GDP growth even surpassed 8% briefly, in 1968. In addition, growth looked to be on an upward trend from the mid-1960’s. Unemployment over the period was stable, and hovered between 4-6% for all but the last observation. In general then, the Irish economy looked to be growing over the period, with unemployment remaining at a relatively low level. Figure 1: Irish Real GDP Growth 1960-75 0 1 2 3 4 5 6 7 8 9 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 % Source: OECD Database, PCInfos 2 O’Sullivan (1993) 18 Figure 2: Irish Unemployment 1960-75 4 4.5 5 5.5 6 6.5 7 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 % Source: OECD Outlook database, PCInfos Oil Shocks Hit... However, around the time that Ireland joined the EEC, the first oil shock hit the world, and the price of oil rose sharply in response. A worldwide recession followed, and the response of the Irish government was to strongly boost government spending. This Keynesian-type approach aimed to offset the decline in aggregate demand resulting from higher import prices, and was financed by foreign borrowing. The large inflow of capital was followed by an appreciation of the Irish currency, and a rise in interest rates. Another consequence of increased government current spending was a skyrocketing current budget deficit3, which rose from 0.4% of GDP in 1973 to 6.8% by 19754. However, GDP did continue to grow during the period 1973-77, by around 4% per year, although the unemployment rate also grew, reaching 9% in 1977. The budget deficit fell as the recession passed, although only to 3.6% of GDP, not nearly as low as in 1973. However, in 1978 the new government boosted spending in a ‘think-big’ style as an attempt to reduce unemployment. This 3 The narrowest definition of the budget deficit in the Irish case is the current budget deficit, which comprises the difference between government current spending and current receipts (tax and non-tax). 4 Haughton (1995) 19 spending was pro-cyclical, in contrast to the counter-cyclical spending carried out between 1973-75. It did have the appearance of success, with economic growth continuing, and unemployment falling to around 7% in 1979. However, the effects of this spending are still being felt, as the large increases in the public services have not yet been fully rationalised. Ireland’s Luck Runs Out... Unfortunately though, Ireland’s luck ran out after 1979. As the government was forced to borrow heavily to finance the increased current expenditure, the debt to GDP ratio rose from 52% in 1973 to reach 129% in 1986. The cost of servicing this debt in 1986 came to 94% of all revenue from personal income tax. The solutions that successive governments tried to implement were based on tax increases, but these increases failed to raise the tax take by a significant amount. Much of the spending had gone to finance imports, and the current account deficit had widened accordingly. Growth was just 1.5% per annum between 1979-86, unemployment rose to reach 17% in 1986, and the Irish pound was devalued several times within the EMS structure in the early 1980’s. The Turning Point... The turning point came with the election of the Fianna Fail party once again in 1987. This government set out immediately to cut the fiscal deficit, even though they had campaigned on continued fiscal generosity. The main measures employed were eliminating or reducing social initiatives, cutting public sector employment and controlling wage settlements with state employees, and reducing public capital expenditure5. The fiscal deficit fell, and confidence in the economy began to grow. However, while this fiscal reform was vital, it did not address the underpinning economic structures  a big difference between the New Zealand’s and Ireland’s reforms. Reducing interest rates was also a priority. The Irish government assisted by convincing the markets of their intention to stick to the reform program and to the maintenance of the exchange rate within the EMS. Credibility was enhanced through such initiatives as ECU-denominated bond issues, using market rates instead of the higher Irish rates (so taking on the exchange rate risk)6. Ireland may also have borrowed some credibility from the EMS, since the credibility of the system itself was enhanced by the converging economic performances and exchange rate stability of the member states. Participation in the EMS allowed a convergence of interest rates and inflation towards German levels, and as such Irish rates, both real and nominal, fell from 1987. 5 Mawdsley (1995) 6 Massey (1989) 20 Regarding other policy initiatives, the Irish government continued to provide support and incentives to foreign investors, as they had done since the 1950’s. Other policies included the setting up of a special agency to help address the problem of unemployment, a selection of tax reforms, and a national wagesetting agreement. The table below details a few key indicators over the period 1960-96, broken down into rough periods of economic history that parallel those discussed. Table 2: Key Indicators 1960-96 (%) 1960-75 1976-86 1987-93 1994-96 GDP Growth 4.5 3.2 5.0 9.2 Exports/GDP 3.8 27.1 55.1 71.7 Agricultural exports/GDP 43.3* 32.2 23.7 19.8** Unemployment (%) 5.1 11.1 15.2 12.9 Government Deficit/GDP -1.5* -7.0 -3.1 -1.8 * data from 1970-75 only ** 1994-95 data only Source: OECD Database, PCInfos, Department of Agriculture and Food. It can be noted that Ireland started on the ‘reform’ track earlier than New Zealand. The joining of the then EEC in 1973, and the EMS in 1979, were effectively large reforms to the trading sector and monetary policy. However, fiscal reform started at around the same time as in New Zealand. It is likely that there are lags in the gains from reform, particularly from the opening up of the economy. But, if anything, this highlights the need for more understanding of adjustment paths. The remainder of this paper explores in more detail the growth experience of Ireland, and outlines the main policy areas of interest, with special emphasis on the role of foreign direct investment. 21 3. IRELAND’S GROWTH PERFORMANCE Economic Growth The growth experience of Ireland post-reforms has been impressive, both in terms of GDP and GNP. Generally growth has exceeded 2% since the late 1980’s, and has reached peaks of over 8%, as can be seen from the graph below. However, the spike in growth in the early 1990’s was referred to as a period of jobless growth. While recorded growth was impressive, anecdotal evidence suggests the economy did not feel as if it were growing  indeed there was large-scale migration at this time. Figure 3: Irish Real GNP/GDP Growth -2.00 0.00 2.00 4.00 6.00 8.00 10.00 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 % GNP GDP Source: World Bank database, PCInfos An interesting view of Irish economic performance preand post-1987 reforms can be provided by breaking down the growth data into smaller time periods. Growth certainly seems to have moved to a higher level since 1987. Table 3: Economic Growth (average annual %) Time Period GNP Growth GDP Growth 1980-86 1.1 2.2 1987-96 5.3 5.4 22 One other feature to note is the divergence between GDP and GNP per capita in absolute terms. This is due to the large amount of foreign owned activity in the economy, with outward factor income flows increasing in magnitude over recent years. Figure 4: Irish Output/capita 1970-95 0 2000 4000 6000 8000 10000 12000 14000 16000 18000 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 US $ GNP per capita GDP per capita Source: Calculated from OECD database, PCInfos Growth Accounting Growth accounting is a useful tool for attributing Ireland’s growth to changes in labour and capital inputs. This method takes the growth rate of output, and breaks it down into contributions by labour, capital, and total factor productivity (TFP). Total factor productivity is the output growth which cannot be accounted for by growth in inputs, so it captures such elements as productivity gains or technological advance. Growth accounting calculates TFP as the rate of growth in output less the weighted growth rates of labour and capital inputs. Results for Ireland... A recent piece of work by Kenny (1996) dealt with accounting for Irish growth for the period 1970-1996. Kenny uses both GDP and GNP growth rates to signify output growth, and finds that the results are fairly similar. The contribution of TFP when using GDP growth as the focus is approximately 59%, 23 compared to a contribution of approximately 50% when using GNP. Kenny notes that studies of other countries have generally yielded a TFP contribution of between 30-50%, therefore Ireland’s TFP growth appears to be above average, particularly when using GDP as the measure of output. He does make the caveat though that the data on labour is not adjusted for quality of the workers. Irish GDP growth has been varied over the period, with cyclical peaks and troughs. Cyclical low points in 1976, 1983 and 1986 saw growth below 1%, but growth reached 8% in 1978, 1990, and 1995. This yields an average growth rate over the sample period of 4.11% per annum. Kenny finds TFP growth has also been volatile over the period, but that it tended to follow cyclical trends. In general it has been positive, so the interpretation could be that overall efficiency in production has been improving steadily over time. To abstract from the cyclical variations, Kenny looks at the average contributions of capital, labour and TFP to Irish growth over the sample period 1970-1996. The average GDP growth rate of 4.11% is accounted for by: • average annual growth in TFP of 2.4%; • a labour contribution of 0.55%; • a capital contribution of 1.16%7. These numbers suggest that TFP accounts for 59% of growth, while 28% is attributable to capital growth, and the remaining 13% to labour. The low contribution of labour may reflect weak employment growth relative to output growth. This could raise questions about how well the labour market operates, and this is discussed later under ‘Wage Setting”. Strong TFP growth could well be due to the concentration of FDI in high-tech, high productivity sectors of industry. This would have had the effect of shifting resources from low valueadded sectors to high value-added ones, and extracting greater outputs from resources. Results for New Zealand... The Irish growth accounting literature can be compared to that for New Zealand. Data from Janssen (1996) reveals that for the period 1970-96, New Zealand’s average growth rate of 2.28% was accounted for by: • annual average TFP growth of 0.83% • average labour productivity growth of 1.23% • average capital productivity growth of 0.22%. These numbers imply that TFP accounted for 36% of growth, with 54% attributable to labour and the remaining 10% to capital. These numbers are a 7 To make these calculations the average shares over the period, 0.68 and 0.32 for labour and capital respectively, are used to weight an average growth of labour of 0.81% and capital stock growth of 3.64%. 30 4. MONETARY POLICY Monetary Policy and the EU Monetary policy in Ireland has been somewhat constrained since 1979 by their membership in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS). Prior to 1979 Ireland had a fixed one-to-one exchange link with the UK. Ireland saw EMS membership as allowing it to link its monetary policy to a lower inflation country, namely Germany. It was a good time to break the tie with the sterling, as continued maintenance of the tie would have entailed a large overvaluation of the Irish pound. Ireland has drawn great benefits from the ERM, in the form of low inflation and a relatively stable real exchange rate. Ireland seems to have a number of goals as far as monetary policy is concerned. One is the maintenance of low and stable inflation, which has certainly been achieved since the mid-1980’s. However, the Irish authorities also seem to strive for a stable exchange rate, and competitiveness against the United Kingdom. This trio of goals can be hard to achieve simultaneously in a fixed exchange rate environment, and will be harder still once Ireland moves to join the European Monetary Union (EMU). The implications of the imminent EMU for Ireland are far-reaching, as they are for every potential player in this arrangement. The Governor of the Central Bank of Ireland expressed concerns in 1991 that the monetary policy prevailing will be that which suits the central members, not peripheral economies such as Ireland12. These views are no longer voiced, publicly at any rate. However, if these concerns were realised, then given that the exchange rate is no longer available as a tool, inflationary pressures in Ireland would not be met by rising interest rates throughout the EMU area. Rather, the resulting fall in competitiveness would have to be met by other adjustment procedures such as greater unemployment, migration of capital or labour, countervailing policies from the centre, or a combination of these things. These are changes which may be hard to implement, or may be relatively more painful than a simple exchange rate adjustment. Certainly the final completion of the single market is likely to lead to more intense competition in the EU, which may lead to clusters of production near the core rather than the periphery. This would increase the risk of sustained divergence between the periphery and the EU core. There is also a danger that Ireland is overly vulnerable to a global slowdown in high-tech sectors, and that such an asymmetric shock will not be able to be addressed through the exchange rate. Again, internal adjustment would bear the brunt. 12 Doyle (1991) 31 Inflation The battle with inflation had historically been an ongoing one for Ireland. Even after joining the EMS inflation was still a problem, due to concerns over Ireland’s policy credibility. Specifically, until the early 1980’s the Exchequer’s borrowing requirements stemming from sizeable fiscal deficits were met by large scale monetary financing. The resulting imbalances were reflected in high inflation, a weakening exchange rate and a substantial current account deficit. The weakening exchange rate was propped up somewhat by the large-scale use of foreign exchange intervention - however the foreign currency used for this was also acquired through extensive and ultimately unsustainable foreign borrowing. This behaviour undermined Ireland’s credibility in maintaining it’s exchange rate within the ERM. Since the mid-1980’s inflation has been steady and low, ranging between 2-4% per year. This reflects the direction of the Central Bank of Ireland, whose main objective is “to safeguard the integrity of the currency”, which in practice is taken to mean the maintenance of low and stable inflation in Ireland13. The initial fall in inflation in the early 1980’s was aided by fiscal consolidation and a subsequent fall in borrowing. It should be noted though that inflationary pressures are currently building in Ireland, with the strong growth performance heating up the economy. Figure 8: Inflation 0 2 4 6 8 10 12 14 16 18 20 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 % Source: OECD database, PCInfos. 13 Kenny & McGettigan (1996) 32 Interest Rate Policy In terms of interest rate policy, the Irish Central Bank seeks to smooth temporary and predictable fluctuations in domestic interest rates, since with a fixed exchange rate the bank cannot actually control interest rates14. The motivation behind this policy was to reduce the harmful effects of volatile interest rates on investment decisions. Figure 9: Short Term Interest Rates 0 5 10 15 20 25 30 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 % New Zealand Ireland Germany Source: OECD, PCInfos Note: Short term interest rates are taken as follows • Germany - 3 month FIBOR • Ireland - 3 month interbank rate • New Zealand - 90 day bank bills The ERM currency crisis in 1992/3 saw Irish short term interest rates skyrocket to around 40% (point not shown on graph), as the Central Bank sought to defend the currency from expectations of devaluation. Devaluation became unavoidable however, and short term interest rates fell to a fairly stable level of 14 Leddin & O’Leary (1995) 33 just over 5%15. Short term rates have certainly moved nearer to the level exhibited by Germany, although the gap has widened since the 1995 currency crisis, sparked by instability in Mexico, as the Irish pound depreciated against the German mark. New Zealand short term interest rates have been both more volatile and at a higher level than these European countries. Figure 10: Long Term Interest Rates 0 2 4 6 8 10 12 14 16 18 20 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 % New Zealand Germany Ireland Source: OECD, PCInfos. Note: Long term interest rates as follows • Germany - 7-15 year public sector bonds • Ireland - 15 year government bonds • New Zealand - 10 year government bonds Long term interest rates in Ireland have been steadily converging to German rates and are now practically identical. Ireland is therefore benefiting from the links with Germany as they are now able to access lower interest rates. Once again New Zealand exhibits higher rates than both these countries, although the rate has shown convergence towards German levels. It may be that the openness of international capital markets in developed countries is reflected in the convergence of interest rates. 15 It did not help that the centralised wage agreements in place prevented nominal wages from falling. Theoretically, when the Irish pound became overvalued the domestic price level should have fallen to compensate, with a corresponding fall in nominal wages to hold the real wage constant. The wage agreements inhibited wages from falling and so devaluation did prove to be inevitable. 34 It is worth noting that, although not shown on the graphs, the Irish interest rates follow United Kingdom rates very closely indeed, no doubt reflecting ongoing linkages to the UK economy. Exchange Rate Policy Upon joining the EMS it was expected that in the initial period the Irish pound would be overvalued. Indeed, the failure of the real exchange rate to return quickly to its 1979 level indicates the adjustment process was prolonged, which further suggests adjustment costs were high. Leddin and O’Leary (1995) comment that the overvaluation was an important determinant of the rise in Irish unemployment, although they acknowledge the impact of factors such as the downturn in the world economy, tax increases, and rising oil prices. One notable feature of Ireland’s real exchange rate as compared to New Zealand’s is its stability. Since 1984 Ireland’s real exchange rate has moved within a band of around 16 points, while New Zealand’s more volatile exchange rate has fluctuated within a band of around 36 points. This is most likely a byproduct of Ireland’s membership of the ERM, but is worth noting nonetheless. Higher volatility of exchange rates may have a negative impact on productivity and investment, as the heightening of uncertainty may discourage new firms entering. Stable exchange rates probably served to increase Ireland’s desirability as an investment destination. Figure 11: Real Effective Exchange Rates 75 80 85 90 95 100 105 110 115 120 Jan-72 Jan-74 Jan-76 Jan-78 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 1990=100 Ireland New Zealand Source: OECD, PCInfos 35 The real exchange rate has still not yet fallen back to the level exhibited pre1982, although it has moved to a lower level since the devaluation of 1993. This went against the views of many Irish economists who believed that the competitive gain resulting from a devaluation was short-lived. It seems that the movement in the nominal exchange rate has given Ireland a competitive gain, and it has apparently highlighted the need to “find a realistic and workable exchange rate policy”16. The kind of statement made above serves to highlight the lack of clear targets for monetary policy. The literature and empirical evidence suggests that inflation has been a primary target, yet a stable exchange rate, and competitiveness against the United Kingdom, also feature strongly. Certainly the goal of competitiveness against the United Kingdom leads to a difficult balancing act if the sterling/Dmark exchange rate changes; should the sterling parity be maintained so as not to affect competitiveness against the UK? Or should the link with the German currency be maintained so as to ensure that inflation remains stable and that Ireland remains in contention for EMU? Perhaps Ireland has simply been fortunate in recent years that all factors have remained relatively stable. In any case, Ireland has committed to locking itself into the EMU, so future monetary policy decisions will be effectively out of their hands. 16 Leddin & O’Leary (1995) 36 5. FISCAL POLICY The Main Objective Since 1987 the overriding objective of Irish fiscal policy has been to reduce the ratio of government debt to GNP. As noted earlier, the Irish budget deficit first emerged as a problem when the government began offsetting the contractionary effects of higher oil prices. Unfortunately the lack of a coherent or consistent fiscal policy from 1973 through to 1986 meant that the budget deficit did not disappear once the original purpose became redundant. Instead the increase in borrowing that appeared was fuelled by conscious policy changes. Tax increases in the early 1980’s were not useful in stemming the deficit. Growth of government debt also resulted from Exchequer borrowing for capital purposes, and by the end of the 1980’s the level of debt had reached a highly concerning level. Figure 12: Government Indebtedness as % of GNP, 1977-95 40 50 60 70 80 90 100 110 120 130 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 % GNP Ireland New Zealand Source: Leddin and O’Leary (1995), PCInfos. Note: Figure refers to Gross Government debt. While debt as a percentage of GNP has fallen, it is important to note that economic growth has had a large hand in this. Reforms have not been as comprehensive as those carried out in New Zealand, and there have not been intense efforts to reduce expenditure. Indeed the current continued growth of expenditure in the order of 6% pa has resulted in warnings from the EU and EU 37 Central Banks that government spending must be reined in to dampen down inflationary pressure. Fiscal Balance The chart below illustrates Ireland’s fiscal balance. The chart uses several definitions of the government’s balance, which require explanation. The narrowest definition of the budget balance is the current balance, which is the difference between government current spending and current receipts. A wider measure is the Exchequer Borrowing Requirement (EBR) which also includes the balance between the capital receipts and capital spending of the exchequer. The primary balance is defined as the EBR exclusive of interest payments. A measure which has increased in usage since the signing of the Maastricht Treaty is the General Government balance, which goes one step further than the EBR and includes the balances of local authorities and the non-commercial semi-state bodies. Figure 13: Irish Fiscal Balance Source: IMF Staff Report for the 1996 Article IV Consultation - Ireland. 38 The current budget balance has improved sharply since the mid-1980’s, with reductions in expenditure being the main explanatory factor. A widening of the tax base and a decline in interest rates also assisted. The fall in interest rates was fueled partly by an increase in financial market confidence in Ireland as the Irish government brought their finances under control. The Irish government cites the Maastricht Treaty as the principal parameter guiding their budget. This is useful in terms of keeping finances under control, but gives a focus to the balance between tax and spending, rather than the actual levels of them. Leddin and O’Leary (1995) call this a satisficing approach, and note that since 1990 the primary budget surplus has actually fallen, although it is still within the bounds of Maastricht. They comment that the Irish public finances may currently be benefiting from a sort of virtuous circle, based on the combination of a primary budget surplus, low interest rates, and robust economic growth, but the circle is not unbreakable. Revenue and Expenditure Method of Recording... It is important to note the system of accounting that lies behind the Irish revenue and expenditure figures. The levels (in percent of GNP/GDP) do vary across data sources, and this can cause confusion, as the differences are large. The reason is that the Irish Budget sets out spending into Gross Expenditure and Net Expenditure, where Net Expenditure equals Gross Expenditure less Supply Services Receipts. These receipts are made up of employee and employer social security levies. The use of Net Expenditure tends to understate the involvement of the government in the economy. In addition the absence of these receipts on the revenue side of the budget tends to understate the level of taxation in the economy. By adding the Supply Services Receipts to revenue, instead of subtracting it from expenditure, a more accurate picture of Irish revenue and expenditure levels can be gained. This adjustment reconciles the figures with those presented by the OECD and therefore this method is used in this investigation. However the figure below, taken from the IMF Staff Report for Ireland, does not add Supply Services Receipts to the tax revenue figure. 39 Figure 14: Irish Revenue and Expenditure Source: IMF Staff Report for the 1996 Article IV Consultation - Ireland Irish Government expenditure as a percentage of GNP has dropped from a high of over 60% in the early 1980’s, to a more moderate level of around 43% from 1989 to 1996. The corollary of this though is that while expenditure as a percentage of GNP is stable, GNP is rising rapidly  thus as noted earlier, Irish expenditure is growing in absolute terms by quite a sizeable amount. Revenue comprised around 42% of GNP in 1996, down from levels of around 50% in the early 1980’s. Tax revenue has followed the trend and level of total revenue fairly closely since the late 1980’s, with tax revenue being 40.9% of GNP in 1996. 46 slowly, and the complexities and distortions of the present system remain. However, increasing pressure from outside Ireland, in the form of EU requirements, will eventually institute change. The 1998 Budget certainly introduced several changes in the rates of tax, with downward movements ranging between 2% and 20%. Wage Setting Since 1987 the control of inflation has been assisted by a system of wage moderation, brought about by national pay agreements between unions, employers and the government. This type of wage bargaining is referred to as corporatism. There were several agreements in the 1970’s but the period between 1981-87 saw none, although moderation in wages was achieved during this time simply because of rising unemployment. A series of agreements were then negotiated later in the 1980’s to consolidate that moderation  Programme for National Recovery (1988-90), Programme for Economic and Social Progress (1991-93), Programme for Competitiveness and Work (1994-96) and Programme 2000: Employment, Competitiveness and Inclusion (1997-2000). Leddin and Walsh (1997) note that a feature of the agreements has been that in return for low nominal wage demands the government has held out the prospect of a reduction in income taxation, improvements in social benefits, and a wide variety of other measures. Programme 2000... To give a general flavour of these agreements, the Programme 2000 covers pay policy, government spending, taxation, and social measures to reduce poverty and exclusion20. To increase the extent of social consensus generated by the accord, a wide variety of groups were consulted, including associations representing the Catholic and Protestant churches, the unemployed, women, young people, and community groups. With respect to pay, the new agreement allows for an annual increase of 2.9% for each year in the agreement. The 9.3% cumulative rise over the three year period includes a centrally set increase of 7 ¼ % and a ‘local bargaining’ clause which allows unions to negotiate additional increases up to a ceiling of 2% of the pay bill. Other initiatives encompass: • a national anti-poverty strategy focusing on long-term unemployment, educational disadvantage and low incomes; • a new focus on gender equality and a government strategy for the development and delivery of child care; 20 As discussed in OECD (1997) pg 43-45. 47 • additional spending of £525 million to be spent on indexation to inflation and other social inclusion initiatives over the three year period; • income tax cuts of a cumulative £900 million between 1997-1999, and business tax reductions of £100 million. These initiatives must be addressed whilst keeping to pledges of the debt to GDP ratio falling below 70%, general government deficit remaining below 1 ½% of GDP, and growth of public spending staying below 2 percentage points in excess of inflation. There is pressure on this corporate wage negotiating model, particularly since the agreements only seem to be followed in the public sector. Much of the private sector ignores the national wage agreement, as most of their workers are non-unionised. Rather they use short-term contracts. This situation has led to increased calls from the public sector for wage settlements to match those seen in the private sector. The expected acceleration of inflation leading up to the next round of negotiations for a new programme are likely to increase these tensions further. Effects of Wage Control... Leddin and Walsh (1997) comment that the centralised wage bargaining may have contributed to relatively subdued domestic inflationary impulses in the economy, but that persistent high unemployment is also very relevant in subduing inflation. They say that the test of Irish corporatism will be reconciling falling unemployment with moderate wage inflation and/or dealing with a major adverse shock, where the rigidity of the labour market due to this method of wage setting could inhibit its ability to adapt. While growth in wages may have been controlled, labour inflexibility remains, and this could act as a constraint on the economy. However, it may be impossible in the future to maintain this type of corporate model anyway, given that the majority of the private sector utilises short-term contracts. Keeping wages under control may have helped to attract FDI. The IDA website displays a graph of the cost of payroll, which shows hourly compensation including additional costs, in $US for 1995, for a number of countries in Europe. The data is sourced from the Swedish Employers Confederation, and clearly shows Ireland’s level of wages to be quite low relative to most of the other countries. 48 Figure 15: Cost of Payroll - Hourly compensation, 1995 0 5 10 15 20 25 30 35 Ireland Spain Portugal UK France Netherlands Belgium Germany US $ Source: IDA website There is a lack of literature on the effects of these wage agreements. What is clear however, is that a dual labour market is operating, and it is beginning to put strain on the bargaining model. 49 6. FOREIGN DIRECT INVESTMENT The level and type of Foreign Direct Investment (FDI) has been identified by many commentators as being a crucial element in the success of the Irish economy in recent years. Ireland has had a history of free markets, and since the late 1950’s Irish governments have actively encouraged foreign capital into the country, predominantly through the use of grants and tax concessions. In this section the focus is first on the features of FDI inflows into Ireland, with the role and structure of the incentive system following from this. FDI Inflows A 1994 OECD study of FDI in Ireland showed that foreign firms accounted for half of Ireland’s industrial output and employment, and three-quarters of its manufactured exports and imports21. Indeed, the fastest growing sectors in the Irish economy since the early 1980’s have been foreign owned. Most foreign investment has been concentrated in the ‘modern’ sector of computers, semiconductors, office equipment, software, pharmaceuticals, electrical engineering and soft drink concentrates22. The financial services sector has also been a recipient of large investment inflows, with the advent of the International Financial Services Centre in Dublin. The underlying conditions determining the incoming investment, as noted in the 1997 OECD Ireland country study, included the cumulative number of foreign firms (perhaps reflecting an agglomeration effect), skilled labour availability, a relatively high rate of return (likely partly due to the low tax environment), and the fact that the education system is seen as being relevant to the needs of business. FDI into Ireland was also encouraged by Ireland’s entry into the then EC in 1973. Many US firms have opened subsidiaries in Ireland as a way of accessing the European market and, overall, 70% of the manufacturing companies operating in Ireland as at 1994 had set up since Ireland joined the EC23. There were no statistics in the Balance of Payments accounts on direct investment flows at the time of the OECD FDI study, although a new system was under construction which would include such statistics. In the absence of this kind of data, statistics were drawn from the Irish Industrial Development Authority (IDA). However, the IDA only records investment eligible for grant assistance, which includes most investment in manufacturing and 21 Foreign firms operating in Ireland seem to import most of their raw materials and componentry, thereby accounting for quite a large proportion of total Irish imports. 22 OECD (1997) pg. 13 23 OECD (1994) pg. 7 50 internationally-traded services but not all24. The IDA comments that although the data is incomplete it does account for a high (although decreasing) proportion of total fixed asset investment by foreign-owned companies. Surprisingly Small Inflows? From 1974 to 1980 the amount of foreign fixed asset investment in Ireland was relatively stable, averaging 3.15% of GDP per year25. However, FDI inflows as recorded by the OECD have been rather uneven since 1983, and are relatively small with respect to the size of Irish GDP. According to the OECD data, New Zealand’s FDI inflows as a percentage of GDP have exceeded Ireland’s since the mid-1980’s; in the period 1981-91, the average percentage of FDI to GDP in New Zealand was 1.4, while in Ireland it was 0.5. In 1991-92 the difference was particularly pronounced, with the average for New Zealand being 4%, while Ireland achieved only 0.2%26. This seems to present a puzzle, as FDI is consistently advanced as one of the leading drivers of Ireland’s recent strong economic growth. However, using recent data from Ireland’s Central Statistics Office (CSO) yields a different story. Net inward FDI, including reinvested earnings, gives a figure for FDI as a percentage of GDP that is much higher. The chart below illustrates the OECD and CSO data together. Clearly the CSO data accords better with the notion that FDI has been a major driver of growth in Ireland, and the figures themselves are far more complete by virtue of including reinvested earnings. 24 The data does not include investment in fixed assets which are not grant aided; investment in working capital; investment by foreign companies which are not IDA clients; and investments for mergers and acquisitions. 25 Bacon, Durkan & O’Leary (1982) pg 24 26 OECD (1994) pg 51 Figure 16: Foreign Direct Investment Inflows 0 200 400 600 800 1000 1200 1400 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 US$ million -0.5 0 0.5 1 1.5 2 2.5 3 % Inward FDI Net FDI inflows (CSO) FDI/GDP FDI/GDP (CSO) Source: OECD (1994), CSO. Green Fields and Exports... The majority of the investment in Ireland has been in greenfield investment and expansion with very little merger or acquisition activity; again a different experience to that of New Zealand. The OECD study suggests the reason for this is that Ireland’s relatively small initial industrial base, and hence potential for growth, would present many more opportunities for new start ups than in a larger more mature economy27. However, it may also be due to the structure of investment incentives, since the IDA offers special industrial sites and buildings to potential investors. Most of the foreign investment in Ireland is concentrated in the export sector, again unlike New Zealand, particularly that investment in the modern sector. Foreign firms operating in Ireland export over 85% of their gross output, with 72.8% of these exports going to EU members. US-owned firms export 96% of their output, with 74% of that going to the EU28. In 1991 the share of total exports of the modern sector increased to 62%, with computer hardware and software alone accounting for 29%. Who Is Investing? United States firms are the most important investors with respect to the value of investment, number of firms, and number of people employed. This may well 27 OECD (1994) pg. 14 28 Barry and Bradley (1997) 52 be a function of the number of Irish people that have moved to the US in the past. There is certainly a strong cultural link that has been forged between these two countries. The US firms entered the Irish market relatively early, in the 1970’s, with investment in the electronic and pharmaceutical industries. Half of the total foreign investment since 1983 has been by US firms. The United Kingdom and Germany are the next biggest investors, followed by the Netherlands and France. This suggests that access to the EU is not the only driver of FDI inflows to Ireland, as these four countries are already able to access that market due to their membership status. Nonetheless, Ireland’s membership of the EU is important as these European countries may well have invested elsewhere had Ireland not had duty-free access to the European market29. Indeed, Ireland has now become part of an EU-wide integrated manufacturing system. Figure 17: Foreign fixed asset investment flows by country, 1983-92 0 10 20 30 40 50 60 United Kingdom Germany Other Europe United States Other % 1983-87 average % of total 1988-92 average % of total Source: OECD (1994) Note: Excludes Shannon Free Airport industrial zone 29 It is interesting to note that the OECD’s reasons for negligible Japanese investment include Ireland’s small domestic market and its location on the periphery of the European mainland. They then comment that Japanese investors seem to give particular value to being close to large markets, which seems at odds with their previous statement. Japanese investment in the EU constituted 18.3% of total outward Japanese FDI in 1992 (Bora 1996). It may be that Japanese investors focus on longer term issues rather than short term incentives, or perhaps they have had bad experiences in the past? 53 In terms of numbers of firms, in 1992 the US dominated with 387 firms operating in Ireland, equating to 38.2%. The UK had 19.8%, Germany 14.6%, Netherlands 5.5%, and Other countries accounted for the residual 21.8%. Employment in the Foreign Sector... Regarding employment, the OECD notes that the level of employment in areas such as financial services may be quite small, as they are at an early stage of development. In more mature industries where there has been FDI over a longer period of time, there is a higher level of employment. For instance, in the electronics sector there are over 250 firms employing more than 25000 people generating a quarter of Ireland’s manufactured exports. Industrial employment in Ireland is very dependent on foreign owned companies: as at 1992 half the employment in the industrial sector and 75% of its output were attributed to foreign firms. The following chart shows the percentage of employment in various sectors that is accounted for by foreign firms. Figure 18: Employment by foreign companies by sector, 1992 (%) 0 10 20 30 40 50 60 70 80 Non-metallic minerals Chemicals Metals and engineering Food Beverages and tobacco Textile Clothing and leather Paper and printing Timber and furniture Financial services Miscellaneous % of total employment Source: OECD (1994) 54 The average level of foreign firm employment in these sectors in 1992 was 44.8%, with 94200 out of 210400 employees working for a foreign firm. Barry and Bradley (1997) note that a large proportion of employment in the foreign owned sector of Irish manufacturing is in high technology sectors, and this fits with the fact that skill levels are higher in foreign industry than in indigenous industry. It is worth noting that any expansion of activity in the modern sector has a flowon effect in the service sector due to the linkages created by such activity. Multinational companies’ purchases of Irish inputs are only a small proportion of their total sales, but in terms of purchases of domestic services per employee, it is higher than for indigenous firms. The OECD notes that the number of jobs in the service sector indirectly linked to those in the modern manufacturing sector was estimated to be 105% of direct employees in the modern manufacturing sector. This compared with only 80% in traditional manufacturing industries. In addition this link has become stronger over time while it has fallen or stayed the same for the other sectors. O hUallachain (1984) commented that foreign firms seem to be predominant in sectors where linkages are relatively low in any case, and that the low level of integration of foreign firms may be quite typical. His study focused on the purchase of inputs, and his results showed a consistent lack of relationship between sectoral growth and inter-industry backward linkage. He therefore concluded that concern for improving linkages may be shortsighted given more pressing policy objectives. Perhaps a more important concern is that FDI may be squeezing out domestic entrepreneurship, as it seems more profitable to work for a foreign firm than to start up a firm. Earnings in the Foreign Sector... The average wage in foreign industry yielded an annual pay packet of £16,000 in 1993. This was approximately 25% higher than in indigenous industry. Looking just at industrial workers, the average wage in the foreign dominated sectors of beverages/tobacco, segments of textiles, chemicals, and electrics and optics (including computers) was £14,000 compared to an average for the rest of manufacturing of around £12,00030. Growth in manufacturing wages in general has been steady. The average Irish manufacturing wage is Ir£14,400, which equates to approximately NZ$36,900. This compares to an average New Zealand manufacturing wage of NZ$34,100. The chart below illustrates the growth in real hourly manufacturing earnings in Ireland, compared with a steady decline in New Zealand. 30 Barry and Bradley (1997) 55 Figure 19: Real Hourly Manufacturing Earnings, 1980-96 80 85 90 95 100 105 110 115 120 125 130 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1990=100 Ireland New Zealand Source: Calculated from OECD database, PCInfo The following table examines manufacturing plants by nationality of ownership, and clearly shows the divergence between indigenous and foreign firms in wages paid, average size of plant, and output per employee. Table 10: Manufacturing Plants: Characteristics by Ownership (1) (2) (3) (4) (5) (6) Net O/P per person (Ir£000) Profit per person engaged (Ir£000) Wage (1) - (2) (Ir£000) Total persons engaged Total wage bill (3) * (4) (Ir£000) Average size of plant - persons engaged Irish 30.8 17.7 13.1 111167 1456288 28.8 Other EU 55.3 39.3 16.0 33345 533520 104.9 - UK 71.2 52.8 18.4 12763 234839 114.0 - Ger. 30.7 17.3 13.4 10866 145604 108.7 Non EU 116.4 100.1 16.3 55491 904503 149.2 - US 126.2 109.8 16.4 42806 702018 160.3 Total foreign 93.5 77.3 16.2 88836 1439143 128.7 Total 58.6 44.2 14.4 200003 2880043 44.0 Source: Barry and Bradley (1997) 62 7. SAVINGS AND INVESTMENT Total Economy... The early 1980’s in Ireland was characterised by a shortfall of domestic savings relative to capital formation, as reflected in the large current account deficit. By the end of the decade the savings less investment (S-I) relationship had turned positive, mainly due to a decline in investment rather than an increase in aggregate savings. The chart below depicts savings and investment for the whole economy for both Ireland and New Zealand. It is notable that Irish gross fixed capital formation has been declining since 1980. Savings increased by 6 percentage points between 1980-90, but has remained fairly steady from 1990 onwards. For New Zealand the story is rather different. Gross fixed capital formation has consistently, with the exception of one year, exceeded savings, although the relationship has become closer towards the end of the period36. Figure 20: Total Economy Savings/Investment 14 16 18 20 22 24 26 28 30 1980/81 1985/86 1990/91 1991/92 1992/93 1993/94 1994/95 % GNP NZ GFCF Irish GFCF NZ GNS Irish GNS Source: Irish Central Statistics Office, and PCInfos Note: GNS (Gross National Savings), and GFCF (Gross Fixed Capital Formation) 36 It is worth noting that savings data in particular is often unreliable. However, these statistics are the IMF’s best guess. 63 It is interesting to note that gross fixed capital formation in New Zealand has generally exceeded that in Ireland since the early 1980’s, yet Ireland has experienced such rapid growth. Indeed, surprise has been expressed by some that the growth in Ireland followed a decline in investment. Leddin and Walsh (1997) suggest the puzzle may be explained by the altered structure of the investment, with the share of private investment, predominantly FDI, in total investment growing. The higher productivity of this private investment is reflected by a lower incremental capital/output ratio, as compared to public sector investment. Leddin and Walsh also suggest that perhaps the earlier public investment in infrastructure, both physical and social, had a long gestation period and is now enhancing the private sector investment productivity. Certainly public investment in the late 1970’s and early 1980’s was high, and was focused mainly in infrastructure and utilities. Manufacturing investment in that time tended to be capital-intensive, and the heavy investment in utilities has left a legacy of excess capacity that is not yet fully utilised. The IMF (1996a) note that recent investment is less capital-intensive, especially that in the modern sector, and is far more productive, particularly with the increase in skilled workers. It therefore seems that the quality of investment is an important issue to think about when analysing the saving/investment behaviour within an economy. Looking only at the levels of investment may over-simplify the relationships between investment and other variables, for example the current account. With investment in New Zealand higher than that in Ireland, yet growth much lower, it could suggest that the quality of New Zealand investment may be lacking. The sectoral composition of investment and the availability of other resources such as skilled labour, are obviously other important factors though. The figures also suggest that perhaps the focus on the savings/investment behaviour of New Zealanders is overemphasised, since the numbers are relatively close to those of Ireland yet the outcomes are quite different. 64 The Government Sector... The figures for the total economy mask the behaviour of savings and investment for particular groups within Ireland. Looking first at government investment, it is notable that as a percentage of GNP it fell from 6.1% in 1980 to 2.4% in 1990. The Irish government reduced investment expenditure in line with attempts at fiscal consolidation, both in the early 1980’s and in 1987. The 1987 consolidation was more effective at reducing the deficit due to the expenditure constraint approach rather than the tax increase approach, thus decreasing public sector dis-saving quite sharply. Figure 21: Government Sector Savings/Investment -8 -6 -4 -2 0 2 4 6 8 1970 1975 1980 1985 1990 1991 1992 1993 1994 % GNP Gross Fixed Capital Formation Gross Savings Provision for Depreciation Source: Central Statistics Office The Household Sector... It is noticeable that as public savings have increased (that is, the public sector deficit decreased) the private sector savings fell. For instance, in 1980 the government sector savings were -5.6% of GNP, while household sector savings were 16% of GNP. In contrast, in 1990 government sector savings were -0.9% of GNP while household sector savings were 9.6% of GNP. This suggests a Ricardian Equivalence type relationship between private and public savings, 65 whereby private sector savings fall in response to an increase in public sector saving as it suggests lower tax liability in the future. The moderation of growth in real wages (perhaps via wage agreements) is also suggested to have had a negative impact on savings. The chart below illustrates the fall in savings in the household sector, along with the relatively static trend of investment. Figure 22: Household Sector Savings/Investment 0 5 10 15 20 25 1970 1975 1980 1985 1990 1991 1992 1993 1994 % GNP Gross Savings Gross Fixed Capital Formation Provision for Depreciation Source: Central Statistics Office Household saving is higher in Ireland than in New Zealand, but it is interesting to note that the OECD talks about the historical Irish preference for holding property assets. In fact, the high rate of home ownership has been identified as one of the reasons why the Irish stock market is relatively undeveloped37. Demand for housing has also been fuelled by tax system incentives. The recent growth in Ireland has additionally increased demand for housing mortgages, with the real estate and construction sector accounting for more than half of the increase in credit to the domestic private sector38. Residential construction as a percentage of GDP was hovering around 5% for both Ireland and New Zealand in 1995. 37 OECD (1994) pg 43 38 OECD (1997) pg 38 66 The Business Sector... With respect to the business sector, Walsh (1996) states that private spending on domestic capital formation declined when the level of foreign direct investment in the economy was increasing, and that this meant Irish companies were investing more and more outside the country. Certainly investment has been on a downward trend, particularly since around 1980. The IMF suggest that this was partly a result of exchange restrictions being lifted and businesses being able to diversify and expand abroad in response to the small domestic market size and peripheral location. Rising real interest rates in the 1980’s may also have deterred investment. Recently strong economic growth has arrested the sharp fall in investment, although it is still lower than the EU/OECD average39. Figure 23: Business Sector Savings/Investment 0 2 4 6 8 10 12 14 16 1970 1975 1980 1985 1990 1991 1992 1993 1994 % GNP Gross Savings Provision for Depreciation Gross Fixed Capital Formation Source: Central Statistics Office The increase in business sector saving can be attributed to a marked improvement in profitability, coinciding with wage moderation and productivity increases resulting from structural changes in the manufacturing sector. The IMF comments that the failure of investment to increase with profitability can 39 IMF (1996b) 67 again be attributed to the small market size. This may be a problem that New Zealand faces also. 68 8. CURRENT ACCOUNT The current account has been one of the major ‘success stories’ in Ireland. Coming from a large current account deficit in the early 1980’s Ireland now has a sizable current account surplus. This sharp turnaround is illustrated in the chart below. Figure 24: Irish Current Account Balance -3000 -2500 -2000 -1500 -1000 -500 0 500 1000 1500 2000 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 $US million Source: World Bank database, PCInfos However, one point to note with the Irish current account data is that the method of classifying the activities of foreign multinationals and firms in the IFSC may exaggerate the size of the surplus. The IMF suggests that these distortions may overstate the current account surplus by as much as one-third. Nevertheless, the sharp turnaround in the current account in the 1980’s cannot be simply explained by this alone, hence the interest in the underlying components of the account. 69 Trade Performance... The improvement in the current account stemmed partly from the dramatic improvement in trade performance, illustrated in the chart below. From 1979 to 1995 the visible trade balance moved from a deficit equivalent to 17% of GDP to a 19% surplus, due mainly to the growth of exports40. This may be due to the government policy of attracting FDI, which was directed into dynamic, export-oriented sectors. Figure 25: Merchandise Trade Balance -4000 -2000 0 2000 4000 6000 8000 10000 12000 14000 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 $US million Source: World Bank database, PCInfos. The composition of merchandise trade also altered, with high-tech sectors making a large contribution to the growth. In terms of the Standard Industrial Trade Classification (SITC) classes, while SITC 0 (Food and Live Animals) grew 93% between 1987 and 1995, SITC 5 (Chemicals) grew 322% over the same period. Pharmaceuticals, which comes under SITC 5, was a notable performer, with growth of 458% over the 9 year period. SITC 7 (Machinery and Transport Equipment) grew 201%, with one of its high-tech components, Office Equipment, growing at 179%41. Walsh (1996) notes that a small number of 40 Walsh (1996) 41 Growth rates calculated from data given in OECD (1997) pg. 174. 70 non-traditional, high-tech sectors, including organic chemicals and pharmaceuticals, contributed disproportionately to the boom in exports. He also comments that these sectors are controlled in the main by Irish subsidiaries of multinational firms, with75.6% of all manufacturing exports originating from foreign firms in 1993. Services... Trade in services has also grown, although imports of services still far outweigh exports. Nevertheless, exports of services have picked up, particularly since 1989, which could be attributed to the International Financial Services Centre beginning to operate at a normal level, since it only opened in 1987. Figure 26: Balance on Services -6000 -5000 -4000 -3000 -2000 -1000 0 1000 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 $US million Source: World Bank database, PCInfos. 71 Factor Income Flows... Apart from trade in goods and services, the current account also incorporates factor income flows. The new Irish system of national income accounting, which implements some of the methodological changes recommended in the new European System of National and Regional Accounts, treats the entire profits of an Irish-based multinational as a factor income outflow in the current account. Reinvested profits are then treated as an inflow on the capital account. Factor income outflows have been far greater than inflows in recent years, no doubt reflecting the level of foreign activity in the economy. Factor income inflows have been static however. Figure 27: Factor Income Flows 0 1000 2000 3000 4000 5000 6000 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 $US million Factor Income Exports Factor Income Imports Source: World Bank database, PCInfos. 78 Migration... Ireland has also experienced large levels of emigration in response to conditions in the domestic labour market as compared to labour markets overseas44. This of course means that the level or rate of unemployment does not accurately reflect labour market conditions in Ireland. The United Kingdom is a particularly popular destination for Irish workers, especially given the lack of controls and the proximity, common language, and number of Irish people already living there. As such, it seems that the Irish and UK unemployment rates seem to follow similar trends. The US is also a popular destination. Most migrants that leave Ireland are young, educated people who go abroad to find work or take up employment, leading to the concern of ‘brain-drain’. However, over half of migrants return to Ireland, and this is particularly encouraged by the fact that employers have appeared to like hiring graduates with overseas work experience, rather than recent graduates in Ireland. This may not be the case so much any more though, considering the increasing skills shortages in Ireland. Figure 30: International Migration (% labour force) Addressing Unemployment... In order to help address the problem of unemployment the Training and Employment Authority (FAS) was established in 1988 under the Labour 44 OECD (1997) pg. 71 79 Services Act 1987. Its functions are to oversee the operation of training and employment/recruitment services, run an advisory service for industry, and to provide support for co-operative and community based enterprise. The agency is run by a wide collection of people representing trade unions; employer and youth interests; and the Departments of Education, Finance, Enterprise Trade and Employment, Social Community and Family Affairs. Active labour market programmes are also run by the Department of Social Welfare. Total expenditure by all agencies on these programmes totalled £698.2 million in 199545. Looking at the impact of taxes and benefits on incentives is also a priority of the Irish government. Reducing the high marginal tax rate, changing the rules of the unemployment benefit to strengthen work incentives, reforming the child benefits system which currently favours the unemployed, and improving the system of housing related benefits, were all suggestions made to Ireland under the OECD Jobs Study in this area. Another area which has been suggested as needing addressing is the institutional features of the labour market, in particular the method of wage bargaining, which some say has resulted in the Irish labour market becoming too inflexible to react to changes in the environment. Santaella notes that the wage agreements have helped to preserve a rigid structure of relative wages that may not correspond to productivity differentials and structural changes occurring in the economy. This could well prove to be a large constraint on growth in the future. Unemployment and Education... Sheehan notes that in 1980, those leaving school with no qualifications had an unemployment rate of around 20%, those with intermediate/group certificate (NZ School Certificate level) had a rate of just under 10%, while those with leaving certificate (NZ UE level) had an unemployment rate of around 5%. By 1991, the data looks a little different, with those with no qualifications having around 53% unemployment, intermediate/group certificate with a rate of just over 30% and those with leaving certificate with a rate of around 11%. 45 OECD (1997) pg. 97 80 The OECD 1997 report on Ireland provides detailed information for 1995 on the unemployment rate by level of education. Table 14: Unemployment and Education (% in 1995) 15-24 years 25-34 years 35-44 years 45-54 years 55-65 years Over 65 years Total U/e rate by level of education Primary 45.5 31.6 24.5 15.5 9.1 1.9 19.0 Lower secondary 27.6 19.1 12.6 10.0 9.7 6.4 17.3 Upper secondary 14.6 7.8 6.1 5.9 6.8 2.7 9.5 3rd level, non-uni 9.6 5.2 4.0 5.6 3.2 0.0 5.9 University 8.5 4.4 3.1 2.8 2.5 0.0 4.0 Total 19.4 11.3 11.0 10.2 7.7 2.4 12.1 Share of the u/e Primary 4.9 5.1 7.8 7.9 2.9 0.2 28.8 Lower secondary 12.1 11.1 7.8 3.9 1.4 0.2 36.4 Upper secondary 10.6 6.8 4.7 1.9 0.7 0.1 24.8 3rd level, non-uni 2.2 1.9 1.1 0.7 0.2 0.0 6.1 University 0.9 1.5 0.8 0.5 0.2 0.0 3.8 Total 30.6 26.4 22.3 14.9 5.4 0.5 100.0 Source: OECD (1997) 81 The figures show that unemployment is concentrated among persons with only a primary or lower secondary school education, in fact 65.2% of unemployment comes from this group. Of concern must be the fact that this group accounts for about half of the labour force in 1995, as detailed in the table below. Table 15: Unemployment and the rise in educational qualifications U/e rate Highest level of educational qualifications 1995 1989 1991 1992 1994 1995 % of labour force aged 25-64 % of population aged 25-64 Primary 18.6 36.9 33.2 31.7 28.1 26.9 Lower secondary 14.7 25.2 26.6 26.1 26.7 25.9 Upper secondary 7.6 23.2 24.3 25.3 26.7 27.3 3rd level, non-uni 4.9 7.4 7.9 8.6 9.7 9.8 University 3.5 7.3 8.0 8.3 8.8 10.1 Weighted u/e rate 12.9 12.6 12.3 11.9 11.7 Source: OECD (1997) Note: The weighted unemployment rate weights the 1995 unemployment rate for each education level by the share of the population aged 25-64 with that educational level. It seems that despite the improvements in the education system in recent years, there is still a problem with youth unemployment, with 30.6% of 15-24 year olds being unemployed in 1995. Generally though, those persons that complete tertiary level education do experience a far lower rate of unemployment, particularly once they reach the 25+ age group. The proportion of the labour force with only primary education fell dramatically from 36.9% in 1989 to 26.9% in 1995, reflecting the retirement of many people who completed their education before the introduction of free secondary schooling in 1968. The share with tertiary education had risen to nearly 20%, and the OECD report suggests that rising education levels have reduced structural unemployment in Ireland, together with other factors such as changes in the tax and benefit systems which increased work incentives. 82 10. EDUCATION According to the IMD World Competitiveness Report, 1996, Ireland has an exceptional availability of skilled people, and has the most relevant educational system in Europe for a competitive economy. The following table, extracted from a table in OECD (1997) shows the educational attainment in Ireland and New Zealand in 1994. Table 16: Educational Attainment (% of population 25-64 years of age by the highest completed level of education), 1994 Ireland New Zealand Lower secondary school 55 43 Upper secondary school 27 34 Non-uni tertiary education 10 14 Uni-level education 9 9 Total 100 100 Govt spending on education as % GNP 5.6 (1998 Budget) 6.3 (1997/98 Budget) Source: OECD (1997), The Treasury It can be seen from this table that the educational attainment in New Zealand is slightly higher than that in Ireland. Nevertheless, much emphasis has been put on education in Ireland, both by the government and by families. Private provision adds a great deal to the education of Irish people, through such means as private tuition, ‘swot’ classes and so on. Since education has traditionally been a passport to overseas opportunities, there has been a strong entrenchment of positive attitudes towards academic study. Young people work extremely hard to achieve good grades, in order to be accepted into soughtafter tertiary places. In the early 1980’s a debate was emerging about the economic relevance of education, particularly its importance for employment. Some groups felt the education system was producing too many people trained in the ‘liberal arts and traditional professions’, with not enough emphasis being placed on vocational skills46. However, a document produced by the government, the 1992 Green Paper on Education, took a broader view of what is vocationally relevant. It 46 Sheehan (1992) notes these comments taken from the Report of the Industrial Policy review Group. 83 generally suggested that new subjects such as Business and Technology Studies should be encouraged, vocational programmes should be widened, and links with business should be further developed. Certainly there is now a strong emphasis on ‘technical universities’ and on developing industry-related courses. Figure 31: Primary Degrees Awarded, 1980-88 0 5 10 15 20 25 30 35 Arts Law Medicine Commerce Engineering Science % of total graduates Ireland NZ Source: Sheehan (1992), Education Statistics of NZ (1993) pg79. Clearly Arts has a large share of total graduates in both countries. Sheehan notes that Arts in Ireland experienced an increase in students in the late 1980’s due to the tightening of budgets. This precluded the expansion of expensive laboratory and work-shop based programmes. He also notes that most of the increase was focused in modern continental languages, economics, and other ‘vocationally relevant’ areas. It is obvious however that Ireland is ahead of New Zealand in terms of students in engineering and science. In fact the IDA states that 6 out of 10 of Ireland’s 3rd level students major in engineering, science or business studies subjects. As mentioned earlier, there is an emphasis in Ireland on technical subjects. 84 11. FUTURE PROSPECTS Ireland’s future is uncertain, but there are some indications of what may be round the corner. With strong growth in the economy, Ireland is starting to see fairly large asset price bubbles. Workers are demanding higher pay, and there are signs of skilled labour shortages. In addition, the output gap measuring the difference between actual GDP and potential GDP is strongly positive. However, there are limited options for addressing overheating due to the imminent EU currency union. The job of restraining demand is left mainly to fiscal policy  tax increases and spending cuts would serve to quickly dampen down the economy. But in fact, planned spending is to increase by 6% this year, and taxes have been lowered. Nevertheless, it seems fairly likely that the Irish government will have to change its fiscal stance in response to the current environment. Putting the relatively short-term issue of overheating to one side, there are other concerns that Ireland faces. The first revolves around the imminent currency union in Europe. As mentioned in the section on monetary policy, there are worries that geographically peripheral countries such as Ireland will be marginalised in policy decisions. This may lead to policies being put in place that will benefit the core, rather than the periphery. Now given that Ireland is fairly dependent on exports of hi-tech items, any slowdown in demand in this area will have severe negative consequences for the economy. Without the prospect of exchange rate movements to offset such a shock, and with interest rates likely set to levels that suit countries such as Germany and France, Ireland would have to rely on internal adjustment. This means that labour and goods markets must be flexible enough to cope. Another issue mentioned earlier in the paper is that of labour market pressures. Not only are wage demands increasing due to the recent growth in the economy, but the favourable labour force growth trends exhibited in recent years are likely to subside in the medium term  meaning more pressure on wages. There are also growing shortages of skilled labour. In the future then it is likely that labour force growth will be much slower, and wages will rise to reflect the reduced availability of labour, both skilled and unskilled. This may affect the competitiveness of Ireland, particularly as compared to emerging East European nations. Finally, it could be suggested that some of Ireland’s economic policies will need attention in the future. For example, the tax system is very complex, with the array of tax incentives and allowances serving to distort decisions on savings, investment and production. Certainly tax arrangements in the housing area are helping to inflate the bubble even more. It may be too that Ireland will have to undertake microeconomic reforms to help enhance its ability to adjust without the exchange rate/interest rate tools. In particular, the labour market could be 85 made more flexible. Ireland seems to be moving in the opposite direction however, with plans to introduce a minimum wage in 2000. Despite these concerns, the evidence so far suggests that recent strong growth is not a temporary phenomenon. The Economic and Social Research Institute in Dublin expects annual average growth rates of over 4 % until at least 2010, and in the immediate future, Consensus Forecasts predict growth of 6.7% and 5.6% in 1998 and 1999 respectively. While these figures represent a decrease from levels seen currently in Ireland, they are very strong relative to New Zealand’s growth performance. This shows the continued importance of strong fundamentals, and the advantages of location. It seems that, given careful management and some prudent reform, Ireland can continue to grow strongly well into the future. 86 12. CONCLUSIONS So what are the determinants of Ireland’s impressive growth performance? It seems that there is no one factor  it is more a constellation of influences. First of all, Ireland is an English-speaking nation on the edge of a huge European market. Their entry into the then EEC in 1973 served to solidify and further enhance the already open economy. It also set Ireland up as a prime investment destination for countries seeking access to the European market, but who found it easier to do so from an English-speaking country. This was particularly so in the case of the US  possibly also because of historical connections arising from past migration. Coupled with foreign investment incentives such as special low tax rates and high-profile country marketing, Ireland’s EU membership and geographic position attracted reasonably large amounts of capital into the country. Due to the investment incentive structure this capital was attracted into high-tech, export-oriented sectors, which created job opportunities for highly skilled workers in Ireland and pushed Ireland’s current account into surplus. Foreign investment was one of the key drivers of growth and increases in productivity. Ireland also had the advantage of macroeconomic stability. Low inflation was achieved in the mid-1980’s, and the real exchange rate has remained within a 16 point band since 1984. Both these features were achieved with the help of membership in the ERM. In recent years Ireland has been benefiting from an exchange rate that is not ‘overvalued’. Government expenditure reductions were undertaken in the early and mid-1980’s, and fiscal moderation was practised with the goal of meeting the fiscal terms of the Maastricht Treaty. The complex tax system does not seem to have inhibited growth, although reforms are now underway to reduce the distortions created by relatively high marginal tax rates and selective tax allowances. In the labour market Ireland has experienced high labour force growth due to favourable demographics. In particular, Ireland has a young population and has had increasing female participation, along with rising levels of immigration. Workers are generally very well educated and highly skilled, and there is an increasing focus on technical subjects such as engineering and science. Wages have been restrained by a series of agreements between unions, employers and the government, although tensions are building now as workers covered by the agreements seek increases closer to those seen in the nonunionised sector. However, the mixture of well skilled, relatively low waged workers, has enabled the growth of high value-added sectors within the economy. Ireland received some assistance from the EU in the form of structural grants and agricultural support. This may have promoted some sectors that serve the agricultural sector, and possibly helped ease the transition from the farm to the 87 factory. It is unlikely that these grants had a large impact on growth, but nevertheless they had some positive effect. Lastly, some people talk about the ‘luck of the Irish’. Perhaps Ireland has been fortunate to have had investment in sectors where global demand is rising; to have had favourable demographics; to have had the chance to join the EU and the ERM. Perhaps they were lucky to have had all their policies ‘come together’ at a time when their markets were growing. There are issues that Ireland will have to work through in the future, most imminent is the danger of overheating. There are also concerns about the operation of the currency union, the future competitiveness of Ireland, and structural change. Yet growth forecasts are bright, both for the short-term and for the longer-term. So what can New Zealand learn from Ireland? We cannot put the country on a barge and ship it to a position just off the coast of Western Europe; we simply have to accept our geographical location as a small island on the edge of the world. Nor can we do much about our demographic structure, unless immigration plays a large role in reshaping our population. Perhaps New Zealand has to run twice as fast to achieve the same gains as other countries. We already have low inflation, and have undertaken intensive fiscal reforms. These were achieved a little later than Ireland however  perhaps the gains are yet to fully be seen? The lack of microeconomic reform in Ireland does not seem to have proved a barrier to growth. For New Zealand though, following the ‘run twice as fast’ mentality would suggest that this economy may not get away with letting issues lapse. The stable macroeconomic environment may be something we can learn from though  is a stable exchange rate more conducive to growth in a small open economy? Are there different ways of looking at monetary policy that New Zealand needs to consider? The quality of factors is also something New Zealand may need to think about. With foreign investment flowing into Ireland, the quality of investment rose  more emphasis was placed on high-tech, high value-added sectors. Does the tax incentive system matter? Should New Zealand be considering the merits of a competitive tax regime? Is our FDI policy a growth-maximising one? Could we market New Zealand as an investment destination more effectively? The quality of labour in Ireland is also high, reflecting their attitudes towards and investment in education and training. Should New Zealand be focusing more strongly on developing workforce skills? It is unlikely that we can compete on price for our labour, but surely we can attempt to compete on quality. What can we do to our education system to improve the quality of our labourforce? New Zealand is growing, but according to the OECD we will fall further and further behind the OECD average if the status quo performance is maintained. The message is that New Zealand must seriously think about ways to become