Transcript Document

Rise and Fall of the Celtic Tiger
• See BPEA by Honahan and Walsh
– http://www.brook.edu/es/
commentary/journals/ bpea_macro/papers/
200204_honohan.pdf
• Short-loan PC 18940
• Chapter 24 of Walsh and Leddin
1
Outline
• The nature of the Irish economic boom
• Not a productivity ‘miracle’
– But the growth of employment was
‘miraculous’
• The rising employment/population ratio
the key to understanding the speed with
which we caught up with the leaders
• No ‘magic bullet’
• Several factors – including luck – came
together in the 1990s
2
Belated real convergence
• When Ireland began to catch up,
it moved very rapidly
• like a hare
• Rapid spurt in 1990s
• By the end of the 1990s we had gone
ahead of the average and, by some
measures, were one of the richest
countries in the world
– See the graphs
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US $
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Figure 2: Real convergence
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EU15 GDP per person at PPS=100
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Ireland closed the gap with rest of EU in
the 1990s
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EU15 GDP per person at PPS=100
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Greece
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Real GDP growth rate
12%
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0%
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-2%
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Employment growth rate
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0%
-4%
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Basic Idea
• Convergence postponed
– By policy errors prior to 1987
• Convergence achieved
– By return to traditional, sound policies
– By removal of obstacles
– By rapid rise in ratio of non-agricultural
employment to population
– No productivity miracle
• No magic bullet
• Alternative Q:
– Why did it take so long?
9
Two Questions
1. Where did the growth come from?
•
Accounting Question
2. Why did we grow?
•
•
Lessons for the future
Lessons for other countries
10
Real convergence
Note that “real convergence” usually refers to
the level of GDP per person, that is
GDP/Population
We can see that this is made of two elements,
(GDP/person at work)
x
(Persons at work/population)
11
Sources of growth in
GDP/person
GDP/person at work = productivity
Persons at work/population = employment rate
Rate of growth of GDP per person 
Rate of growth of productivity
+
rate of growth of employment rate
12
Where did the economic growth come
from in the 1990s?
38%
62%
Productivity
Employment growth
13
Where did the employment growth
come from in the 1990s?
32%
68%
Working age population
Employment rate
14
Output and productivty growth, 1993-2000
annual average growth rates
9
8
%
7
6
5
4
3
2
1
0
Productivity
Employment
Output
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Answer to Q of Where Growth
came from
Convergence due to
1. Rapid rise in ratio of non-agricultural
employment to population
•
–
This in turn due
Demographic factors
•
–
Decline in proportion aged under 15
Exceptional growth in numbers at work outside
agriculture
2. Reasonable growth in productivity
•
•
High by some standards
But no miracle
16
Sources of growth in GDP/person,
1985-2000
The employment/population ratio rose from
24% to 41%
With no change in the level of productivity
this alone would have raised GDP/Person by
over 60%
17
Non-agricultural employment as share of population
45
40
35
30
25
20
60
65
70
75
80
85
90
95
00
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What actually happened was much
less smooth
• Drastic set-backs between 1973 and
mid-1980s
– Shrinking productive base
– Growing burden of dependency
• 224 dependants per 100 employed in 1986
• Rapid recovery and catch up from
late 1980s
– 124 dependants per 100 employed in
2001
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Summary
•
•
•
•
Prior to 1987: depression (negative growth), high
unemployment (18%), high inflation (16%), public
finances in crisis (deficit of 15.1%) , balance of payments
deficit (14.6% of GNP) and depreciating exchange rate.
Mass emigration, rising poverty. “Basket Case” economy.
1994 to 2001: 7 years of spectacular growth (average 9%),
low unemployment (3.6%), low inflation (1.4%), surpluses
on fiscal budget (3.5%) and balance of payments (3.7%).
The “Celtic Tiger” economy.
2001+: Return to more normal economic performance
See Economist covers
20
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
From 1960 to 2000
• One huge macroeconomic loop in terms of unemployment
– We ended up in 2000 much where we started from in 1961
• Path was not smooth
–
–
–
–
–
Policy errors after1973
Led to enormous fiscal and balance of payment deficits
Painful correction during 1980s
Steady rise in the tax burden until 1986
This trend reversed as spending was brought under control
• The correction became self-reinforcing by the late 1980s
– Virtuous circle of declining burden of debt and taxation
21
Why Did We Grow?
Why did employment grow?
1. Demographic factors
– Sharp fall in birth rate after 1980
– led to fall in proportion of young dependents
in population
2. Economic Policy
– We saw some of this in the fiscal policy
section
22
Demographics
The fall in birth rate after 1980 could be
regarded as
– Ireland’s belated convergence to the
demographic norm for a developed
country
• Facilitated by rising female educational
levels and
• Changes in attitudes and laws concerning
contraception
• Triggered by rise in unemployment in early
1980s?
23
Economic Policy in the Tiger
•
•
•
•
•
•
•
•
•
•
•
Distinguish between pre-boom factors:
1. Foreign direct investment (Industrial policy).
2. External assistance.
3. Investment in education.
Factors that combined to ignite the boom:
4. Centralised wage bargaining.
5. Fiscal policy.
6. Upturn in World (US) economy.
7. Achieving EMU entry criteria.
8. Exchange rate policy.
9. Small is beautiful.
24
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
1. Industrial Policy
•
Success of IDA in attracting high-tech foreign
multinational companies (MNCs): microelectronics,
pharmaceuticals, medical instrumentation, computer
software, financial services, telemarketing.
• However, the contribution of MNC’s can easily be
exaggerated.
• Need to take into account their high level of imports
(including payments for patents and royalties) and
repatriated profits.
• Contribution to GNP in 1998 was only €4.8 billion.
Considerably less than the sales figure.
25
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
2. External Assistance
•
•
•
•
•
1973-2001:
Total net receipts = €33,853.5 million.
Annual average of €1,167.4 million or 3.9 % of GNP.
The peak was 6.6% of GNP in 1991.
Paid under a variety of headings: agriculture, social,
regional and cohesion funds.
• Money mostly spent on roads, railways,
telecommunications.
• Greatly improved the country’s productive capacity.
26
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
3. Investment in Education
• The importance of “human capital formation” in the
growth process.
• 2000:
Primary
€1,068 m
Secondary €1,243 m
Third level €838 m
• Well educated labour force acts as a magnet to
foreign multinationals.
• Much of this investment took place in the 1970s
and early 1980s.
• Note: Factors 1 to 3 were in place in the 1980s
and do not explain the spurt in growth in the
1990s. Considered to be essential pre-conditions.27
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
4. Wage Bargaining
• Wage moderation following a return to centralised
wage bargaining.
• National wage agreements involving the trade
unions, employers and government.
• In return for moderate increases in nominal wages,
the government promised tax cuts at budget time.
• For a number of years, inflation was greater than the
basic wage awards resulting in a fall in real earnings.
• Improved Ireland’s competitive advantage.
• Only applies to workforce of 500,000 out of total
employment of 1.7 million.
• May or may not have facilitated the IDA’s industrial
policy.
28
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
5. Fiscal Policy
• Restoring oder to the public finances in late 1980s was a precondition for a resumption of economic growth.
• Improved investor confidence and reduced the outflow of
capital.
• Tax rates cut from 35% and 58% in 1988 to 20% and 42% in
2002.
• Difficult to disentangle cause and effect.
• Tax cuts in recent budgets increased the supply of labour and
stimulated aggregate demand.
• Government expenditure under the 1994 and 2000 National
Development Plans was €28 billion and €51 billion
respectively.
• Expenditure went into improving infrastructure (road conjestion),
environmental pollution, education and training, and housing.
29
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
6. World Economy
• Ireland is very open to trade.
• Non-EMU countries account for 80.4 % of
Irish trade.
• Very dependent on the US economy. Exports
of €1.6 billion in 2001.
• Economic performance in USA has been
major factor behind the growth in Ireland.
• Current slowdown in Ireland is due in large
part to slowdown in US, terrorist attack 11th
September and the foot and mouth disease.
• Tourism increased by 8% per annum
throughout the 1990s.
30
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
7. EMU Entry Criteria
• To join EMU, Irish inflation had to drop to below 2.7 %.
• Hence, EMU forced the government to adopt an antiinflationary stance.
• EMU membership also entailed a fall in Irish interest
rates down to the low German rates.
• By the late 1990s, negative real interest rates stimulated
the demand-side of the economy and fulled house price
inflation.
31
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
8. Exchange Rate Policy
• Over-valued exchange rate combined with high
interest rates can seriously curtail a country’s growth
potential.
• Devaluations in August 1986 (8%) and January 1993
(10%) prevented over-valuation.
• Central Bank followed a policy of stabilising the
effective exchange rate.
• Involved playing off the strength of sterling against
the weakness of the DM. Middle ground.
• From August 1997, the DM rate was allowed to drift
down to the EMU entry rate of 2.4834.
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 Leddin and Walsh Macroeconomy of the Eurozone, 2003
9. Small is Beautiful
• Obviously a lot easier to turn around a small country
like Ireland than a very large country.
• The same level of foreign direct investment would
have much less of an impact on, say, the Spanish
economy.
• Factor number 10 was “luck”. Most of the above
mentioned factors complemented each other in
moving in the right direction at the right time.
33
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
How Did these Factors
Influence Output?
•
•
Examine how factors 1 to 9 impact on the
demand-side (AD) and the supply-side (AS)
of the economy.
This analysis is subjective because:
1. Some factors impact on both AS and AD.
2. The factors interact with each other.
3. It is virtually impossible to quantify the effect of
each factor on economic growth, unemployment
and inflation.
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LRAS
• Long-run (natural real GNP) and short-run AS curves
are determined by:
– A. The size of the labour force.
– B. Physical and human capital.
– C. Advances in technology.
• Some of the Policies affect AS
1. Foreign direct investment
2. External assistance
3. Investment in education
4. Centralised wage bargaining
5. Fiscal policy
6. World economy






Affects B and C.
Affects B.
Affects B and C.
Short-run AS curve.
Affects A, B and C.
Affects B and C.
• Result: the long-run and short-run AS curves shift to
the right.
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AD
• AD curve is determined by: Consumer
expenditure (C), Investment (I), Government
expenditure (G) and Net exports (NX).
• 5. Fiscal policy

affects C, I and G.
• 6. World economy  I and NX.
• 7. EMU entry criteria
 C, I and NX.
• 8. Exchange rate policy 
NX.
• Result is a shift of the AD curve to the right.
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Overall
• Equal movement of the AS and AD curves resulted in
very fast real growth rates with little or no effect on
inflation.
• 1994 – 2000.
• Average real growth rate = 8%
• Average inflation rate = 2%
• If the shift in AD > shift in AS, inflation would have
increased by considerably more.
• Employment increased from 1,118,300 in 1993 to
1,745,000 in 2002.
• Unemployment rate fell from 14.5% to 3.6%.
37
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
Graphical Representation
Natural real
GNP
Inflation
AS1
 AS2
1
 AD1
 AD2
Real growth rate
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
38
The End of the Celtic Tiger
Era
•
After 2000, the real growth rate fell
significantly.
– The era of the Celtic Tiger ended in 2000.
•
Ireland suffered periodic adverse shocks:
1. Downturn in the US and European economies.
2. Fall in equity markets due to unrealistic profit
expectations and corporate accounting
scandals.
3. Foot and mouth crisis in 2001.
4. September 11th terrorist attack in 2001.
5. Subdued domestic demand.
39
 Leddin and Walsh Macroeconomy of the Eurozone, 2003
The business cycle
Rate of growth of real GNP
12
10
8
% 6
4
2
0
2000
2001
2002
2003
2004
40
Slowing employment
growth
Numbers at work
(Quarterly growth rate : year on year)
7
6
5
4
%
3
2
1
0
19
1
1
2
2
2
2
2
98 999 999 000 000 001 001 002
q4
q2
q4
q2
q4
q2
q4
q2
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Explanations for slow-down
• Growth at the pace reached in the late
1990s not sustainable
– Catch-up phase must come to an end
– By 2000 full employment had been reached
– Capacity constraints
• Especially infrastructure, housing
– Inflationary pressures
• Loss of “super competitiveness”
• Relatively high inflation could be seen as an inevitable
part of the adjustment process under a fixed exchnage
rate
42
External factors
• The US economy entered a recession
early in 2001
– Bursting of the great technology bubble
– Followed by 9/11
• The flow of FDI from the US slowed
sharply
• The decline of the euro was reversed
– Ireland loses competitiveness vis a vis UK, US
• Foot and Mouth Disease in 2001
– Impact on Tourism
43
Composition of employment
growth
• Since 2001 the numbers at work in
Industry have fallen by about 10%
– Over half of this fall was in the “high
tech” Electronics sector
• Forecasts of labour shortages a thing of the
past!
• Illustrates hazards of “manpower
forecasting”
44
Importance of service employment
• Service employment has continued
to grow
– But recently most of this growth has
been in public sector services
• Health
• In modern, wealthy economies the
service sector is the growth sector
• Breakdown of total employment
– Services 66% Agriculture 6%, Industry
28%
– Manufacturing 17%
45
• Most of this period unemployment did not rise by
much
– Not much evidence of rise in hidden unemployment,
such as a fall in participation rates or an increase in the
numbers of “discouraged workers”
• May be changing now
46
Medium-term prospects
Remember that the growth of an
economy in the long term is
determined by two factors
• The rate of growth of employment
• The rate of growth of productivity –
output person at work
47
The rate of growth of
employment
• Negative in 2008/9
• But in medium term (2012?) likely to be
fairly high for some year to come
– Due to demographic factors
– Some further increases in participation
– Immigration?
• Maybe 1% to 1.5% over the medium term
48
Productivity growth
Remember, there was no productivity
miracle in the 1990s
But we should be able to maintain a
2% to 2.5% growth in output per
person employed
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Total growth
Labour force 1% - 1.5%
Productivity 2% - 2.5%
Total growth 3% - 4%
Remember we’re talking about real
GNP
50