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Ireland's journey from economic struggles to prosperity in the late 20th century, with rising living standards, reduced unemployment, and robust tax policies that fueled growth. Explore the factors behind Ireland's rapid development and economic success during the 1980s and 1990s.
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The Centre for the Study of Small States, The Source of Wealth in Small States University of Reykjavik Small States as Financial Centres Ireland as a Case Study Brendan Walsh University College Dublin 14th September 2007
The Irish Experience Between the 1980s and the end of the 1990s, Ireland moved quickly up the international league tables in terms of average living standards. The Irish labour market was also transformed from one of the worst-performing to one of the best-performing in Europe.
Rising living standards Despite the opening up to external trade and investment in the 1960s and entry to the EEC in 1973, Ireland in the 1980s remained relatively poor by western European standards. However, between the late 1980s and the year 2000, very rapid growth in GNP raised Irish income per person (adjusted for differences in purchasing power) to or even above the EU average.
Not “just” wealthier . . . Healthier also Irish life expectancy had been slowing rising, and mortality rates slowly declining But since the late 1990s they have surged ahead and caught up with the most advanced nations Belies the complaints over the poor delivery of state controlled health services
During the boom The rich got richer and the poor . .. Got richer too Dramatic decline in absolute poverty The the biggest cause of social exclusion – unemployment – fell extraordinarily raidply during the second half of the 1990s
The Irish labour market was completely transformed Since the early nineteenth century Ireland had been a prime example of a “labour surplus economy” • Overt unemployment kept in check • By emigration • By large subsistence agricultural sector • By low labour force participation rates Until the 1980s….
A renewed population Net emigration turned into net immigration so that by the end of the 1990s Ireland had the fastest growing population and labour force in the EU – reversing the long decline in our population that was the clearest symbol of our national failure after Independence
Explaining the boom • No single “magic bullet” We can classify the key factors into • Favourable demand side shocks and • Favourable supply-side responses
Demand-side developments • Fiscal correction and renewed confidence • Reduced tax burden • Cross party support for tough policies • Falling real interest rates • Run-up to Euro • Strategic exchange rate weakness • Global boom
Supply-side developments • Increased inflow of FDI • Full integration into the EU • Increased attractiveness of Ireland’s low corporation tax regime • Investments by premier US companies in IT and Pharmaceuticals • Increased inflows of EU structural funds
Supply side developments • Elastic labour supply • High initial unemployment • Return migration • Low initial participation rates • Rising educational attainment of outflow from education system • Wage moderation • Role of centralised wage bargains
Structural labour market reforms • Stricter social welfare regime • Falling unemployment benefit replacement ratio • Active labour market policies
Changes in social welfare code • Stricter eligibility criteria • Reduced replacement ratio • (facilitated by cuts in income tax rates) • Some reclassification of the unemployment into “inactive” • More spending on active labour market policies, less on income support
The Contribution of Tax Policy • The rising burden of taxation, and widening tax wedges, contributed to the protracted recession of the 1980s • The reversal of these trends contributed to the rapid recovery of the 1990s. • A return of “social partnership” in 1987 facilitated these developments • Trade of nominal wage claims for income tax cuts
The facts • During the first part of the fiscal correction, the economy seemed to shrinking • When the emphasis shifted to expenditure control – rather than tax increases – the economy grew strongly • Cause and effect less straightforward!
Corporation Tax Policy The tax regime experienced by business in Ireland has remained stable over long periods and consistently favour a low tax rate on profits: • A zero tax rate on profits from exports lasted from 1954 to 1980. • A 10% tax rate on manufacturing profits applied from 1980, and will continue until 2010 for those entitled to it in July 1998. • A 12½% tax rate on corporate trading income applies from 1/1/2003 and is EU approved.
Corporation Tax Policy Full repatriation of profits was always permitted However, a generous corporation tax regime not sufficient to attract FDI: But when combined with a well-educated labour force, competitiveness wage levels, and open access to the large EU market, it worked wonders
Not all the effects of this policy are positive Transfer pricing and the growth of an entrepôt economy Sectors with extraordinarily high value added per employee Round Island One (Microsoft) • Turnover $3.9 billion • Value added per employee $2.5 million • Corporation taxes paid in Ireland: $3.8 million
Impact of transfer pricing Very marked in sectors such as • Pharmaceuticals • Soft ware • Microelectronics • Certain food concentrates (Coca Cola) The gap between GDP and GNP is now 15% of GDP – a world record
Corporation Tax Policy The present uniform low rate of corporation tax has been used in particular to drive the development of Ireland’s international financial services sector, where employment has grown spectacularly. It has also generated uneasy among some EU members, who fear that “tax competition” will lead to a “race to the bottom” Ireland is strongly opposed to “tax harmonization” as a response to this.
International Financial Services The International Financial Services Centre (IFSC). established with EU approval as a tax-incentive zone in 1987. Initially a ring-fenced tax jurisdiction in a designated area in the north inner city of Dublin. Since December 2000 new cross-border international-financial services companies are taxed at the new standard rate of 12.5 per cent The Centre has become an integral part of the jurisdiction of Ireland
International Financial Services The initial employment target of 8,000 jobs has long been exceeded. The level of employment in the wider Irish international financial services sector has reached 22,000 by 2006. The largest single sub-sector was banking, which employs 9,923, followed by Fund Management, with 9,227, and Insurance, with 3,027. Thus the original scheme has been extremely successful, exceeding its overall employment targets and creating a significant international financial service centre in what was until recently a derelict area of Dublin. Attracted large inflow of service FDI
Fallout from US sub-prime mortgage market • On 15th August 2007 Sachsen LB Europe plc confirmed that its Dublin subsidiary in Dublin, the Ormond Quay conduit, had to be rescued by a loan of €17.3 billion. • This episode highlights the need to have a single financial regulator across the Eurozone and drew some unwelcome attention to the nature of some of the firms in Irish International Financial Services Industry.
Summary Many favourable factors came together to create the Irish economic “miracle” Rapid economic growth was facilitated by • Favourable external developments • A successful fiscal correction • An elastic labour supply and increased flexibility of the labour market • Increased inflows of FDI • Increased flows of EU structural funds
Summary The reversal of the upward trend in the burden of taxation after the mid-1980s was undoubtedly a key feature of the fiscal adjustment This reduced tax wedges, especially on labour, and stimulated an increased supply of work effort It was facilitated by the return to “social partnership” in 1987 The effectiveness of Ireland’s low corporation tax rate greatly increased in the new global economic environment of the 1990s.
Summary The extension of Ireland’s low corporation tax rate to a ring-fenced International Financial Centre in Dublin in 1987 proved hugely successful There are now 22,000 people employed in International Financial Services in Ireland and the sector has been integrated into the economy.
The future… The economy has now entered an adjustment phase. The construction sector, which accounts for 12.5% of employment and fuelled a very high level of immigration, is now contracting How rapidly? The exceptionally buoyant fiscal situation is deteriorating
The future It remains to be seen how steep the slowdown will be and which sectors of the economy will be the engines of growth going forward