TCS Daily


The Celtic Tiger: Secret of Success Unveiled

By Hans H.J. Labohm - March 28, 2005 12:00 AM

Europe's economic performance is nothing to get excited about. Yet one European member state seems to defy the law of economic gravity: Ireland - the Celtic Tiger.

Workforall, an independent European think tank, based in Belgium, has compared the economic performance of various European economies -- particularly Belgium and Ireland -- over the period 1984 - 2002. They found that there were surprisingly large differences in economic growth and GNP p.c. (Gross National Product per capita). Belgian real growth over this period of 18 years amount­ed to 42%, while Ireland achieved 167%! Consequently, the Celtic Tiger has moved to the top of the European league: from one of the poorest to one of the most prosperous countries. What is the secret of its success?

 

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

           


 

In 1985, the Irish economy was in a shambles. It was facing excessive budgets deficits and minimal growth. Its GNP p.c. amounted to only 65% of the Belgian level. In addition, Irish unemployment stood at 17% against 10% for Belgium. Until 1985 both countries followed similar Keynesian policies of deficit spending. In 1983 Belgian public spending even exceed­ed 50% of GNP.

Excessive spending triggered a vicious circle of continuing rises of the tax burden and public debt. The graphs above show that until 1980 Irish public spending followed the same path as that of Belgium, with similar growth performance. However, in 1985 Ireland made a u-turn. It drastically lowered the tax burden. All wasteful government spending was eliminated. In three years time public spending was reduced by no less then 20%. The result was that Ireland entered a period of explosive GNP growth, averaging 5.6% from 1985 to 2002. This is rough­ly three times the Belgian growth rate. The boom went hand in hand with the creation of new jobs, which was far in excess of that in Belgium.

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

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

But can the Irish model be emulated by other (European) countries? What about the fallacy of composition? One could argue that some formulas which perform well on a small scale, are not successful on a larger scale. For instance, the theatre visitor whose view is hampered by the hat of the lady before him, will be able to gain a better view by rising. But if all people will follow his example, his initial advantage will vanish. But I don't believe that this is true in this particular case. Anyhow, it is not what Adam Smith has taught us: economic exchange is a positive sum game.

It that all there is to say? I don't think so. Because Ireland belongs to the Anglo-Saxon world with English as its main language and its shared values, such as (economic) freedom. These assets may give it an edge over many continental European countries as regards direct foreign investments. But it seems to me that these extra advantages do not detract from the central conclusion of the study: reduction of taxes is conducive to growth.

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As a Scot I think this is one of the most important items TCS has ever done

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