Question

(a) Briefly characterise Irish economic policy from the foundation of the State in 1922 until the late 1950s.

(b) What is stabilisation policy? What are the difficulties of implementing a stabilisation policy?

(c) Describe the Irish experience with stabilisation policy and active budgetary management in the 1970s and 1980s.

Answer 1

a. Over the period 1912 to 1923, from the introduction of the third Home Rule bill and associated
Ulster crisis to the creation of the dominion of the Irish Free State in 1922, Ireland underwent a
constitutional revolution. The aim of this essay is to detail the economic context of the Irish revolution
and also to outline longer term effects that the revolutionary period had on Irish economic
development. The answer to the above question is predominantly on the area of the island that became the
dominion of the Free State, although comparison and reference is made to the ‘home rule’ polity of
Northern Ireland. The period of reference is 1914 through to 1938 as political and economic
grievances from this period were unresolved until 1938. Thus the Irish revolution straddles the FirstWorld War, the interwar period and the outbreak of the Second World War. In addition, key
international economic factors will be discussed. The IFS and NI were born into an unprecedented
economic environment. The effect of the war time boom is crucial to gaining an understanding of the
difficulties of post-war adjustment; in addition, the global economy experienced one of its greatest
contractions from 1929 to 1933.
Nationalist politicians and propagandists in the late nineteenth and early twentieth centuries
appear to have had clear views of what the economic benefits of an independent Ireland would yield.
To them, independence either in the form of Home-Rule or legislative independence would see the
development of ‘Irish’ industry via protection from international competition. However, notably
absent from this southern nationalist paradigm of economic development was the industrialised north
of the island. Unsurprisingly, predominantly northern Unionists had opposing views of political
economy that perceived free trade as the foundation of their success. The polarised views of the Irish
economy, north and south, were crystallised before the outbreak of the First World War and the
subsequent dislocation of the global economy. Both polities that emerged from the partition of
Ireland faced a changed and evolving economic environment and as small open economies they also
were exposed to similar international economic trends; however, at the outset the north was more
industrialised and remained part of the Union (and thus did not engage in a trade war with the UK in
the 1930s).
Independence gave the Irish Free State (IFS) greater potential control over all aspects of economic
policy. Notably, the IFS was distinctly different from what had been envisaged from the 1886, 1893,
1914 Home Rule bills (act in the case of the latter) and the 1920 Government of Ireland Act in that it
enabled the IFS to have control over excise and customs, i.e. protection; whereas Northern Ireland
(NI) became an example of Home Rule economic structure. Notably, however, the nascent
revolutionary clique involved different personnel to the pre-war Home Rulers and the first Dáil’s
democratic programme also raised the spectre of alternative Bolshevik/socialist options prevalent in
post-WWI Europe. Despite these revolutionary changes, economic policy in the IFS adhered to
contemporary orthodoxy’s. And although a revolution in trade policy occurred in the IFS with the
arrival of Fianna Fáil in government in 1932, even here the actions were more a response to a
changing international environment rather than the IFS acting independently. That being said, this did
not stop the IFS taking the process further and becoming one of the most heavily protected countries
in Europe.
. First I will set out the developments from 1914 through to
independence in 1922, secondly it focuses on the period 1922-1931, the establishment of the IFS until
gradual protection was introduced, and lastly centres on the period 1932-1938, when Fianna Fáil
were in office until the signing of the Anglo-Irish agreement.

1 Boom and bust, War and Revolution, 1914-1922
Both the IFS and NI inherited economic structures shaped by interactions with the increasingly
integrated global economy of the late nineteenth century. The Irish (north and south) economy had
operated in integrated commodity, capital and labour markets. Commodity market integration was
evident in the free trade practices of the UK and both agriculture and industry operated in competitive
international environments where prices were a reflection of international conditions. Detailed trade
statistics are unavailable for the nineteenth century; however, when the Department of Agriculture
and Technical Instruction began publishing trade statistics it is evident that Ireland’s largest trading
partner in terms of both imports and exports was Britain. Capital market integration was evident in the
adherence to the international gold standard – implying a fixed exchange rate with other countries on
the gold standard – and the free movement of capital. Labour markets were highly integrated and
emigration rates were high in nineteenth century Ireland as migrants entered labour markets in the
New World and also in Britain. The growing global economy from 1870 to 1914 created the
incentives and markets for both industry and agriculture in Ireland as a whole. However, these
developments were dramatically halted by the outbreak of War in August 1914 and the gold standard
was quietly suspended soon after,
ending a prolonged period of relative economic and monetary
stability. Debate exists over the economic performance of Ireland in the late nineteenth and early
twentieth century, recent estimates by Geary & Stark suggest that Ireland was one of the fastest
growing regions in the UK over the period 1870-1911 and that growth was primarily caused by
traditional forces namely capital accumulation and total factor productivity growth.
The First World War was something of a boom time for the Irish economy (north and south).
Agriculture and industry profited from reductions in international competition and increased demands
resulting from the War effort. The boom conditions are evident from trade data which show how net
exports peaked, in real terms, in 1918. The boom lasted until 1920 but was followed by a prolonged
depression in prices both north and south of the border.
The war dislocated traditional migration patterns as transatlantic avenues were effectively closed
off for the duration of the War. However, the War recruitment drive was an outlet for many would-be
migrants. According to recent estimates by Bowman, as many as 210,000 Irish men, in addition to a
few hundred Irish women, served in British armed forces and of these approximately 19 per cent died
in battle with countless others returning maimed or wounded. Those serving and dying represented
approximately 15.15 and 2.88 per cent respectively of the 1911 occupied male population. Recruits
were predominantly from urban areas with Army reports on recruiting in 1916 indicating that recruits
from Belfast (31 per cent) and Dublin (19 per cent) comprised 50 per cent of total recruits over theperiod 2 August 1914 to 8 January 1917. Moreover, the recruits from Belfast and Dublin were also
disproportionately large, with rates per 1,000 population of 148 and 74 for Belfast and Dublin
respectively compared to the nationwide figure of 39. War recruitment thus had a disproportionate
impact on urban areas compared to the rural hinterland. It is unclear why urban areas were more
represented in the recruitment drive. Rumpf and Hepburn suggest that unemployment,
underemployment and low wages were powerful recruiting agents in Ireland, which may explain the
predominance of urban recruitment. Those returning from the War entered a changed labour market.
Although emigration outlets re-opened, employment prospects for ex-servicemen were bleak,
however a number found employment as auxiliaries and temporary constables in the RIC (Black and
Tans) to counter the Irish insurgency.
The service sector of the Irish economy was reasonably developed in areas such as banking and
finance, postal services, transport and retail. This is evident in the case of the banking sector which
was prevalent throughout the island via the operation of branches. The suspension of the payment of
notes on demand during the war led to an increase in the note issue of Irish banks and contributed to
the general inflationary environment. Ireland also had an extensive rail network; however, the Irish
rail system had a significantly lower profit to mileage ratio compared to the British rail system due to
the lack of high-value goods being transported. During the War, railways in the UK were placed
under state control and in the case of Ireland this lasted until 1921.e control resulted in wage
increases to placate labour demands and left the railways making heavy losses in 1920 and 1921; thus
the new polities inherited an unhealthy transport infrastructure.
The revolutionary period led to some economic dislocation, however as evident from the trade
data in , the economy did not come to a standstill. As noted by De Valera in the second session
of the Dáil in April 1919: ‘it is obvious that the work of our government cannot be carried on without
funds.’ The counter-state apparatus and revolutionary campaign were financed by loans raised in
Ireland (£0.38m) and a US$5.7m (c. £1.29m) loan from the US raised through bond issues. On the
other hand by 1917, illustrative of the support for the War effort, £29m worth of British War debt was
held in Ireland by both the general public and the banks.
Revolutionary activity led to reprisals from auxiliaries and Black and Tans, which included the
looting of shops and pubs and the burning of houses and creameries; the burning of Cork City being a
particularly infamous case. Attacks on cooperative creameries were noted by contemporaries,
particularly the cooperative parent body the IAOS, and later historians. What is often overlooked,
however, is that attacks on creameries were sometimes linked to underlying commercial disputes. For
example, in 1919 the proprietary creamery Slattery’s was attacked with gelignite. This incident
followed the victory of McEllistrim, a supplier of Slattery’s, in a restraint of trade suit against the
Ballymacelligott cooperative creamery in in the House of Lords. The attack on Slattery’s resulted in
further litigation, as Slattery’s sued the Ballymacelligott cooperative for damages and loss of trade.

2 Change yet continuity? 1922-1932
After the establishment of the IFS in 1922, the newly created government faced challenges
putting its finances in order and had to rely on short-term borrowing from Irish banks for the first few
months of its existence. There were also difficulties raising and collecting taxes in the early years
due to evasion and avoidance. Initial inquiries made by the Department of Finance to the Irish banks
and the Dublin stock exchange about long-term borrowing suggested that a UK guarantee would be
essential for a loan floatation to be successful. However, these views proved to be incorrect and the
First National Loan was in fact over-subscribed and succeeded without the assistance of the Irish
banks. The government share of the economy grew slowly from 23 per cent of national product in
1926/27 to 30 per cent of national product by 1938/39. However, government debt increased from
17.2 per cent to 38.4 per cent of National Income from 1928 to 1935.
Contemporary opinion was positive, the Economist noted how the IFS government had ‘restored
order within its boundaries and having completed its organisation as the Government of an
independent unit, politically and economically, is in a position to close the list of applications for its
first national loan.’ It noted how the £10m loan had been fully subscribed by the public, without
support from the banks, and highlighted how ‘it is a notable event, which cannot be without important
reactions upon the prestige and stability of the new system...and as it is an internal loan, it constitutes
a declaration of faith which will operate and continue to operate with cumulative effect. Abroad, the
event will do much to wipe out the unhappy impression created by Irregulars' hysteria, which has
been so completely suppressed by Government firmness.’ Although outstanding debts increased
over the period 1923-1938, National loans mainly traded at a premium and current
yields ranged between 3 ½ and 5 ½ per centIn terms of fiscal policy, there was no stampede towards protectionism in the IFS. In fact, free
trade was the norm in the 1920s as the UK (including NI) and the IFS attempted to return to pre-war
orthodoxy. Although a tariff Commission was established in the IFS, it did not result in a blanket
introduction of tariffs. No formal trade agreements existed or were required between Ireland and the
UK during this period as both partners adhered to pre-war orthodoxy. The IFS and NI also inherited
the burgeoning welfare spending of Edwardian Britain, which included pensions and social insurance.
The IFS policy of balanced budgets required cuts to be made in this area, NI was able to maintain
welfare spending at British levels thanks in part to a Westminster subsidy. In addition, income tax was
cut in the IFS to levels below those inherited from the Union. There were orthodox economic
underpinnings to this policy as it would prevent capital flight and to encourage return migration,
however a more important consideration was to keep Irish rates in line or below UK rates so as not to
lose the few existing direct tax payers resident in the IFS.
Another important facet of early IFS policy was also picked up by The Economist, namely that the
IFS did not create a separate currency and ‘was in no hurry to establish one.’ With a de-facto common
currency during the 1920s, the IFS and NI shared a similar monetary experience. The Irish pound
was pegged to Sterling and experienced similar trials and tribulations of the restoration of gold at
parity that was experienced in Britain, i.e. deflationary pressures as the IFS was required to adhere to
balanced budgets and ‘sound finance’. When Britain abandoned the gold standard on 26 September
1931, the IFS followed shortly after: the IFS pound was essentially a sterling-backed currency. The
close relationship between British and Irish monetary regimes is reflected in price levels with changes in the Irish and British CPIs experiencing almost perfect correlation over the
period 1901-1979 and various sub-periods.
Why was the IFS rigidly conservative regarding the possibilities of monetary change? There are
several possible explanations. As the majority of civil servants were in office prior to the
establishment of the IFS and were trained by HM Treasury, perhaps there was little willingness or
ability to adopt a radically different course. In addition, the new state was aware of the importance
of creating confidence in the state and radical institutional change would have threatened business
interests in Dublin. Contemporary events also appear to have been a factor. The experience of hyper-
inflation in post-War Europe was an obvious deterrent to any monetary experimentation. This is
evident in Dáil debates surrounding the 1926 coinage act when Major Cooper warned that ‘once you
begin to tamper with currency you being to operate an inflation that leads to national disaster…the
first step that France is now treading – the road to national humiliation, because she is absolutely
unable to meet the demands of her creditors’.
Moreover, perhaps Irish orthodoxy was simply a
reflection of the conventional wisdom of the time which equated monetary stability to a currency
backed by gold. For example, Arthur Griffith’s thoughts relating to monetary matters were for the
Irish public to refuse to accept paper money and demand to be paid in gold in order to build up Irish
supplies of gold. When Britain left the gold standard in 1931 it was an unexplored policy option.

Pre-partition, the economic geography of the island of Ireland saw the concentration of industrial
activity in the north-east of the island; geographic concentration was also a common feature across
Europe. Thus, when new political boundaries created the NI was not the reflection of the
existing economic geography and created a political necessity to develop industrial capacity within
the IFS. One of the most famous industrial developments south of the border was the establishment of
a Ford factory in Cork, although this pre-dated the establishment of the IFS and Ford had personal
rather than purely business motivations for the choice of location in Cork. Later developments of the
Cork Ford factory were influenced by trends in the domestic and international trading environment.
The 1920s also saw the development of semi-state bodies in the IFS. A prominent example of this is
the construction between 1925 and 1929 of the Ardnacrusha hydroelectric dam by the German
electrical firm Siemens-Schuckert, the proposed cost of the scheme was estimated to be £5.2m. The
Electricity Supply Board (ESB) was established in 1927 to administer the distribution of electricity.
The symbolism of the ESB and the construction of a modern hydro-electric dam were perhaps more
important than its immediate economic function.

The IFS had a delayed experience of the Great Depression. This is partly explained by the fact
that the IFS was primarily an agricultural producer specialising in livestock and had a limited
manufacturing sector. But the IFS (as well as the UK) was also helped by a stable financial system
which did not experience any of the US-centric banking crises as outlined by Friedman and Swartz
between 1929 and 1933. More importantly, as Eichengreen argues, countries that left the Gold
Standard earlier recovered from the Depression more quickly. Thus, by following British monetary
policy, the IFS may in fact have been spared a possible worse fate in the 1930s. However, despite this,
rising unemployment coupled with a strain on US and UK labour markets led to changes in economic
policy. Import tariffs were introduced in November 1931 to prevent dumping; these werecontemporaneous to similar measures in the UK (which applied to NI). With the increasing
unemployment and reduction in emigration outlets, it was likely that demand for some form of
government intervention might occur.

3 An economic revolution or a sign of the times? 1932-38
The election of Fianna Fáil in February 1932 is seen as a radical change in economic policy in the
IFS. Yet the 1930s was characterised by three separate factors: the Great Depression, the Economic
War, and Fianna Fáil protectionist policy. All three are interrelated and difficult to disentangle, thus it
is difficult to make definitive statements over which factor had the greatest impact. NI also
experienced the Great Depression but began to operate in a protected environment too as the UK
implemented protectionist measures. The NI agricultural sector also received protection and subsidies
from Westminster. However, the NI government was unable to attract and develop new industries as it
was for all intents and purposes insolvent, as a result NI had some of the highest regional
unemployment rates in the UK.
The escalating protectionism of the IFS must be seen both in the context of the global depression
and in the light of an Anglo-Irish trade war following a default by the IFS on inter-governmental
obligations. As noted above, the Cumann na nGael administration introduced protective tariffs in
November 1931. The tariffs introduced in 1932 were primarily the result of a political dispute. In June
1932 the IFS defaulted on obligations under the Treaty and subsequent financial settlements; the first
(and only) default in the history of the IFS. These were primarily repayments of loan instalments by
farmers under the pre-independence land acts, in total these payments amounted to £5m per annum.
The dispute has conventionally been portrayed as an inter-country payment dispute rather than a
default. However, recent work by Foley-Fisher and McLaughlin illustrate how the default impacted
on Irish land bonds, securities issued to finance Irish land reform. Prior to the default in 1932 there
was a premium on land bond yields reflecting the uncertainty that bondholders had regarding the
repayment of these bonds. When the Irish government defaulted on these bonds the British Treasury
met its guarantee and the premium on land bonds disappeared. At the same time, the premium on land
bonds issued by the IFS increased.
The political context of the annuities dispute helps to understand the underlying motives of the
Fianna Fáil administration. The annuities were part of a deliberate strategy to remove the remaining
vestiges of the Treaty that were unpalatable to De Valera and his Fianna Fáil colleagues (e.g. the Oath
of Allegiance to the British Monarchy and the Governor General). The British response to the
default was to levy tariffs on IFS imports, most notably cattle, in an attempt to recoup the expense of
servicing these debts. This too was politically motivated as it was believed that by hurting Irish
farmers it would undermine the support for Fianna Fáil. However, the IFS immediately retaliated
against the British tariffs with its own counter-tariffs. The dispute led to further tariffs levied on the
IFS by virtue of it being unable to reach an accord at the Ottawa meeting of the Commonwealth. Also,the dispute did not harm the electoral prospects of Fianna Fáil and when the opposition Cumann na
nGael declared it too supported Fianna Fáil policy, attempts were made to reach a settlement. The
economic war was gradually ended with bi-lateral trade agreements between the UK and the IFS in
1934 and then again in 1938. The 1938 Anglo-Irish agreement led to the payment of a lump sum of
£10m as a settlement for the underlying default, further agreements were also reached on trade and on
the treaty ports.
The rise of economic nationalism along the lines of import substitution/infant industry arguments
has its roots in Griffith’s ‘Sinn Fein policy’ and the first Dáil programme. The implementation of
these ideas through the protection of Irish industry can also be viewed as a nationalist solution to the
problems of unemployment and emigration from the IFS which continued throughout the 1920s and
30s, although slowed somewhat by the depressed economic conditions abroad. The 1930s is seen as a
radical change given the protectionist policies adopted by Fianna Fáil but in the context of the time
there was not much else the government could do given the self-imposed monetary constraints of the
IFS. Apparent gains in employment are evident from existing statistical material although serious
doubts have been raised about the Irish censuses of production as the increases in employment have
been attributed to the wider scope of the returns. Protected industries – despite local lobbying – were primarily located around key ports as
they were dependent on imported raw materials and the majority of employment was located in and
around Dublin. Further efforts were made to increase employment in agriculture by encouraging
tillage, however here too there were limited gains.

b. Stabilization policies are fiscally oriented and designed to reduce fluctuations in certain areas of the economy (e.g., inflation and unemployment) while aiming to maximize associated national income levels. Fluctuations can be controlled through various mechanisms, including policies that stimulate demand to counter high levels of unemployment and those that suppress demand to counter rising inflation.A stabilization policy is a macroeconomic strategy enacted by governments and central banks to keep economic growth stable, along with price levels and unemployment.

Limitations in implementation of the policy:

There are certain limitations to society's ability to achieve macroeconomic goals such as economic growth and stability through monetary or fiscal policies.

• One limitation of monetary and fiscal policies concerns the timeliness of the government's response to changing economic conditions. Time lags occur between the recognition of an economic problem, and the creation and implementation of appropriate stabilization policies to deal with the problem. For example, it was not until December 2008 that the National Bureau of Economic Research (NBER) announced that the U.S. economy had entered into a recession in December 2007. Thus, the NBER announcement came a year after the change in the business cycle had occurred. Time lags are inevitable considering the complexity of modern economies. Time lags are especially troublesome when formulating fiscal policy because a greater number of elected representatives in Congress must agree on a suitable set of tax policies and spending programs.

• A second limitation is the politicization of economic problems. Political pressure on elected officials has risen dramatically in recent years. The architects of fiscal policy in Congress feel these pressures. Political gridlock has thwarted the spirit of compromise on sensitive issues related to taxation and government spending—the two main tools of fiscal policy. From 2009 to 2012 this gridlock even prevented the federal government from passing a federal budget. Political gridlock associated mainly with the funding of the Affordable Care Act also resulted in a partial federal government shutdown in October 2013. Appointed governors of the Federal Reserve System, on the other hand, are more sheltered from political pressures as they form the nation's monetary policy.

• A third limitation is the uncertainty of policy coordination. There is sometimes disagreement between the Fed and the nation's highest elected officials about what constitutes an appropriate stabilization policy. In the early 1980s, for example, the United States faced two economic problems: rising inflation and recession. Fed chairman Paul Volcker implemented a tight money policy, which decreased aggregate demand, to fight skyrocketing inflation. Meanwhile, President Ronald Reagan and Congress pursued aggressive tax cuts—an expansionary fiscal policy—to reverse the economic downturn and revive the sputtering economy. These conflicting policies sent mixed messages to the economy.

c. In the early part of the century Irish living standards were judged comparable to
those of north European economies such as Norway and Finland (O Grada 2001), with
per capita levels of about 50 per cent of the UK, but greater than countries such as Italy,
Greece and Portugal, and were converging toward levels in Britain and most of Western
Europe (Lee 1989). Following independence in the 1920s Ireland's relative position
began to slip. Explanations offered for this dismal economic record include institutional
and cultural constraints on performance (Lee ibid); the policy of import-substituting
industrialization, pursued by the Fianna Fail Party after coming to power in 1932; and
more recently the effect of the fiscal response to the oil crises of the 1970s (O Grada and
O'Rourke (1995). For most of the twentieth century, even well into the late-1980s, the
economic record was a rather dismal one. The seemingly chronic unemployment situation
led to a large flow of emigrants and dampened any form of entrepreneurial activity.
Ironically the civil service was a beneficiary as this offered one of the main possibilities
of employment for those who chose not to emigrate. Entry was by an extremely
competitive exam, and this led to a stable and technically competent cadre, who later
played an important role in implementing the policy initiatives that followed.
The cultural ethos of Ireland meant that during these economically dismal times,
there had always been an ongoing empathy with the less fortunate; even during the
toughest time there was a general willingness to ensure they had some, albeit small,
social benefits for unemployment, health and education. Stipends were available to the
unemployed. Virtually all had access to some minimum health care. Education, at least
up to the primary school level was available to all, and was supported by a school
network that ensured that almost all potential students were within walking distance of a
school.
2.2 Needfor Change
The overall approach to development sought to reflect to some extent the cultural
and social values of the society, but any significant improvements were largely stymied
by a seemingly ongoing chronic economic situation. The immediate impact of the two oil
shocks of the 1970s, further aggravated in the early 1980s by the high interest rates
resulting from the Volker anti-inflationary policies, led to further difficulty for the Irish
economy. By the mid-1980s the situation had reached crisis proportions. In spite of
ongoing emigration, unemployment levels were around 18 percent by 1987, while theexternal debt-to-GDP ratio was close to 120 percent. There was even some discussion
about a possible default. There was an increasing awareness that much of the population
had reached the limits of their tolerance. A broad consensus emerged among all major
players that the situation needed to be addressed, and in particular public finances needed
to be sorted out. In 1987, the recently elected Prime Minister, C. Haughey, pushed
through a set of dramatic actions, by using all political means to win support for reform
measures to address the situation. The opposition showed political maturity by supporting
the required cuts, even at their own political cost. It was evident that the fiscal situation
needed to be addressed as soon as possible, but there was also a serious unemployment
problem, a strong resurgence of emigration, poor economic growth and generally
deteriorating living standards. A centerpiece of the reform was a social pact, Program for
National Recovery (1987-1990), which essentially removed most of the rancor from the
macro debate and resulted in stable labor relations.
3. The Setting for Policy Change
3.1 Change
In addition to the social pact, and the associated improvement, several other
factors played salient roles. These included the openness to Europe, the break with
Sterling, the role of foreign direct investment (FDI), changes in technology, industrial
organization, and an increased awareness of the role of information. Because these
changes were contemporaneous, their specific impacts are quite difficult to unravel.
On the external side Ireland became a member of the European Community in
1973. This led to a broader free trade regime and introduced significant changes in
benefits especially to the agriculture sector. Perhaps even more significant, it heralded a
change in behavior and perceptions. Previously the United Kingdom and the United
States tended to have a dominant role, not only in economic terms but also in terms of
how people framed their view of the world. Ireland had a long tradition of emigration and
cultural exchanges to both these countries, while economic policy was heavily influenced

by the United Kingdom, the dominant trading partner. The increasing importance of the
European dimension led to a new awakening of a more global nature. The younger
generation especially, began to look to Europe, and education became more
cosmopolitan. At a different level, policymakers were more aware of the de facto
constraints of Europe and the associated rewards for prudent action. Foreign business saw
the advantages of an English-speaking, well-educated populace with ready access to the
large European market, and the broad institutional stability provided by the European
umbrella. This institutional framework helped foster more transparent and responsible
behavior, supported by better monitoring and accountability, especially in the use of
public funds. As this virtuous cycle got underway there was a steady increase in the
overall entrepreneurial spirit and a more positive "can do " attitude. First, we discuss
briefly some of the steps that led to the opening to Europe.
3.2. Opening to Europe
The direct implications ofjoining the European Economic Community in 1973
provided policy makers with clear markers to guide the economy along a more efficient
and less distorted path. While there were changes in many aspects of the economy some
of the more substantial were in two areas: trade and the agriculture sector.
Trade. Ireland became committed to joining a customs union with common
external barriers and, by 1977, had no internal trading barriers. Under the new free trade
regime Ireland's exports grew rapidly from 38 percent of GDP in 1973, to 62 percent by
1991, and to 86 percent by 1999. At the same time the composition and direction of trade
moved from exports of primary goods (mainly agricultural) to manufactures. The
direction of trade moved away from the traditional dominant share of the United
Kingdom . The share for the European Union (EU) remained stable at
close to 40 percent while that for NAFTA.increased substantially from 9.1 percent in
1987 to 17.9 in 2000.

Agriculture. Ireland benefited greatly from transfers through the Common
Agricultural Policy (CAP). This policy sought to support agricultural goods sold on the
world markets by maintaining them above world prices through closed markets. The
consumers paid the cost. Ireland, being a net exporter of farm goods, was a major
beneficiary. There are various estimates of the size of this transfer but it typically
represented around 2 to 6 percent of GNP per arnum. In 1981 agriculture accounted for
about 14.7 percent of employment. As the economy developed this share fell steadily to 9
percent in 2000. The numbers employed in agriculture fell from 167,000 to 117,000 over
this period. While one may argue about how appropriate the structural change was in
agriculture, the CAP transfers did provide a cushion during this transition. It remains an
open question whether providing a protective shield from the global competitive forces is
a good idea for the longer term. Many countries have also experienced the decreasing
importance of agriculture as an employment source. What is notable about the Irish
experience is that the sharp drop in agricultural employment was not accompanied by
major social unrest. Much of the surplus labor was absorbed into other sectors. For most
of the post 1973 period the other sectors were in the UK and US up to 1990. In the
nineties this was facilitated by having strong growth in other sectors, especially the
service sector, while at the same time support was provided by an active policy to address
unemployment.In addition Ireland also received resources from three structural funds, the
European Regional Development Fund (ERDF), designed to assist development of the
poorer regions; the European Social Fund (ESF), and the Guidance Section of the CAP
funds (EAGGF). A fourth fund, the Cohesion Fund directed at transport infrastructure
was established under the Maastricht treaty (1993). While some of these flows were
offset by government contributions the net receipts are estimated at around 3 percent of
GNP.
The broad objective of the structural funds was to enable Ireland to compete
unaided in the Single Market. Initially the allocation of these funds had varying degrees
of success, but over time a number of measures contributed to improved effectiveness of
these funds. They were targeted at the development of physical and social infrastructure.
For instance Community Support Framework (CSF) for the period 1994-99 sought to
allocate funds to priority areas in industry and human resources with an emphasis on
transport and tourism. This framework was integrated with domestic policy and
resources. There has been considerable analysis of the performance achieved under these
funds. In a detailed mid-year evaluation of the CSF 1994-9 Honohan (1997) chose to
dwell on a number of problem areas and suggested recommendations for change. For
instance he identified the need for upgrading certain types of public infrastructure, such
as non-urban roads and urban public transport to meet the needs of the rapid economic
growth. He also felt the need to better focus the active labor policy on those in need.
Sabel (1996) also reviews many of the institutional innovations introduced by the Irish
government. His focus is more on how they sought to address issues of social exclusion
in a more flexible, decentralized and participative way. He identifies the important role to
be played by local partnerships in reforming public administration. While he praises the
innovative dimension of these initiatives he raises some question about the need to build
stable institutions to sustain them, especially as the CSF resources are likely to diminish
in the near future.
The transfer of funds made a substantial contribution, but some of the benefits of
the EU association have come in a more indirect manner. The Maastricht Treaty that
became effective in 1993 provided a clear outline for achieving Economic and Monetary
Union (EMU) by the end of the century. This treaty came after the stabilization but it
helped remove (or at least sharply reduced) the possibility of inappropriate fiscal
expansionary experiments from the repertoire of policymakers by future governments.
Ireland joined the European Monetary System (EMS) in 1979. The initial
expectation was that Ireland would benefit from the low inflation Deutsche mark. A
series of devaluations took place, on average about one a year, with larger ones in 1983,1986, and 1992. For a small open economy like Ireland exchange rate policy is a major
concern as one seeks to balance the stability of a pegged system with the volatility of a
float. The Balassa-Samuelson dilemma of pegging a high to a low growth economy is
also likely to create some difficulty through inflation on non-tradables Presently the
European Council has established a European Central Bank and by 2002 the EMU will be
completed when the euro enters circulation. At that point Ireland will have as much
direct control over fiscal and monetary policy. This will create another set of challenges
not only in the economic sphere but also possibly politically, as some measure of
sovereignty is lost. In parallel with the opening to Europe was the increasing role to be
played by Foreign Direct Investment (FDI)
3.3 Foreign Direct Investment (EDI)
As the stabilization measures progressed it became evident that additional action
was needed to stimulate economic growth and address the unemployment problem. Given
the large external debt at the time (120 percent of GDP in 1987), it was evident that the
export sector needed to play a larger role. This in turn required a competitive economy
supported by adequate investment both in quantity and quality. With the macro situation
essentially out of the debate and stable labor relations in place, the focus then turned to
growth. The domestic economy after years of indifferent performance was largely ill
prepared to face international competition; much of the public sector had structural
difficulties in terms of communications, transport, and power. The Industrial
Development Authority (IDA), which had considerable experience in attracting foreign
firms but a mixed record in earlier years, sought to attract dynamic American firrns. A
well-educated work force, English-speaking, good labor relations and access to the large
European market was a major attraction, along with a low corporate tax rate, 10 percent
after 1979. However the experience in the 1970s and early 1980s indicated that although
some foreign firms took advantage of the various enticements, it did not lead to a strong
impact on the economy. Linkages to the rest of the economy were often weak, and some
of these companies tended to gravitate toward more favorable offers as they appeared in
other countries.
In the late 1980s a number of factors changed at the global level. Major changes
in industrial structure occurred as multinationals moved from the mass production modeltowards the Japanese style of greater flexibility. This in turn led to foreign branches of
these companies moving away from relatively insulated units, and toward a more flexible
model and one more integrated with the local economy. At the same time the companies
of the "new" economy were intrinsically more flexible. In particular new technology
reduced transport and communications costs, so that the geographic disadvantage of
being an island economy was sharply reduced. The IDA strategy was quick to perceive
these new trends, and was able to attract a number of flagship companies enjoying rapid
growth at the global level, such Intel and Microsoft. At the same time the IDA offered a
good platform for many of the large chemical and pharmaceutical multinationals. While
the domestic companies were somewhat slower in reacting to the improved economic
conditions, these multinationals were able to produce a dramatic increase in exports. By
1990 exports showed an annual increase of 8 percent.
During the initial three-year pact the strong increase in GDP and especially in
exports was not accompanied by serious inroads into the unemployment problem. There
was some discussion about these multinationals producing growth without employment,
while other critics felt they were simply using transfer pricing to take advantage of the
favorable corporate tax rates. However these new companies were building linkages with
domestic suppliers, and this was to become increasingly evident during the next few
years. Given the small size of the domestic market, the output of these companies was
heavily dependent on external demand, and therefore sensitive to the health of the global
economy. In a favorable global climate, especially for the technology sector, this FDI
strategy has a lot to offer. In addition to the direct impact on employment and exports, it
helped foster links to many domestic companies and also strengthened entrepreneurial
skills. In the event of a less favorable global climate, however, especially for the
technology sector, policymakers will face serious challenges. While one can expect a
long term benefit from gains in knowledge and entrepreneurial externalities, the fact
remains that many of the companies will continue to seek market advantages wherever
they occur and may be foot loose. The feature of greater links to the domestic economy
may turn out to be a disadvantage in any dramatic economic downturn. In this context it
would be helpful to examine to what extent the FDI success is driven by a favorable tax
regime and to what extent other features such as access to Europe, English speaking well
educated workforce play a role.