Debunking Myths: What Really Explains the Irish Economic Recovery?


Regan_Aidan HDIt has been a truly remarkable few years for Ireland and the European Union. In the space of five years Ireland has gone from being the basket case of the European Monetary Union to it’s number one success story. Economic growth is now the strongest in the Euro area, and according to the most recent data, this growth is having a real impact on employment. The dominant narrative among policymakers in the EU is that other peripheral states of the Eurozone should follow the Irish adjustment back to the market. This leads to two important questions. First, what explains this remarkable turnaround in fortunes for Ireland? Second, why are other Eurozone countries who pursued a similar adjustment still struggling to recover? Dr. Aidan Regan argues that the Irish recovery has nothing to do with the Troika-led adjustment of austerity and everything to do with the path dependent effect of a state-led developmental strategy.

Let’s unpack the official story. The European Commission argue that the Irish recovery is an outcome of the governments successful implementation of their structural adjustment program. This technical adjustment can be explained as follows. Ireland had to increase taxes and implement radical cuts in expenditure to bring down its fiscal deficit. Given that Ireland had lost competitiveness during the 2000’s (measured as increased labour costs), wages also had to be reduced. A reduction in wages and public expenditure negatively impacts domestic demand. But this negative effect is offset by the positive effect on exports. A strong state commitment to macroeconomic stability and improved cost competitiveness improved the real exchange rate (REER) and facilitated an export-led recovery. To put it simply, a growth in external demand (consumers outside Ireland buying more Irish produced goods and services) compensated for a contraction in the internal demand caused by austerity (Irish consumers, households and government spending less). It’s the German model of adjustment: commit to macroeconomic stability, compress domestic demand and expand exports.

Figure 1

Exports

Figure 1 clearly shows that Ireland has experienced an export-led recovery vis-a-vis other crisis afflicted countries of the Euro area. But is this growth in exports really associated with an improvement in price competitiveness? A decline in competitiveness for the European Commission runs as follows: increased labour costs = more expensive products = decline in exports = current account deficit. Therefore an improvement in competitiveness runs as follows: declining labour costs = better priced products = increase in exports = increased current account surplus. This model of competitiveness assumes a traditional industry and a classic manufacturing firm (think shoemaking, candle making or metal fabrication). The shoemaker who reduces (or at least stabilizes over a long period of time) the labour costs of his or her workers will be able to sell more shoes at a better price in bigger markets. It is this logic that underpins the structural reform strategy of the European Commission. National governments that reduce rigidities in their product and labour markets increase competitiveness, which in turn facilitates an export-led growth in a period of austerity.

The problem with this old fashioned concept of competitiveness is that the firms driving Ireland’s export-led recovery are in high-wage price inelastic sectors (biotech, pharmaceuticals, finance, business and computer services). What this means is that their products are less sensitive to movements in international prices. According to recent data from the CSO job churn survey, these sectors of the Irish economy (particularly ICT and Finance) experienced increased not decreased labour costs during the period of adjustment. They have been increasing wages and expanding jobs before, during and after the crisis. It is worth restating this clearly as it has important policy implications: Ireland’s thriving export sectors increased wages and jobs in a period when the public sector was reducing wages and costs. These exporters are primarily large US multinational firms who trade in complex international supply-chains in the expanding service sectors of the global economy. To compete they must move up not down the value chain. The German-EU structural reform agenda is premised on the assumption that all countries are built around the Rhine-Westphal metal manufacturing firm, where the classical model of competitiveness does apply. Ireland’s manufacturing sectors have been in decline for over a decade (computer hardware, optical equipment and medical machinery). It is true that if these firms (and the government) had radically cut wage costs in the 2000’s (in order to compete with Eastern and Central Europe) then these firms could have been kept in Ireland. But would we call this competitive success?

Figure 2

ServicesThe most important observations on Ireland’s export-driven recovery since 2009 is that it has occurred in the internationally traded services sectors of the economy: business finance and computer services  (see Figure 2). This expansion in ICT services has generally compensated for the decline in ICT manufacturing.  Many economists and policy commentators argue that the expansion of these ICT services is a total illusion and that there is no recovery at all. Those critical of the austerity agenda argue that the supposed  growth in exports reflects an accounting entry by US multinationals rather than real economic activity. It is a tax evasion strategy that facilitates a current account surplus, which makes Ireland’s adjustment look like a success story, whereas in actual fact the adjustment has decimated local Irish producers, who predominantly trade with the UK.

There is an element of truth in this, much like there is an element of truth in the macroeconomic stability and cost competitiveness structural reform narrative.  ICT computer services now account for over 50% of Irish service exports. This is primarily driven by large global US MNCs such as Google, Oracle, Facebook, Adobe, Linkedin, Amazon and Microsoft, to name but a few. Total service exports now account for approximately 90 billion, and these global tech firms, born out of Silicon Valley, account for around 40 billion of this. Google’s revenues are astronomical, and despite most of this revenue being generated through complex global supply chains, over 50% of it is booked in Ireland for tax purposes. Therefore, the figures are undoubtedly exaggerated. However, recent data from the annual Forfás employment survey does suggest that there has been a rapid expansion in jobs in the computer services sector, compensating for a decline in manufacturing jobs. To put this expansion in a qualitative context, Google established its Dublin European base in Dublin in 2004, employing less than 50 employees. They expanded during the crisis and now employ over 2,500 workers. Overall ICT services jobs increased from 2,900 in 2008 to almost 12,000 in 2013. In total, over 104,000 full time jobs have been created since 2012.

The export-driven Irish recovery is real (albeit somewhat exaggerated) and it is primarily occurring in the high-tech (and high-wage) sectors of the economy, leading some to conclude that Ireland is experiencing the side-effects of a new emergent Tech bubble in Silicon Valley. Provisional research by Brazys and Regan (2015) does suggest that Ireland is indirectly benefiting from QE in the USA. But the important point to note is that this expansion of inward investment has nothing to do with the policies of the Euro area or the Irish fiscal adjustment. It is the direct effect of a path dependent state-led developmental strategy to attract inward FDi from large global firms in high-wage, high-tech service sectors. To explain the Irish economic recovery one must trace the role of the state in the development of high-technology industries. Or, more precisely, the role of the public sector agent, the Industrial Development Agency (IDA), in attracting inward investment.  On the one hand this is related to low corporate taxes (precisely what the EU wanted to challenge in Ireland), but on the other, it is related to the cluster effect of having a large pool of skilled labour with general experience of working in the tech sector, and experience of the corporate culture of working in large US MNCs. Once Google set up in Ireland, they were soon followed by dozens of other companies, and most of these companies source their multi-lingual labour force from across the European Union.

The public policy story of Ireland’s FDI-development strategy has very different policy implications than what is being prescribed to Greece to get out of the crisis. To begin with, the industrial-enterprise policy begins in the public sector not the market. The core actor driving the Irish development strategy is an international network of low-key but highly influential political actors in the Irish Industrial Development Agency (IDA). Furthermore, the IDA are successful at attracting ‘winners’ not because of a specific administrative state structure but because they have the policy autonomy to operate independently from political parties in government. They were established in 1969, four years before Ireland joined the European economic community, and two years after a free-trade agreement was signed with the UK, and specifically tasked with promoting and attracting inward FDi. In the mid-1990’s their FDI strategy was explicitly changed to attract “high-performance” sectors, whose competitiveness is shaped by factors very different to classical manufacturing.

Figure 3

FDI

It is important to call the Irish recovery what it is: a state-led development strategy, coordinated by an autonomous public sector agent, specifically tasked (and adequately resourced) to attract investment from global firms in an internationally liberalized market (see Figure 3). Most economists assume that this type of state strategy will lead to clientelistic rent-seeking, whereby the agency gets captured by domestic business interests. All the state has to do is set strict rules, regulate for market competition and then get out of the way of private business. Therefore it is assumed that market liberalisation, not politics, shape FDi flows.  This is the assumption that underpins the European Commission DG for ECFIN analyses of industrial and enterprise policy. The only role for the state is to implement structural reforms of product and labour markets. Once this liberalization is achieved the positive effects of inward investment and entrepreneurship will emerge, naturally, by itself. In the Troika memorandum of understandings with the Irish government, and the country specific recommendations on how to tackle macroeconomic imbalances, there is zero mention of enterprise, education, skills or industrial developmental policy. Micro-economic supply-side policies imply nothing more than reducing costs, particularly in the labour market.

None of this is meant to suggest that if Greece and Portugal develop a functional equivalent to the ‘Irish Enterprise State that they will somehow develop the conditions for export growth. The Irish FDI development strategy did not suddenly emerged in 2009 but can be traced right back to the 1960’s. It is a deeply embedded state-development project that has changed and evolved over time (see O’Riain 2004). The most recent major change occurred when the IDA and it’s affiliate agencies gave increasing priority to attracting born on the internet firm, and to shift from attracting ‘hardware’ to ‘software’ digital enterprises. The enterprise policy strategy is not to capture a whole industry but to attract parts of a firm’s supply chain that specialize in specific activities of an industry. In the high-tech internet firms that now operate in Ireland, most of the focus was put on establishing user support services, marketing and sales. The state and the IDA, in effect, nurtured these large MNC firms over many years, offered executive leaders a ready made business model for their companies to establish operations in Ireland, which in turn immediately enabled them to overcome various collective action problems in the local market: sourcing office space, recruitment agents, and linking into domestic supply-chains.

This is not a celebration of Ireland’s FDi developmental model. One of the biggest trade offs in prioritizing FDI, and foreign-owned companies, is a lack of priority accorded to the indigenous enterprise sectors. But when you compare the trajectory of sectoral change in Ireland to Finland  it is perhaps unsurprising that the Irish State puts more emphasis on attracting large global firms as a replacement for declining ICT manufacturing industries. Both Finland and Ireland have experienced a rapid decline in the computer manufacturing sectors since 2005. In Finland there has been no replacement in the ICT services sector, creating a serious crisis of their export and employment growth model. This is not the case in Ireland, given that the state has actively nurtured “born on the internet” firms emerging out of Silicon Valley. There was a recognition that competitive success (and attracting inward FDI) is unlikely to occur in those high-tech manufacturing sectors that can produce their goods at a fraction of Irish labour costs, and therefore the strategy was to attract global MNCs in internationally traded services.

Whether one likes it or not, the State strategy in shaping economic recovery in Ireland is the outcome an embedded relationship between the public sector and large foreign owned global tech firms. This deeply embedded role for the state in the international market underpins Irelands capacity to make the transition to export-led growth in internationally traded services, rather than austerity, declining labour costs or macroeconomic stabilization. It is, fundamentally, about strategic political decision making, rather than market competition. If the European Commission is serious about generating the conditions for economic and employment growth in the Euro area it needs to rethink its textbook approach to supply-side “structural reform”. It needs a State-led industrial and enterprise policy.

For a more detailed social scientific analysis on this question follow @aidan_regan and @sabrazys_ucd over the coming months.

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