The Enduring Influence of Ireland’s 1987 Adjustment

When I was a junior economist in short trousers, the first research I ever did was inspired by Ireland’s successful 1987-89 fiscal adjustment.  Many international researchers looked at Ireland and decided that our successful adjustment stemmed from consumers stepping into the breach filled by the government spending cuts. The story was that increased consumer confidence, fueled by expectations of lower future taxes, was the key to the recovery.

From the research I did on this topic (both on my own and with John Bradley) I came away fairly convinced that this was not what had happened. Rather, the 1987 boom seemed to be fueled more by strong exports to the UK thanks to Nigel Lawson’s tax cutting exercise.

However, Ireland’s 1987 experience continues to pop up in discussions of fiscal austerity. I have to admit that I’ve not been too impressed by Alberto Alesina’s work (here and here) on how fiscal adjustment can be expansionary—work that has had a lot of influence this year. Well, sure enough, Paul Krugman now cites work from Arjun Jayadev and Mike Konczal showing that the only country that ever cut its way to growth in a slump was, you guessed it, Ireland in 1987. The power of this datapoint endures.

33 thoughts on “The Enduring Influence of Ireland’s 1987 Adjustment”

  1. I was is much shorter trousers at the time and even I recall that a big factor, much over looked these days, was the spike in emigration. Ask most people today and they will believe that emigration in the 80s was highest under FG/Lab when in fact the 2 years under FF at the end of 90 were the peak years. This gave the government wiggle room in what was an incredibly tight fiscal environment as it lead to a drop in unemployment. Most but not all of those went to England to work on the construction boom there.

    This compares to the FG/Lab government which had to keep paying increases in unemployment benefit coupled with the raw numbers claiming raising too, meaning they were always playing catch up with that large element of public expenditure. In that sense it was not the government which cut public expenditure but the people themselves in particular the young by simply removing themselves from the situation.

    And ya tell that to older people today and they won’t believe ya!

  2. 1987 was the height of monetarism – Miltons ideas have been tested and found wanting.
    It is the height of folly to resurrect this dodo.
    Yes there is spare capacity everywhere in this economy but for one vital area – energy
    A major goverment fiscal policey in this area is badly needed – how do we get the money you may ask ?
    Somehow get the French to continue to supply us with low cost sov debt and in exchange buy their reactors and rail technology.
    They are familiar with such deals and while they may not make money on our debt they will be more then happy with their industries being subsidised.
    “Make a deal – a what? – a deal deal”
    http://www.youtube.com/watch?v=pykD8UkUABQ

  3. Whether the return of people from the black economy to the white? affected the recovery then?
    How many of us asked for a vat free price etc?

  4. 1987 may have sewn the seeds but the economy only really got going after the devaluation of 1993. Younger economists may have to look up ‘devaluation’.

  5. Simpleton.
    We can still devalue our debt if we write off our external bank debt – our workers will become instantly more competitive as they would not need to service huge mortgages.
    We may however have to give back our tax advantages in return – this may bring back the 1990s era of light manufacturing although the competition from eastern europe will be fierce.
    Low valued added manufactering may be the future for this country as the high valued added sector is only here for the corperate tax structure.

  6. Krugman hints at an exception in his argument, for small economies without control of their own currencies (such as Ireland):

    “The skeptics countered that Greece is a special case, trapped by its use of the euro, which condemns it to years of deflation and stagnation whatever it does. The interest rates paid by major nations with their own currencies — not just the United States, but also Britain and Japan — showed no sign that the bond vigilantes were about to attack, or even that they existed. [skip]

    You see, then, why I find myself thinking in terms of strange and savage cults, demanding human sacrifices to appease unseen forces.

    And, yes, we are talking about sacrifices. Anyone who doubts the suffering caused by slashing spending in a weak economy should look at the catastrophic effects of austerity programs in Greece and Ireland.

    Maybe those countries had no choice in the matter — although it’s worth noting that all the suffering being imposed on their populations doesn’t seem to have done anything to improve investor confidence in their governments.

    But, in America, we do have a choice.”

    As I read this, Krugman is saying that large countries with their own currencies (U.S., U.K., Japan) have a choice regarding fiscal austerity at the moment but small, troubled economies in the Euro perhaps do not.

    Hopefully in a few years time there will be at least two data points for fiscal austerity leading to a boom: Ireland 1987, Ireland 2010. The case for fiscal austerity in Ireland at the moment seems compelling.

  7. If you look at Krugman’s blog, its obvious that he at least does not buy into the expansionary fiscal contraction story for Ireland for the 1987-1989 period. The main paper cited at the time was by Giavazzi and Pagano and any close reading of their work showed that they had relatively little knowledge of what actually happened in Ireland at that time. But, hey, we were a (small) data point which suited their story, so why let facts get in the way?

    As mentioned, it was the devaluation of 1986, coupled with the Lawson boom in the UK which rescued us. We should also give some credit to the very first manifestation of social partnership in 1987 which helped ensure that the competitive gains from that devaluation were not lost in subsequent wage claims (record levels of unemployment obviously also played a role in moderating wage claims).

    Here’s another factor which does not get mentioned so often: the tax amnesty of 1988 brought in a windfall amount of revenue to the government and gave them some crucial elbow-room to grant limited tax cuts in subsequent years and move from a vicious to a virtuous circle. Maybe this is what Al is suggesting above.

  8. Ireland may have no choice but to adopt fiscal austerity, but it can do quite a lot about the level of domestic costs and prices. As the following table shows:
    http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=en&pcode=tsier010

    that Irish price levels, despite some limited improvement, remain significantly out of line with the EZ average. Some countries, such as Finland and Luxembourg, for a variety of reasons are able to organise thier affairs to cope with significant price diverences, but I don’t think Ireland has that luxury.

    With sovereignty in most other areas gone, this is an area that Ireland can tackle because it is being driven by inefficiencies and profit-gouging in the state, semi-state and sheltered sectors. But it barely registers on the policy agenda.

  9. @Paul
    How or why should Ireland adopt fiscal austerity – the banks will not produce personel credit for decades.
    The only increase in money will come from increased goverment debt – you cannot have a growing economy when the money supply contracts.

    You will produce a debt spiral vortex – maybe you want a nondebt money system as this will produce a depression of mamoth propertions that only can be stopped via monetory revelution.

  10. Am I the only card-carrying member of DANSE still willing to raise his head above the parapet? During 1989-90 the economists at UCD made a convincing argument to me about this, and were proved correct. While
    Karl was at the central bank writing his paper, I was listening to the policy debates in the UCD faculty lounge with Moore McDowell and many others.

    A fundamental component of Ireland’s economic success the 1990s was the late 1980s-and-on acceptance of the DANSE principal of improved fiscal discipline. That was key for example in encouraging foreign multinational investment and domestic entrepreneurial activity. The situation is different now, but once again a bit of painful fiscal austerity is needed.

  11. Another aspect of the story that is often ignored is the role played by EU Structural Adjustment Funds. Arguably, these acted as a mini-stimulus of which no functional equivalent exists today. This (coupled with the tax windfall in 88′) provided the macro-economic context for organsied labour to believe government would commit to a reduction in income tax and thus enabled them to accept significant wage restraint for the next 10 years.

  12. Greg, trying to put together exactly how and why Ireland sorted out its late 1980s fiscal crisis so relatively quickly is tricky. A move to a credible policy of fiscal adjustment no doubt helped, but the expansionary fiscal contraction (EFC) proponents at the time seemed to suggest that all, or at least most, of the recovery was owing to the reaction of consumption and investment to fiscal policy. As I say, some of this may have been going on, but both C and I had been depressed for so long that some type of recovery in them was overdue. People had been postponing the replacement of consumer durables for example.

    But my view is that too much credit is being given to the EFC story without looking at the other factors at work. And I think you can make a reasonable case that the Finance minister most responsible for Ireland’s recovery in the late 1980s was Nigel Lawson, rather than Ray McSharry. Don’t get me wrong, I am not saying that the fiscal adjustment should not have taken place, but just that external factors were higely helpful.

  13. @ Greg

    Just to clarify, I wasn’t at the Central Bank in the 1990s. I did my work on this topic while at the ESRI and later as part of my thesis at MIT. I recall the most useful work I did was this paper published in Economic Modelling with John Bradley.

    http://www.sciencedirect.com/science/article/B6VB1-3SWVKCJ-2/2/f52a76b4df6448a2e8c3d7ec482aba0f

    Behind a paywall, I’m afraid, but available to university types with library subscriptions.

    I also don’t recall UCD economists at the time as being all pro-EFC. Frank Barry was certainly a sceptic.

  14. Just to make one further (short) comment here: while pretty much all UCD economists were in favour of fiscal discipline, very few, to my recollection, were EFC adherents. The only Irish economist I can recall who presented a paper in favour of EFC was Dermot McAleese. There may have been others.

  15. @Karl

    Thanks for the paper link, which I just read after piercing the pay wall using the university library subscription. I agree with your sentiments in the Introduction:

    “Of course, most empirical macroeconometric models still retain Keynesian orientations and thus, like the theoretical approach upon which they are based, have weak intertemporal foundations and suggest that fiscal contractions should have strong negative effects on the economy. Quite rightly, this had led to doubts concerning the adequacy of many neo-Keynesian macroeconometric models as tools for empirically assessing fiscal policy impacts. ”

    … and I note that you try to avoid this trap by adding some intertemporal rational expectations. But I think that the long-run investment impact of fiscal discipline is under-estimated by your model. Fully capturing the effect of fiscal discipline on Irish growth in the 1990s would require a more complex investment equation bringing in tax rates, inflation expectations, and such. However, I take your point about the imported UK stimulus as explaining part of the good outcome in the early 90s.

    @Kevin O’Rourke

    It is a matter of terminology but to me recognizing that a State that is near bankruptcy has to retrench is close to saying that when a State is near bankruptcy its fiscal multiplier is negative. Just a difference of terminology. I am basically a finance guy so I tend to focus on the investment side where there is a big potential impact from a risky fiscal path on private investment, especially in a small open economy.

    @All you macro guys

    EFC captures an important microeconomic idea dressed up in macroeconomic clothing. For investment-based long-term growth, Ireland in 2010 needs a credible fiscal path. Given the enormous, horrible waste of government resources and government risk capital associated with the bank bailouts and bank liability guarantee, this requires painfully strict fiscal discipline over the next few years. Call it EFC or not-EFC as you wish. The situation in 1989 was not too different, as I recall, in this respect.

  16. @Greg: EFC isn’t just an idea but an assertion about the relative sizes of different effects, which is unsupported by empirical evidence. I don’t think terminology has anything to do with it.

  17. Here are the raw data. In constant price terms, consumption grew by 2.8% 1985-6, and then 2.1% 1986-7, 3.6% 1987-8, 3.3% 1988-9, 3.2% 1989-90, 1.1% 1990-91, 2.9% 1991-2, 2.6% 1992-3. So: a steady upward trend with some acceleration in 1988-90.

    The same numbers for investment are: -0.5%, -2.3% (1986-7), -0.2% (1987-8), 13.5%, 13.8%, -6.5% (1990-91), -1.8%, -3.6% (1992-3).

    And for exports: 2.7%, 13.9% (1986-7), 8.2%, 11.4%, 9.2%, 5.6%, 13.9%, 9.8%.

    By 1989 investment was growing rapidly, but it then declined from 1991-93.

    The dynamic factor in 1987 and 1988, and from 1987-93 as a whole, was exports. In a SOE, exports matter.

    See
    http://www.cso.ie/px/pxeirestat/database/eirestat/National%20Accounts%20Historical%20Series%201970%20to%201995/National%20Accounts%20Historical%20Series%201970%20to%201995.asp

  18. The politics of 1987 also very important. FG not doing to FF what FF had done to FG/Lab. For which FG was rewarded by … Alan Dukes being made the chairman of Anglo. It’s a funny old world.

  19. @ Aidan R

    I think we will also look back at the European funding as the time when local and national government lost the run of itself spending others nations money.
    Probity may have been long gone by the time of the tiger…

  20. @ Kevin

    I remember being taught the EFC thesis by McAleese and there was another data point of either the Netherlands or Denmark in the early 1980s that was also mentioned. I think it was in his Economics for Business book.

  21. I don’t doubt you Mick but not even his own country fit the thesis! No version that I know says that EFC will work through rising exports.

  22. Great discussion.
    To summarize some of the key points made so far about Ireland’s economic boom in the 1980s–

    Key factors (not necessarily in order of importance) were:
    1) change in UK tax policy (lower UK taxes), which boosted UK consumer spending, which helped Irish manufacturers export more to the UK
    2) 1986 devaluation of the punt
    3) Massive input of EU Structural Funds which served as a stimulus to the Irish economy (paid for by EU taxpayers)
    4) Irish government fiscal restraint
    5) Emigration, which supported 4)

    There is disagreement about the relative importance of the above factors.

    Most public debate never mentions 1, 2, 3 or 5.

    Based on the discussion on this and prior threads, the government’s expectation that Ireland will “export” and “innovate” its way out of the current crisis based on Fiscal restraint is not realistic.

    Fiscal restraint is necessary and long overdue. It’s doubtful it can or will cause significant growth in exports. Points 1, 2 and 3 seem more likely explanations for previous export growth, IMHO.

    Expectation of significant growth resulting from exports due to indigenous innovation is unlikely to materialize to the extent of government predictions. (My synthesis of discussion on prior threads, also my opinion.)

    As discussed on prior threads, MNC growth may well continue in some sectors (e.g. pharma) and is vital. But MNC profits leave the country, and the low corporate tax rate advantage may not be sufficient to generate the funds required to reduce the depth of the hole in Irish coffers.

    Lastly, some questions re: the “investments” in the data above (thx KOR)–
    * To what extent do the “investments” include investments in property?
    * To what extent do they consist of investments in Irish businesses in non-financial, non-property, non-construction sectors?

    It’s largely the non-financial, non-property, non-construction sectors where we’re hoping to see huge growth. It’s my impression (data needed!) that these sectors got less than their share of investment when the money was flowing.

    It’s hard to see how EFC, MNC growth, or proposed indigenous innovation can singly or together provide growth of the order of magnitude required to restore balance and stability to the Irish economy.

    Additional external factors will play a key role in the fate of the Irish economy, and whether/how/when it heals.

  23. @Al
    We (public & private) wasted so much money when it was available. So much corruption, so little long-term planning, so little to show for it now. (More harm than good, when the long-term effects of bad/no planning are considered.)

    And so little accountability–then and now.

  24. The current crisis has revived quite a lot of mythology about the 1987-1990 fiscal correction , including the ‘swingeing’ cuts in current spending. These never happened, as I argue in the link below. The main ingredients were cuts in capital spending (from a much lower base than currently!), rapid export and tax revenue growth following a well-executed devaluation in 1986, and luck (a tax amnesty brought in the remarkable and unexpected sum of 2% of GNP in a single year (1988).

    OAC above has most of it right, but the EU funds came late – the big jump was in 1990, after the budget gap had closed.

    http://centreforum.org/assets/pubs/dealing-with-debt.pdf

  25. So all we have to do is get the british to shelve their austerity plan and devalue our currency…oh, hold on a minute.

  26. Greetings from Atlanta, Georgia. As the Hotel Atlanta Midtown, where I’m posting this from, charges $7 per 15 minutes internet time, my post will be brief.

    The reality is that the post 1987-growth was not due to any one single factor. It was primarily a return to the pre 1980-global recession growth. The return was delayed by the presence of Labour in government from 1982 to early 1987. AS always, they acted to prevent any necesessary fiscal adjustment, or any move in the direction of a more enterprise-oriented economy. Once Labout got the boot from government, growth resumed. FF got the credit, but FG on their own might have done as well.

    Since 1958, Ireland has been a chronically high-growth economy, with average growth over half a century of around 4.5pc, by far the highest in the EU. There have been several interruptions to this growth, caused by shocks of one kind or another. For example, 1975/76, 1982-86, and 2008-09. But, growth always resumes once the effects of the shock wear off, just like it is now. As always, the economists of the day fail to predict the resumption of growth and we are deluged with media comment from said economists predicting decades of economic gloom. But, it never happens and growth always comes surging back, and the reason can not be attributed to any one single factor.

    I expect that, in 20 years time, economists on here will be debating whether or not the resurgence in growth from 2010 on was due to Lenihan’s fiscal adjustment budgets or to the growth in global trade. The answer then, as now in relation to the growth from 1987 on, is that its a combination of many factors.

  27. The decison of Intel in 1989 to make the most important FDI investment in Ireland since Henry Ford’s, was the tipping point.

    Former Intel CEO, Craig Barrett, said last year that thare were 14 factors that swung the decision. I assume that the improved focus on the public finances was one.

    1n 1987, the export/GDP ratio was 45.9%; 49.7% in 1990 and by 1995 it had jumped to 72.3%.

    The ratio exceeded 100% in 2000 and has changed little in the decade since.

    Following Intel’s decision, as the US high-tech boom accelerated, many other big scale investments followed, involving the employment of thousands of people in each project.

    Dr. Garret FitzGerald wrote in the Irish Times in 2006 that during the brief Celtic Tiger period from 1993 to 2001, our living standards rose by one-half. But this was due to two special factors – – both of which were essentially temporary in character.

    The first was the impact upon our national productivity of a quite exceptional inflow of new US investment. For a number of years Ireland, with only 1 per cent of Europe’s population, attracted up to 25% of all US greenfield industrial investment in our continent. The new technology and skills that this inflow brought contributed to a 4% annual increase in output per worker at national level, ie productivity.

    The second factor, which played an even larger role in boosting our living standards during this time, was the huge increase in the total number of people at work, and the corresponding drop in the proportion of dependants in our population. Several factors contributed to this: the exceptional inflows of young workers emerging from the educational system and of women transferring from “home duties” to the labour force, and also the flow of unemployed people returning to work and of recent emigrants coming back to jobs here.

    Within a decade these inflows into our labour-force reduced from 230 to 115 the number of dependants that every 100 workers had to support, either directly within their families or indirectly through taxation.

    FitzGerald wrote that the huge increase in the proportion of our population engaged in work, and the consequential drop in our dependency ratio – – more rapid than had ever previously been seen anywhere in Europe in peacetime – -accounted for more than half of the improvement in our living standards. But that extraordinary combination of productivity growth and reduced dependency, which distinguished the 1990s in Ireland from any other decade, was a temporary phenomenon.

  28. The decision of some many US and other multinational to establish operations in Ireland was closely dependent upon the DANSE-inspired Irish fiscal contraction of 1987 and subsequent years. Foreign capital and domestic entrepreneurs need long-term reassurance about the fiscal climate. To understand Irish GNP look away from short-term fiscal multipliers and concentrate on the quote from the entry above:

    For a number of years Ireland, with only 1 per cent of Europe’s population, attracted up to 25% of all US greenfield industrial investment in our continent. The new technology and skills that this inflow brought contributed to a 4% annual increase in output per worker at national level, ie productivity.

    Intel is still here, 21 years later, but the export impact of Nigel Lawson’s 1987 UK tax cut has long ago dissipated. Instead of EFC we should call it a Growth Enhancing Fiscal Contraction (GEFC) – an important effect on medium-term growth from a credible fiscal path, which is too-low-frequency to be statistically identified in per-annum GNP decompositions. It requires ten-year-or-longer lag effects and so becomes difficult to identify in the annual GNP, G, I, C, X, M numbers (as Kevin O’Rourke showed clearly in his calculations). But GEFC is still there under certain circumstances, in the long run.

Comments are closed.