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Minding the Celtic Tiger

Friday, October 19, 2007

As an economic slowdown looms, JURGEN REINHOUDT wonders if Ireland will stick with the model that made it the envy of Western Europe.

Dublin Sky

For many decades, Ireland was an economic laggard that saw millions of its citizens emigrate abroad in search of better opportunities. As recently as 1987, it faced high unemployment, a national fiscal crisis, and relatively low standards of living. It was widely regarded the “sick man of Europe.”

Ten years later, however, Ireland was experiencing robust growth. Between 1993 and 1998, its employment rate grew by about 25 percent. In the first six months of this year, Ireland’s GDP grew by 6.7 percent, more than double the European average. The current growth comes even as Ireland’s real-estate market and one of its most important trading partners, the United States, are facing slowdowns. What, then, are the keys to its success?

Some Europeans, particularly European Union officials in Brussels, praise significant EU structural subsidies—in the tens of billions—for planting the seeds of Irish prosperity. It is certainly true that many of the EU structural funds Ireland received were invested in economically sound infrastructure projects, technological research and development, and education. For the most part, such funds contributed to economic growth.

But EU structural funds alone would not have helped Ireland escape its economic predicament. Many nations receive outside financial aid without any appreciable increase in their economic prosperity. The real credit belongs to Irish fiscal policy. Beginning in the late 1980s, successive Irish governments pursued vital spending cuts and tax relief.

As economic growth picked up, Ireland made another sound decision: rather than discontinue or reverse the earlier tax cuts, it financed new tax cuts, creating a virtuous cycle. In 2004, then-Irish finance minister Charlie McCreevy, who now serves as EU commissioner for internal markets, proudly declared: “In Ireland, I have reduced the standard and top rate of tax by 6 percentage points each since 1997 and have put in place measures which have resulted in a situation where 35 percent of all income earners are now outside the tax net.” In the same speech, McCreevy urged envious nations calling for Ireland to raise its corporate tax rate to mind their own business.

Tax relief—particularly corporate tax relief—has played an indispensable role in Ireland’s economic success.

At present, Ireland has a 12.5 percent corporate tax rate, which has made it a magnet for powerhouse firms: Google, Yahoo, Microsoft, and scores of other companies have established their European headquarters in Ireland. Costas Miranthis, deputy CEO of the insurance company PartnerRe, has credited Ireland’s “efficient regulatory structure, quality of the staff available, [and] its low tax rate.”

Some allege that Irish economic growth “came first,” which then enabled tax cuts to be passed, rather than the other way around. It is difficult to disprove this theory, but it is not difficult to see that Ireland’s growth would almost certainly have stalled had no tax relief been enacted from the early 1990s onwards. Regardless of which came first, tax relief—particularly corporate tax relief—has played an indispensable role in Ireland’s economic success.

Ireland is also cognizant of the value of scientific research and the economic spinoffs made possible by such research. “If you have an invention in Ireland, you don’t pay income tax on royalties,” Frank Gannon, head of the Science Foundation Ireland, recently told The New Scientist magazine. John Boland, a native Irish scientist who spent years in the United States after getting his Ph.D. in chemical physics at Cal Tech, recently moved back to Ireland to do research at Trinity College Dublin. “The advantage of Ireland is clear—it has the best funding environment in the world,” Boland told The New Scientist. “I was quite happy [in the U.S.] and didn’t think I would leave, until I was attracted by the opportunities back home.”

Cindy Coleman, an American scientist who recently moved from Boston to Galway, is also satisfied. She now works at the Regenerative Medicine Institute and told The New Scientist that Irish support for scientific R&D is “phenomenal,” adding, “I don’t see as many openings in the U.S. for new investigators as I do here.”

Of course, with economic success come the perils of affluence. Irish real-estate prices have skyrocketed, and increased immigration has brought new challenges to a country long accustomed to mass emigration and “brain drain.” Brisk employment growth has led to a tight labor market, in which professionals can be hard to come by. Compared to what Ireland dealt with in the 1980s, however, these problems seem like small beer.

The real question is, Will Ireland stay with the formula that has made it so successful, or will it become complacent in its prosperity? A slight economic slowdown, caused by the subprime-lending crisis, is expected in 2008, with growth now projected at 3.5 percent compared to earlier estimates of 5 percent. But if Ireland’s housing market does not enjoy a soft landing, the slowdown could come much sooner and be far more severe.

How Irish politicians respond will tell us a great deal about the future prospects of the Irish economy. Will they attempt to tax their way out of it, or will they stick with the model that has made Ireland the envy of many Western European nations? We will soon find out.

Jurgen Reinhoudt is a research assistant at the American Enterprise Institute.

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