The “Luck” of the Irish Requires Economic Freedom

The Celtic Tiger, also called “Ireland’s Economic Miracle”, was something of a fairy tale. Starting in the early 1990s, Ireland went from being one of Europe’s poorest countries to one of Europe’s wealthiest in less than a decade. During that time, the size of the economy doubled and by 2007, the average household income was the ninth highest in the world.

Yet, soon after it peaked in 2007, Ireland’s economy reversed course. By November 2010, Irish banks required a $113 billion bailout from the Irish government. By July 2011, Moody’s Investors Services downgraded Ireland’s government bonds to “junk”, reflecting the complete lack of confidence people had in Ireland’s ability to pay back its massive debt. What happened?

One key to understanding Ireland’s economic rise and fall is grasping Ireland’s mixed relationship with economic freedom. While Ireland set the 1990s ablaze with sweeping economic reform that opened the Irish market considerably, there was also a darker side to the decade: declining economic freedom in the form of government subsidies and interventions that eventually led to the demise of the Celtic Tiger.

 

Unleashing the Tiger: The Boom Years (1987-2007)

In the late 1980s, Ireland began an economic restructuring that increased the country’s economic freedom and resulted in more than a decade of economic growth and prosperity for the country.

Slashing Taxes

An important step in Ireland’s economic reform was dramatically cutting tax rates —specifically the income and corporate tax rates —creating the fuel that unleashed the Celtic Tiger. Between 1987 and 1995, the income tax rate fell from 35 percent to 27 percent, and then all the way down to 20 percent. The corporate tax rate fell from 50 percent to 38 percent between 1987 and 1995, and then to 12.5 percent during the 2000s.  With this increased economic freedom, the country became a very attractive place for businesses to invest.  Net foreign direct investment skyrocketed from $627,433,374 in 1990 to $22,410,807,389 in 2003 — an increase of 3,471 percent.

Additionally, lower taxes meant people kept more of what they earned increasing their spending power. Private spending, which doubled between 1987 and 2004, helped feed the ravenous Celtic Tiger, fueling economic growth.

Curbing Spending

At the same time, the government reduced public spending relative to private sector spending across a wide range of areas.  Health expenditures were cut by 6 percent, education by 7 percent, agriculture spending by 18 percent, roads and housing by 11 percent, and military spending by 7 percent. When the government spends less, taxpayers are allowed to keep more of what they earn and put that money back into the economy.

 

Was the Irish Tiger Just Blarney? The Bust Years: 2007-Present

In the midst of Ireland’s roaring 90s, there was another narrative occurring which eventually sank the Irish economy. With one hand, the government was cutting taxes and spending; with its other hand, the government was handing out massive subsidies and tax credits to select industries — particularly housing — which distorted the market and significantly contributed to the economic collapse.

The Irish Housing Bubble

In the housing industry, the Irish government issued large tax incentives to housing developers in the form of tax deductions fueling a massive housing bubble that created the illusion of wealth.  Essentially, the government made housing and commercial development significantly cheaper than other investments — and especially lowered the upfront costs of building new homes and structures.

As the building industry grew in response to these tax incentives, the supply of new housing quickly outstripped the real demand for housing. New houses and buildings were being built before there were people to fill them, and many were never filled — in 2010 there were more than 300,000 empty homes in a country with only 4.5 million people. This disparity led to a housing “bubble,” where the prices of houses rose far above their real value or demand. Because housing accounted for a quarter of the country’s economic output and one-fifth of the country’s employment, when the bubble eventually burst, it left the country in shambles.

As individuals began to default on their home loans, banks collapsed and cost the Irish government more than $100 billion to bailout.  The collapse of Ireland’s banks sent shockwaves throughout the economy that severely and negatively affected other major industries in Ireland.

 

The End?

Increasing economic freedom can have a tremendous impact on a country, bringing prosperity and increased quality of life. Conversely, as Ireland has shown us, policies and practices that decrease economic freedom are detrimental to economic stability. While the Irish embraced certain aspects of economic freedom, they simultaneously discarded other important principles which proved destructive.

The story of Ireland is not over but is continually unfolding. Whether the country will ever attain the wealth and prosperity it experienced in the 1990s remains to be seen. Regardless, Ireland’s story presents a lesson to nations across the globe not to let short-term prosperity fool them, but to protect their economic freedom by guarding against government intervention.