Is Ireland a Cautionary Tale?

Paul Krugman is warning that America may go the way Ireland if its not careful, pointing to that country's current economic crisis as a symptom of excessive economic freedom. His essay is a clear case of revisionist history, and as my Irish grandmother would have said, "Shame on him."

First, the context. The Economist says Ireland is in "a deeper recession than any other euro area country. The economy probably shrank by 2.5% in 2008 and may contract by another 6.5% this year. Unemployment has jumped from 5% to 10.4%, a faster rise even than in America." Further, the government may have worsened the crisis with poor policy choices. Krugman, for those just tuning in, thinks that nationalizing banks is a much better course of action than bailing them out of toxic assets. That's what Ireland did when it faced a banking crisis last year, which arguably failed, and it's what the Obama administration is essentially doing now. 

Krugman may be right about nationalization; I share the same skepticism of bank bailouts and toxic asset purchases. That's not the issue. The problem with Paul Krugman is that he can't resist using a free-market straw man to make his point. Red Flag! Foul! Bad Journalism! Here's the offensive Krugmanian paragraph:

How did Ireland get into its current bind? By being just like us, only more so. Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore.

Boil this down, and he is saying that economic freedom is the same as "unsupervised" laissez-faire markets, with the implicit judgment that this is dangerous. Krugman is preaching cartoon Keynesian economics, as if having state enforced contract law and property rights were somehow equal to no law. Not to mention, glibly asserting that free trade is bad and high taxes good.

Specifically, Krugman is taking aim at the Index of Economic Freedom, which most readers know that I directed in 2006-07 including a major refinement in its methodology with the 2007 edition (this chapter with Bill Beach from the 2008 version is online). And it's true, reforms in Ireland since the mid 1980s catapulted that nation from one of the least free to one of the most free places on Earth. This policy shift coincided with one of the starkest economic miracles ever.

The "Celtic Tiger" story is much different than development miracles in the Third World, say in Asia or Latin America. Those places were untouched by modernity in some sense. But Ireland was the opposite: a stagnant economy surrounded by modernity. Indeed, no country was closer to the birth of the Industrial Revolution in Britain, and yet it had still not received the diffusion of its benefits. None. So in a very powerful way, Ireland is the ultimate case study in the story of bad policy as a barrier to growth.

Let's examine the facts. First, consider Ireland's economy right now. Here is the full text of the "Economy Overview" from CIA's World Factbook page on Ireland (updated 9 April 2009):

Ireland is a small, modern, trade-dependent economy. GDP growth averaged 6% in 1995-2007, but economic activity dropped sharply in 2008 and Ireland entered into a recession for the first time in more than a decade with the onset of the world financial crisis and subsequent severe slowdown in the property and construction markets. Agriculture, once the most important sector, is now dwarfed by industry and services. Although the export sector, dominated by foreign multinationals, remains a key component of Ireland's economy, construction most recently fueled economic growth along with strong consumer spending and business investment. Property prices rose more rapidly in Ireland in the decade up to 2006 than in any other developed world economy. Per capita GDP also surged during Ireland's high-growth years, and in 2007 surpassed that of the United States. The Irish Government has implemented a series of national economic programs designed to curb price and wage inflation, invest in infrastructure, increase labor force skills, and promote foreign investment. In 2008 the COWEN government moved to guarantee all bank deposits, recapitalize the banking system, and establish partly-public venture capital funds in response to the country's economic downturn. Ireland joined in circulating the euro on 1 January 2002 along with 11 other EU nations.

Want to know the in-depth story of Ireland?  Ask the Irish. In 2006, I authorized the publication of a Heritage report written by Sean Dorgan, the Chief Executive of IDA Ireland since January 1999. Dorgan shows that the decades of nationalism, massive government social programs, and protectionism were simply abject failures. Only when Ireland slashed its corporate tax rate to 12.5 percent - one of the lowest in the world - did its economy boom. But before thinking about what worked, step back and consider what did not:

The role of the state also increased during the 1960s. Public expenditure grew from 32 percent of GNP in 1960 to 42 percent in 1973. Social services and education, in particular, expanded with the state. ...

Between 1980 and 1986, total government expenditure grew from 54 percent to 62 percent of GNP, and public debt increased from 87 percent to 120 percent of GNP while annual budget deficits exceeded 10 percent of GNP.

And then the party Fianna Fail won the 1987 general election and began "a pro­gram of severe cuts in expenditure." Reform after reform was emboldened by growth, which kept the critics on their heels, if not silenced outright.

The same story told by the Heritage/Wall Street Journal Index is also told by the World Bank's Doing Business Report. It's a story that shows with data that government spending to make economies grow is an empirical failure. The story of economic freedom explains how to fight global poverty. And it's pretty clear that Paul Krugman does not like that story. While the current market and government failures deserve scrutiny and correction, we have to be wary of ideologues like Krugman who will use the crisis to smear all pro-growth policies (and other ideologues who will smear all government solutions). The only way to do that is with the perspective of history.

Using purchasing-power-parity data from the latest IMF World Economic Outlook, Ireland had per capita GDP of $6613 in 1980.  That means the typical family of four had $2000 a month to survive on. By 1996, that number had tripled. In 2007, it peaked at $43,414.  All of Krugman's fury boils down to the fact that GDP per capita in Ireland fell in 2008 to $42,780. It may drop further, maybe below $40,000, but it is criminal to suggest that Ireland should return to its auld ways.

Comments

[brian]

While I certainly agree that Krugman is often annoying and will argue things in broad statements that miss finer details, I get the same sense from this post.

You seem to be presenting a false dichotomy; the debate isn't "free market" vs "socialism." It's regulated vs. unregulated finance. The vast majority of financial economists agree that some degree of regulation is needed to prevent the issues of moral hazard and adverse selection in capital markets. This doesn't mean that they embrace full-on socialism.

Most people agree that many free market reforms in Ireland were a good thing for the country's economy. But that doesn't mean that every reform was.

For example, it is perfectly reasonable to believe that slashing the corporate tax rate was a good decision from Ireland's point of view (though it exacerbated distortions in the international allocation of resources), while believing that heavily deregulating finance was a bad idea, as it allowed banks to invest more in opaque derivatives that came back to bite them in the butt.

Some reforms fueled growth whereas others fueled volatility. Can't we distinguish between them rather than lumping them into one broad theme of "deregulation?"

This shouldn't be an emotional or ideological issue; it should be a fact-based one that distinguishes between different policies even if they have the same ideological grounding. However, both Krugman's rhetoric and yours creates a polarized debate devoid of fine distinctions, dividing the world into warring camps who refuse to listen to each other.

[Tim Kane]

Not at all, brian, but thanks for commenting. The error is suggesting the the financial failures unmasked in 2008 can be used to dress down economic freedom in general.

I'm giving huge credence to the idea Krugman champions that nationalizing failing banks may be okay. That's no small concession. But we have to draw the line when Krugman and others want to pretend that all the growth from free-market reforms was a mirage. That's a deeply misleading generalization.

[Devin Cheevers]

Hi Tim,

Great article, I went to high-school in Ireland and nearly all my family live there. Not that this makes an expert on the topic, but I agree 100% with your sentiments.

[Valuethinker]

Tim

The key thing in Ireland's growth path was the demographics, which were 20 years behind Continental Europe (maybe 30).

Once the Irish fertility rate began to fall in the 70s, the stage was set for the demographic windfall. Lower government spending (relative to GDP), low dependency ratio, lots of foreign investment (all that money spent on quality education and healthcare in the 50s, 60s, 70s left Ireland with a generation of healthy, highly educated workers: the Celtic Bangalore), housing boom (to shelter those same workers).

The low tax rate on corporates sucked in the Foreign Direct Investment.

This is not primarily a story about rejuvenating Thatcherism, but about a government that stuck grimly to human capital investment for 3 decades.

The other factor was massive EU financed investment in infrastructure, giving Ireland a modern infrastructural base, a further attraction to foreign industrial investment-- Dell, the pharmacos, Cisco etc.

The public sector 'shrank' then because the private sector was expanding so fast.