Before the Boom: The Historical Background

Abstract

The Celtic tiger boom was a major departure from previous experience since the Irish economy had a long previous history of relative weakness compared to many other European countries. The Irish economy had a chronic problem with insufficient generation of employment, resulting in high rates of emigration, as well as relatively low incomes. Previous attempts to promote industrial development included a period of protection and a focus on indigenous industry, followed by a more externally oriented free trade approach with a welcome for foreign investment after the late 1950s. By the mid-1980s, just before the boom, the economy was facing very serious problems, with record unemployment, a high rate of emigration and a major government financial crisis, as well as an industrial sector that was in crisis and an industrial policy that appeared to be failing.

The Celtic Tiger boom was a major departure from earlier experience since the Irish economy had a previous history of relative weakness compared with many other European countries. In particular, for a long time before the boom the Irish economy had a problem with insufficient generation of employment which commonly resulted in substantial emigration. It also had relatively low-income levels compared with most of Western Europe.

2.1 Employment, Emigration and Incomes: Long-Term Trends

Mass emigration resulted in a steep population decline from 5.1 million in 1851 just after the Great Famine to 3.0 million in 1926. This represents a decline from 25% of the size of Great Britain’s population in 1851 to just 7% in 1926.¹ The number of people at work in 1926 was 1,223,000 and throughout the next 60 years, 1926–1986, the number at work either remained approximately stable in some periods or declined in other periods, except for the 1970s when there was growth in employment (see Fig. 2.1). By 1986 the number at work was down to 1,091,000.

Fig. 2.1

(Source CSO StatBank and ESRI Databank. Creative Commons Attribution BY 4.0)

Total number at work, 1926–1986 (thousands)

Even in periods of employment stability, there was usually significant emigration because employment would have needed to grow to provide job opportunities for all of a potential labour force that was naturally tending to increase. For example, between 1961 and 1971—one of the better periods for the Irish economy in most respects—the total at work scarcely changed and net emigration amounted to about 13,400 per year. This rate of net emigration was equivalent to about one-quarter of the number reaching the age of sixteen each year.

As regards incomes and wages, Irish average income per head of population was 61% of the UK level in 1913 and was also a little over 60% in the mid-1980s (Barry 1999).² There were some fluctuations between those dates but Ireland’s average income per head did not rise much above 60–65% of the UK level before the late 1980s. A number of studies made the further point that, as average income growth was slower in the UK than in most of Europe, income per head was growing more slowly in Ireland than in most of Europe (e.g. Kennedy et al. 1988; Ó Gráda and O’Rourke 1996).

Wages in Ireland were about 100% of the UK level by 1913 and about the same in the 1980s, although Irish wages fell well below that level at the time of the Second World War and then took a few decades to regain approximate parity with the UK (Barry 1999). Thus, over the period from 1913 to the late 1980s there was little evidence of convergence in Irish average income per head of population towards the level of higher-income countries, whereas wages were apparently drawn quite close to the UK level for much of the time.

This tendency regarding wages can be seen as essentially a consequence of the fact that there was generally free movement of labour between Ireland and the UK, although the freedom of movement was in practice hindered at times by recessions and unemployment while there were also other factors that had an influence on relative wage levels in Ireland and the UK.

There were two main reasons why the average income per head of population remained far lower in Ireland than in the UK despite the recurring tendency towards approximate parity in wage levels. First, compared with the UK a high proportion of people in the Irish labour force were not wage-earners but self-employed farmers, mostly small farmers with relatively low incomes. Agriculture accounted for 53% of the total at work in 1926 falling to 15% by 1986. This 1986 figure was still high compared with a figure of just 2.5% for the UK, but clearly the influence of Ireland’s low-income agriculture on the relative income levels of the two countries was diminishing over time.

The other main reason why the average income per head of population was much lower in Ireland than in the UK was because a smaller proportion of the population was at work in Ireland compared with the UK. The influence of this factor was increasing over time since employment as a percentage of the population in Ireland declined in each decade from 41% in 1951 to 37% in 1961, 35% in 1971, 33% in 1981 and 31% in 1986. For comparison, the figure for the UK was 47% in 1986.³ The difference between these figures for the two countries in 1986 would have resulted in Ireland’s average income per head of population being at just 66% of the UK level, other things being equal. Thus, this factor explains the bulk of the difference in the two countries’ incomes per head at that time.

Ireland had a relatively low proportion of its population at work mainly because there was usually insufficient growth of non-agricultural employment to compensate for the secular decline in the numbers engaged in agriculture, and to cater for the natural potential growth of the total labour force. This usually resulted in significant emigration of people of working-age as outlined above, as well as unemployment. As Ó Gráda and O’Rourke (1996) put it, the proportion of the population in employment “is not just a function of birth rates, death rates and attitudes towards female labour force participation. It is significantly affected by emigration, which is in turn produced by the same problem as leads to unemployment: a failure by the economy to create sufficient employment”.

When discussing the long-term record of economic growth in Ireland, a distinction is sometimes made between “intensive” growth and “extensive” growth. Intensive growth means the growth of average income or output per head of population, whereas extensive growth means the growth of the absolute size of the economy. In much of the nineteenth century and the early years of the twentieth century, Ireland was able to have quite strong intensive growth, despite the fact that extensive growth was weak as the labour force and population fell. Heavy emigration and a declining population meant that there was an increasing area of agricultural land per head of the remaining population and—in a largely agricultural economy—this helped substantially to boost the intensive growth rate of the whole economy.

However, as the relative importance of agriculture diminished during the twentieth century, this effect became less significant. Instead, the more influential effect of weak employment trends and continuing emigration was the effect that they had in leaving a low proportion of the population in employment. Consequently, it became a good deal more difficult than it had been for Ireland to have a strong trend in intensive growth without also having a strong trend in employment and in extensive growth.

2.2 Industrial Development

A fundamental difference between Ireland and other European countries that developed more successfully was the fact that Ireland did not have a strong process of industrialisation. This was the basic reason why Ireland usually had insufficient growth of non-agricultural employment.⁴ Ireland did experience the beginning of an industrial revolution in the late eighteenth century, and by the early nineteenth century it had a fairly substantial industrial sector by the standards of many countries at that time. In the Belfast area in the north-east, in what is now Northern Ireland, industrial growth continued into the twentieth century in a manner similar to that of large industrial centres in Great Britain. In the rest of Ireland, however, early industrial growth turned into industrial decline during much of the nineteenth century.

A number of different explanations have been suggested for the decline of industry in most of Ireland, but the most convincing type of explanation focuses on Ireland’s position as a relatively late starter in industrialisation compared with Great Britain, which was the leading industrial country in the world at that time. As part of the UK, Ireland had to compete in a free trade relationship with Great Britain.

In most of the important nineteenth-century industries, it was generally important for producers to develop relatively large-scale, specialised and centralised production in the quite early stages of mechanisation, while proximity to large markets could also be important. Unprotected industries found it difficult to grow successfully from relatively small beginnings into large-scale producers after competitors had already made substantial progress in mechanisation and large-scale development elsewhere. Rather, those regional centres of an industry that began the process relatively early tended to gain increasing advantages from scale, specialisation and geographical centralisation, disposing of lesser competitors as they did so. Within the UK in the nineteenth century, this process generally favoured a number of growing urban areas in Great Britain, as well as the Belfast area in Ireland, while relatively small and late-developing industries in other regions of the UK, including most of Ireland, were gradually eliminated by competition.⁵

2.2.1 Independence and Protection

When it became independent in 1922, the new Irish state had a very small industrial sector that employed only about 5–9% of the labour force.⁶ Almost half of industrial employment was in the food and drink industry. The government’s economic policy in the 1920s was predominantly orthodox, relying on free trade and free market forces, although a small number of protective tariffs were introduced in order to support the growth of certain selected industries.

From 1932 onwards, a much stronger and more wide-ranging policy of protection against imports was introduced and rapid growth of industrial employment followed for two decades, apart from during the Second World War when it was difficult to import necessary inputs. Manufacturing employment increased by 4.2% per year between 1931 and 1951 (Census of Industrial Production). Ireland’s experience of considerable industrial growth beginning during the international depression of the 1930s corresponds quite well with the experience of some of the less-developed countries (e.g., Argentina, Brazil, Chile and Mexico) that were independent at the time and resorted to protection during the depression.

Labour productivity growth in Irish industry tended to be sluggish as the volume of output per worker increased by only 1.4% p.a. in 1931–1951. If this labour productivity trend suggests that the protected industries were inefficient, this impression is strengthened by the fact that sales were concentrated on the small protected domestic market, and few industries were able to compete effectively in export markets. Food, drink & tobacco had been the only substantial export industries in the 1920s, and they exported 25% of their output in 1951, but the rest of manufacturing exported only 6% of its output in 1951.

The Committee on Industrial Organisation (1965) reported further evidence of industrial inefficiency in the early 1960s. They noted that companies commonly had high production costs because of old equipment, small scale, short production runs and wide ranges of products (resulting from the prevailing orientation towards the small protected domestic market).

Although many former imports had been substituted by domestic production in protected industries, there continued to be other imports that had not been replaced by domestic production, including many of the capital goods, materials, fuels and components required to sustain production. These imports had to grow whenever the economy was growing. As the economy grew over time, the cost of imports of goods that had not been substituted by domestic production eventually grew to exceed the cost of all imports before the process of import-substitution began. The failure to achieve much growth of exports then became critically important, because the result was a chronic balance of payments crisis that emerged in the 1950s. The deflationary measures taken to reduce imports resulted in prolonged recession, rapid decline in employment and large-scale emigration during most of the 1950s.⁷

The industrial structure generated by protection was rather inefficient and largely unable to export, thus ultimately causing further growth to be constrained by a lack of foreign exchange. This does not mean, however, that the introduction of protection was the original cause of industrial and economic stagnation. Seen in a longer-term perspective it is evident that there had already been industrial decline or stagnation, in a context of free trade and reliance on free markets, for a century or so before the introduction of protection. Protection, for a time, probably generated considerably more industrial growth than would have occurred under a continuation of the former policies.

Ireland’s experience in the 1950s was a fairly typical conclusion to a process of import-substituting industrialisation, in which wide-ranging protection was the main policy used. Other late-developing countries with the same type of policy commonly experienced a similar problem eventually with a balance of payments constraint on further growth. However, many of them went through these difficulties later than Ireland did, because they acquired the independence necessary to adopt protection later than Ireland.

2.2.2 Outward-Looking Policies and Industrial Growth

In view of the difficulties experienced in Ireland in the 1950s a number of major changes in industrial policy were introduced. The new approach that evolved in the 1950s and 1960s was much more open or outward-looking in three important respects. First, the emphasis shifted to developing exports, and new tax concessions and grants were introduced to encourage and assist firms to produce for export markets. Second, measures were introduced to attract foreign industrial firms to produce in Ireland for export markets. The potential for attracting such investment was still a newly emerging opportunity at that time since export-oriented foreign direct investment (FDI) in industry was only starting to become a significant phenomenon in the international economy in the 1950s.⁸ Third, the protectionist measures against imports were gradually dismantled, opening the home market to foreign competition.

The reorientation of industrial policy towards a more outward-looking approach was an evolutionary process that took some time.⁹ Steps to attract export-oriented FDI began in the early 1950s, and grants intended primarily to assist export-oriented firms were introduced during the 1950s. Major tax incentives for exporters were introduced in 1956 and 1958. As a result, no corporation tax was charged on profits arising from increases in export sales above the 1956 level. This meant there was no tax on all profits arising from the exports of firms that started up after 1956, including new foreign-owned establishments.

The main elements of the policy package to promote exports, and to encourage FDI for that purpose, were in place by the end of the 1950s, although further additions and refinements to the same general approach were made over the next 25 years. Such later changes included the introduction of grants to support R&D and training. Also, beginning in the 1970s, companies engaged in specified internationally traded services became eligible to benefit from industrial policy supports. The tax relief on export profits remained in place during the 1960s and 1970s. However, beginning in 1981, it was replaced by a new low rate of corporation tax of just 10% for all of the manufacturing industry’s profits (not just for profits relating to exports), and also for profits of specified internationally traded services.

In the 1970s and early 1980s, a number of observers concluded that the Irish package of tax and grant incentives for industry, and particularly for exports, was one of the most attractive in Europe. They also concluded that the efforts to market Ireland as a location for export-oriented foreign industries were among the most effective (O’Malley 1989, Chapter 5).

The process of dismantling protection and returning to free trade began in 1963 and 1964 with small reductions in all tariffs. This was followed in 1965 by the Anglo-Irish Free Trade Area Agreement, which required Ireland to remove protection against imports of British manufactured products by ten annual reductions of 10% each. When Ireland, the UK and Denmark joined the EEC (now the EU) in 1973, Ireland agreed to remove protection against other EEC manufactured products by five annual tariff reductions of 20% each.

Under the new outward-looking strategy, industrial production grew significantly faster in the 1960s and 1970s compared with the 1950s. Manufacturing output had grown by just 1.7% p.a. in 1951–1958, and the growth rate then increased to 6.7% p.a. in 1958–1973 and 5.1% p.a. in 1973–1979. Manufacturing employment had grown by just 0.2% p.a. in 1951–1958 and it then grew by 2.4% p.a. in 1958–1973 and 0.8% p.a. in 1973–1979 (Census of Industrial Production). This period of growth was characterised by particularly rapid export growth. The percentage of manufacturing output going for export had increased only slightly from 16% in 1951 to 19% in 1960, but this figure rose to 41% in 1978 and further to 55% by 1986. This trend helped to ease the balance of payments difficulties that had been a feature of the 1950s, and thus it facilitated growth of the economy.

In the 1980s, however, the trends became more worrying. Manufacturing employment declined by one-fifth between 1979 and 1987. A decline in manufacturing employment of such a magnitude and duration had not happened before during Ireland’s time as an independent state. On the other hand, during most of the period 1979–1987 industrial output continued to grow quite rapidly. The roots of these apparently paradoxical developments lie in the major structural changes that had been occurring within Irish industry, and in the differing experience and performance of Irish indigenous companies and foreign-owned multinational companies.

2.2.3 Irish Indigenous Industry

Even in the 1960s and 1970s, Ireland’s industrial growth had an important weakness.¹⁰ While new investment by highly export-oriented foreign-owned companies was largely responsible for the improved performance of industrial employment, output and especially exports, native Irish-owned or indigenous industry did not fare so well. Most of indigenous industry was apparently not able to increase its export-orientation significantly, while at the same time it was losing market share to competing imports in the home market as the protectionist measures were dismantled.¹¹

Thus, leaving aside new foreign-owned companies, the exports of other industrial companies amounted to 0.26% of manufactured exports of all developed market economies in 1966, and the same percentage in 1976. The exports of these companies grew, but only in line with the market and without any improvement in market share. Meanwhile the rising domestic market share taken by competing imports cost these companies about 15% of the home market between 1966 and 1979, which was equivalent to about 15% of their total sales.¹² Consequently, leaving aside new foreign-owned companies, the rest of the industry in Ireland was a significant net loser of market share during the transition to free trade. Competing imports continued to take a rapidly rising share of the domestic market in 1980–1988 (Employment Through Enterprise, 1993, Appendix 3), while there was little or no increase in the export-orientation of Irish indigenous industry until about 1986 (O’Malley 1998a).

In this context, indigenous industrial employment did not grow between the mid-1960s and the end of the 1970s, and it then fell by 27% in just seven years in the 1980s. Indigenous industry had just about maintained its overall employment level while domestic demand was growing sufficiently strongly in the late 1960s and 1970s to compensate for the loss of domestic market share. But when domestic demand weakened considerably in the 1980s, its employment slumped.

Within indigenous industry, however, some sectors fared relatively well. These were mostly engaged in either basic processing of local primary products such as food, or else in sheltered or non-traded activities which have a significant degree of natural protection against distant competitors and do not have much involvement with international trade. Some non-traded activities can be sheltered in the local market by high transport costs for products with a low value-weight ratio (e.g., building materials, packaging materials, soft drinks). Others can be sheltered because of a need for local knowledge, close contact with customers, or a significant element of on-site installation or servicing (e.g., general printing, newspapers, structural wood and metal products). While indigenous firms in these types of activities grew and increased in relative importance, other internationally traded activities declined.

A second structural change within indigenous industry was a particularly rapid decline among larger companies in internationally traded activities, while the number of small companies grew. This point was acknowledged by Mac Sharry and White (2000, p. 305) who observed “The casualty rate among Irish industry in this progression towards free trade was horrendous … in the bigger companies with over 500 employees, the losses were even more devastating … the stars of the traditional Irish industrial firmament were grievously, if not mortally, damaged”.

The larger companies were generally engaged in activities in which there are significant economies of scale—hence their relatively large size by Irish standards. But they were generally not large enough to match larger foreign competitors under free trade, so that they were at a competitive disadvantage which hastened their decline. Thus, the National Economic and Social Council (1989, Chapter 6) noted that it is usually expected that introducing more free trade will induce an increased concentration of industry because of the existence of economies of scale. But they found that this did not hold true in Ireland’s case, observing that “even the larger Irish producers, instead of eliminating the tail of smaller higher cost local producers, were themselves a part of the tail of smaller producers in a British and Irish, or European Market”.

At the same time as many larger firms were declining, smaller firms, which would generally have been engaged in activities in which economies of scale are not important, increased in numbers. Even during the slump in indigenous industrial employment in the 1980s when there were many closures of existing firms, there was quite a high start-up rate of new small firms so that the total number of indigenous manufacturing firms scarcely changed.

By the mid-1980s, Irish indigenous industry was relatively lacking in large-scale enterprises, and there was relatively little indigenous activity in the sectors where economies of scale were most important and which were dominated by large firms in advanced economies. For example, there were seven sectors where large firms employing over 500 people accounted for over 70% of the sector’s employment in West Germany, France, the UK and Italy in the mid-1980s.¹³ About 40% of manufacturing employment in the European Community was in these seven sectors, but only 12% of Irish indigenous manufacturing employment was in the same sectors in 1987.

The existence of significant economies of scale, and the consequent presence of large established firms in many important industries in advanced economies, can be seen as a substantial barrier to the development of these industries by indigenous firms in a late-developing country that trades with advanced countries. For the indigenous firms generally would not have the resources needed to enter into competition on a competitive scale, or to survive a period of losses while trying to gain an adequate market share to be competitive. Protection was supposed to make it possible for Irish industries to get established by shutting out overwhelming competition from stronger firms already existing elsewhere. This succeeded to some extent but the Irish firms, in their small home market, often did not attain a scale of operation that was adequate to match foreign competitors under free trade.

Apart from economies of scale, there are also other significant types of barriers to entry for new or small firms arising from the strength of established competitors.¹⁴ For example, new or small firms may not be able to match the technological capabilities already developed by established companies in sectors where technology is of key importance. Also, if strong marketing is an important requirement for an industry, the marketing strength of existing firms is a real entry barrier for new or small firms.

In addition, the advantages of external economies in existing industrial centres or districts can be a further obstacle to the development of newcomers in late-industrialising countries. Such external economies consist of the benefits of close contact with related firms, specialist suppliers and services, specialised labour skills, supportive institutions and perhaps a large local market. These types of advantages are commonly reflected in the existence of large and often specialised industrial towns and “clusters” of related industries. If external economies are important for an industry, it may be relatively easy for new firms to grow in existing locations of that industry, but this is a good deal less likely to happen in late-industrialising countries that do not have such strong industrial locations if they have to compete with the existing industries.

It is likely that such barriers to the development of latecomers are a major part of the explanation for the relatively poor development of Irish indigenous industry until the late 1980s. Many other potential explanations are not convincing. For example, the record of quite a high rate of start-ups of new small firms (see O’Farrell and Crouchley 1984) indicates that a spirit of entrepreneurial initiative was not lacking. Rather, the problem was that new start-ups were mostly restricted to small-scale activities, while large firms were declining. Also, many foreign MNCs found the Irish economic environment quite attractive (see Chapter 6), and they operated successfully in it. This shows that there must have been reasonably acceptable conditions in areas such as the quality of the labour force, transport and communications, the tax system or the political and administrative system.

It may be that the quality of native management skills had room for improvement, but it seems clear, nevertheless, that there was a certain amount of good quality management talent available. Thus, most of the foreign-owned MNCs in Ireland were willing to recruit their local management from within the country. Also, many of the larger Irish firms, including those in non-traded types of business, showed that they had the competence to engage successfully in international markets by taking over foreign firms in their own type of industry and becoming MNCs.

It has been argued that part of the problem of Irish indigenous industry in the 1980s was excessive wage increases, driven in particular by the presence of foreign-owned companies, which had higher and faster-growing productivity, and could therefore afford to pay wage increases that were excessive for indigenous companies with slower productivity growth. Barry (1996) argued along these lines, distinguishing between a group of “modern” predominantly foreign-owned sectors and a group of “traditional” predominantly Irish-owned sectors.¹⁵ He found that, in 1980–1986, average weekly earnings increased by 12.4% per year in the modern sector while the rate of increase was almost as high at 11.2% per year in the traditional sector. At the same time, he found that the volume of net output per person engaged grew by 11.0% per year in the modern sector but at a much slower rate of 4.9% per year in the traditional sector.

However, this situation looks rather different if we also consider the growth rate of the value of net output per person engaged, for the purpose of comparing with earnings increases that are measured in current values. In fact, the value of net output per person engaged increased by 14.1% per year in the traditional sector in 1980–1986, which was more than the 11.2% per year increase in average weekly earnings. The value of net output per person engaged increased at an even higher rate of 18.1% per year in the modern sector.¹⁶ Thus, rather than wage increases being too high for the traditional sector because they were more appropriate for the modern sector with its faster productivity growth, wage increases were in fact low enough to enhance the profitability of the traditional sector while being of even greater benefit to the profitability of the modern sector because of its faster productivity growth. Consequently, these wage trends do not help to explain the decline of traditional/indigenous industry in the years before the Celtic Tiger boom.

2.2.4 Foreign-Owned Industry

The main source of growth of industry in Ireland from the 1960s to the 1980s was new investment by export-oriented foreign-owned MNCs.¹⁷ By 1987 foreign firms accounted for 43% of manufacturing employment, 52% of manufacturing output and 74% of manufactured exports (Census of Industrial Production, 1987).

Until about the end of the 1960s, most FDI was in production of technologically mature, labour-intensive products such as clothing, footwear, textiles, plastic products and light engineering. Mature industries such as these, with standardised products, were most capable of being located in industrially undeveloped countries because they did not require close contact with the specialised skills, suppliers and services found in advanced industrial areas (Vernon 1966). Because they were generally quite labour-intensive, they had a motivation to move to relatively low-wage locations. The international relocation of such industries began quite early in relatively low-income countries on the periphery of the developed world, such as Puerto Rico and Ireland. Part of the attraction of Ireland was its tax concessions and grants while its wage levels were also lower than in the UK and much of Western Europe in the 1960s. From about the mid-1960s, such internationally mobile industries went increasingly to less-developed economies with much lower wages.

From about the late 1960s, export-oriented FDI in Ireland increasingly involved newer, more technologically advanced products, such as electrical and electronic products, machinery, pharmaceuticals and medical instruments and equipment. Typically, these industries placed only certain stages of production in Ireland, which were usually not the most technically demanding on local inputs and skills.

Again, there were some similarities here to the type of mobile industry that began going to less-developed countries from about the late 1960s (Helleiner 1973). However, the industries arriving in Ireland included some more highly skilled activities, particularly in electronics and pharmaceuticals, even though they usually lacked the most important business functions of the firm. Thus, in the early 1980s, the electronics industry in Ireland employed a significantly higher proportion of engineers and technicians than the electronics industries in Singapore or Hong Kong. At the same time, the industry in Ireland had a substantially lower proportion of engineers and technicians than the industries in the USA or UK, while the industry in Ireland undertook much less R & D in relation to sales than in the USA or UK (O’Brien 1985).

As regards the motivation for export-oriented FDI in Ireland, at first the main attractions were tax concessions, grants and relatively low-wage costs. After Ireland joined the EEC in 1973 there was the further significant attraction of assured access to the large EEC market, which was a major draw for growing numbers of companies from the USA. The basic objective of many of the foreign investors after that time was to establish a factory somewhere within the EEC (and later the EC or EU), to produce for sale in European markets, and then they selected Ireland as suitable for that purpose. Consequently, Ireland's main competitors in attracting such industries were usually other Western European countries rather than developing countries with far lower wages.

Another influence in attracting FDI to Ireland was the fact that the Industrial Development Authority (IDA) was doing an effective job in marketing Ireland as a location for expanding multinational companies. At the same time, the Irish education system managed to produce a good supply of graduates with the types of qualifications that were in strong demand for some rapidly growing industries internationally, e.g., electronics, pharmaceuticals and software. More generally, the fact that the Irish labour force is English-speaking was also an attraction for many overseas investors, particularly those from the USA.

Whereas employment in foreign-owned manufacturing grew almost continuously in the 1960s and 1970s, it reached a peak at 88,400 in 1980 and then fell continuously to 78,700 by 1987. Although this was a distinctly lower rate of decline than in the indigenous sector, it amounted to a decline of 11% over seven consecutive years.

The output of foreign-owned firms continued to grow quite fast for much of the 1980s, even while their employment was declining. But a problem as regards the contribution of this growth to the Irish economy was that most of the growth occurred in a small number of mostly foreign-owned sectors that had relatively limited linkages with the domestic economy. Thus, nearly all of the growth of industrial output in 1980–1987 was attributable to five sectors—pharmaceuticals, office & data processing machinery, electrical engineering, instrument engineering and “other foods”—while there was almost no growth in all other sectors combined (Baker 1988). These five sectors were importing a high proportion of their inputs and withdrawing very substantial profits from Ireland, so that data on their output alone would give a rather misleading impression of their impact on the economy.

What mattered for the Irish economy was not just the value of the output of foreign firms, but rather how much of that value was retained in Ireland, mainly in the form of payments of wages and taxes and purchases of Irish goods and services as inputs. Such expenditures in the Irish economy were a much lower proportion of the value of output in foreign-owned industry than in indigenous industry, and this was especially true of the five fast-growing sectors mentioned above. Thus in 1983 “Irish economy expenditures” amounted to 79% of the value of sales in indigenous industry compared with 44% in foreign-owned industry, while the figures for the five high-growth sectors ranged between 24 and 39%.¹⁸ Therefore, although there was quite high growth of output in foreign-owned industry in 1980–1987, the declining trend in its employment was a serious indication that its contribution to Irish economic growth weakened in that period compared with the 1960s and 1970s.

Part of the reason for this weaker performance of foreign-owned industry was because the inflow of new foreign investment became somewhat weaker after 1981. This was partly because new US investment in Europe was declining or stagnating for much of the 1980s, while there was also growing competition from other European countries which were trying more actively to attract FDI.

Apart from the slowing down of new FDI in Ireland in the early 1980s, it had also become clear that foreign companies already established in Ireland tended to decline in employment eventually after an initial period of employment growth. This pattern was already established during the 1970s. For example, employment in foreign-owned manufacturing firms established before 1969 fell by 12% in 1973–1980, while total manufacturing employment was growing faster than in all other EC countries. This meant that the growth of total employment in foreign industry depended on a continuing strong inflow of new first-time foreign investors. As time went on, the overall employment trend in foreign-owned industry was increasingly influenced by the large stock of older plants with declining employment. Consequently, a continuously increasing inflow of new first-time investors was needed to maintain a given growth rate. In the 1980s, when new FDI was reduced, the result was that employment declined in most sectors in foreign-owned industry and in the foreign sector as a whole.

2.2.5 Industrial Policy Developments in the 1980s

In the early 1980s, the Telesis (1982) report to the National Economic and Social Council (NESC) made a number of criticisms of the practice of relying so heavily on FDI, and this point was largely taken on board by the NESC (1982). Trends in industry in the 1980s tended to support the view that more should be done to develop the indigenous sector, since heavy reliance on foreign industry was no longer producing the sort of results seen previously.

Beginning in the mid-1980s, a number of significant changes were made in industrial policy. The White Paper on Industrial Policy (1984) and subsequent official policy statements put an increased emphasis on the aim of developing Irish indigenous industry. This did not by any means imply an actual rejection of foreign-owned industry, but it did reflect some acceptance that there were limits to the benefits that could be expected from FDI and that the relatively poor long-term performance of indigenous industry called for a greater focus on addressing that problem.

More specifically, policy statements referred to a need for policy towards indigenous industry to be somewhat more selective, aiming to develop larger and stronger firms by building on those with a good record, rather than assisting a very large number of start-ups and very small firms indiscriminately. Policy was also intended to become more focused on specific areas of weakness that would be common in indigenous firms, such as technological capability, export marketing and management skills. It was intended to shift expenditures on industrial policy from simply supporting capital investment towards greater support for technology, export marketing and management (Industrial Policy 1984, Chapters 1 and 5; Department of Industry and Commerce 1987, Chapter 2).

Another prominent theme in statements of industrial policy objectives after the early 1980s, in a context of serious concern about the growing public debt, was an emphasis on making industrial policy measures more cost-effective in order to obtain better value for money. And a further notable theme was the objective of promoting greater integration of foreign-owned industry into the Irish economy. This meant aiming to have them purchase more of their inputs from Irish sources and to undertake in Ireland functions such as R&D and marketing, so as to increase their expenditures in Ireland and to generate greater technical spillovers for the domestic economy.

The introduction of policy changes in pursuit of these objectives was somewhat hesitant and gradual, and indeed there was some questioning about the real strength of commitment to the objectives. However, quite a number of relevant policy changes—of an incremental rather than a radical nature—were introduced over a period of some years.¹⁹

For example, the Company Development Programme was introduced in 1984. This involved staff of state development agencies with a range of expertise working with selected relatively promising indigenous companies on formulating and implementing strategic development plans. In addition, the National Linkage Programme commenced in 1985 with the aim of building on selected indigenous sub-supply companies which could supply components to the foreign MNCs. This programme also involved participation by development agency staff with a range of expertise. The role of the state agencies in these programmes was not to dictate development plans to the companies involved. Rather their role was to act as catalysts, sharing opinions, acting as information brokers and making suggestions on how they could assist a company's long-term development through their financial supports and services.

After the mid-1980s capital investment grants were awarded more selectively to firms with relatively good prospects for growth in international markets, in order to concentrate more on building larger firms. Thus, the group of existing firms (i.e., excluding new start-ups) that were awarded grant assistance in 1990 was only about half as large as the group awarded grants in 1984 (O’Malley et al. 1992, Chapter 3). Significantly, too, the award of such grants was increasingly made dependent on firms having prepared overall company development plans. In order to obtain better value for state expenditure, the average rate of capital grant was reduced after 1986 and a shift began towards repayable forms of financial support such as equity financing rather than capital grants. Given these constraints, together with the focus on relatively promising indigenous firms, the share of the industrial policy budget going to support capital investment declined from 61% in 1985 to 47% in 1992.

There was a corresponding shift towards measures other than capital grants. From 1985, new initiatives were introduced to strengthen export marketing capabilities of Irish firms, and expenditure on marketing measures increased from 11% of the industrial policy budget in 1985 to 17% in 1992. Such marketing measures were redirected from short-term operational support towards developing companies’ long-term potential, and this support was focused more selectively on indigenous firms. Science and technology policies for industry were also substantially reorganised and new measures were introduced such as technology acquisition grants, subsidised technology audits of firms and subsidised placement of graduates and experienced technologists in firms. Expenditure on science and technology measures increased from 11% of the industrial policy budget in 1985 to 21% in 1992. Other new measures introduced starting in the mid-1980s included management development grants to strengthen the quality of management in indigenous firms.

In addition to these policy changes, there was also a substantial reorganisation of the institutional arrangements for implementing policy. Responsibility for promoting indigenous industry was separated from the task of encouraging FDI, to ensure that there would be a body of state agency staff focusing their full attention on the indigenous sector.²⁰

Another type of initiative beginning in the mid-1980s was the formulation of sectoral development strategies or plans for some selected sectors. The purpose of these strategies was to identify development opportunities, and to help to focus the state agencies on building on areas of actual or potential competitive advantage and on correcting identified weaknesses.

It was argued above that Irish indigenous industry often faced various barriers or obstacles to its development arising from the established advantages of competitors in advanced countries such as superior scale, technological capabilities, marketing, etc. If so, then some of the changes in Irish industrial policy in the 1980s look like relevant responses—including the measures to build larger and stronger firms and to focus assistance more on improving specific capabilities such as technological and marketing capabilities rather than just providing general support for investment.

While policies to develop Irish indigenous industry changed quite significantly after the early 1980s, there was less change in policies for foreign-owned industry. The National Linkage Programme, as mentioned above, was relevant for foreign-owned companies since it aimed to strengthen the local purchasing linkages between foreign multinationals and indigenous suppliers. More generally, policy placed more emphasis on the desirability of attracting foreign firms which would establish key business functions in Ireland such as R&D or marketing, rather than production alone. To this end, the IDA had flexibility to negotiate on the rate of grant assistance it would offer to foreign investors. The rate of grant assistance offered to a project could be made to depend on the expected level of linkages with Irish suppliers and on the type and quality of business functions that would be located in Ireland, as well as other factors.

2.3 Macroeconomic Trends 1960s–1980s

For much of the 1960s and 1970s overall economic growth in Ireland was quite strong, but this was followed by a period of persistent recession or slow growth in 1980–1986. Table 2.1 shows the main trends in output, employment and income per head in these decades before the Celtic Tiger boom. In 1961–1973 GDP grew by 4.4% p.a. and the growth of GNP was almost identical. However, the growth of employment in industry and services was barely sufficient to offset a decline in agricultural employment so that there was only a slight increase in total employment. As noted in Sect. 2.1, this resulted in a rate of net emigration amounting to about one-quarter of the annual number of school leavers.

Table 2.1 Annual percentage change in output, employment and income per head

With the arrival of the oil crisis in 1973 there was a marked slowdown in growth across the international economy but growth in Ireland slowed relatively little. Thus, GDP grew by 4.0% p.a. while GNP grew by 3.4% p.a. in 1973–1980. In addition, this period was exceptional compared to Ireland’s previous experience in the sense that there was considerable growth in total employment and the traditional pattern of net emigration was replaced by net immigration.

All the main trends worsened substantially in 1980–1986. Growth of GDP was much slower while there was no growth in GNP, employment declined considerably, population growth slowed down, GNP per head declined and net emigration resumed. However, the scope for emigration was relatively limited in this period because of rising unemployment in the UK and other countries.²¹ The combination of constraints on emigration, declining employment and natural growth of the labour force resulted in an unprecedented increase in the unemployment rate to 17% in 1986. In addition, the current account of the balance of payments was in deficit by more than 10% of GNP from 1979 to 1982, and the public finances became a serious cause for concern as high levels of public borrowing pushed the national debt up to 115% of GNP by 1986 and further to 118% in 1987.

Although the economic crisis in 1980–1986 looks very different from the relatively good times that preceded it in the 1960s and 1970s, there were weaknesses in the economic performance of the earlier period that are not very evident in the principal macro-level trends, and there were connections or continuities between the crisis in the 1980s and developments in the preceding period.

For one thing, as was discussed above in Sect. 2.2, the internationally traded branches of Irish indigenous industry had generally not fared well in the transition to free trade in the late 1960s and 1970s since they experienced a net loss of market share. This point was recognised by the National Economic and Social Council (1989) who concluded:

“… the economic performance in the first period of EC membership (1973–1980) was not as strong as is suggested by growth rates of aggregates, such as income or consumption or even manufactured production. In particular, the position of indigenous industry in traded sectors was disturbing. But this implies a distinct continuity between the seventies and eighties – for indigenous manufacturing suffered even greater losses in the later period.” (NESC 1989, pp. 207, 208).

The growth of FDI was more than sufficient to outweigh the weakness of indigenous industry and to generate strong industrial growth in the 1970s. Ireland’s EEC membership from 1973 onwards encouraged a surge of new FDI by US companies aiming to produce for the EEC market. As was outlined in Sect. 2.2, however, the overall process of industrial expansion had become very dependent on obtaining a continuously increasing inflow of new first-time FDI. Consequently, if the inflow of new FDI were to weaken the result was always going to be a much poorer performance for the industrial sector as a whole. Such a weakening of new FDI eventually happened after 1981, reflecting the fact that new US investment in Europe was declining or stagnating while there was also increased competition from other European countries who wanted to attract FDI.

Another connection between economic developments in the 1970s and the 1980s was the conduct of fiscal policy. An important but ultimately unsustainable factor that enhanced the growth of output and employment in the 1970s was the growth of public borrowing and public service employment. In response to recessionary trends in the international economy the current budget deficit was first increased from 0.4% of GNP in 1973/1974 to 6.8% in 1975 while the total exchequer borrowing requirement (EBR) rose from 7.5 to 15.8% of GNP. Public borrowing was then reduced in 1976 and 1977 as the international economy improved. However, with Irish unemployment remaining relatively high by previous standards, the current budget deficit was pushed up again from 3.6% of GNP in 1977 to 6.8% or more in 1979 and the early 1980s while the EBR rose from 9.7% of GNP in 1977 to over 15% in the early 1980s.

This debt-financed expansion of public expenditure had a major impact on employment. While total employment grew by 8.3% in 1973–1980, employment in “non-market services” (public administration & defence, health and education) grew by 34.2% and employment in the rest of the economy grew by just 4.2%.²² This meant that almost 60% of the increase in total employment was in public services. Expansionary public spending would also have been partly responsible for the employment increase in other sectors through its impact on domestic demand so that probably at least three-quarters of the increase in total employment was attributable to the growth of public spending. Consequently, in the absence of this growth of public expenditure, 1973–1980 would not have been a particularly exceptional period for employment growth and net emigration would probably have continued or else unemployment would have increased more rapidly.

However, high levels of public borrowing to fund growing expenditure led to a growing national debt as well as large current balance of payments deficits. It became accepted in the 1980s that these trends were not sustainable. Consequently, tax increases and spending cuts were implemented during the 1980s and this had a depressing effect on domestic demand, which contributed to the severity of the 1980s recession.

A further connection between events in the 1970s and the crisis in the 1980s lay in the experience of the agriculture sector. As a large net exporter of agricultural products, a major motivation for Ireland in joining the EEC in 1973 had been to gain access to the large EEC market, which had high prices for agricultural output under the Common Agricultural Policy (CAP). Although there were some initial complications and setbacks, Ireland’s EEC membership led to strong progress in Irish farm incomes between 1973 and 1978 as prices for Irish products were aligned upwards during a transition period. However, this progress in farm incomes was subsequently reversed in 1978–1986 as product prices weakened under a more restrictive CAP while the cost of agricultural inputs rose more rapidly (NESC 1989, pp. 89–92). The operation of the CAP involved a considerable net transfer of resources into the Irish economy. The value of these net transfers into Ireland rose from zero before 1973 to almost 10% of GNP by 1979 according to one definition, but then dipped to little more than 5% of GNP in 1981–1983 with a partial recovery towards 8% in 1985 and 1986 (NESC 1989, pp. 92–96).

To summarise, three significant factors combined to outweigh the weakness of indigenous industry and to boost the Irish economy temporarily in the 1970s—a surge in FDI on joining the EEC, debt-financed expansion of public expenditure and an initial boom in the agriculture sector as EEC membership took effect. All three factors contributed something to the exceptional growth of employment in the 1970s, but the expansion of public expenditure was the major influence in that regard. Without these factors, especially the growth of public spending, the old weakness concerning poor employment trends and constant emigration or unemployment would have continued to be evident.

The long period of recession or slow growth in 1980–1986 was partly caused by the international recession that followed the second oil crisis in 1979. But Ireland’s recession in the 1980s was a good deal more severe and prolonged than in most other countries, mainly because of the continuing weakness of Irish indigenous industry combined with the weakening or reversal of the three factors outlined above that had boosted growth temporarily in the 1970s.

Incidentally, some of the same trends discussed above also explain (see Box 2.1) why the growth rates of GDP and GNP began to diverge in the 1970s and diverged even further in the 1980s, as was seen in Table 2.1.

Box 2.1: Why GDP and GNP Diverged

The values of GNP and GDP were the same in 1973 but GNP amounted to just 97% of GDP by 1980 and 91% by 1986.

The difference between GDP and GNP is the net flow of factor incomes from or to the rest of the world. Such factor incomes consist of items such as interest payments, profits and dividends that can flow either into or out of the country. If there is a net inflow of such factor incomes, GNP is higher than GDP and the country’s income is higher than the value of its production, whereas a net outflow of such factor incomes makes GNP lower than GDP and the country’s income is lower than the value of its production.

In most countries GDP and GNP are usually almost equal. In Ireland’s case GNP was falling increasingly below GDP mainly because there was an increasing outflow of profits, dividends and royalties from foreign-owned companies as the sales and profits of such companies grew, and because there was an increasing outflow of national debt interest arising from the part of the national debt that had been raised abroad. By 1987 the gross outflow of profits, dividends and royalties amounted to over 6% of GDP while the gross outflow of national debt interest came to 4% of GDP.

Some economists (for example, Honohan and Walsh 2002) have offered an interpretation of the experience of the Irish economy in the 1960s–1980s that differs significantly from the account outlined above. In particular, some suggest that the economy was performing well under broadly orthodox policies until about 1973, and the future outlook for the economy was promising with the potential for living standards to catch up with UK or other advanced European levels. However, the economy was then driven into major difficulties by a series of fiscal policy errors, which derailed the potential for such a rise in living standards.

In this account the fiscal policy errors involved borrowing in order to increase public expenditure, especially the decision to respond to continuing high unemployment with a highly expansionary fiscal policy from 1977 onwards. It was argued that this helped to drive up wages, undermining competitiveness and deterring investment. The rising public debt eventually led to tax increases in the 1980s, placing more upward pressure on wages and causing a reduction in domestic demand, while high-interest rates were a further deterrent to investment. This made Ireland’s recession in the 1980s more severe than the general international experience.

This view is fairly widespread, and indeed Honohan and Walsh (2002) were probably quite right in suggesting that many people in 1973 felt that the economy was doing well and had good prospects. Economic growth had been quite strong since about 1960 and there was undoubtedly a general awareness that trends in employment and emigration had been much more favourable in 1960–1973 than in the 1950s. Nevertheless, the fact remains that there had been virtually no employment growth over the period 1960–1972 which resulted in a rate of net emigration amounting to about one-quarter of the annual number of school leavers. This was relatively good by comparison with Ireland’s experience in the 1950s, but it was still very unsatisfactory compared with common experience in many other European countries. It is particularly significant that employment as a percentage of the population in Ireland had declined from 37.1% in 1960 to 34.8% in 1973. As long as that trend continued, there could be no realistic prospect of a convergence in living standards to reach the level of the UK and other advanced European economies, since such a convergence would have required Ireland’s output per person employed to rise far above the levels attained in those countries—probably about 35–50% above their levels.

In addition, looking deeper than such macro-level trends, there were weaknesses in the industrial sector as discussed above. These were only beginning to emerge in the early 1970s, but they were set to become increasingly evident regardless of fiscal policy decisions. Fiscal policy in the 1970s was not the primary or essential cause of major difficulties in the economy, since the economy already had real problems that were quite independent of fiscal policy.

The fiscal policy of the 1970s mainly had the effect of postponing problems, by alleviating real difficulties in the 1970s while pushing the costs of doing so back into the 1980s. Thus, if there had been a more conservative and essentially neutral fiscal policy in the 1970s, growth would probably have been slower in that decade and there would have been very little employment growth with consequent continuation of net emigration and/or more rapidly rising unemployment. The policy that was adopted in the 1970s increased the rate of economic growth and particularly boosted employment growth directly and indirectly. The price that had to be paid for this was the growing national debt which eventually led to fiscal retrenchment in the 1980s with consequent reduction in domestic demand. This was one of a number of factors that reduced the rate of economic growth and put downward pressure on employment in the 1980s.

The costs of this fiscal policy on the downside in the 1980s were somewhat greater than the benefits on the upside in the 1970s because debts have to be repaid with interest, and interest rates were rising internationally. However, the evidence does not support the contention that expansionary fiscal policy was more damaging than that because it drove up wages and deterred investment.

As was discussed in Sect. 2.1, Irish wages had been close to the UK level for a few decades before the Second World War, had dropped well below that level in the 1940s and had then risen again towards the UK level during the post-war period. This rising trend flattened out as Irish wages arrived fairly close to parity with the UK level in the late 1970s. From the late 1970s until after 2000, Irish labour costs fluctuated around 90% of the UK level, with the fluctuations mainly arising from changes in the exchange rate (FitzGerald 2004).

Rather than fiscal expansion generating exceptional increases in labour costs, it can be seen in a chart presented by FitzGerald (2004) that the long-term rise in Ireland’s labour costs relative to the UK stopped temporarily in 1973–1975 coinciding with the first phase of fiscal expansion. That long-term rise stopped more permanently as the second phase of fiscal expansion began in 1977, apart from subsequent fluctuations caused mainly by the exchange rate.

Similarly, the National Economic and Social Council (1989, Fig. 5.10) showed that Ireland’s hourly earnings in manufacturing, adjusted for exchange rate changes, were rising relative to the UK until 1977 but then flattened out and declined somewhat relative to the UK in the early 1980s. Looking at the same indicator relative to all main trading partners, NESC (1989, Fig. 5.12) found a slowly rising trend in most of the 1970s but no further rise from 1978 to 1985. NESC (1989) also reported that if one examines unit labour costs, so as to take account of productivity growth, Ireland’s relative unit labour costs generally rose more slowly or declined more rapidly than the trends in its relative earnings—with favourable implications for Ireland’s cost competitiveness.

In addition, in Sect. 2.2 above it was noted that average earnings rose more slowly than the value of net output per person engaged in both the “modern” and “traditional” branches of Irish manufacturing in 1980–1986. This trend would have enhanced profitability and it could have been of some benefit for competitiveness. Specifically, average weekly earnings increased by 12.4% per year in the “modern” sector while the value of its net output per person engaged increased by 18.1% per year. In the “traditional” sector average weekly earnings increased by 11.2% per year while the value of its net output per person engaged increased by 14.1% per year.

2.4 Conclusion

In the mid-1980s, just before the Celtic Tiger period began, the Irish economy had very serious problems. The longstanding failure to generate sufficient employment was very much in evidence as there was a substantial rate of emigration together with an unprecedented level of unemployment. Consequently, the proportion of the population that was in employment was exceptionally low at just 31%. Largely reflecting that situation, average incomes (GNP per head of population) were relatively low at little more than 60% of the UK or EU levels, and there had been little sign of convergence towards EU levels for decades. In addition, the national debt as a percentage of GNP was very high and still rising until 1987 despite measures that had been taken to cut budget deficits since the early 1980s.

An important factor underlying these problems was an industrial sector that appeared to be in crisis. Much of Irish indigenous industry had been experiencing major difficulties as a result of stronger competition under free trade. Reliance on FDI as a substitute had perhaps seemed like a viable strategy in the 1970s but looked increasingly inadequate in the 1980s. Some new industrial policy measures had been introduced in the mid-1980s but it remained to be seen if they would make any difference.

Despite this unpromising situation, the Irish economy was about to begin two decades of extraordinary growth. That remarkable experience has naturally prompted many people to try to explain what caused this growth. The next chapter provides a survey of the literature that has aimed to explain what caused the boom, including some preliminary assessment of the explanations that have been suggested.