Patrick Honohan: Irish exceptionalism in the world economy
Address by Mr Patrick Honohan, Governor of the Central Bank of Ireland, at the Royal Irish
Academy, Dublin, 10 March 2014.
* * *
Accompanying charts can be found at the end of the speech or on the Bank Ireland's website.
For one hundred years after the Great Famine, the Irish economy was at the extreme end of
the international spectrum in numerous demographic dimensions (population growth, family
formation, fertility). For the past fifty years it has been characterised by an increasingly
exceptional degree of internationalisation - not only in trade, but also and especially in the
ownership of industry. The past thirty years have seen extreme swings in net international
indebtedness and extreme sensitivity of net migration flows to employment conditions at
home and abroad.
The persistence of distinctive characteristics illustrates the fact, nowadays often neglected,
that national policy choices do have lasting effects and structural features of the national
economy are not all necessarily washed away by forces of international economic
convergence. The swings also suggest an adaptability of the Irish economy which has
enabled the nation, through decisive policy action, to recover from situations of extreme
macroeconomic imbalance.
National capacity to influence the type of economy we live in, and to recover from setbacks,
means that there is scope for choice and innovation across a range of policy dimensions.
Research based on global experience suggests that national success in generating
sustainably high average living standards and employment levels does not pre-suppose a
narrowly defined type of economic society. Albeit satisfying a vital shared institutional
underpinning, successful economies, both within Europe and elsewhere, have displayed
economic diversity in numerous dimensions, ranging from the type of financial system to the
distribution of income and wealth across households.
Thus, although experience has taught us the importance of ensuring that the economic
incentives built into our economies are not destructive, and that fiscal and monetary
discipline is crucial to long-term prosperity, there is still room for important policy choices.
Of course countries differ because of their natural resources, or their geographical location.
That is not what I have in mind; rather it is matters which are in principle subject to policy or
collective action. I hope there will be indulgence for my succumbing to professional
deformation by drawing somewhat disproportionately on finance for examples, but on this
occasion I will not focus on day-to-day financial policy issues.
The false new normal
There was a period some years ago, peaking around 1996-7, when it seemed that a new
normative standard for national economic policy was coming into fashion worldwide.
Economic growth was strong in what are called the advanced economies and in the
emerging markets, and stable conditions had prevailed for several years in the international
financial markets, allowing the expectation that - in what was soon to be dubbed the "Great
Moderation" - economic conditions in most countries of the world would at last begin to
converge to a satisfactorily high level.
In Ireland, the Celtic Tiger period was well under way, with its seemingly miraculous
performance in delivering increasingly high employment, increasing living standards and a
balanced budget.
And there is much to admire about economic performance in the mid-1990s. We should not
forget, just because of what happened subsequently, the very substantial and sustained
improvements in living standards in those years. And we should not forget that those
improvements reflected the correction of previous policy errors which had resulted in the
disruptive high inflation, unemployment and economic stagnation of the 1970s and 1980s.
By the mid-1990s, then, it was not unreasonable to ask whether there would soon be any
point in studying the differences between economies. In our continent, with apparent
consensus on a European way of conducting economic policy in a consistent and largely
cooperative way, and in particular with the creation of the single currency, what future would
there be for students of the Irish economy if the object of their analysis was blending into a
broader European background as a merely regional economic entity?
As the millennium turned, everywhere deregulated financial firms seemed to be at the
forefront, spearheading this era of prosperity with their support for investment backed by
increasingly sophisticated risk management systems.
By now everyone understands that the exaggerated and over-reaching reliance on
financialisation (see later) for generating prosperity was sowing the seeds of the global crisis.
Indeed, just as a warm winter allows insects and disease to survive into spring, the
prolonged period of stability itself had lulled many into a sense of false security, creating an
environment that provided no warnings to those with growing risk appetite. In particular, the
combination of stability and hubris lured Ireland into a disastrous extreme - exceeded only
by Iceland - in this dimension.
One casualty of the crash should be the idea of inevitable convergence of national economic
models. Some of the countries which most conformed to the conventional view of
bestpractice, and which had been held out as exemplars, have stumbled more heavily. True, the
weaknesses that have been exposed are now easy to interpret in terms of crude failures of
private and national housekeeping. It is crucial not to lose sight of those fundamental rules:
the need to retain sufficient internal and external balance in order to ensure budgetary and
financial stability. But that is not my focus today.
What I want to reflect upon instead is something that has also been in evidence during the
boom and bust: the fact that national economies preserve long-lasting and persistent
differences, one from the other, which can together affect the economy's ability to generate
high levels of employment, productivity growth and resilience to shocks as well as affecting
the distribution of income and wealth and the quality of life in other dimensions. Successful
economies continue to differ in many ways and - I would argue - are likely to continue to do
so. While departing from budgetary and financial discipline is never a successful strategy in
anything other than the shortest of time horizons, the idea that economic structure
differences must inevitably erode over time is unsupported by evidence.
It is not hard to illustrate ways in which the Irish economy has differed - in some respects
quite sharply and measurably - from otherwise comparable countries. One dimension is
demography, and that brings us back to the Great Famine.
Faint echoes of pre-Famine in the recent bubble
I hope it will not be considered invidious or distasteful to draw some parallels between the
Famine and more recent events. A million dead and a million emigrants - the traditional
aphorism, now regarded by scholars as conservative (Ó Gráda, 2012) - are not to be
compared in scale or nature with the consequences of what has happened in the recent
crisis. But there is some similarity in the build-up of vulnerability and monoculture through
early marriage, subdivision of land-holdings and reliance on a single nutritious but vulnerable
foodstuff that preceded the Great Famine and the property bubble banking monoculture of
the recent bubble.
True, even if there have been mistakes, it is surely the case that the Irish policy response
has been less ideologically contaminated than that of the 1840s. But, as with many other
episodes of economic downturn, international policy activism was stayed, not only by the
constraints of infeasibility, but by censoriously excessive concerns about moral hazard.
The boomerang effects of a failure to recognise exceptional needs at exceptional times, on
the part of those who could help more, but who are infected by such ideology, is something
that continues to require the active efforts of scholars on the global and European stage to
find the convincing arguments and evidence of the collective benefit of a more holistic
approach to policy action. The need for Ireland to engage with partners in modelling the
future macroeconomic policy for Europe and mapping out Ireland's position within that
landscape is by now well understood.
Demographic exceptionalism
One legacy of the Famine was Ireland's persistent exceptionalism in demographic statistics -
a topic about which I inherited my father's fascination. As late as the 1950s, Ireland really
stood out for its weak demographic dynamism.
Best-known here is the decline in the population of Ireland right up until 1961, when it
reached a nadir at about half the pre-Famine level of well over a century before. This was
quite exceptional (Figure 1).
Reviewing a worrying demographic situation in the early 1950s, the Government-sponsored
Commission on Emigration and Other Population Problems still found Ireland at the extreme
end of the spectrum in many dimensions, not only in regard to emigration, but especially
related to family formation and childbirth. Thus, although the crude birth rate was exactly at
the average of twenty comparator countries, this was the product of two outlying features
with offsetting effects: an exceptionally high rate of fertility within marriage (fully 50 per cent
above the average elsewhere) and very delayed marriage (with average age of women at
marriage almost 2 years above the average along with the highest proportion of women
remaining unmarried throughout their life) (Figure 2).1 These distinctive features clearly
pervasively influenced Irish family, politics and society generally, and not least its economic
development.
As far as I know, long-conventional interpretations attributing these remarkable demographic
anomalies to altered risk perceptions following the Great Famine remain largely
unchallenged. The Great Famine had drastically changed the perception of risk and perhaps
the risk aversion of the survivors of the Famine who stayed in Ireland and caused them to
delay family formation, in many cases indefinitely.
Faced with such a persistent situation a modern-day development economist would look for
alternative risk-pooling and risk-sharing mechanisms - such as crop insurance - as
welfareimproving initiatives that could offset the impact of increased perceptions of risk. The 19th
Century Irish financial system offered none of these, of course. Indeed, Ireland is generally
considered to have been backward in the development of community-focused financial
intermediaries. For a variety of reasons that are still debated by scholars,2 the cooperative
credit movement of Raiffeisen and his competitors on the continent did not at first take a
strong hold in Ireland despite Horace Plunkett's effort to bring the credit dimension into the
cooperative movement in the late 19th Century.3
Globalisation
Gradually in the 1960s and 1970s Irish demography began to normalise.4 But in one
demographic dimension Ireland remains extreme, namely in the extent to which migration
continues to respond to economic incentives. The emigration story is an old one, but in
improving times, such as we saw in the two decades before 2007, net immigration surged,
bringing the share of foreign nationals in the population up to record levels for Ireland, and to
an extent which is at the high end of the European scale. The openness is partly a
consequence of policy decisions.
One remarkably persistent consequence of the Irish propensity for openness to migration is
the way in which British unemployment rates still seem to exert a powerful influence on Irish
rates. I first wrote about this thirty years ago, drawing on data between 1963 and 1983.
Although the boom times made the idea seem obsolete, the past decade has shown that the
relationship has not gone away. Much though I would like to give as much credit as possible
to Irish policymakers for the way in which unemployment in Ireland has begun to turn down in
the past couple of years, at a time of increases in the euro area, the chart shows that some
of this must be attributed to the parallel improvements in the UK economy, which has
managed in several respects, including unemployment, to survive the recession rather better
than the euro area (cf. Lane 2012) (Figure 3).
The connection with foreign labour markets, enabling migration to swing rapidly in response
to pressures and opportunities, is only one lasting and pervasive aspect of Ireland's deep
embeddedness in the global economy.
The most conspicuous dimension here is the extent to which the business sector, especially
the manufacturing and export services sector is dominated by foreign-owned firms. This story
is well-known and does not require much rehearsing here. It is manifested in various
statistical comparisons, some more directly and obviously connected with the presence of
multi-national corporations (MNCs) than others.
Ireland shows up as one of the international outliers in the ratio of exports to GDP, for
example: Ireland's ratio here of well over 100 per cent is matched or exceeded only by
Luxembourg and a handful of entrepôts such as Singapore. Another indicator - the ratio of
GNP to GDP - awards Ireland bottom ranking among any sizeable country (Figure 4).5
To be sure, it is easy to exaggerate the extent of MNC dominance, inasmuch as a sizeable
fraction of the output and exports generated by that sector are not attributable to the inputs of
domestic factors of production, but depend heavily on imported materials and services, and
the value of foreign-produced patents. Nevertheless, less problematic indicators, such as the
share of manufacturing employment accounted for by MNCs confirm the importance of the
foreign-owned sector.
While the importance of foreign-owned firms can be traced back to pre-independence times,
the present patterns of foreign ownership dominance have emerged as a clear consequence
of Government policy from the 1950s on to encourage inward foreign direct investment. The
efforts of the IDA and other agencies, combined of course with the tax structure, have played
a powerful role. The model has been a significant driver of Ireland's success in achieving
high average living standards, even if critics have long-noted the potential vulnerability
associated with such heavy reliance on this segment of enterprise.
One hoped-for element of the policy of encouraging foreign-owned firms is the inward
transfer of technology and business know-how including to locally controlled firms. As the
decades passed, this transfer does seem to have happened to an increasing extent. But the
reliance on foreign-owned firms has lasted a long time. Irish-owned companies have grown
and prospered over the past half-century, and the most pessimistic of prognostications have
not materialised. Nevertheless, this systemic dependence on foreign capital and know-how
has skewed Irish development. In the interests of robust diversification, most Irish
economists observers would hope for a greater convergence towards normality in this aspect
of Irish economic development, with a stronger emergence of innovative Irish companies
alongside those steered from abroad.
One side-effect of the heavy reliance on multinational corporations for driving employment
and productivity growth has resulted from the fact that these companies generally bring most
of their financing with them, thereby reducing the pressure on the local financial
intermediaries and markets to innovate in the direction of designing and appraising financing
packages for modern industry. While this did not discourage Irish banks from expansion, it
likely contributed to their slide into a monoculture of property lending.
Debt
That leads us to the third dimension of exceptionalism, namely indebtedness. Here Ireland's
history once again displays some dramatic and exceptional evolutions. Unlike demography,
debt was not a particularly prominent part of Ireland's economic history until the past forty
years or so.
Indeed, rather the opposite was the case: Irish banks typically shipped a large segment of
the funds mobilised through deposits into the London money market, where they remained
relatively safe but yielding little (Figure 5).6
As far as government debt is concerned, it was not until the early 1970s that the conservative
fiscal discipline maintained by all parties started to weaken. Even before the first oil crisis of
1973, the Government had abandoned its self-imposed rule of borrowing only for investment
purposes. The global crisis that followed hard upon the heels of this slippage was associated
with imported inflation, counter-cyclical Government spending and eventually a loss of fiscal
control. By 1986 the Government's debt ratio had risen to an alarming level (Figure 6),
prompting some distinguished commentators to forecast and even recommend (at that time)
some form of debt restructuring or default. But the corner had been turned. The correction in
the fiscal accounts that took hold and accelerated in the 1990s saw Ireland's public finances
return to health extraordinarily quickly. Indeed, a recent IMF study identifies Ireland's fiscal
turnaround after 1986 as quite exceptional and not replicable by other countries.7 Especially
noteworthy is the fact that this reduction in the debt ratio occurred without a surge of high
inflation; rapid inflation and depreciation was part and parcel of the often-chaotic reductions
in the real value of local-currency denominated debt issued by other over-indebted countries
in the past.
The Irish banking sector was a sizeable financier, but ultimately not the main financier, of the
Government's debt explosion in the late 1970s and early 1980s. The banks did draw down
their net foreign assets and built up a limited net foreign liability position, but beyond a certain
point it was for the Government to finance itself from abroad (cf. Barry et al., 2011). When
the Government got its borrowing under control, its debt ratio began, as mentioned, to
decline sharply. Without the Government as a source of lucrative lending opportunities, the
banks began to look elsewhere for business opportunities.
For almost a decade up to 2007, even though public spending expanded sharply, Ireland's
public debt ratio continued to decline even from the low levels which it had reached by the
end of the millennium. This was because tax revenue from the property boom was so high.
But if public debt was under control, private debt was not. Returning to Figure 5 shows the
rapid expansion in net foreign debt of the Irish banks. Recalling what I have said about the
banks' earlier behaviour, the speed and scale of this accumulation was altogether new. The
Irish banks were moving into unfamiliar deep waters, where they would soon get into
difficulties and drown.
Growth in the new millennium relied increasingly heavily on bank-financed property-related
revenues to support - directly or indirectly - employment, profits, dividends, wage and salary
income levels, and tax revenue. The rapid reversal in the trend of public debt after 2007 has
been quite explosive. It reflects both the injection by the Government of funds into the failed
private banking system, as well as the emergence of a huge deficit on the rest of the
Government's accounts, shorn as they now are of the boom-time tax revenues.8 Once again,
it seems that the Irish economy has shown a propensity for rapid changes of fortune. It is not
to understate the severity of the debt challenge, public and private, currently facing the Irish
economy to recognise this propensity, and to believe that it reflects in part a flexibility which
will clearly be a very helpful ingredient in the recovery.9
Had it not been for the official funding from EU and IMF sources, the budgetary cutbacks
would have had to be much more severe, and economic wellbeing would have been much
more badly affected. Indeed, the collapse in incomes and the rise in unemployment in the
crisis largely predates the arrival of the Troika. Unemployment at the end of the programme
was lower than at the beginning. But now the legacy of debt, public and private (only some of
which can be attributed to the famous bank guarantee) presents major challenges for
government and for over-indebted households, firms and their bankers. For the Government,
there has been the challenge of dealing with indebtedness.
Of course the early decision to socialise the risks of bank losses has turned out to be much
more of an unnecessarily open-ended gamble than it can have seemed at the time to the
decision-makers, blindsided as they were to the lack of well-quantified underpinning of the
advice they were being given. From that point on, as more and more information emerged
about the banks, and indeed as the extent to which tax revenues had become dependent on
the now-vanished property boom, management of the rapidly accumulating official debt has
become a central priority. It has included efforts to improve the terms of the debt (notably
negotiating with European partners the lengthy debt maturities and reduced interest rates
eventually secured on both the budgetary and bank-related debt), as well as phasing the
adjustment in such a way as to protect firms and households from too sudden a contraction
of aggregate demand while at the same time accomplishing the adjustment sufficiently
quickly to help speed the restoration of confidence by local and foreign investors. So far the
judgment of the markets and of official lenders is positive.
An exceptional bubble
Coinciding as it did with similar developments in other advanced economies, it is not
straightforward to isolate what was truly exceptional about the Irish construction and property
boom and bust. Certainly some elements were exceptional; others less so.
In particular, should we interpret the way in which Ireland allowed a truly exceptional property
bubble to emerge in such an uncontrolled manner as reflecting some unique and inherent
broad-based failures of the national psyche? After all, it is not only in Ireland, but in many
countries around the world also, that bankers and regulators are - or should be - acutely
conscious of the mistakes - sometimes breathtaking - that they too made. Over-confidence
in the risk management capacity and self-regulating properties of modern finance were
widespread. Hubris, and over-optimism, combined with greed, were by no means confined to
the Irish economy. It was fatally easy in such an environment for Irish decision makers to buy
in uncritically and unreflectively to naïve and to some extent ideological attitudes.10
The aggravating Irish ingredient was the fact that it had just experienced the employment
miracle of the 1990s: against that background a continuation of double-digit growth rates did
not feel as outrageously unsustainable as it should have. The earlier period - the true Celtic
Tiger period - represented a solid and exceptionally fast catch-up to attainable living
standards based on productivity and value for money (cf. Honohan and Walsh, 2002). But
the catch-up was so fast as to encourage illusory expectations. The inflow of bank borrowing
in the 2000s was turbocharged by the momentum of that period. It is the speed of Wile E.
Coyote's chase that brings him so far over the abyss before he realises his mistake. When
the crash came, Ireland was further out than most of the others.
Yes, those in charge should have been more aware of the risks than a cartoon character, but
before claiming world exclusive rights to this type of error, let us not forget the foreign banks
from Britain, Denmark and the Netherlands who, in their enthusiasm not to miss out on the
money to be made from the Irish boom, lost just as much of their book as did the Irish
controlled banks.
This is not to question the value and importance of understanding in greater depth how these
mistakes were made, thereby helping avoid such behavior in future. That promises to be a
valuable function of the forthcoming Oireachtas hearings and inquiry.
The wrenching adjustment that followed the abrupt end to the Irish property and construction
bubble (coinciding as it did with a sharp global recession) has presented exceptional
challenges for Irish economic actors, both in respect of short-term crisis management, and in
setting course for the longer-term future. As far as the short-term is concerned, output and
employment in Ireland fell exceptionally sharply during 2008-9 by amounts matched by few
others (Figure 7). Since then, after three years of little change, a more positive tone emerged
in 2013 with employment in particular recovering almost to its end-2009 level - while still
over 11 per cent below the 2007 pre-crisis peak. Despite the need for further fiscal
adjustment, all the signs are for a continued recovery, albeit slow.
"Varieties of capitalism"
Nor, I think, is Ireland all that exceptional in the spectrum running from liberal and
coordinated market economies, seen as a key distinction in the current literature in Economic
Sociology and Political Economy examining what are termed the "varieties of capitalism".
Even if I am not an adept of this method of comparatively analysing the economies of
different countries, there is clearly something in this literature. It rightly exposes and
emphasises that the characteristics of successful national economies can differ for extended
periods: there is no ineluctable convergence to a single straitjacket determined by the logic of
the market or of technology.
In recent decades, Ireland has oscillated between these varieties, having exhibited some
features of each and at different times.
One dimension discussed in the literature on varieties of capitalism is the growth of
"financialisation" in recent decades. Another - not unrelated - is the degree to which the
varieties of capitalism may be correlated with levels and trend of inequality. Let me close by
discussing these two dimensions.
Financialisation and the future contribution of finance
The term "financialisation" evokes the growth in size, revenue and influence of the financial
sector which was especially striking in the US, UK and some other so-called liberal
economies, though noted also to a lesser extent across most of the world.
Let's not forget the extensive body of empirical literature finding that financial deepening
(usually measured as a growth in the ratio of the assets of financial firms to the size of the
economy) is clearly causal for more rapid growth in developing countries. There is no
evidence that financial deepening has systematically worsened inequality in those countries;
if anything rather the opposite. But neither proposition seems to hold for advanced
economies. Beyond a certain point, greater "financialisation" is not unproblematic.
The symptoms of "financialisation" are evident in Ireland in the developments of the early
years of the new millennium (Cf. Ó Riain, 2012). The total size of the financial assets located
in the "IFSC" firms and funds places Ireland on the edge of some international comparisons
as having a very large financial sector relative the size of the economy, and even globally
significant in absolute terms (cf. Lane, 2013). But most of these assets are at most
tangentially linked to the rest of the economy. Stripping away that international enclave
business allows us to focus on what matters more.
As we have seen, the domestic Irish banking system was traditionally rather passive as an
investor, stable, but contributing comparatively little to economic growth. From the early
2000s, though, massive growth in its activities and apparent profitability told a new story. It
would be hard to deny that this was "financialisation" even if, as I would argue, on a smaller
12
scale than in the US.11, Smaller because the exploitative predatory lending evidenced in
parts of the US sub-prime mortgage lending market spilled-over to Ireland to only a limited
extent. Nor does it seem that, in contrast to the United States (Rajan, 2010), provision of
easy mortgage credit was seen by the political establishment as an attractive way of meeting
the living standard aspirations of lower income households.
Yet in the aggregate, the behaviour of the banks in fuelling the property bubble with their
unrestrained lending both to developers and to final purchasers was hugely damaging to
economic wellbeing. Their shallow credit analysis meant that the banks greatly
underestimated the risk of both forms of lending. Fixing the banks along those dimensions
should be a relatively uncontroversial and mundane task. Probably it is much more important
in finance that fundamentals of soundness are restored than that any particular flavour of
financial sector development is pursued in preference to others.
But we should envisage far more than avoidance of failure from this sector in the future.
Nobel laureate Robert Shiller, a perceptive critic of the US financial system and its excesses,
is nevertheless an advocate of greater use of financial engineering in improving the
performance of the economy, notably by devising and making available better instruments for
risk-pooling and risk-sharing. (Shillerian finance might have come up with a risk-sharing
instrument sufficient to ease the anxieties that generated that post-Famine deferral of family
formation.) In credit, the value of soft information and local knowledge is being
re-appreciated, leading to some reappraisal of the relationship model for SME lending.
Community-based lenders can be key actors in this dimension.13 And innovations in such
areas as crowd-funding could also come to complement other forms of non-bank finance
which are sure to grow in importance as banks repair their balance sheets and respond to
regulatory demands. Not every financial innovation makes sense; finance attracts many
crackpot schemes and is a happy hunting ground for populism. But it is clear that there are
several different proven models of organising finance that are equally good in delivering
growth outcomes,14 and which can have different impacts in other dimensions.
Income inequality
Returning to the question of income inequality, I would argue that Ireland is not exceptional in
this dimension either. As far as the income share of the top 1 per cent is concerned, the last
quarter of the 20th Century saw Ireland's figure growing midway between that of a group of
"Anglo Saxon" countries and a group of "continental" countries (Alvaredo, Atkinson, Picketty
and Saez, 2013).
Indeed, in Ireland, despite the substantial loss of national income in the bust, policy has gone
some way towards limiting the rise in poverty in the downturn (Callan et al., 2013). This
surely reflects a broad political consensus in Ireland; indeed some will argue that more
should have been done. Actually the data suggest that the later years of the boom did allow
relative poverty to decline in Ireland, at a time when the opposite was happening in many
countries (Figure 8). And the corresponding data for 2010 and 2011 suggest that any
reversal in this improvement has been small and mainly concentrated among young adults
(the data for 2012 are not yet available). A similar story is shown by the Gini coefficient,
another indicator of inequality. Of course, holding inequality or relative poverty constant at a
time of falling aggregate income still means a loss of purchasing power for those at the
bottom of the income distribution who can least afford it. And these inequality data are
probably not as reliable as some of the other more familiar macroeconomic data. But on this
evidence the Irish record here seems better than in some of the adjusting countries in
Europe. Here is an area where Ireland is not at an extreme: there is scope for policy to have
a lasting impact.
A long-argued issue in the economics of growth and development is whether greater equality
of income is causally associated with more or less development - this is a topic that has
been receiving a welcome degree of renewed interest internationally. What is clear is that
countries at equally high levels of average living standards can exhibit very different internal
income inequalities, reflecting different approaches to economic policy. "Growth is still good
for the poor" is the self-explanatory title of a recent study by some of the leading experts in
the field by which they mean that there is no systematic tendency for growth to worsen
income inequality: economic growth is accompanied by growing inequality in s