With A Little Help From Our Friends

Ronan Clarke – Junior Sophister

One of the defining features of the Irish economy in recent years has been the unprecedented level of economic growth. Ronan Clarke asks how much of this is due to EU transfers to Ireland, and concludes that this aid does not always get the credit it deserves.

Introduction

The contribution of the EU to the Irish economy has taken many forms over the past 26 years. The importance of various policy initiatives such as the Single European Market, and Economic and Monetary Union to the Irish economy are widely appreciated. The cultural impact on business, public administration and the social partners is also significant. This essay, however, concentrates on the most tangible and high-profile form of support we have received from Brussels - transfers of money under various initiatives.

The performance of the Irish economy in recent years has been quite remarkable. In accounting for this story of extraordinary growth, the significance of the role played by the EU is often down-played, and understandably so, as confidence in our own ability is surely a vital factor in sustaining this success. Commentators typically cite a mixture of contributory factors, and most often they emphasise past investment in education, industrial policy and favourable demographics.

In addition to demonstrating the significant impact that EU transfers have made here, this essay will seek an understanding of how and why they have been so beneficial. Thus, as well as examining empirical evidence on the impact of the Structural Funds, this essay will attempt to locate the issue within current economic thought on the causes of growth, and seek a more in-depth understanding by making a connection with the issue of aid to developing countries. This essay will conclude that greater recognition needs to be given to the importance of transfers and the ways in which they benefit an economy like ours.

The story of recent Irish economic performance is one of phenomenal growth. Table 1 shows that GNP has grown at rates of between 6.0 and 8.8 percent per annum since 1994. Cumulatively, the economy has grown by around 60 percent in the last 10 years while the average for OECD countries has been below 30 percent. The effect on living standards has been remarkable. According to ESRI forecasts, living standards in Ireland will reach the EU average by around 2005.

The fruits of this performance are especially evident in employment figures. Between 1991 and 1997 over 200,000 new jobs were created in Ireland, and the total labour force is currently the highest in the history of the state at almost 1.5 million. At the same time, the unemployment rate has been reduced from 15.7 percent in 1993 to 7.7 percent in 1998, and 17,000 people left the ranks of the long-term unemployed in the year to last April.

In addition, a dramatic turnaround in the public finances has been achieved in the last decade. From a high of 116.0 in 1987, government debt as a percentage of GDP was reduced to just 79.7 in 1996. As shown in table 1.2, the increase in economic activity generally has led to higher government revenues through increased tax receipts and for the last three years the budget has been in surplus, a situation without precedent in Ireland in recent history.

The benefits of EEC membership began soon after Ireland joined in 1973. Receipts under both the European Regional Development Fund (ERDF) and the European Social Fund (ESF) made a significant impact over the first decade or so. In 1988, however, transfers received a major boost when payments were rationalised and increased in the form of Structural Funds. The Structural Funds encompassed the ERDF, the ESF and the guidance section of the agricultural fund FEOGA.

The rationale for the Structural Funds was a consensus among member states at the time that some would benefit more than others from the proposed Single Market and EMU projects. For countries such as Ireland it was acknowledged that, given factors such as the absence of innovative sectors and limited scope for exploiting economies of scale, some form of compensation was justified. Also, by targeting areas such as infrastructure where regional imbalances could potentially be overcome, transfers were seen as vital to promoting economic convergence, which was highly desirable for all participants in the single market.

Two Community Support Frameworks (CSFs) have provided the basis for programming and distributing structural funds in the last decade. The first CSF covered the period 1989-93 while the second ran from 1994-99. In addition, Ireland has received payments from the Cohesion Funds since 1994. In terms of examining the impact of transfers on the current economic boom, the two CSFs are highly significant. Table 2.1 shows that the combined payments from the three relevant categories (ERDF, ESF and FEOGA guidance) jumped from £273 million in 1985 to £797 million by 1994 and reached £867 million by 1997.

Structural funds are targeted at four main areas: investment in physical infrastructure; development of human capital through education and training; production and investment aid to the private sector; and direct income support. According to Honohan, the largest beneficiaries of the 1994-99 allocation of structural funds were infrastructure and human resources with 36.3 percent and 28.4 percent of total spending respectively.

Although the structural funds are clearly important in themselves, in all the years surveyed in table 2.1 they represented total payments substantially less than those received under the FEOGA guarantee fund, more commonly known as the CAP price and income supports. The enormous significance of EU support of the Irish agriculture sector is highlighted by the fact that in 1996 income from farming was £300 million less than the value of direct transfers.

The combined impact of the structural funds and CAP support is highlighted in table 2.2. Although transfers peaked in the early part of the decade their impact is still substantial, representing 3.2 percent of GDP in 1997. Considerable uncertainty surrounds Ireland's long term entitlement to such large payments from both sources, but it is clear that in attempting to explain the economic boom in the 1990s, the role of Brussels warrants careful investigation.

The impact of transfers on the Irish economy has been the subject of several major studies. Most notably, the ESRI's Medium-Term Macromodel has been applied by Bradley, Honohan and others to measure the impact of the two CSFs at different stages. Typically, the short-term effect on aggregate demand is considered separately to the longer-term effect on the supply capacity of the economy.

The immediate demand impact operates mainly through increased spending on non-tradable services and construction sectors and its multiplied effect on aggregate demand is relatively easily measured. The longer-term, supply-side effects operate through an increase in the productive capacity of the economy by enhancing the productivity of workers and the profitability of firms. FitzGerald reports the most recent ESRI findings as suggesting that the cumulative effect of both demand and supply impacts is between 2.5 and 3 percent of GNP by 1998-99.

Meanwhile, the balance of payments surplus is estimated to be 1.2-1.7 percent higher and the government surplus (negative borrowing) almost 1.5 percent greater due to the structural funds. Some 30,000 additional jobs are estimated to have been created up to 1997 and the combined effects of both CSFs, after the initial demand impact fades out, will be to increase GNP by over 2 percentage points in the long-run.

These results have, according to McAleese, surprised many observers by their modesty. It could be that the full impact of the extra expenditure is not felt in the domestic economy. Beutel has found a multiplier associated with the second CSF of 0.692, implying substantial leakages. However, this does not explain the entire shortfall and it is likely that shortcomings of the various studies, often acknowledged by the authors, have contributed to an underestimation of the true impact.

Barry points out that the surveys generally employ conservative estimates of the externality elasticities identified in each case. This criticism applies only to the externalities that have been taken into account and it is certainly the case that many more positive effects of the structural funds are omitted, not least because their effects are simply not quantifiable.

The CSFs introduced long-term horizons to public planning and more rigorous methods of evaluation of public spending. Furthermore, they have undoubtedly created a positive image of the EU in the Irish public's eye, thus generating a positive approach to other EU initiatives such as EMU. It is also arguable that the very evident efficiencies and productivity gains associated with EU-supported capital investments has had a positive demonstration effect on the public, making it more acceptable politically in the long term to prioritise public investment over other spending requirements.

There is a tendency for some commentators to downplay the overall importance of the structural funds in creating the current economic boom. Fitzgerald, for instance, attributes to them a "minor, though important, role", while Duffy et al is inclined to believe that the Single European Market will have a more significant impact in the longer term. Yet it is possible to argue that the structural funds have played a major role in sustaining many of the other factors that are repeatedly highlighted. For instance, the increased exchequer receipts and reduced demands on government revenues associated with the transfers have surely boosted the government's ability to compete on tax terms for foreign direct investment.

What is generally acknowledged by most commentators is the importance of the timing of the two CSFs in creating the prosperity of the 1990s. In particular, the first CSF came at a time of long-delayed fiscal retrenchment and was met with "a backlog of postponed projects" according to Honohan, and eased the pain of reform in the late 1980s by making fiscal responsibility more palatable.

The enormous impact of CAP expenditure, meanwhile, is less controvertible. In the period 1990-95 receipts from the FEOGA guarantee section equated to about 53 percent of gross agricultural product at factor cost according to Kearney. In addition, it must be considered that the CAP has indefinitely postponed for Ireland the need to implement serious and costly structural reforms of agriculture sector.

The approach taken to assessing the impact of transfers often involves simply presenting the empirical evidence relating to Ireland in isolation, and rarely involves establishing a historical or theoretical context. However, there is a lot to learn in economic literature about the effectiveness of aid in stimulating growth and the role of aid in developing countries generally.

It may seem strange in the current economic climate to think of Ireland as a developing country, yet we still have some way to go before we will reach average EU living standards and it is just over a decade since the National Economic and Social Council described the government's fiscal position as "almost unremittingly grim". From this perspective, we can better appreciate the significant scale of receipts from Brussels. The World Bank estimates that aid flows to middle income developing countries represent, on average, just one percent of GNP of recipient countries.

Furthermore, a significant difference in Ireland's case is that the money we receive is free from the stringent conditionality which attaches to most assistance. Although Matthews points out that the CSF sets out an "elaborate system for appraisal, monitoring and assessment" of projects, the system has no real teeth and hardly resembles the programme of policy reform and austerity measures which is part and parcel of IMF assistance and frequently causes significant reductions in public sector budgets.

The rationale for development aid is to help countries overcome structural and other weaknesses and attempt to close the gap with more developed states. However, there is as yet no consensus on a single theory on the role of foreign capital in the growth of less developed countries. Early aid theorists such as Chenery and Stout (1966) adopted the Howard-Domar ‘two-gap' model of economic growth and emphasised the importance of aid in supplementing deficient domestic saving and foreign exchange earnings and thus allowing for greater investment.

Although the aid debate has come a long way since, there is still much emphasis on the importance of supplementing government capital investment. Gasper and Pariera see Ireland as a capital-importing country with significant constraints on financial resources. As such, unilateral transfers help to overcome many problems such as high taxation and borrowing, and in addition they find that public expenditure on infrastructure may ‘crowd-in' greater private investment before concluding that transfers affect GDP growth "substantially and permanently" .

Conclusions drawn by the World Bank on the effectiveness of aid have particular resonance for Ireland. They find that investment in infrastructure can deliver major benefits in economic growth for developing countries but it is important that it expand at the right time to accommodate growth. Frequently, it says, when budgets are tightened infrastructure investment is the first sector to suffer a cutback, yet such investment is vital to renewal of economic growth. This further supports the argument that the timing of the structural funds was vital for Ireland's current success.

It seems likely that, in terms of economic growth, the 1990s will come to be viewed as a golden age for Ireland. The reasons for this performance range from sound long-term economic planning to sheer luck and timing. The impact of transfers from Brussels is often understated yet its true influence is pervasive both in its own right and in its knock-on effects.

Economists have long asked questions about the optimum use of assistance aid to developing countries and Ireland is now a model of success in this regard. Yet we are also unique in the sense that our receipts are very large in the context of world transfers and are also free of the usual strings attached. Although we still have a lot to learn about how aid works best, it is likely that the concentration on physical infrastructure and human capital in the two CSFs has paid off hugely. It is difficult to imagine the current level of success without the marked progress in these particular fields in the last decade.

It now seems likely that adverse changes in the amount of money received by Ireland as a whole from both the CAP and Structural Fund categories will happen sooner rather than later. We are in this sense victims of our own success. Just as we like to believe that our rapid growth has benefited all our European neighbours, so we should acknowledge the major importance of transfers to our economy and pass on the lessons learnt here to other developing countries.

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