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The secret behind the Irish economic miracle

Ireland's economic miracle – at Moneyweek.co.uk - the best of the week's international financial media.

In a generation Ireland has been transformed. Whereas once it had a poor agricultural economy with high emigration Ireland now has the fourth highest effective GDP per head in the industrial world and a per capita income 11% higher than the UK. But there is a widely held belief that Ireland's success is attributable to funds transfers from the European Union. This is a popular misconception. Let me explain.

If subsidies and regional aid were a major cause of economic growth, you would expect to see two things. First, the highest growth years would coincide with the periods when Ireland was receiving the greatest transfers. Second, other poor countries, which receive the most subsidies, would experience high economic growth rates. The facts suggest the opposite.

Ireland began receiving subsidies after joining the EEC in 1973 when it was the community's poorest nation. For 13 years the Irish economy was feeble, recording an average annual economic growth rate of less than 2% a year. During this period, net receipts from the EU averaged 4% of GDP. By 1987 Ireland's per capita income was only around 63% that of the UK.

But from 1990 to 1995 the Irish economy grew by 5% per annum. And in the next five years it really took off, growing at more than 9% a year. Now, during this period when the Irish economy began to boom, net receipts from the EU fell back to 3% of GDP, while Ireland's payments to the EU budget rose from €360m euro in 1990 to €1,530m in 2000. Yet in 2000, receipts from the EU were actually 11% lower than in 1991.

Moreover, if subsidies were the main force behind Ireland's success then you would expect to see this replicated in Greece and Portugal, while Southern Italy and Sicily, which has enjoyed 40 years of regional aid, would be the richest region in Europe. That it is not tells its own story.

In 1990-2000 EU Structural and Cohesion Funds amounted to 4% of Greece's GDP and 3.8% of Portugal's, yet their average annual growth rates were a meagre 2.2% and 2.6%, respectively.

So if it wasn't EU subsidies that were behind the Irish economic miracle, what was the secret? Well, in the mid-1980s Ireland took a radical course of slashing public expenditure, abolishing agencies and cutting taxes and regulations. The top marginal rate of tax was cut from 80% in 1975 to 44% in 2001. The standard rate of income tax was reduced from 35% in 1989 to 22% in 2001. Corporation tax was cut from 40% in 1996 to 12.5% in 2003.

Ireland is now a technologically advanced economy with a well-educated labour force, many with experience of working abroad. In the last decade many Irish working overseas in the world's large high tech companies have been persuaded to return home.

The real attraction of Ireland is the absence of restrictions on doing business. Employees are relatively free to hire and fire, and social security payments are much lower than in other EU countries. As multinational companies have moved in and agriculture has declined, productivity has gone through the roof. Ironically, EU subsidies were actually holding back this leap in productivity.

This success story is not lost on the new EU entrants in Eastern Europe, which are adopting low tax regimes, but it appears to be overlooked by the likes of Chirac and Schroeder who witter on about preserving their social model and bleat for a return of Britain's rebate. Talk about fiddling while Rome burns!

By Brian Durrant, the Investment Director of The Fleet Street Letter 

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