How did Ireland recover so strongly from the global financial crisis?

The global financial crisis of 2007-09 had a huge impact on Ireland, with soaring unemployment and a big rise in public debt as the government bailed out the country’s banks. But the Irish economy has bounced back strongly since 2012, primarily due to globalisation and foreign direct investment.

Thirteen years ago, the Irish economy was on the rocks. Unemployment had soared from below 5% in 2007 to almost 16% by 2011. At the same time, net emigration was running at about 0.6% of the population per annum and the Irish government’s debt had quadrupled to reach 135% of gross national product (GNP).

With its bonds yielding more than five percentage points above those of Germany (despite being denominated in the same currency), the government in Ireland had lost access to international financial markets and had to seek assistance from official International Monetary Fund (IMF) and European Union (EU) funds.

Fast-forward to 2024 and unemployment is back below 5%, there is net immigration at 1.5% of the population annually and total numbers of people in work have grown at 3.4% per year on average over the past decade. Today, the Irish government’s international credit rating is the same as that of the UK.

How should this strong recovery be interpreted?

The financial crisis in Ireland

Ireland’s sharp economic decline began just before the global financial crisis broke. It was triggered by the unravelling of an unparalleled rise in property prices and a construction boom financed by bank lending, which was ultimately sourced from buoyant international financial markets (especially between 2003 and 2006).

With employment booming, especially in the construction sector, the Irish government had taken advantage of the plentiful tax revenue to lower income tax rates and expand public service pay and social benefits.

But soon after property prices peaked around the end of 2006, the whole dynamic mechanism went into reverse. This exposed the over-indebtedness of residential mortgage-holders, property developers, construction firms and a wide range of other businesses that had increased their leverage in order to expand their property investments.

Construction activity then collapsed and employment in the sector fell by over 60%. Economic decline in Ireland was exacerbated by rising household precautionary savings and weakening foreign demand (as the global financial crisis deepened).

For example, despite falling prices, the peak-to-trough decline in real personal disposable income per capita was 7% over a four-year period (see Figure 1).

Figure 1: Real personal disposable income per capita in Ireland, 1995 to 2023

Source: Central Statistics Office

With the recoverability of their lending to the property sector in doubt, Irish banks became increasingly dependent on central bank refinancing in 2007-08. This lasted until – faced with a sudden stop at the end of September 2008, just after the Lehman Brothers bankruptcy – the banks sought and received a blanket guarantee of their liabilities from the Irish government.

At the same time, branches and subsidiaries of foreign-owned banks, whose sizable Irish operations were equally damaged, relied on their parent companies for support. (Eventually, all of them exited the Irish retail banking market in subsequent years.)

In the end, the guarantee provided by the Irish government only stabilised the situation temporarily.

The loss of the boom-time revenue sources and the expense of the deepening recession revealed the underlying imbalance between public spending in Ireland and income from tax and other revenues (Ireland’s fiscal accounts).

As the extent of the banks’ emerging loan losses became more worrying – especially in relation to developer loans and, to a lesser extent, residential mortgages – the knock-on effects on the government’s accounts, resulting from the guarantee to the banks, weighed on its creditworthiness. Indeed, with property prices continuing to fall (until 2012), financial markets over-estimated the likely net fiscal costs of the bank guarantee.

International support for Ireland and the bailout

The role of the European Central Bank (ECB) and Ireland’s adoption of the euro as its currency from 1999 is a distinctive dimension of the crisis. Had Ireland still been using a national currency, the crisis would likely have been equally severe, but different in important ways.

For one thing, it is unlikely that euro membership was a pre-requisite for financing the boom with so much bank borrowing from abroad. This is apparent from how easy it was for non-euro countries, such as Iceland and Latvia, to borrow huge sums in international markets in foreign currency.

Yet when the crisis broke, it would not have been possible for the Irish authorities (absent the ECB) to avoid a very deep devaluation and inflation – much as happened in Iceland. Instead, it was the ECB that provided the liquidity to meet the bank withdrawals that occurred during 2007-11. These withdrawals peaked in an open bank run in November 2010 as markets began to doubt the government guarantee.

ECB financing of the bank run avoided an even more severe financial crash, but it also impeded the needed adjustment of real wages. This likely temporarily deepened the decline in employment.

The IMF-EU programme of financial assistance, negotiated in November and December 2010, endorsed a plan of fiscal adjustment, but it did not restore stability immediately. The EU funds were provided by the member countries of the euro area, while the governments of Denmark, Sweden and the UK all made bilateral loans to Ireland.

This programme did provide financing to the Irish government, thereby averting the need for even more drastic austerity. But the interest rates at which the official funds were initially provided were so high as to make debt sustainability questionable. Indeed, the interest rates embodied surcharges reflecting the scale of Ireland’s borrowing relative to its IMF quota.

But by mid-2011, the European funds brought the interest rates that they were charging to all three borrowing countries (Greece and Portugal being the others) down to little over the cost of funds.

The biggest banks were recapitalised, largely with money borrowed by the Irish government, and they were gradually able to recover market confidence and repay their central bank borrowings. The banks were able to do this in part by shedding large elements of their portfolios through asset sales.

The two weakest banks (Anglo and INBS) – which were dependent on Irish government promissory notes for their solvency – were eventually liquidated. Their substantial indebtedness to Ireland’s central bank was repaid over a period of years, during which the interest costs were very low, thanks to a complex mechanism devised at the time of their liquidation in early 2013 (Honohan, 2023).

It is worth stressing that although the ultimate cost of making the creditors of the banks whole was high (at almost a quarter of 2011 GNP), this was only a part – perhaps a quarter – of the fiscal burden of adjustment. In reality, the imbalance in the rest of the public finances had become quite severe, with the collapse of tax revenue and the need for increased spending on unemployment and other income supports (Honohan, 2019).

An interruption to growth

Despite the two sharp downturns –the global financial crisis and the Covid-19 pandemic – growth in total employment in Ireland since 1990 has been remarkable (see Figure 2). This is especially the case when one considers the relative stagnation that characterised previous decades in the country.

It is only in the period from 2000 to 2007 that employment growth was so heavily related to a construction boom. Before and after that period, it reflected Ireland’s competitive participation in the great wave of globalisation.

At first, in the 1990s, growth in the exporting sectors stemmed long-term emigration, and absorbed a large pool of unemployment despite growing labour force participation. Ireland’s membership of the EU has been credited with contributing to this great expansion.

This was especially the case after the over-indebtedness of the Irish government in the late 1970s and early 1980s was brought under control, a competitive real exchange rate and industrial peace were achieved and maintained, and after the EU’s single market was deepened in the early 1990s (FitzGerald and Honohan, 2023).

The tax-advantaged multinational corporation (MNC) investment – especially in internationally traded services – was wholly insulated from the Irish financial crisis. They depend not on sales in Ireland but on export demand, and the low rate of Irish corporation profits tax was not changed during the crisis. These firms also became increasingly important providers of employment, including of the growing numbers of immigrants and returned emigrants.

Figure 2: Total employment in Ireland, 1956-2024

Source: Central Statistics Office, ILO basis

Beware of exaggeration

Although the recovery of Ireland’s economy since the global financial crisis has been remarkable, it is often exaggerated. In international rankings by per capita gross domestic product (GDP), Ireland today appears among the top three or four. But that greatly over-states Ireland’s prosperity.

On the one hand, genuine progress has been made. This is clearly evident, for example, in the employment numbers and in terms of personal disposable income.

But on the other hand, it is important to distinguish this progress from the froth of the paper profits and depreciation on the activities of MNCs assigned to Irish GDP but with little substantial relation to activity on the ground. The scale of the data distortions created by such tax-driven accounting practices mean that any analysis using Irish GDP, GNP, productivity or exports are wholly misleading.

Specifically, because of the low rate of corporation profits tax, and the ease with which US MNCs – especially those in information technology and services, and pharmaceuticals – can shelter much of their global profit from higher tax rates at home or elsewhere, Irish GDP has greatly exceeded gross national product or income (GNP/GNI) for several decades.

Changes in international tax practices about a decade ago added further dimensions to the distortion that the activities of MNCs introduce into GDP and GNP/GNI. Seemingly, tax avoidance schemes involving other countries that had been used by a number of large US-based MNCs became less advantageous than they had been. Instead, these firms found it advantageous to transfer ownership of huge blocks of their intellectual property to Irish subsidiaries. This resulted in them reporting sizable depreciation charges, which (since both GDP and GNP/GNI are gross of depreciation) bloated the Irish figures.

As one of the main global centres of the aircraft leasing industry, Ireland’s statistics are also heavily distorted by the gross transactions of that industry, even though most of the aircraft concerned never visit the country.

The Irish Central Statistics Office publishes a ‘modified GNI’ (or GNI*) series, excluding depreciation on intellectual property and leased aircraft. Also excluded from this measure are the profits of some foreign-controlled MNCs that have relocated their group headquarters to Ireland for tax purposes.

The GNI* aggregate is more suitable for comparing Ireland with GDP for other countries. In recent years, GNI* has been as low as just over half of Ireland’s GDP. Using GNI* brings Ireland’s ranking down quite a lot – including in the United Nations Development Programme’s human development index.

Instead of ranking third in the world in 2022 for GDP per capita at purchasing power parity, in Worldometer’s list of countries, using GNI*, Ireland would come in 15^th place. This is still extremely high, but not astonishing (Honohan, 2021).

To be sure, the activities of foreign-owned MNCs in Ireland go well beyond the management of their international tax liabilities. Indeed, these companies have come to account for more than one-third of people employed by firms in Ireland and more than two-thirds of corporate and personal income tax receipts.

Conclusion

Ireland’s prosperity has become increasingly associated with its enthusiastic participation in the process of globalisation. This has included both leveraging its membership of the EU and its long-standing cultural and economic ties with the United States and Britain.

The global financial crisis was severe in Ireland and had long-lasting effects on many. But when interest rates fell sharply on the indebtedness assumed by the government as it struggled to recover, economy activity began to turn around in 2012. This came with a resumption of the rapid growth in employment that had characterised the economy since the early 1990s.

Further, credible adherence to a needed fiscal adjustment meant that the confidence of foreign investors was not lost. In fact, inward foreign direct investment was a notable contributor to Ireland’s recovery.