What were the economic consequences of Irish independence?

Following partition of the island of Ireland in 1921, the two successor states had to forge separate paths, both politically and economically. The experience of the early years of the Irish Free State offers lessons for today’s debates about independence from the UK.

This year marks the 100th anniversary of partition of the island of Ireland. On 3 May 1921, the 1920 Government of Ireland Act came into force, creating two devolved parliaments: one for the six counties of Northern Ireland; and one for the 26 southern counties that would become the Republic of Ireland.

This division, and the experiences of the two polities as they forged separate paths, have come under renewed focus in the past few months, and not just as a result of the centenary. Brexit has raised new cross-border challenges and the spectre of potential future withdrawals of nations from the UK (as highlighted by both the Financial Times and The Economist in recent weeks).

Lessons from the Irish experience may well be applicable for the future of Scottish, Welsh and possibly Northern Irish participation in the Union. Here, the focus is on fiscal foundations, sovereign debt, currency and trade – all pertinent issues in today’s debates about possible independence.

Fiscal foundations of the new state

Historically, Ireland was intertwined with the larger economy of Great Britain and shared a currency, legal system and other institutions (O’Rourke, 2017). While the island was partitioned in 1920, independence – established by the Anglo-Irish Treaty of 1921 – gave the Irish Free State (IFS) greater potential control over all aspects of economic policy.

Most notably, the IFS had complete autonomy over customs and excise (trade protections), whereas Northern Ireland became an example of Home Rule economic structure – in other words, customs and excise were controlled by Westminster. Despite earlier nationalist calls for protectionism, free trade was the norm in the 1920s. Indeed, a Tariff Commission was established in the IFS, but it did not result in a blanket introduction of tariffs (Devlin and Barry, 2019).

In terms of fiscal policy (government spending and taxes), the IFS (and Northern Ireland) inherited the burgeoning welfare spending of Edwardian Britain, which included pensions and social insurance. The IFS policy of balanced budgets required cuts to be made in this area, while Northern Ireland was able to maintain welfare spending at British levels thanks in part to a subsidy from Westminster.

In addition, income tax was cut in the IFS to levels below those inherited from the Union. There were orthodox economic underpinnings to this policy as it would encourage return migration and keep money and assets within the state, preventing capital flight (Rumpf and Hepburn, 1977). But a more important consideration was to keep Irish tax rates in line with, or below, UK rates so as not to lose the few existing direct taxpayers resident in the IFS (Meenan, 1970).

Sovereign debt

After the IFS was established, the newly created government faced financial challenges and had to rely on short-term borrowing from Irish banks for the first few months of its existence (Fanning, 1978). There were also difficulties in raising and collecting taxes in the early years due to evasion and avoidance (Meenan, 1970).

Initial inquiries made by the new IFS Department of Finance to the Irish banks and the Dublin Stock Exchange about long-term borrowing suggested that a UK guarantee would be essential for a loan flotation (the offering of credit and mortgages) to be successful. Yet these views proved to be incorrect and the First National Loan (worth £10 million) was in fact over-subscribed (Fitzgerald and Kenny, 2020).

Contemporary opinion was positive. The Economist noted on 8 December 1923 how the IFS had ‘restored order within its boundaries’ and reorganised its economic and political administration. It went on to state that the £10 million loan had been fully subscribed by the public, highlighting how this internal loan meant that there was no need for external borrowing, signalling public confidence in the new state.

The article in The Economist also argued that this sent a signal abroad and would ‘do much to wipe out the unhappy impression created’ by the civil war following independence. Subsequent national loans mainly traded at a premium (see Figure 1) and yields ranged between 3.5% and 5.5% (Foley-Fisher and McLaughlin, 2016). In comparison, UK yields ranged between 2.7% and 4.8% over the same period (Bank of England, 2018) and only in 1934 was there any discernible premium on IFS government bonds relative to UK Consols (Fitzgerald and Kenny, 2018).

An important facet of this was how the pre-existing sovereign debt was distributed between the IFS and the UK, an issue that is a concern for countries currently contemplating leaving the Union. Under article V of the Anglo-Irish Treaty, the IFS was to assume liability for a fixed share of existing UK debt, estimated to have been 80% of IFS GDP (Fitzgerald and Kenny, 2020).

The IFS was subsequently released from this sizeable obligation as a concession for the acceptance of permanent partition of the island and the existing border (Fitzgerald and Kenny, 2020). The importance of the border issue was a uniquely Irish predicament; but comparison could be made with North Sea oil reserves today.

There was, however, one other debt for which the IFS remained liable: the outstanding debts relating to bond-financed land purchase schemes in Ireland, roughly 40% of IFS GDP (Foley-Fisher and McLaughlin, 2016). Ireland was the only part of the UK where this policy was implemented and Offer (1983) argues that the scale of the purchase programme had restricted government policies in other areas, such as education reform, in Britain.

Alongside the issues surrounding the creation of a functioning state was the unresolved nature of the ‘Land Question’, the name given to conflict between landlords and tenant farmers that pre-dated the formation of the IFS. The 1923 Land Act in the IFS was an attempt to complete land purchases (for example, the sale of land from landlords to tenant farmers) of the pre-independence land acts, and it was reciprocated by the 1925 Land Act in Northern Ireland (Foley-Fisher and McLaughlin, 2016b).

Unlike the First National Loan, the IFS government could not have undertaken the 1923 Land Act without the assistance of the UK government. The latter had to agree with the contents of the legislation in order to secure a British guarantee on the £30 million loan for continued land purchases. Renewed land agitation in the Irish countryside spurred the British government to accept the terms in order to avoid an unstable state developing on its doorstep.

Figure 1: First, second, third and fourth national loans, current price (par = 100)

Sources: McLaughlin, 2015

Currency and credit

Another important facet of early IFS policy was also picked up by The Economist, namely that it did not create a separate currency and ‘was in no hurry to establish one’. With a de facto common currency during the 1920s, the IFS and Northern Ireland shared a similar monetary experience (Daniel, 1976).

The Irish pound was pegged to sterling and experienced comparable trials and tribulations with the restoration of gold at parity that was experienced in Britain, namely a fall in prices or deflationary pressures. This was because the IFS was required to adhere to ‘sound finance’ (balanced budgets). When Britain abandoned the gold standard in September 1931, the IFS followed shortly afterwards – see Figure 2. The IFS pound was essentially a sterling-pegged currency until 1979 (Bielenberg and Ryan, 2012).

Banking practices, such as the structure of bank assets and liabilities as well as branch banking, were unchanged from the pre-partition period. The creation of a political border did not result in the establishment of an ‘Irish’ (north or south) money market, and Irish banks continued to use the facilities of the London money market.

But from a technical standpoint, this now meant that IFS banks were exporting capital. Equities were traded on the Dublin Stock Exchange, but this was small and market capitalisation fell in both real and nominal terms from the early 1900s (Grossman et al, 2014). Later, the state investment bank, the Industrial Credit Corporation (established in 1933), played an important role in underwriting shares of new companies founded in the 1930s. It underwrote 60% of all shares issued between 1934 and 1939 (Daly, 1992).

Why was the IFS rigidly conservative about the possibilities of monetary change? There are several possible explanations. As most civil servants were in office prior to the establishment of the IFS and were trained by HM Treasury, perhaps there was little willingness or ability to deviate from conventional wisdom about currency (Johnson, 1985).

In addition, there was an awareness of the importance of creating confidence in the new state and radical institutional change would have threatened business interests in Dublin. Contemporary events, such as the experience of hyperinflation, which drastically increased prices in post-First World War Europe, were an obvious deterrent to any monetary experimentation (Dáil debates, 27 January 1926).

Figure 2: US/Ireland foreign exchange rate in Ireland, January 1922 to December 1998

Sources: Bank of England and Central Bank of Ireland

Protectionism, economic nationalism and a trade war

The election of Fianna Fáil, the Republican Party, in February 1932 is traditionally seen as a moment of radical change in economic policy in the IFS because of the introduction of protectionism and economic nationalism. But the 1930s were characterised by three separate factors: the Great Depression; the Anglo-Irish ‘economic war’; and the implementation of protectionism. All three are interrelated and difficult to disentangle, making it hard to determine which factor had the greatest impact (Kennedy et al, 1989).

The IFS had a delayed experience of the Great Depression. This is partly explained by the fact that it was primarily an agricultural producer specialising in livestock and had a limited manufacturing sector. But the IFS (as well as the UK) were also helped by a stable financial system, one that did not experience a banking crisis.

More importantly, countries that left the gold standard earlier recovered from the depression more quickly (Eichengreen, 1996). Thus, by following British monetary policy, the IFS may have been spared a worse fate in the 1930s.

Despite this, rising unemployment coupled with a strain on employment in the United States and the UK – both traditional emigrant destinations – led to changes in economic policy. Import tariffs were introduced in November 1931 to prevent dumping, whereby products are exported at below normal prices. These tariffs echoed similar measures in the UK, which applied to Northern Ireland.

Protectionist policies were adopted by Fianna Fáil because at the time there was not much else the government could do given the self-imposed monetary constraints of the IFS. Protected industries – despite local lobbying – were primarily located around key ports as they were dependent on imported raw materials and the majority of employment was located in and around Dublin (Daly, 1992). Further efforts were made to increase employment in agriculture by encouraging the preparation of the land for crops, or tillage, but here too there were limited gains.

The escalating protectionism of the IFS must be seen both in the context of the global depression and an Anglo-Irish trade war. In June 1932, the IFS defaulted on obligations under the Anglo-Irish Treaty and subsequent financial settlements (Foley-Fisher and McLaughlin, 2016). These were primarily repayments of loan instalments by farmers under the pre-independence land acts, which in total amounted to £5 million per annum.

The British response to default on the annuity payments was to levy tariffs on IFS imports, most notably cattle, in an attempt to recoup the expense of servicing these debts. This action was motivated by the belief that by hurting Irish farmers, it would undermine the support base of Fianna Fáil. But the IFS immediately retaliated and imposed its own counter-tariffs. In all, the dispute did not harm Fianna Fáil’s electoral standing and the economic war gradually ended with bilateral trade agreements between the UK and the IFS in 1934 and then again in 1938 (O’Rourke, 1991).

The political context of the annuities dispute helps to understand the underlying motives of the Fianna Fáil administration. They were part of a deliberate strategy to remove the remaining vestiges of the Treaty that were unpalatable to Fianna Fáil, including the Oath of Allegiance to the British Monarchy and the post of Governor General (McMahon, 1984).

Lessons for today

What lessons might the Irish experience offer to other UK nations considering independence? One of the major issues of the 2014 Scottish independence referendum was the question of currency, and this is again at the forefront of debate today. The Scottish National Party’s (SNP) current economic plan is to continue to use the pound for an extended period (in other words, to peg to sterling) before creating an independent currency, echoing the IFS approach.

Maintaining a peg for 57 years was not without its challenges, including a recession induced in 1955 by not following London’s rate increase, but it was not an insurmountable burden (Honohan and Ó Gráda, 1998). Currency stability (shown in Figure 2) is something that is perhaps undervalued in historical narratives of Ireland’s success.

Other valuable lessons relate to the management of public finances post-independence. The Financial Times recently estimated that an independent Scotland would face a large hole in its finances, which means that sacrifices may need to be made.

Ireland had to reduce social payments and live within its means in the years immediately following independence. This was because previous social payments had effectively been financed by the largesse of HM Treasury – although the question of whether this repayment was rightfully owed to Ireland is another issue. These levels were eventually restored thanks to a growing economy.

The early years of independence in Ireland was a time of cautious experimentation, but as Rumpf and Hepburn (1977) concluded, independence was ‘more directly concerned with securing the power of the nation to direct its own destiny than with achieving prosperity or social progress as such’. Ultimately, as O’Rourke (2017) argues, independence was essential for Ireland to exploit its later membership of the European Union, as it gave the nation policy flexibility that other regions of the UK did not possess.

Where can I find out more?

The financial implications of Ireland leaving the union: John Fitzgerald discusses the UK’s reduction of the Irish Free State’s debt in 1925.
‘Till Debt do us Part’: John Fitzgerald and Sean Kenny discuss the political economy of Ireland’s debt relief in 1925.
Writing the Economic History of Ireland since Independence: Eoin McLaughlin reviews recent work published on the economic history of Ireland in the twentieth century.
Economic Impact of the Irish Revolution: Eoin McLaughlin’s chapter on the economic implications of independence from the Atlas of the Irish Revolution.
Sovereign Debt Guarantees and Default: Lessons from the UK and Ireland, 1920-1938: Nathan Foley-Fisher and Eoin McLaughlin tease out the investor credibility of guarantees on bonds issued to finance land reform in Ireland in the post-independence period.