Other People’s Money: Explaining the Celtic Tiger Boom and Bust

From the early nineties until 2007, Ireland was known for its economic miracle. The Irish economy was dubbed the Celtic Tiger for its boundless growth. Asset prices and living standards rose year after year. In 2008 that “miracle” derailed and in the years ahead Ireland will come to be known for its spectacular fall from grace. How did it all happen, the dizzying growth and the paralyzing fall?

The answer lies in capital, getting access to it and ensuring the means to repay it.

In the 1980s Ireland had no money and no capital. Without capital it is nearly impossible to launch businesses, where it is needed to pay for buildings, equipment, wages, etc. What little capital was available within the country was rationed by the banks, who demanded a high return on their scare resource and who rarely entertained ambitious business ideas. As a result, economic activity in Ireland was very low at the time.

But Ireland spotted a clever way to get capital, and in the early ’90s cut corporate tax rates to very low levels. This attracted foreign capital, as multinational corporations saw that their capital could achieve better returns in Ireland than elsewhere. The capital influx was just what Ireland needed. It employed our underutilised workforce, whose spending created a domestic consumer market, and whose taxes funded infrastructural projects.

Of course capital demands a return, and the MNCs got it from their productive new Irish workforce. Their capital had purchased a competitive and skilled workforce whose output, often in high-tech and bio-pharma products, easily compensated the use of that capital.

Low corporation taxes worked well and Irish exports continued to rise into the early 2000s. But in the late ’90s, Ireland found another source of capital: the Euro. Membership of the European Union’s single currency would give Ireland access to the vast pool of capital in continental Europe, and at the same rates enjoyed by Germany and other well capitalized economies. This must have been a glorious prospect to the once cash-starved state.

Ireland joined the EMU in 1999, completing the process in 2002. From this point Irish banks could lend to domestic customers from the huge pool of Eurozone capital at interest rates determined by the ECB, much lower than those traditionally known in Ireland. Unlike the capital provided by MNCs, this capital was available to any Irish person who sought it, for whatever purpose. But like the MNCs, it demanded a return; That is, it had to be repayed with interest.

Had the new capital been employed productively, like the MNC capital, repaying it with interest should have been easy. Instead, the capital converged on one particular and non-productive asset class: property. Lending for property exploded from 2002 on and prices, already rising rapidly since 1996, surged higher with it.

This created a problem not immediately obvious, but that would ultimately lead to the economy’s collapse in 2008.

There are limits to the productive returns of property. It provides a service, shelter, but beyond that it does not generate wealth for its owner. It allows the owner to defer paying rent to a landlord, or to charge rent if not living in the property themselves. But to pay more for any property than is achieved by this is an indulgence, not an economy.

The Irish bought property from each other at ever more indulgent prices. Mistaking the self-perpetuating phenomenon of rising prices for a perpetual path to riches, they accumulated a massive debt owed to their Eurozone neighbours.

This debt was being serviced not from income returned by their investment, but by capital gains in that investment, which could only last as long as their own appetite for investing. The Ponzi scheme reached a top in the summer of 2006, after which insufficient investment followed and the scheme toppled. House prices collapsed, down 30% by Jan 2009 and falling, but the enormous debt remained.

That debt is sinking Ireland. With no means to repay even the principal, never mind the interest, Ireland is facing default both at a private and a national level. The legacy of Ireland’s grand malinvestment is a debt burden that could cripple the country for a generation.

Tags: bubble, capital, celtic tiger, crash, economics, economy, emu, ireland, lending, money, property