Options and Potential for the Northern Ireland Economy

Michael Smyth, Irish Association Seminar "Towards an All Ireland Economy", QUB on 29th April 2006.

North/South Economic and Policy Differences

The most obvious difference between Northern Ireland and the Republic of Ireland is that the Republic is a sovereign country with a network of embassies and a diplomatic presence across the world. As a sovereign country the Republic has control of its public expenditure and its tax revenues. This can be a great advantage but it can also be a severe handicap. Prior to the emergence of the so-called Celtic Tiger, the Republic's economy went through a very dark, difficult period of economic performance and adjustment. Some of us can remember the dying days of the Keynesian orthodoxy in the 1970s or what might be termed "the O'Donoghue dash for growth". Then in his first Budget as Minister of Finance Alan Dukes reminded the Dail that almost one third of the taxes raised went towards servicing Ireland's mounting national debt. The Republic of Ireland managed to do what Margaret Thatcher couldn't, namely to cut public expenditure in real terms, because it had to! These experiences of profligacy followed by severe fiscal retrenchment and hard times were character-forming to say the least. All the macro-economic policy mistakes were their own and they had to deal with the consequences on their own. This underscores the Republic of Ireland's sovereignty warts-and-all. The phenomenal economic resurgence of the Republic over the past 18 years has restored the country's self-confidence and it is this self-confidence that as much as anything will carry the Republic forward in the years ahead.

Northern Ireland, on the other hand, is a region of the United Kingdom and has relatively little policy autonomy. Furthermore if we examine the bare facts of our public finances Northern Ireland runs an annual fiscal deficit of around £6 billion or almost 25% of its GDP. This is often presented as evidence of economic failure but it needs to be viewed within the wider setting of the fiscal union of the United Kingdom.

Economics of the Union

What does the United Kingdom really mean in terms of hard economics? The principle of parity of public services means that citizens of the United Kingdom, in whichever region they live, are entitled to the same level of public service provision and this principle has been implemented subject to periodic adjustment for relative need. If, for any region, public service need is greater than the region's ability to fund from its own fiscal resources, then it is normal for the Central Exchequer to fund an acceptable level of public service provision through the appropriate fiscal transfers.

On the contribution side, the principle of parity does not necessarily imply that members of the monetary and fiscal union contribute identical sums on a per capita basis towards the cost of these public services. If economic activity was spread evenly across the United Kingdom then, with a common fiscal framework, the relative contributions of the counties and the regions would be more equal. This is manifestly not the case in reality. The North-South divide is just as great as it was 30 or 40 years ago. Last week Experian published some research showing that as the UK economy grows, the North-South divide is widening. Is it reasonable therefore to expect Northern Ireland to "pay its way" any more than say Merseyside (Shaun Woodward's political base) or West Wales and the Valleys (Peter Hain's political stomping ground)?

Northern Ireland does indeed enjoy the biggest financial subvention among the regions of the United Kingdom. Merseyside however also enjoys a large annual fiscal transfer as does West Wales and the Valleys. If NI receives a £6 billion subvention from Westminster and if this is estimated on a pro rata basis then Merseyside receives around £3.4 billion and West Wales and the Valleys £1.25 billion per annum. Yet I cannot remember any calls for the economies of Merseyside and West Wales to become self-sustaining so why is the spotlight invariably focused on this rather unique part of the United Kingdom? For that matter, within the Republic of Ireland, the Border Midlands and Western (BMW) counties largely remain economic black spots and receive large transfers from the Central Exchequer in Dublin. Are they any more or less sustainable?

Is it even fair to compare Northern Ireland with other GB regions? Northern Ireland is unlike any other part of the United Kingdom. In case you had not noticed, for more than 30 of the past 40 years this has been the only region of the United Kingdom that has been at various times close to civil war. This is a divided society. Terrorism may be over but its legacy is all around us.

• This is the only region of the United Kingdom that does not have a land frontier with the rest of the Kingdom.
• This is the only region of the United Kingdom that has a land frontier with the eurozone.
• This is the only region of the United Kingdom with a land frontier with the fastest growing economy in Western Europe.
• Economists frequently talk about a concept called opportunity cost. Opportunity cost refers to the cost of something in terms of an opportunity forgone and the benefits that could be received from that opportunity. In this sense the opportunity cost of the terrorism of the last 30 years can be seen in the volumes of foreign direct investment located in the Republic. I scarcely need to remind this audience about the significance of the Fortune 100, a listing of the top 100 corporations in the US. More than 20 of the Fortune 100 companies have their European operations centred in the Republic. Needless to say there is not one such company in Northern Ireland.

Looking further ahead at our medium to longer term economic prospects, I was struck by Roger Bootle's article in last week's Sunday Telegraph (23rd April). While making the argument that good governance does not necessarily guarantee economic success, he published two remarkable tables of international economic performance and I would like to share them with you this morning. The first chart shows the level of GDP per capita of a large number of developed and developing economies. It is noteworthy because it shows, at the bottom, economies such as Saudi Arabia, Russia, South Africa, Turkey, China and India. These are the rapidly growing economies but they remain extremely poor on a per capita basis. The table is also noteworthy because the wealthiest economy in the world, on this basis, is the Republic of Ireland! The second chart illustrates the aforementioned fact that China, India, Saudi Arabia and Russia are the fastest growing economies in the world - but it also illustrates the 5th fastest growing economy is the Republic of Ireland! How long can we in Northern Ireland continue to delude ourselves about our relatively parlous economic position vis à vis our nearest neighbour?

The public sector in Northern Ireland is large but if we wish to debate the relative size of the public sector in Northern Ireland then it is only fair that we do so by first recognising why it has become so dominant. After the commencement of Direct Rule in 1973, public expenditure in Northern Ireland grew extremely rapidly in an attempt to catch up on public service provision in Great Britain and to give full effect to the principle of parity. Great Britain and the rest of the developed world struggled to cope with the inflationary and recessionary aftermaths of the first oil shock. Between 1973 and 1979 the Northern Ireland economy grew very rapidly, boosted by swelling public expenditure levels. Much of the public sector and governance infrastructure of Northern Ireland today was laid down between 1973 and 1979.

As terrorist violence and civil unrest sounded the death-knell for private sector investment, the public sector willingly stepped in to fill the void. The public sector became a surrogate for the private sector. Herein lies the roots of our current economic development dilemma. With Direct Rule the democratic deficit was to some extent filled by a surge in the growth of quangos. The cumulative effect of the rapid build up of public expenditure, institutions and governance structures was to make the regional economy very unbalanced. Having created so many structures and institutions, their upkeep made increasing demands on government current expenditures. As economic activity remained below its potential because of terrorism and lack of investment, current transfers to cover the lower levels of economic activity rose and cumulatively contributed to what has become known as the dependency culture.

Could or should successive British Governments have done anything other than use public expenditure to hold the NI economy together while the search for a political settlement continued? I think not. For all our problems, constraints and difficulties, the NI economy has performed relatively well in recent years. Unemployment, on an ILO basis, is now below the UK average for the first time in our history and there are far more people in work than ever before.

Some Urban Myths.

"We need to cut the size of the public sector in Northern Ireland".

This is a myth. Does anyone seriously want fewer doctors, fewer nurses, firemen and policemen? Who rationally wants (arguably) poorer public service delivery? Calls for substantial cuts in the size of the public sector are what I would have expected from a bunch of accountants! Fact. The public sector in the Republic of Ireland today is one third larger than it was in 1988. The private sector in the Republic of Ireland is more than twice its 1988 size. The task for economic development policy in Northern Ireland for the foreseeable future is to achieve rapid growth in private sector activity, not to cut the size of the public sector per se.

"Quantity of Public Administration versus the quality of Public Administration".

Hitherto the debate about public service reform has tended to concentrate on reducing the scale of the public sector. There should also be a serious debate within Northern Ireland about the meaning of the "public sector" and the "private sector". There are several dimensions to this debate:

(a) People talk about Public Private Partnerships and Private Finance Initiative and other glib euphemisms such as Social Partnership or even the European Social Partnership Model. Is there any basis for having confidence in any of these arrangements? It is extremely difficult to find effective and mutually profitable collaboration between public sector and private sector organisations. Experiments in Local Development Partnerships based on the European Social Partnership Model tend over time to become dominated by the two non-private sector views. This leads to widely different perceptions of the public and private sectors. Among large sections of our people, the private sector carries overtones of sleaze, exploitation, rip-offs and profiteering, while the public sector smacks of inefficiency, "Yes Minister", waste, delayed-decisions, red tape or excessive bureaucracy.

(b) It is astonishing to see just how little our public policymakers know and understand the realities and pressures of private sector entrepreneurs. There exists an ever-widening experiential gulf between public policy makers and private economic agents. How can this lead to good policy-making?

(c) The probity constraints on public servants and decision-makers in Northern Ireland are tightening to such an extent that there is now virtually no discretion that can be exercised. The recent hullabaloo about gratuities and gifts received by public servants only serves to make them less willing to think and act autonomously. The nightmare of a public flogging in front of the Public Accounts Committee undoubtedly keeps senior civil servants awake at night.

(d) The absurd anomaly in Northern Ireland that average non-manual earnings in the public sector are more than 20% higher than those in the private sector means that there is no compelling reason for people to seek a career in the private sector. In addition the emerging horror story that is the "pensions crisis" casts the public and private sectors in very different lights.

Policy Options?

If one accepts the argument that the current structure of the NI economy is the result of a wholly unique set of conditions over the past 30 years (terrorism, civil unrest, political instability) then it follows that what is required to return the economy to a more normal growth trajectory is an equally unique or abnormal set of policies.

What are these policy options? I can identify four main policy choices: (i) The status quo;

(ii) Enhanced capital allowances and R &D tax credits;

(iii) A corporation tax concession to match that of the Republic;

(iv) High level North-South industrial development co-ordination.

(i) The status quo. This is an attractive option because it does not require us to do anything. It means that NI continues to depend on public expenditure for maintaining living standards etc. The problem with this option is that over the medium to long term, public expenditure growth will be constrained and so therefore will economic growth and living standards in NI, other things being equal.

(ii) Enhanced capital allowances and/or R&D tax credits. There have been some hints recently that NI might receive some enhanced capital allowances and R&D tax credits. The prospect of enhanced R&D tax credits is more attractive, not least because it might enhance NI's relative attractiveness to foreign investors. A few weeks ago Amgen opted to locate its global R&D centre in Cork. NI was not a feasible location option for Amgen but with the carrot of, perhaps a 300% tax credit that might have changed……

(iii) Corporation Tax break for NI. There has also been much talk in recent weeks and months of NI being granted a corporation tax break to rival the Republic's 12.5%. If this issue was dealt with solely in an economic or fiscal manner, then there is little likelihood of it ever happening. The Treasury will simply not countenance it. As I understand it from the advocates of this option, the chances of getting such a tax break depend upon two non-economic factors. First of all do our main political parties agree that Northern Ireland needs such a tax break for its future industrial development? Secondly how badly does Tony Blair want a settlement to the Northern Ireland question? The advocates of a corporation tax break for Northern Ireland claim that the DUP and Sinn Fein, as well as the Ulster Unionists, Alliance and SDLP support the proposal and that they will attempt to secure it as part of a political accommodation. That leaves the First Lord of the Treasury, Tony Blair. If a lasting political accommodation between erstwhile enemies can be secured, then it may not be so unrealistic to expect the Prime Minister to accede to requests for a time-bounded corporation tax break for Northern Ireland. There are many economic and political objections to this proposal: