G8 leaders could use some local knowledge

Welcome to Northern Ireland. Julien Behal/PA

Global leaders will discuss tax, trade, and other international issues at the G8 summit next week in county Fermanagh, Northern Ireland. If they want to achieve anything, they must recognise that economics and politics and closely linked. Progress on offshore finance, for instance, requires us to understand both the role tax havens play in the global economy and the politics of all the various interested nations.

But if world leaders were to step outside of their plush resort next week, they could learn a thing or two. Northern Ireland itself provides important insights into the connections between politics and economics.

Adam Smith argued that an institutional infrastructure of “peace, easy taxes and a tolerable administration of justice” was required if the invisible hand was to lead to wealth. While the economy has improved since 1998, the connection between the political-institutional settlement and prosperity since the Good Friday (or Belfast) Agreement has been far from simple.

Investing in peace

Peace attracted inward investment from UK retailers, many of whom had given the region a wide berth during the troubles. The arrival of major supermarket chains has offered consumers cheaper groceries as well as offering employment opportunities and a stimulus to the local food-manufacturing sector: local bakeries and butchers lost out in this process.

Predictably, as Northern Ireland’s high streets have become more like Britain’s, the closure or retrenchment of major retail chains such as Peacocks and HMV during the current recession has been felt acutely in its town centres. To hide the problem, some towns near to the G8 summit venue have even taken to painting fake shop fronts on derelict premises.

But some of the major weaknesses that remain in the areas of skills, innovation and productivity predate the troubles. Only in the 1950s and 1960s, following a series of official reports, did the issues associated with the decline of the region’s staple industries (linen, tobacco and shipbuilding) gain major policy focus.

However, the introduction of direct rule in 1972, which followed the onset of the troubles, led to a greater attention to non-economic issues. It became conventional wisdom that a focus on job creation was in large part a “hearts and minds” policy response to security and political considerations, rather than economics. Those projects during the troubles that did gain substantial taxpayer support – both the failed DeLorean car project and Harland and Wolff shipbuilders – did so as part of this policy response.

The official fear during the 1980s was that market-based economic adjustment could reduce stability. Thatcherite policies of privatisation and trade union reform were therefore either postponed or diluted; public spending became the centrepiece of regional economic policy.

The public sector in 1970 accounted for only a quarter of total regional employment. By 1992 it accounted for 39% and, despite the post-agreement boom, the estimate for 2010 was that nearly a third of jobs still remained in the public sector.

The cautionary economic tale that followed the agreement reflects the region’s long-standing economic weaknesses. In the decade after 1998, the unemployment rate went from the highest UK regional rate to one of the lowest; by the third quarter of 2012, however, it had reverted to the national average.

The economic renaissance of 1998-2007 was based on shallow foundations. As in Britain, the growth was due mainly to a combination of public expenditure growth and consumption fuelled by easy credit. Productivity levels have consistently hovered at approximately 80% of the UK figure since 1998 and the most recent official figures (2010-11) place the region’s fiscal deficit per head at more than twice the national average.

Balancing act

The current economic debates in Northern Ireland surround the so-called “rebalancing agenda”. Approximately two thirds of all regional output in 2011-12 was public expenditure, and there is a clear recognition that the economy needs to shift away from such dependence on taxpayer support.

The political class, with the approval of well-organised business interests, have advocated reducing the region’s corporation tax rate as a way to stimulate the private sector. The proponents of such a policy have stressed the claim that lower corporation tax would stimulate job creation via greater inward investment. However, such an analysis downplays or even ignores the higher compliance and administrative costs that would arise if the region did have lower corporation tax rates than the rest of the UK.

Commercially, it is easy to see why business leaders want a tax reduction. The calculations that have led to support for the proposal from each of the main political parties are not hard to understand either.

For its part, Sinn Fein argues that having the same corporation tax rate across Ireland, north and south, is part of a process of economic harmonisation needed to precede political unification. This line of argument also explains Social Democratic and Labour Party (SDLP) support.

On the unionist side, the Democratic Unionist Party (DUP) desire to signal to the business community that it is serious about economic reform has led it to support the proposal, while the Ulster Unionist Party (UUP) has followed suit. Historically, it is not unusual for politicians from across the sectarian divide to agree on economic proposals.

While there is an undoubted need for rebalancing, corporation tax is not a game changer. Analysis concerning the proposed devolution of taxation powers in Scotland and Wales indicates that the potential restriction of corporation tax reductions to a specific region has highly uncertain outcomes in equity and efficiency terms.

The precise institutional design associated with tax reductions is crucial in determining the overall impact. If skills determine the type of foreign investment that Northern Ireland can attract, then the failure to boost skills prior to attracting investment could reinforce the region’s low skill, low wage and low productivity equilibrium. Furthermore, the public expenditure reductions required legally to finance any proposed corporation tax cut would promote additional inequitable outcomes. Treasury support for the proposal is in any case lukewarm.

The UK government will not decide whether to grant Northern Ireland corporation tax cutting powers until after the Scottish referendum in 2014. This delay has led to some calls for a more pragmatic approach, focused on increasing exports to emerging economies like China or India.

When combined with institutional reforms based on raising innovation, educational standards and skills, this new export focus is Northern Ireland’s best bet. The symbolic and risky option of corporation tax reduction simply does not offer the same long-term economic gain, despite what politicians may say.

The danger is that political consensus wins out over economic evidence, and that institutional change does not translate into shared prosperity. Let’s hope that after the G8 we aren’t complaining about these same mistakes on a global level.