ireland economy`s resistance to economic shocks

ISM UNIVERSITY OF MANAGEMENT AND ECONOMICS
MANAGEMENT AND BUSINESS ADMINISTRATION PROGRAMME
BACHELOR STUDIES
IV year student
Adomas Sabockis …………….
2011.05.10
IRELAND ECONOMY’S RESISTANCE TO ECONOMIC SHOCKS
BACHELOR THESIS
Supervisor:
Dr. Lineta Ramonienė …………….
KAUNAS 2011
SUMMARY
Sabockis, A. Ireland economy’s resistance to economic shocks: bachelor thesis, Economics.
Kaunas, ISM University of Management and Economics, 2011.
The purpose of this bachelor thesis is to determine Ireland’s resilience to economic shocks. The
analysis includes finding relevant indicators to measure country’s external vulnerability, analysis of
recent and current economic situation in the country, overview of existing literature on the subject.
These two research methods have been used: comparative analysis and linear regression model. In
comparative analysis, in more detail Ireland was compared to Portugal, Japan and Lithuania. Also,
resilience to economic shocks index was constructed and applied for a panel of 103 countries. Ireland
ranked 10th. When making linear regression model, Ireland’s economic indicators from period 19702009 were compared, showing which indicators have most influence on Ireland’s resilience to
economic shocks. The findings show that increase in population size and financial depth has the most
effect.
Key words: Economic shocks, external vulnerability, GDP growth, regression analysis
2
SANTRAUKA
Sabockis, A. Airijos atsparumas ekonominiams šokams: bakalauro baigiamasis darbas, Ekonomika.
Kaunas, ISM Vadybos ir Ekonomikos Universitetas, 2011.
Pagrindinis šio bakalauro baigiamojo darbo tikslas yra nustatyti Airijos atsparumą ekonominiams
šokams.Ieškoma svarbių ekonominių indikatorių nustatyti šalies išorinį pažeidžiamumą, tiriama
istorinė ir esama ekonominė situacija šalyje, nagrinėjama jau esama literatūra šia tema.
Panaudoti du tyrimo metodai: palyginamoji analizė bei tiesinė regresinė analizė. Palyginamojoje
analizėje detaliau nagrinėjami skirtumai tarp Airijos, Portugalijos, Japonijos ir Lietuvos.Taipogi,
sudarytas šalies atsparumo ekonominiams šokams indeksas, kuris vėliau pritaikytas 103 šalių
dabartiniam atsparumui nustatyti.Airija jame užėmė dešimtą vietą. Regresinėje analizėje panaudoti
Airijos duomenys apimantys 1970-2009 metus, tirta kuris indikatorius daro didžiausią įtaką jos
atsparumui ekonominiams šokams. Tyrimas parodė, kad didžiausią teigiamą efektą turi populiacijos
dydis ir finansinis išsivystymas.
Reikšminiai žodžiai: ekonominiai šokai, išorinis pažeidžiamumas, BVP augimas, regresinė analizė.
3
TABLE OF CONTENTS
SUMMARY
2
SANTRAUKA
3
LIST OF TABLES
6
LIST OF FIGURES
7
INTRODUCTION
8
1. SITUATION ANALYSIS
9
1.1. Introduction
9
1.2. Population
9
1.3. Geography
10
1.4. Political overview
11
1.5. Main economic indicators
12
1.6. National debt
13
1.7. External debt
15
1.8. Foreign direct investments
16
1.9. Trade openness
17
1.9.1. Exports
17
1.9.2. Imports
18
1.10. Situation analysis conclusions
19
2. LITERATURE REVIEW
21
2.1. Introduction
21
4
2.2. Macroeconomic stability
21
2.3. Microeconomic efficiency
23
2.4. Government involvement
24
2.5. Social development
24
2.6. Research methodology
25
2.6.1. Comparative analysis
25
2.6.2. Linear regression analysis
28
2.7. Data collection, validity and availability
3. ANALYSIS OF IRELAND’S RESILIENCE TO ECONOMIC SHOCKS
30
32
3.1. Comparative analysis of Ireland, Portugal, Japan and Lithuania
32
3.2. Regression analysis
34
3.3. Conclusions
37
LIST OF REFERENCES
38
APPENDIX A
40
APPENDIX B
43
5
LIST OF TABLES
Table 1. Population by Age: 2005-2009
10
Table 2. Population by Age: 2010-2020
10
Table 3. Main economic indicators 2006-2010
13
Table 4. External debt comparison
15
Table 5. Foreign direct investment, net inflows (% of GDP)
16
Table 6. Breakdown of exports from Ireland, 2010
18
Table 7. Breakdown of Ireland’s imports year 2010
19
Table 8. Regression model summary
34
Table 9. Analysis of Variance table
35
Table 10. Regression model coefficients
36
6
LIST OF FIGURES
Figure 1. Changes in National Debt
14
Figure 2. Total exports from Ireland
17
Figure 3. Total Imports to Ireland
18
7
INTRODUCTION
In recent years the world economy has experienced a strong financial crisiswhich is said tobe
“the worst financial and economic crisis since the Great Depression”(Bardhan, Edelstein,Kroll (2009))
and that the measures taken to deal with it “were unprecedented in their scale” according to OECD
Chief Economist, Klaus Schmidt-Hebbel. It was triggered by subprime mortgage crisis in the United
States, followed by liquidity shortfall in the banking system, and has made large financial institutions
to collapse and require aid from national governments, which then resulted in downturns in financial
markets around the world. This financial crisis that originated in the United States had a different effect
on a number of countries, reducing their financial and economic strength and shocking their economies.
According to the American Heritage Dictionary of Business Terms, an economic shock is “an external
and unexpected event that impacts an economy”. Being unpredictable by definition itstill has different
levels of impacts on different economies, making it possible that certain indicators have greater
influence.
Ireland has been shaken by the economic shock even more than most countries of the Western
world. There were many reasons for that, including high dependency on international trade and high
households and public sector debts. For an economy that is growing and wants to sustain the growth it
is necessary to know its weaknesses that could result in strong economic shocks like this financial
crisis. Now the problem arises how does one know how resilient the Ireland’s economy is to exogenous
shocks? What indicators measure resilience and how what is their influence for Ireland?Answering
these questions is the goal of this study and it will be reached by meeting several objectives:
(1)to analyze the effects of an economic shock in Ireland;
(2)to establish a set of indicators that would determine the resilience of an economy;
(3) to determine how resilient to economic shocks Ireland find ways to improve it.
To determine Ireland’s economy resistance to economic shocks these research methods will be
used: comparative analysis and linear regression analysis.SPSS Statistics 17 software was used to make
regression analysis. The data that is used consists of but is not limited to real GDP per capita, trade
openness, financial development, population size, economic, trade and financial freedom indexes.
If applied the results of this study will increase Ireland’s resistance to economic shocks, help
Ireland increase and stabilize GDP growth, increase income, reduce unemployment and the chance of
regressions.
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1. SITUATION ANALYSIS
1.1 Introduction
First of all it is important to know some basic information about Ireland to understand its economy.
That is why short introduction to Ireland’s demography, geography and political situation is made.
Then more detail on Ireland’s GDP, national and external debt, trade openness and foreign direct
investment will be revealed. All these sections will prove the need to study further whether Ireland is
resilient to economic shocks or not.
1.2 Population
With most of the western world having low birth rates during the last few decades the population is
ageing and that is creating new issues for policy-makers to deal with. Population changes directly affect
the size of the labor force and consequently potential employment and output growth. In addition,
changes in demographic trends strongly influence savings and investment behavior, the outlook for the
public finances, a range of financial market variables and, more controversially, may impact on the
pace of productivity growth in an economy (Mc Morrow, Röger (2003)).
Knowing the structure of Ireland’s population and the forecast for next decade allows identifying
problems in labor market, which in turn shows probable economic stability problems (Loayza, Raddatz
(2007)).
Ireland had population of almost 4.5 million in 2009. That made Ireland one of the smallest
populations in Western Europeand it is dwarfed by its nearest neighbour, the United Kingdom with
61.6 million citizens. Ireland had a population numbering only around 60% of London alone and
accounted for just 0.93% of the population of Western Europe in 2009.
The population is so small because of long history of emigration. In 1841, the population of what is
now the Republic of Ireland was recorded at more than 6.5 million by a census. Massive emigration to
the UK, Australia and the US, invoked by severe economic problems,divided that number by two, to
around three million, by the 1920s when the country gained its independence. Only in the 1970s the
population began to slowly grow. Then in 1990s, when Ireland’s economy began a spurt, wages were
increasing and employment growing, a process that accelerated rapidly.Encouraged emigrants came
home and many immigrants were attracted from poorer countries, particularly Eastern European
nations like Poland and Lithuania.
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The country’s population is forecast to grow by a further 11% over the forecast period, reaching
just five million in 2020. In the tables below the population composition by age is shown, one
analyzing changes 2005-2009 and the other one is a prediction made by United Nations.
Table 3.Population by Age: 2005-2009
In thousands
2005
2006
2007
2008
2009
851
862
878
893
907
6.6
2,800
2,880
2,942
2,994
3,036
8.4
65+ yrs
458
467
479
492
505
10.1
TOTAL
4,109
4,209
4,299
4,378
4,448
8.2
0-14 yrs
15-64 yrs
% Growth
Source: National statistics, UN, Euromonitor International
Table 4. Population by Age: 2010-2020
In thousands
2010
2015
2020
918
945
926
0.8
3,071
3,217
3,368
9.7
65+ yrs
518
605
702
35.7
TOTAL
4,507
4,766
4,996
10.9
0-14 yrs
15-64 yrs
% Growth
Source: National statistics, UN, Euromonitor International
From the tables above it can be seen that over the next 10 years Ireland will see the highest increase
of non-working citizens (age 65 and more). The ratio of pension-age citizens to working-age citizens
will increase from 0,16 to 0,20 what in turn means more pensions that need to be paid out and less
working class to cover those pensions. This increases the economic burden of ageing and decreases
Ireland’s ability to resist economic shocks using its own market and economy. Also, Mc Morrow and
Röger (2003) studies show that the emergence of periodic bubble conditions similar to those
experienced in Japan and the US in the late 1980’s and 1990’s respectively is more common in
countries with ageing population.
1.3.
Geography
In a study on natural resources and economic growth done by Sachs and Warner (1999) it is shown
that natural resources could be a economy boost and a cause of a self-driven economy. This is why it is
important to see whether Ireland can count on its natural resources to provide some resilience to
economic shocks.
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Ireland which often goes by its shorter name, Eire, is the 20th biggest island in the world, sitting in
the north Atlantic off the European coast. Yet, it is the second biggest member of the British Isles
archipelago, next to Britain which is the largest.
The primary Natural resources of Ireland include natural gas, petroleum, peat, copper, lead,
dolomite, barite, limestone, gypsum, silver and zinc. Key industries based on these and other natural
resources include fishing, forestry, mining, livestock, and other forms of agriculture and fish farming.
Ireland’s zinc-lead mining is worth mentioning, because it currently has three underground zinclead mines in production and is the largest producer of lead concentrates. Ireland now ranks 7th largest
producer of Zinc concentrates in the world and 12th largest producer of lead concentrates. The three
base metal mines are, in order of discovery, Navan, Galmoy and Lisheen.
However, the natural resources Ireland has access to does not provide any substantial safety net in
case of an economic shock. Agriculture accounted for only 1% of Ireland GDP in 2010 1 and crude
materials including ore and metals only accounted for less than 1% of Ireland exports 2.
1.4.
Political overview
Ireland is a republic, with a system of parliamentary democracy. Under the Constitution, legislative
power is vested in the Parliament (Oireachtas). This consists of a President (HE Mary McAleese), who
is head of state; the Lower House (Dail); and the upper house (Seanad or Senate). The President and
Senate have limited functions and powers. The Dail, consisting of 166 seats, is the primary legislative
body, and it selects the Government. It is directly elected at least once every five years by a system of
proportional representation. The Senate, which has 60 members, is elected through a system of
electoral colleges and its periods of office correspond with those of the Dail. In Ireland, the Prime
Minister is known as the Taoiseach (pronounced 'Tee-shock'). The next Presidential elections will be
held in the second half of 2011. Parliamentary elections were held in February 2011.
At the February 2011 elections Fine Gael won the largest number of seats (76), and subsequently
formed a coalition government with the Labor Party (37 seats). The former governing party, Fianna
Fail, won only 20 seats, down from 81. In March 2011 Fine Gael leader, Enda Kenny, was elected
Taoiseach. Labor leader, Eamon Glimore, was appointed Tanaiste (Deputy Prime Minister) and
Minister for Foreign Affairs and Trade.
Active participation in European Union policy-making is a priority for the Irish Government.
Ireland joined the (then) European Community in 1973 and, through the frameworks of European
1
2
Source: World Bank.
Source: The Irish Exporters Association
11
Political Cooperation (EPC) and now the Common Foreign and Security Policy (CFSP), has sought to
coordinate its foreign policy with other member states. Despite the strong support of the Irish
Government, the Irish voted “no” to the Lisbon (EU reform) Treaty in a referendum on 12 June 2008.
Former Taoiseach, Brian Cowen, said in a speech to the Dail that the “no” vote did not signify a
rejection of Europe. Former Foreign Minister Micheál Martin said the Government would need time to
reflect on the way forward, the Union would continue to be indispensable to Ireland, and Ireland had an
important contribution to make to the Union's future evolution. A second referendum on the Lisbon
Treaty was held on 2 October 2009, and Irish voters supported the “yes” vote by a margin of two to
one, with 67.1 per cent of the electorate voting in favor of ratifying the Lisbon Treaty, and 32.9 per
cent against.3
To sum up, Ireland has a stable active democracy. Studies have shown that democracies perform
better on a number of dimensions: they produce less randomness and volatility, they are better at
managing shocks, and they yield distributional outcomes that are more desirable (Rodrik (1997)).
1.5.
Main economic indicators
Ireland has a small, modern and trade dependent economy. In 2002 Ireland joined another 11
European Union countries and introduced euro as its currency. Ireland’s GDP annual growth 19952007 was 6%, but when the world economy slowed down in 2008 it dropped by 3,5%, then by another
7,6% in 2009 and only reached 0,3% growth in 2010. This was the first recession Ireland experienced
in the last two decades, real estate sales and construction dropped dramatically. Agriculture, sector that
used to be the major one in Ireland’s economy, now has contracted and shadowed by industry and
service sectors.
Even though now exports, which mainly consist of trade with foreign business giants, still make up
the major part in Ireland’s economy, construction is reviving and starting to stimulate the economy,
together with increased consumption and business investment. In 2008 government led by Brian
Cowen introduced bank reforms and created a government financed institution to fund new private
business. Simultaneously National Asset Management Agency (NAMA) was created, an agency which
took housing loan and infrastructure loan sectors all accounting for more than 100 billion euro from
different Ireland banks. Also to start saving to meet EMS required 3% budget deficit till 2014 Ireland
government cut 2009 and 2010 budgets greatly4.
In the table below main economic indicators and their change in 2006-2010 are shown.
3
4
Source: Department of Foreign Affairs and Trade, http://www.dfat.gov.au/geo/ireland/index.html
Source: CIA World Factbook
12
Table 3. Main economic indicators 2006-2010
Indicator
2006
2007
2008
2009
2010
5.3
5.6
-3.5
-7.6
0.3
4
4.9
4.1
-4.5
2
Unemployment %
4.4
4.5
6.3
11.8
13.4
Current balance, %
of GDP
-3.6
-5.4
-6.3
-3
-1.4
2.9
0.1
-7.3
-14.6
31.9
24.8
25
44.4
75.2
94.2
Real GDP change %
Consumer price
index change %
Budget balance
Government debt, %
of GDP
Source: World Bank
As it can be seen Ireland economy was still growing in years 2006-2007, but it plunged down in
2008 and 2009 and only recovered in 2010. This was caused by world financial crisis which originated
in United States of America and then echoed with bigger or lesser impact throughout the world. As it
was already said in introduction, this financial crisis is a good example of an economic shock. If an
economic shock can cause a drop of GDP growth by more than 9% it is from this point of view obvious
that Ireland economy could benefit from a better resilience to economic shocks.
1.6.
National debt
As it could be seen in the table above, the government debt, also known as national debt, has
been increasing dramatically in Ireland since 2007.The reason for such a great increase was high
budget deficits in 2008, 2009 and 2010. Fortunately, long and stable growth period that Ireland had
before the financial crisis allows Ireland to have relatively small national debt. Ireland national debt
and GDP ratio dropped dramatically in the last two decades because of good environment for stable
economic growth an
13
d balanced or excess budgets. At the end of year 2007 Ireland national debt was equal to 25% GDP,
which was way lower than Europe‘s average. Though in recent few years, because of high budget
deficit and restructuring bank sector, the ratio increased and reached 94,2% GDP at the end of year
2010.
Figure 1. Changes in National Debt
Source: http://www.ntma.ie/
Now both classical economists such as Modigliani (1961) who says that “debt financing, though
quite advantageous to the current generation, will generally not be costless to future generations” and
Jaime Caruana (head of the Bank for International Settlements, which serves as a bank for central
banks around the world) both agree that debt can be a burden. Jaime Caruana on the second IMF Fiscal
Forum (April 2011)saidthat governments also need to keep an eye on the potential for public finances
to become a risk to the overall economy and the financial system. He said financial markets’ tolerance
for a country’s debt levels can vary and change rapidly, as witnessed with current events in some
European countries, with negative consequences for the economy. Sofrom a financial stability point of
view, it is better for countries to get their fiscal house in order sooner rather than later 5. Now a contrary
situation can be seen in Ireland. The levels of debt are rising and the ratio of interest payments on the
5
Source: IMF Survey Magazine: Policy
14
debt to tax revenues has reached 11% in 20106. This puts a heavy burden on Ireland economy and
therefore, decreases its resilience to economic shocks.
1.7.
External debt
There have been many studies involving external debt and its effects on economic growth and
economy’s resilience to economic shocks accordingly. Deshpande (1992) andCunningham (1993)
showed that a strong negativerelationship exists. Sawada (1994) and Bauerfreund (1985) indicated that
external debtleads to decrease investment and economic growth.Rockerbie (1994) found that external
debtobligations have a significant negative effect oneconomic growth. That is why it is important to
look into Ireland external debt.
External debt (or foreign debt) is part of all national debts, which is owed to creditors from
other countries. The debtor in this case is Ireland. Foreign debt includes debts to private commercial
banks, other countries and international finance institutions like IMF and World Bank.
Table 4. External debt comparison
Rank
Country
Foreign debt
Per capita
% of GDP
2
United Kingdom
8,981,000,000,000
147,060
410%
10
Ireland
2,131,000,000,000
515.671
1224%
67
Lithuania
27,600,000,000
10.924
98%
22
China
406,600,000,000
260
4%
Source: https://www.cia.gov/
Above a comparison of a few selected countries external debt can be seen. United Kingdom has
been chosen because it is the biggest Ireland’s trade partner, Lithuania because of its demographic,
economic and other similarities to Ireland and China as a fastest growing economy in the world.
Ireland has one of the highest external debts in the world, if external debt per capita would be taken
into account. That is so because government is trying to save private banks with money borrowed from
external sources, such as European Central Bank and IMF. Securitizing mortgages also increased the
debt.
Seeing how indebted to foreign entities Ireland it is necessary to be able to pay the interest and not
to get in debt trap. In essence the concept is very simple. If the interest rate on a country’s debt exceeds
its long run growth rate, its external debt tends to rise inexorably relative to GDP. That is one more
reason to know whether Ireland has a resilient economy, whether it can be trusted to be able to pay up.
6
Source: National Treasury Management Agency of Ireland
15
1.8.
Foreign direct investments
In a study on the contribution of Foreign Direct Investment to growth and stability (Fan, Dickie
(2000)) it has been found that FDI has played a significant role in averting external shocks. If there is a
continuation of FDI inflow it reduces the economic and financial fluctuations. It is safe to infer that the
decline in investment and growth would be more severe without such continued inflow of FDI in a year
of crisis.
Ireland has welcomed foreign investors for a long time now. It started with the introduction of
Industrial Development Agency in 1949. This organization offers help to new investors and attracts
them by:

Focusing on business sectors that are closely matched with the emerging needs of the
Irish economy and that can operate competitively in global markets from an Irish base.

We compile up-to-date statistics and facts for research and development in industry, the
economy and foreign direct investment in Ireland.

Building links between international businesses and third level education, academic and
research centers toensure the necessary skills and research and development capabilities are
in place.

Pursuing Ireland’s policy of becoming a knowledge-based economy by actively building
world-leading clusters of knowledge-based activities.

Strongly influencing the competitive needs of Ireland's economy by actively engaging in the
development of infrastructure and business support services, telecoms, education, regulatory
issues especially in relation to EU policy.
Table 5. Foreign direct investment, net inflows (% of GDP)
Year
FDI, % of GDP
2004
2005
-5.93
2006
-15.04
2007
-0.39
2008
9.46
2009
-6.13
11.10
Source: World Bank
The table above shows an unstable foreign direct investment flow Ireland. Applying study
mentioned above, this is not a sign of a resilient economy which could avert external shocks.
16
1.9.
Trade openness
High trade opennessoffer financial systems instability.Thus, more intense the commercial
exchanges
grow,
more
exposed
the
financial
systems
are
tointernational
turbulences(Albulescu, Claudiu (2009)). Also, the development literature assumes that more open
economies suffer more from terms-of-trade volatility, and thus exhibit larger output fluctuations, than
more closed economies (Gregorio, Loayaza (2008)). Analyzing Ireland from trade openness point of
view will clarify further whether Ireland’s resilience to economic shocks is necessary to analyze.
Helped by trade and attractive policies, Ireland’s economy has made the intelligent transition from
an agriculture based economy to a more trade based one. AlthoughIreland’s trade, especially the export
sector, remains dominated by foreign multinationals, exports contribute significantly to the national
income.
1.9.1.Exports
Ireland’s trade has been the reason for the nation’s prosperity. Although the recession devalued the
sterling and forced the government to implement various strategies, foreign companies, such as Apple,
Microsoft, IBM, Oracle, Google, eBay, Pfizer, Cadbury-Schweppes, Dell and Intel, have kept the
exports alive through their wide range of products.
In 2009, the Irish export volume went down to $107.3 billion, from $119.8 billion in 2008
(Figure 4).
Figure 2. Total exports from Ireland
Source: Central Statistics Office of Ireland
17
Table 6. Breakdown of exports from Ireland, 2010
Breakdown in economy's total exports
By main destination
1. European Union (27)
60.8
2. United States
21.7
3. Switzerland
2.9
4. Japan
2.0
Agricultural products
9.1
5. China
1.9
Fuels and mining products
1.6
0.2
Manufactures
Unspecified destinations
By main commodity group (ITS)
85.4
Source: World TradeOrganization
1.9.2. Imports
In 2009 Ireland’s most imported things were boilers, machinery; nuclear reactors (12,9%),
mineral fuels, oils, distillation products (9,9%), electrical, electronic equipment (8.5%), aircraft,
spacecraft, and parts thereof (8.3%), pharmaceutical products (5.3%) and organic chemicals (4.6%).
Figure 3. Total Imports to Ireland
Source: Central Statistics Office of Ireland
Table 7. Breakdown of Ireland’s imports year 2010
18
Breakdown in economy's total imports
By main origin
1. European Union (27)
58.5
2. United States
17.4
3. China
5.7
4. Norway
1.9
Agricultural products
12.7
5. Japan
1.5
Fuels and mining products
11.2
1.5
Manufactures
68.3
Unspecified origins
By main commodity group (ITS)
Source: World Trade Organization
Trade openness measures how involved in trade the country is. In this case it is measured:
Trade Openness=(Exports + Imports)/GDP
As shown in Loayza, Raddatz (2007) study, trade openness has a amplifying effect on negative
external shocks on economy. However, the vulnerability of open economies should not have a
normative implication; it merely reflects the extent of real resource shifts in the presence of price
signals and highlights the need to control for openness in assessing the impact of other structural
characteristics.
1.10 Situation analysis conclusions
Various indicators and various author work have shown that Ireland’s resilience to economic
shocks is relevant and needs to be calculated. The arguments are:

Population of Ireland is ageing. This increases the economic burden of ageing and decreases
Ireland’s ability to resist economic shocks using its own market and economy.

Natural resources in no way provide Ireland with a safety net in a event of an economic
shock. Agriculture accounted for only 1% of Ireland GDP in 2010 and crude materials
including ore and metals only accounted for less than 1% of Ireland exports.

GDP of Ireland dropped by more 9% in 2008, because of an economic shock that came
from USA. This big drop is a sign of a vulnerable and exogenous factors dependant
economy.
19

National debt quadrupled in last 5 years. The ratio of interest payments on the debt to tax
revenues has reached 11% in 2010. This puts a heavy burden on Ireland economy and
therefore, decreases its resilience to economic shocks.

Seeing how indebted to foreign entities Ireland is (large external debt) it is necessary not to
default because of liquidity and credit rating risks. This stresses out the need to know
Ireland’s resilience to economic shocks.

In a study done by Fan, Dickie (2000) on Foreign direct investment it can be seen that
countries with stable FDI are more stable. Ireland does not have stable FDI flow.

Ireland has high trade openness, which is a sign of a vulnerable economy.
Because of all these reasons this paper will continue to study how resilient to economic shocks
Ireland’s is. Next section covers the methodology and theoretical framework that describes country’s
resilience to economic shocks.
20
2.LITERATURE REVIEW
2.1. Introduction
The goal of this study is to find what indicators help define economy’s resilience to economic
shocks and to determine how resistant to economic shocks Ireland is. Resilience to economic shocks
means being to a bigger or lesser extent impervious to negative effects caused by unforeseen events in
economics. These harmful unforeseen events that have exogenous source in this study are called
“shocks”. Possible examples of these external shocks would be: change in international credit
availability, decreases in external trade demand, commodity prices instability, etc. Also, economic
resilience can be divided into two parts: exposure to economic shocks and resilience or capacity to
react.There were calculations of economy resilience to economic shocks made before by Loayza and
Raddatz (2007), Briguglio, Cordina, Farrugia and Vella (2009), Easterly, Islam, Stiglitz, (2000) and
Guillaumont (2000).In this section I will cover literature available topic by topic and will gather
indicators that help countries get more resilient to economic shocks or that endanger them by
increasing their vulnerability to external factors.
2.2.Macroeconomic stability
Since this study analyses countries resilience to economic shocks and not environmental or other
domestic shocks, macroeconomic stability is the most important section and it generates most of the
indicators.One of the studies that analyses macroeconomic stability in more detail is made by
Briguglio and others (2009). According to them, “sustainable fiscal position, low price inflation and
anunemployment rate close to the natural rate, as well as by external balance, as reflected inthe
international current account position or by the level of external debt <…>could act as good indicators of
an economy’s resilience in facing adverse shocks”. I would like to go into more detail here.
Fiscal deficit or government budget position is one of the main tools available togovernment, and
relates to resilience of a shock-counteracting nature. This is because ahealthy fiscal position would
allow adjustments to taxation and expenditure policies inthe face of adverse shocks. National debt and
its burden on economy is also covered in Modigliani (1961). He implies that increasing national debt is
not necessary a burden for future generations, as long as it is fully and successfully invested in proper
economy aspects.
Price inflation and unemployment can also be considered to be valuable indicators of resilience.
However, they are not inherent structural indicators but have a rather high influence by economic
policy, including monetary and supply-side policies. Price inflation and unemployment are considered
good indicators by Briguglio and others (2009) because if an economy has previous history of high
21
levels of unemployment and inflation, it is likely that shocks would have even more significant
influence to economic growth and imply higher overall costs.
According to Easterly, Islam and Stiglitz(2000), interest rate shocks which often follow economic
shocks, may cause a negative net worth shock. Because firms may be in bankruptcy or on the verge of
it and due to complex credit relationships among firms (firms tend to supply credit to customers,
suppliers or both), bankruptcy of one firm can make another go into one too and set off a “bankruptcy
chain”. This is how bankruptcy can become a systematic concern7 and have negative effects on output
and growth. Increased number of default loans may even cause financial institutions to lend less and
furthermore increase risk of non-liquidity.
The integration of the economy into global capital markets is a way to prevent non-liquidity in
domestic markets. However, while high degree of capital account openness could smoothen out
country’s adjustment to a shock, it may also expose the country to another, adverse source of dynamic
reaction (Easterly, Islam and Stiglitz (2000). This could happen if investors saw the situation in firms
and financial institutions getting worse and then they might pull the investments out of the country,
further weakening the domestic economy and fueling the crisis. Another indicator that authors above
have found to have influence on economic shocks is financial depth. Their analysis confirms that
financial institutions play a central role in volatility – financial depth reduces volatility up to a point.
The interaction of capital account openness and financial depth is further analyzed by Loyaza and
Raddatz (2006). They find out that “an increase in financial openness reduces the effect of terms of
trade shock,significantly but by a moderate margin”. That means that the accessto international
financial markets has a stabilizing effect. Please note however, in an event of world financial crisis,
there might be no sources of external credit or investments available, therefore the positive stabilizing
effect would not occur. Also, when making a research on financial depth the authors say thatfinancial
depth is considered an antidote to external vulnerability.
External trade and economic shock resilience interaction is described well in Briguglio et al (2009),
where they measure economic openness as the ratio of international trade to GDP. A high degree of
economic openness renders a country susceptible to external economic conditions over which it has no
direct control. Economic openness is to a significant extent an inherent feature of an economy,
conditioned mainly by the size of the country’s domestic market, affecting the exports to GDP ratio,
and by the country’s availability of resources and its ability to efficiently produce the range of goods
and services required to satisfy its aggregate demand, affecting the imports to GDP ratio. It may be
argued that openness to international trade may be influenced by policy and is therefore a nurtured
resilience issue. Practical experience however shows that trade policies tend to influence more the
7
Orszag, Stiglitz (1999)
22
composition of a country’s external trade flows rather than the degree of economic openness. Countries
with a relatively small domestic market have very few options but to resort to exports, and those with
limited natural resources, tend to be highly dependent on imports. It can be further argued that
openness to international trade could be a source of strength, in that it may indicate that a country is
successfully participating in the international markets. This argument however does not detract from
the fact that by participating more actively in international trade, a country would be exposing itself to
a larger degree of shocks over which it has relatively little control.
Also, Tiberiu (2009) study oneconomy’s trade openness, based on a sample of six East-European
countries (namely Bulgaria, Estonia, Hungary, Romania, Slovak Republic and Slovenia) for the period
1998-2008, shows that thefinancial stability level is negatively correlated with the economy’s trade
openness. He also finds out that financial stability level is negatively correlated with the asset share of
state-owned banks. For his study Tiberiu used a wide range of control variables: GDP growth rate,
foreign direct investments, unemployment rate, GDP gap, nominal short term interest rates and final
demand.
2.3.Microeconomic efficiency
Another big part of economy which is relevant to countries resilience to economic shock is
microeconomics. Now this branch of economics studies behavior of how the individual modern
household and firms make decisions to allocate limited resources 8.There are not many available
indicators of microeconomic efficiency that would have homogenous definitions in various countries.
Loyaza and Raddatz (2006) in their study tests ease of firm entry as one of the possible measures of
microeconomic efficiency, but they find that “ease of firm-entry magnifies the shocks, but mainly the
positive ones, as revealed by an examination of asymmetric effects”. However, since this study focuses
on negative economic shocks, this is not a valid indicator. Briguglio and others (2009) decided to use a
component of the Economic Freedom of the World Index (EFWI) (Gwartney and Lawson, 2005),
entitled “regulation of credit, labor and business” which is aimed at measuring the extent to which
markets operate freely, competitively and efficiently across countries. It is designed to identify the
effect of regulatory restraints and bureaucratic procedures on competition and the operation of markets.
While EFWI would make a possible candidate to measure country microeconomic efficiency,
There is a newer indicator that is used more widely, covers more in number and more in detail parts of
country’s micro economy. It is called Ease of Doing Business. It is yearly research made by one of
World Bank department, Doing Business.
8
Marchant, Mary A.; Snell, William M.."Macroeconomic and International Policy Terms" (1997)
23
A set of regulations affecting 9 stages of a business’s life are measured: starting a business,
dealing with construction permits, registering property, getting credit, protecting investors, paying
taxes, trading across borders, enforcing contracts and closing a business. The indicators are used to
analyze economic outcomes and identify what reforms have worked, where, and why.
The Doing Business methodology has limitations. Other areas important to business such as an
economy’s proximity to large markets, the quality of its infrastructure services (other than those related
to trading across borders), the security of property from theft and looting, the transparency of
government procurement, macroeconomic conditions or the underlying strength of institutions, are not
studied directly by Doing Business 9.
2.4.Government involvement
Government involvement as a structural component of economic resilience is mostly covered by
Briguglio et al (2009). According to that study good governance is essential for an economic system to
function properly and hence, to beresilient. Governance relates to issues such as rule of law and
property rights. Withoutmechanisms of this kind in place, it would be relatively easy for adverse
shocks to result ineconomic and social chaos and unrest. Hence the effects of vulnerability would be
magnified. Onthe other hand, good governance can strengthen an economy’s resilience.The Economic
Freedom of the World Index has a component which is focused on legal structureand security of
property rights. This is considered to be useful in the context of the presentexercise in deriving an index
of good governance. The Index covers the following indicators: judicial independence, impartiality of
courts, the protection of intellectual property rights, military interference in the rule of law and political
system and the integrity of the legal system.
2.5. Social development population
According to Briguglio and others (2009), social development an essential component of economic
resilience, a factor that indicates the extension to which a society is developed. Proper society
development in turn means effective work of the economic apparatus and reduced risk of civil unrest.
In their study social development is measured by using two indicators utilized to construct the UNDP
Human Development Index.
9
Source: The World Bank Group Doing Business department.
24
Another social indicator that is used to construct economic vulnerability index calculated by
Committee for Development Policy of the United Nations is population size. Larger countries are often
more resilient to shocks and have a more diversified economy owing to the presence of economies of
scale supported by a relatively large domestic market. Smaller size is often associated with a persistent
lack of structural diversification and dependence on external markets. Additionally, small economies
experience higher exposure to natural shocks, and most small countries are situated in regions that are
prone to natural disasters10.
Loyaza and Raddatz (2007) in their study to find structural determinants of external vulnerability
found that labor market flexibility is one of them. The shock effect is dampened in countries that have
flexible labor market. Now labor market flexibility is covered in detail in Klau and Mittelstadt (1986)
which results were that labor market flexibility has 15 indicators (short-run real wage rigidity,
intersectoral labor cost differentials, change in ratio of female to male wages, unemployment
replacement rates', change in annual hours worked peremployed person, earnings exempt from
employers' socialsecurity contributions and others).
2.6.Research methodology
This study will use two methods of research to identify Ireland’s resilience to economic shocks:
comparative analysis and regression analysis.
2.6.1 Comparative analysis
Comparative analysis use is that it will show how vulnerable to economic shocks Ireland is
compared to other countries. Also the indicators that resilience to economic shock index consists of
will be overviewed, showing resilience improvement possibilities. The comparative analysis will be
vertical (cross-sectional analysis), as opposed to horizontal (time series analysis), because the finding
current resilience level and its weaknesses is the goal of the study. Using this type of analysis will let us
identify countries that are the least vulnerable to economic shocks.
Comparative analysis has its weak spots too. These are:
1) When comparing objects it is hard to identify main differences or similarities. There is a risk of
subjectivity when only one type of information is introduced. Also, every object in vertical
comparative analysis is unique with its own features, which cannot all be taken into account.
10
“Handbook on theLeast DevelopedCountry Category:Inclusion,Graduation and SpecialSupport Measures” by UN
25
2) Because it is impossible to make an effective and valid analysis when taking all minor object
features, their changes and interaction with each other into account, “ceteris paribus” method
has to be used. That means limiting the scope of the analysis.
The panel of countries that will be used in comparative analysis is generated using various
reasoning. Here are the countries and the reasoning:
1) Portugal – Ireland and Portugal are very similar by their economy size ($127bn and $123bn
respectively) and they are both, as of April2011, having financial troubles 11.
2) Lithuania –Ireland and Lithuania have similar population, size and have both only gained their
independence in the twentieth century.
3) Japan – Taken as an example of a country with a very good resilience to economic shocks (as
seen in following study), high technological development and high standards of living.
These countries will be analyzed and compared to Ireland in detail. Also, there will be a table of all
countries (that have their data available) ranked by the strength of their resilience to economic shocks.
To do the comparison table, indicators that will be used have to be determined. There are lots of
approaches on how to measure country resilience to economic shocks. The choice of indicators this
study will be using for calculating resilience to economic shocks is mainly influenced by Loyaza and
Raddatz (2007) and Briguglio et al (2009) studies. They have the greatest coverage, depth, accuracy
and at the same time simplicity, affordability, ease of comprehension and suitability.
1. Trade openness- measured as the ratio of total trade to GDP. This is an indicator to show the
degree to which a country is susceptible to external economic conditions which it could not
control directly. Total trade includes exports and imports.
11 “New Financial Woes for Portugal and Ireland” by Howard Schneider, The Washington Post April 1, 2011
26
2. Financial depth –measured as the ratio of private credit to GDP. Financial depth means having
access to mutual funds, cash or credit. Being able to access large sums normally means that the
country is wealthy or has the ability to create wealth. Having access to all (mutual funds, cash
and credit) would mean diversified financial depth.
3. Population – indicator used by Committee for Development Policy of the United Nations to
calculate external vulnerability. Smaller countries do not have internal market big enough to
sustain stable growth and therefore suffer more in an event of decreased external demand.
4. Economic Freedom Index - is a series of 10 economic measurements created by The Heritage
Foundation and The Wall Street Journal. The measurements are: trade freedom, monetary
freedom, government size (spending), fiscal and investment freedom, freedom from corruption,
property rights, financial freedom and labor freedom. Its objective is to measure the degree of
economic freedom in different countries12.
5. Ease of doing business rating – This is a rating that World Bank department started. Doing
Business presents quantitative indicators on business regulations and the protection of property
rights that can be compared across 183 economies, from Afghanistan to Zimbabwe, over time.
This rating should cover macroeconomic efficiency aspect in resilience to economic shocks.
6. Financial openness– The Chinn-Ito index (KAOPEN) is an index measuring a country's degree
of capital account openness. The index was initially introduced in Chinn and Ito (Journal of
Development Economics, 2006). KAOPEN is based on the binary dummy variables that codify
the tabulation of restrictions on cross-border financial transactions reported in the IMF's Annual
Report on Exchange Arrangements and Exchange Restrictions (AREAER)13.
Both advanced and emerging nations adopted controls; in basic theory it may be supposed that
large inbound investments will speed an emerging economies development, but empirical
evidence suggests this does not reliably occur, and in fact large capital inflows can hurt a
nation's economic development by causing its currency to appreciate, by contributing to
inflation, and by causing an unsustainable "bubble" of economic activity that often precedes
financial crisis. The inflows sharply reverse once capital flight takes places after the crisis
occurs.
12
13
Source: The Heritage Foundation, http://www.heritage.org/index/FAQ
Hiro Ito and Menzie Chinn description of the Chinn-Ito Index
27
For the comparison table that includes all countries, an index will be constructed. Before that can be
done, indicators will be standardized, because theyhave different measures which would result in
different. That is, their values will be reduced to be among 0 and 1 (0 having the lowest value and 1
having the highest and all other spreading respectively in between). Here is the formula for
standardization:
, where
δ – normalized value,
d – indicator value,
dmin– minimum indicator value,
dmax – maximum indicator value.
The resilience to economic shocks rating will be composed as follows:
, where
NFD - normalized financial depth ratio,
NPOP – normalized population,
NEFW – normalized Economic Freedom of World index,
NFO - normalized financial openness ratio,
NTO - normalized trade openness ratio,
NEB - normalized ease of doing business rating.
28
2.6.2. Linear Regression analysis
Linear regression model with two or more variables is a suitable to determine the most
influencing indicators of Ireland’s resilience to economic shocks, because more than one variable can
be used when creating the model. In this analysis multiple regression line will be generated, which
could be used to explain or predict the value of the dependent variable. Multiple regression works by
calculating residuals or errors, which is the difference between the actual value of the dependent
variable for an observation and the value of the dependent variable predicted for this observation by the
multiple regression line (Minieka, Kurzeja (2001)). The coefficients of the multiple regression line are
chosen so that the total of the squared errors is minimized. The calculation of the coefficients of a
multiple regression line is done by computer, using SPSS Statistics 17 software. The linear
combination of the variables shown below in equation is the multiple regression line:
First of all to do regression analysis indicators that will be used have to be determined. In this
study, one dependent variable and five independent variables will be used.The dependent variable is
GDP per capita and the independent ones are financial openness, population, economic freedom
index,financial depth, trade openness.
After all the data is collected and arranged, next step when doing regression analysis with more
than two variables is comparing them visually and finding a correlation coefficient. This is done to
determine linear relationship among the independent variables and dependent variable. Their influence
on one another and its strength has to be determined. Correlation coefficient (R) has to have value of
0,8 and higher. For the graphic comparison part, “scatter-dot” type of plot is used to find possible
externalities, which should be deleted so there are no distortions in results.
Next step after creating “scatter-dot” plots is testing the overall fitness of the model. This is done
using coefficient of determination (R2). Higher R2 means that the multiple regression line fits the
observed data more accurately. According to Studenmun (2006), an overall fit of 0,5 isconsidered a
good enough result. However R2 tends to go down when the number of independent variables
increases, making it hard to make a fit model with many variables.
Another thing that has to be taken into account when making a model for regression analysis with
more than two variables is the possibility of multi-collinearity. O’Brien (2007) says that “the Variance
Inflation Factor (VIF) and tolerance are both widely used measures of the degree of multi-collinearity”
and suggests a VIF lower than 10 and tolerance higher than 0,1. To achieve lower multi-collinearity
and to increase the accuracy of the analysis more than one model might have to be constructed.
29
Final step is providing results, conclusions and recommendations. The multiple regression line is
built up and independent variables and their levels of influence to dependent variable are revealed.
However, not exclusive from other research methods, linear regression has its weak points. The
restrictions on regression models make it difficult to complete and might even result in the analysis
being not valid. One of the most important ones is construction of a fit regression model and even if
regression analysis is successful and model is accepted as correct and accurate, there still are issues
with the validity of data.
The data taken for regression model is yearly and ranges from 1970-2009. Because there can be no
missing values when doing regression analysis and not all data for previous years and year 2010 is not
available, it cannot be included. Also, regression has restrictions on regression model data (e.g. it has to
be linear) and to achieve that methods of logarithms, squaring and taking square roots.
2.7.Data collection, validity and availability
Data that is needed to calculate trade openness, financial depth and population will be gathered
from World Bank databases. Data needed include countries import, export, GDP, GDP per capita,
private credit and population. Because current country resilience to economic shocks will be found,
only the most recent available data will be gathered, which is of year 2009. However, for certain
countries data for trade openness is available only of year 2008.
World Bank provides professional standards in the collection, compilation and dissemination of
data to ensure that all data users can have confidence in the quality and integrity of the data
produced.Much of the data comes from the statistical systems of member countries, and the quality of
global data depends on how well these national systems perform.
The data that Chinn and Ito use to calculate Chinn-Ito index is taken from IMF’s “Annual Report
on Exchange Arrangements and Exchange Restrictions” which can be ordered from IMF. This report,
published since 1950, this annual reference is based upon a unique IMF database that tracks exchange
and trade arrangements for all 186 IMF member countries, along with Hong Kong SAR, Aruba, and the
Netherlands Antilles.
To make the data comparable across economies, the indicators refer to a specific type of business,
generally a local limited liability company operating in the largest business city. Because standard
assumptions are used in the data collection, comparisons and benchmarks are valid across economies.
30
The data not only highlight the extent of obstacles to doing business; they also help identify the source
of those obstacles, supporting policymakers in designing reform.
The Doing Business data are collected by World Bank department Doing Business. To start, the
Doing Business team, with academic advisers, designs a survey. The survey uses a standardized and
basic business case to ensure comparability across countries and over time—with assumptions about
the legal form of the business, its size, its location and the nature of its operations.
Surveys are administered through more than 8,200 local experts, including lawyers, business
consultants, accountants, government officials and other professionals routinely administering or
advising on legal and regulatory requirements. These experts have several (typically 4) rounds of
interaction with the Doing Business team, involving conference calls, written correspondence and
country visits.
The data from surveys are subjected to numerous tests for robustness, which lead to revisions or
expansions of the information collected. The data for all sets of indicators in Doing Business 2011 are
for June 1, 2010 (except for paying taxes, for which the data refer to Jan-Dec 2009)14.
The data used to calculate resilience to economic shocks in some cases is not one hundred percent
accuratebecause of non-homogenous definitions across countries. Also, some countries did not have
any relatively recent data, or any data for a certain indicators and therefore will be skipped in the
research. In total, 103 countries around the world are ranked.
14
http://www.doingbusiness.org/about-us/faq
31
3. ANALYSIS OF IRELAND’S RESILIENCE TO ECONOMIC SHOCKS
3.1. Comparative analysis
In this section Ireland’s resilience of economic shocks indicators will be compared to Portugal’s,
Lithuania’s and Japan’s resilience indicators. The reasoning on countries chosen is covered in
methodology section of the study. The comparison will be divided into four parts, one for each
indicator this study uses as components for resilience to economic shocks rating. They are Trade
Openness, Financial Depth, Population and Ease of Doing Business rating.
The first one is Trade Openness. This indicator measures how open the economy to trade.
According to this indicator, Ireland is by far more open economy (export and import make a total 162%
of GDP) compared to Portugal (63.5% of GDP) and Japan (24,7% of GDP) with only Lithuania
catching up with 131,9% of GDP. So, when taking this indicator into account as a sign of a weak
resilience to economic shocks, Ireland is doing the worst. High trade openness is mainly caused by
historical government policy, which attracted many investors over the years with low corporate tax (10
to 12,5%),cheap wage costs compared to the United Kingdom, and by the limited and flexible
government intervention in business compared to other Europe Union members, especially to countries
in Eastern Europe.
However, when looking into trade components, export and import, Ireland has trade surplus of
almost 15%, where as Lithuania has a deficit of 11,4%, Portugal – 7,7% and Japan – 0,3%. The surplus
means more stable economy, where external debt, unemployment and exchange rate crisis are less of a
concern.
One of the ways to reduce trade openness is to increase internal consumption. That way the goods
that are currently exported could stay in internal market. According to Dowrick, Golley (2004)
“increases in trade, on average, have a direct and substantial benefit on economic growth. These effects
operate primarily through the rate of productivity growth, with only minor effects operating through the
investment channel”, therefore reducing trade would result in contrary results, reducing economic
growth.
Seeing Japan as an example to follow, it is worth comparing their trade. Similar to Ireland, Japan’s
major exports are high technology products. Japan is very poor in natural resources and arable land is
limited, which is also the case of Ireland, making both countries import energy and at some level food
products. The main difference why Ireland cannot achieve Japan low trade openness is because
Ireland’s internal market is more than twenty times smaller (128 million Japan citizens compared to
just over 6 million in Ireland).
32
Another indicator is Financial Depth. The higher the financial depth of the country is, the better
access to funds for private sector it has. Ireland scores highest on this indicator, having 204% ratio of
private sector credit to GDP. Portugal has 188% ratio, Japan – 171% and Lithuania – 71%. A positive
effect of financial development on economic growth through its sources (capital accumulation and
productivity), and even on income inequality and poverty, has also been reported ( Levine, 2005).
Ireland’s competitive financial system was compromised by the collapse of a property bubble in
which banks were highly exposed. Government took action and established a single regulatory
institution and therefore, implemented additional restrictions on getting credit. This should decrease the
level of Ireland’s financial depth.
Now Japan’s modern financial system after crisis remains vulnerable to government political
influence and interventionist policy choices, because of improving, but still low transparency in
financial sector. Because of deregulation and competition a trend of enterprise consolidation can be
seen and because of that a new law that aims to facilitate financing opportunities for distressed small
and medium-sized enterprises was enacted in 2009. This will increase the overall flow of credit.
Portugal faces problems of consolidation too, having five largest bank groups account for about 80
percent of the banking sector’s total assets. Credit is available on market terms, and the private sector
enjoys access to a wide variety of credit instruments. The government influences the allocation of
credit through a program designed to assist small and medium-size enterprises.
Lithuania has scored lowest among the four countries, one of the reasons being relatively short
history of credit. However, Lithuania’s competitive financial sector offers a full range of financial
services. With no restrictions on portfolio investment, capital markets are well developed but small.
Same as other countries, Lithuania has been in turmoil because of the financial crisis. Although the
system remains relatively well capitalized and stable, non-performing loans are an increasing burden.
The Financial Stability Law, passed in 2009, covers state guarantees for interbank lending, partial and
full bank capitalization by the government, and asset acquisition15.
Next aspect countries will be compared by is Ease of Doing Business. This indicator is best
covered by World Bank research. According to this index, in 2011 out of 183 countries, Ireland ranks
9th, Japan 18th, Lithuania 23rd and Portugal 31st. Ireland’s worst scores are in dealing with construction
permits, enforcing contracts and registering property, Japan’s - paying taxes and starting a business
15Source: Economic
Freedom of World index, Financial Freedom section http://www.heritage.org/Index/Financial-Freedom
33
sections, Lithuania’s - protecting investors and starting a business sections, Portugal’s – dealing with
construction permits and getting credit sections.
Finally a short comparison of population is needed. Ireland is a relatively small island and it has a
excessive emigration history, which are the two factors that contribute to its low population. Compared
to other countries, Ireland (without Northern Ireland, which belong to United Kingdom) has a
population of 4,45 million, Japan – 127,56 million, Portugal – 10,63 million and Lithuania – 3,34
million. Population this low cannot provide a internal market big enough to cushion possible external
economic shocks with internal consumption. Also, scale economies cannot be applied for an economy
this small.
3.2. Regression analysis
To investigate the influence of different indicators to Ireland’s GDP per capita (measured in year
2000 U.S. dollars) a linear regression model should be made. The data was gathered from World Bank,
Ireland Central Statistics Office, Chinn and Ito (2006) work and the Heritage Foundation. The data of
indicators (trade openness, financial depth, financial openness, Economic Freedom index and
population)is for the period 1970-2009, a total of 40 observations.
First of all correlation coefficient has to be found. For the final model the correlation coefficient is
0,986, what shows a very high correlation between the dependent variable and the independent
variables. Also, a correlation can be seen in “scatter-dot” plots16. There are a few cases that might be
considered as externalities, but those are for years 2008 and 2009, years of the financial crisis, they are
very important to the study and cannot be removed.
Another thing that has to be checked to make sure regression analysis is valid is coefficient of
determination, R2.
Table 8. Regression model summary
b
Model Summary
Model
1
R
R Square
.986
a
.973
Adjusted R
Std. Error of the
Square
Estimate
.970
1409.73165
a. Predictors: (Constant), Population, Financial Depth, Trade Openness
16
More information can be found in Appendix B.
34
b
Model Summary
Model
R
1
Adjusted R
Std. Error of the
Square
Estimate
R Square
.986
a
.973
.970
1409.73165
a. Predictors: (Constant), Population, Financial Depth, Trade Openness
b. Dependent Variable: GDP per capita
As it can be seen in the table above, R2 is equal to 0,971. It means that the final regression model
explains more than 97% of GDP per capita values that is close to GDP per capita average and only 3%
is left unexplained.
Third and last thing that has to be covered before going to regression results is the possibility of
multi-collinearity. Financial Openness indicator measured by Chinn-Ito index cannot be used for this
regression analysis model, because it has VIF value of more than 10 (its VIF is 11,38) and tolerance
value of less than 1 (its tolerance value is 0,88). Also, after making a number of models with adjusted
data, Economic Freedom indicator had to be removed because it did not prove to be significant 17,
reaching with the lowest p-value if 0,163.
Once it has been established that the model is significant and its coverage, the next step is checking
coefficients used in the model. Analysis of Variance (ANOVA) table in SPSS allows us to
determinewhether or not the means of several groups are all equal and whether the coefficients are zero
or not.
Table 9. Analysis of Variance table
ANOVA
Model
1
Sum of Squares
b
df
Mean Square
Regression
2.544E9
3
8.481E8
Residual
7.154E7
36
1987343.332
Total
2.616E9
39
a. Predictors: (Constant), Population, Financial Depth, Trade Openness
b. Dependent Variable: GDP per capita
H0 – All coefficients equal 0;
17
More information can be found in Appendix B
35
F
426.762
Sig.
.000
a
Ha – at least one coefficient does not equal 0.
Because the P-value for the F test statistic is less than0.01, it provides strong evidence against the
null hypothesis and therefore the alternative hypothesis is confirmed. That means at least one of the
coefficients does not equal 0.
Table 10. Regression model coefficients
Model
1
(Constant)
Unstandardized Coefficients
Std.
B
Error
-314680 72855.18
Financial
Depth
Trade
Openness
Standardized
Coefficients
Beta
t
-4.319
Sig.
0
75.58
6.831
0.539
11.064
0
0.231
0.057
0.225
4.047
0
49073.27
11244.37
0.289
4.364
0
Population
95.0% Confidence
Interval for B
Model
1
(Constant)
Financial
Depth
Trade
Openness
Population
Collinearity Statistics
Lower
Bound
-462437
Upper Bound
-166923.036
Tolerance
61.726
89.433
0.32
3.124
0.115
0.346
0.245
4.074
26268.63
71877.912
0.174
5.758
VIF
The last step is interpreting regression analysis and constructing linear regression line. Here are the
assumptions that can be made from the table above. The values might be changed because of data
adjustment methods taken before to decrease multi-collinearity.
Result 1.There is 95% probability that if financial depth indicator, or in other words private sector
credit to GDP ratio, increased by one percent point GDP per capita would increase by a value ranging
from 61,726 to 89,433.
Result 2.There is 95% probability that if trade openness, or in other words trade to GDP ratio,
increased by one percent point GDP per capita would increase by a value ranging from 0,339 to 0,588.
36
Result 3.There is 95% probability that if population increased by one percent point GDP per capita
would increase by a value ranging from 262,67 to 718,8.
Result 1and Result 3 anticipated coefficients are as expected, increasing private sector credit and
population increases GDP per capita and resilience to economic shocks. However, Ireland GDP per
capita increases together with trade openness, which opposes the literature (Loyaza and Raddatz
(2007), Tiberiu (2009))
37
3.3. CONCLUSIONS

Ireland’s resilience to economic shocks ranks 9th out of 103 countries, making it one of
the strongest in the world. That is mainly due to its low restrictions on capital flow
(measured by financial openness), well developed financial system (measured by
financial depth) and ease of doing business (measured by Ease of Doing Business
index).

Trade openness and population indicators are the weakest link in Ireland’s resilience to
economic shocks, with standardizedvalues of 0,348 and 0,003 out of 1 respectively.
Trade openness is caused by historical foreign capital attraction with low corporate tax
levels and flexible and educated labor market. Low population is a consequence of bad
geographic situation and excessive emigration history.

Regression analysis shows that Ireland’s resilience to economic shocks is influenced
most by financial depth and population. However, Ireland’s financial system has
suffered a collapse during the recent world financial crisis and is only reviving, therefore
a fast increase cannot be expected. Population also is not a factor that could be
effectively altered by policy.

Recommendations for Ireland to increase its resilience to economic shocks:
o Introduce policy that invites immigrants and promotes citizens to stay to increase
population.
o Keep current levels of financial depth till banking sector is stable and then
gradually increase it.
o Further improve economic freedom and ease of doing business to make Ireland
an attractive place to do business in and by that improve its resilience to
economic shocks.
38
LIST OF REFERENCES
1. Claudiu Tiberiu Albulescu (2009). “Financial Stability, Trade Openness and the Structure of
Banks’Shareholders” University of Poitiers, France. Data retrieved from: http://sceco.univpoitiers.fr/recherpubli/doctravail/M2009-03.pdf
2. Dani Rodrik (1997). “DEMOCRACY AND ECONOMIC PERFORMANCE”Harvard
University.
Data
retrieved
from:
http://homepage.ntu.edu.tw/~kslin/macro2009/Rodrik_1997.pdf
3. Franco Modigliani (2005). “The collected papers of Franco Modigliani” p. 79-103.United
States, Massachusetts.
4. Giovanni Olivei Michael Klein (2005). “CAPITAL ACCOUNT LIBERALIZATION DEPTH,
FINANCIAL, AND ECONOMIC GROWTH” NATIONAL BUREAU OF ECONOMIC
RESEARCH. United States, Massachusetts.
5. IBF Statistics 2010. Data retrieved from www.cbfsai.ie
6. Ireland’s National Statistics Office Data retrieved from:http://www.nso.ie
7. James D. Gwartney, Joshua C. Hall, and Robert Lawson (2010). Economic Freedom of the
World: 2010 Annual Report. Vancouver, BC: The Fraser Institute. Data retrieved from
www.freetheworld.com
8. Juan C. Botero, Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes,Andrei Shleifer
(2004)
“THE
REGULATION
OF
LABOR”.
Data
retrieved
from:
http://qje.oxfordjournals.org/content/119/4/1339.full.pdf
9. Kieran Mc Morrow and Werner Röger (2003)“Economic and financial market consequences of
ageing
populations”
Brussels.
Data
retrieved
from:
http://ec.europa.eu/economy_finance/publications/publication920_en.pdf
10. Lino Briguglio, Gordon Cordina, Nadia Farrugia and Stephanie Vella (2009). Economics
Department, University of Malta “Economic Vulnerability and resilience concepts and
measurements”
Data
retrieved
from:
http://events.um.edu.mt/resilience2007/papers/briguglio_cordina.pdf
39
11. Matthieau Bussierie, Christian Mulder (1999). “External vulnerability in emerging markets”
International
Monetary
Fund.
Data
retrieved
from:
http://www.imf.org/external/pubs/ft/wp/1999/wp9988.pdf
12. Mary A. Marchant and William M. Snell (1997). “Macroeconomic and International Policy
Terms” University of Kentucky
13. Marta Foresti, Isabella Massa, Leni Wild and Dan Harris (2011)“Responding to external
economic shocks: why state capacity and political incentives matter” Data retrieved from:
http://www.odi.org.uk/resources/download/5163.pdf
14. Menzie Chinn, Hiro Ito (2009). “A New Measure of Financial Openness", Journal of
Comparative Policy Analysis , Volume 10, Issue 3 September 2008 , p. 309 – 322.
15. Norman V. Loayza and Claudio Raddatz (2007) “The Structural Determinants of
ExternalVulnerability” The World Bank economic review, VOL. 21, NO. 3, pp. 359–387
16. Patrick Guillaumont (2000).“On the Economic Vulnerabilityof Low Income Countries”.
CENTRE
D’ETUDESET
DE
RECHERCHESSUR
LE
DEVELOPPEMENT
INTERNATIONAL. Data retrieved from: http://publi.cerdi.org/ed/1999/1999.16.pdf
17. Robert P. Hagemann and Giuseppe Nicoletti (1989). “Population ageing: economic effects and
some policy implications for financing public pensions”.
18. Robert M. O’Brien (2007). “A Caution Regarding Rules of Thumb for Variance Inflation
Factors”
University
of
Oregon,
USA.
Data
retrieved
from:
http://web.unbc.ca/~michael/courses/stats/lectures/VIF%20article.pdf
19. Romain Duval, Jørgen Elmeskov and Lukas Vogel (2007) “STRUCTURAL POLICIES AND
ECONOMIC RESILIENCE TO SHOCKS” Economics Department Working Paper No. 567.
Data retrieved from: http://www.oecd.org/dataoecd/12/1/38717819.pdf
20. Thorsten Beck, Asli Demirgüç-Kunt, and Ross Levine (1999) “ A New Database on Financial
Development
and
Structure”.
Data
retrieved
from:
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.18.568&rep=rep1&type=pdf
21. The International Bank for Reconstruction and Development / The World Bank (2011) “Doing
Business 2011: Ireland”. United States, Virginia.
22. World Bank Databases for population, import, export, GDP per capita, private credit, Ease of
Doing Business rating. Data retrieved from: http://data.worldbank.org/
40
APPENDIX A. Country resilience to economic shock data and rankings
Economic
Freedom
Index
Population
in millions
Financial
Depth
Ease of
Doing
Business
Imports
Exports
Trade
openness
United States
7.96
307.01
202.87
5.00
13.92
11.18
25.09
United Kingdom
7.81
61.84
213.52
4.00
30.04
27.67
Denmark
7.69
5.53
231.63
6.00
43.96
Cyprus
7.54
0.87
269.67
35.00
57.43
Japan
7.46
127.56
171.00
19.00
New Zealand
8.27
4.32
147.00
Switzerland
8.08
7.73
Canada
7.95
Spain
Country
ChinnIto
Index
TOTAL
RANK
2.48
2.74
1
57.70
2.48
2.49
2
47.77
91.73
2.48
2.40
3
46.26
103.68
2.48
2.32
4
12.25
12.55
24.80
2.48
2.31
5
3.00
26.53
28.20
54.73
2.48
2.30
6
174.75
24.00
40.74
51.68
92.42
2.48
2.16
7
33.74
128.55
9.00
30.43
28.72
59.14
2.48
2.14
8
7.26
45.96
211.49
48.00
25.59
23.44
49.03
2.48
2.14
9
Ireland
7.74
4.45
204.34
8.00
73.61
88.53
162.14
2.48
2.12
10
Netherlands
7.53
16.53
215.29
29.00
62.19
69.44
131.62
2.48
2.09
11
Portugal
7.10
10.63
187.79
33.00
35.64
27.96
63.60
2.48
2.04
12
Germany
7.46
81.88
112.34
21.00
35.89
40.83
76.72
2.48
1.91
13
Sweden
7.28
9.30
139.35
18.00
41.63
48.50
90.14
2.48
1.91
14
France
7.32
62.62
110.27
28.00
24.99
23.05
48.04
2.48
1.90
15
Finland
7.55
5.34
94.39
11.00
34.91
37.37
72.28
2.48
1.87
16
Australia
7.90
21.87
127.83
10.00
21.61
19.79
41.39
1.15
1.85
17
Austria
7.61
8.36
126.87
31.00
45.99
50.53
96.52
2.48
1.84
18
Estonia
7.73
1.34
110.19
17.00
65.23
70.60
135.83
2.48
1.77
19
Latvia
7.08
2.26
107.75
27.00
43.11
42.17
85.29
2.48
1.71
20
Mauritius
7.82
1.28
85.11
20.00
59.07
48.45
107.52
2.21
1.69
21
Hong Kong
9.05
7.00
157.99
2.00
186.67
193.82
380.49
2.48
1.68
22
China
6.65
1331.46
127.33
78.00
22.33
26.74
49.07
-1.15
1.67
23
Chile
8.03
16.97
97.47
53.00
30.36
38.14
68.50
1.95
1.64
24
Belgium
7.22
10.79
97.92
22.00
70.22
72.96
143.19
2.48
1.59
25
Israel
6.67
7.44
84.52
30.00
32.21
34.65
66.87
2.48
1.57
26
Italy
6.90
60.22
110.83
76.00
24.37
23.97
48.34
2.48
1.55
27
Bahrain
7.58
0.79
79.57
25.00
74.31
96.85
171.16
2.48
1.49
28
Peru
7.39
29.16
24.08
46.00
19.72
23.55
43.28
2.48
1.47
29
Bulgaria
7.31
7.59
75.64
51.00
55.76
47.83
103.59
2.48
1.46
30
Armenia
7.12
3.08
23.12
44.00
36.45
11.99
48.45
2.48
1.40
31
Lithuania
7.34
3.34
70.86
26.00
71.67
60.23
131.91
1.95
1.39
32
Panama
7.43
3.45
85.74
62.00
61.11
77.04
138.15
2.48
1.37
33
Korea, South
7.28
48.75
107.55
15.00
45.98
49.90
95.88
0.43
1.35
34
Slovenia
6.94
2.04
93.99
43.00
57.39
58.92
116.31
1.95
1.34
35
Greece
6.95
11.28
91.70
97.00
29.26
18.65
47.91
2.48
1.34
36
Oman
7.22
2.85
49.00
57.00
37.96
59.29
97.24
2.48
1.32
37
41
Country
Economic
Freedom
Index
Population
in millions
Financial
Depth
Ease of
Doing
Business
Exports
Trade
openness
ChinnIto
Index
Imports
TOTAL
RANK
Hungary
7.44
10.02
71.34
52.00
80.22
81.45
161.67
2.48
1.32
38
Singapore
8.70
4.99
103.20
1.00
202.58
220.53
423.11
2.48
1.31
39
Botswana
7.09
1.95
25.52
50.00
44.60
33.59
78.19
2.48
1.29
40
Romania
6.58
El Salvador
7.44
21.48
47.08
54.00
40.24
33.32
73.57
2.48
1.28
41
6.16
41.31
80.00
37.75
22.26
60.01
2.21
1.24
42
Georgia
7.47
4.26
31.21
13.00
49.02
29.53
78.54
0.73
1.19
43
Mexico
6.89
107.43
23.33
41.00
29.28
27.84
57.13
1.15
1.12
44
Czech Rep.
7.19
10.49
55.26
82.00
63.80
69.52
133.32
2.48
1.12
45
Guatemala
7.10
14.03
25.39
100.00
33.13
23.37
56.50
2.48
1.08
46
Kuwait
7.46
2.79
63.27
69.00
25.64
66.44
92.08
1.15
1.06
47
Egypt
6.68
83.00
36.22
99.00
31.87
25.04
56.91
2.21
1.04
48
South Africa
6.65
49.32
147.07
32.00
28.15
27.29
55.44
-1.15
1.02
49
Trinidad & Tob.
7.10
1.34
31.54
95.00
39.38
68.38
107.77
2.48
0.99
50
Slovak Rep
7.60
5.42
44.74
40.00
103.74
99.46
203.20
1.43
0.96
51
Jamaica
7.19
2.70
28.45
79.00
53.32
34.71
88.03
1.68
0.95
52
India
6.51
1155.35
46.77
135.00
24.02
19.58
43.61
-1.15
0.91
53
Thailand
7.06
67.76
116.30
16.00
57.85
68.37
126.22
-1.15
0.91
54
Malaysia
6.72
27.47
117.05
23.00
74.88
96.42
171.29
-0.10
0.90
55
Dominican Rep.
6.31
10.09
21.33
86.00
30.25
22.25
52.50
1.95
0.87
56
Nicaragua
6.91
5.74
34.39
119.00
61.22
35.13
96.34
2.48
0.87
57
Mongolia
7.08
2.67
43.86
63.00
62.63
55.84
118.46
0.98
0.84
58
Croatia
6.51
4.43
66.29
89.00
39.41
36.09
75.50
1.15
0.82
59
Kenya
6.81
39.80
31.51
94.00
38.31
25.24
63.54
1.15
0.77
60
Costa Rica
7.45
4.58
49.42
121.00
42.10
43.29
85.39
1.23
0.76
61
Macedonia
6.83
2.04
44.31
36.00
67.27
44.30
111.57
0.10
0.75
62
Colombia
6.19
45.66
29.87
38.00
18.32
16.26
34.58
-0.10
0.74
63
Poland
6.90
38.15
52.94
73.00
38.78
38.88
77.66
0.10
0.71
64
Brazil
6.18
193.73
54.04
124.00
11.18
11.12
22.30
0.43
0.63
65
Haiti
6.70
10.03
14.53
163.00
43.91
14.21
58.12
2.48
0.61
66
Ecuador
6.07
13.63
25.32
127.00
48.09
37.14
85.23
2.21
0.60
67
Russia
Bosnia and
Herzegovina
6.62
141.85
45.29
116.00
20.37
27.73
48.10
0.17
0.56
68
6.03
3.77
57.30
110.00
57.98
33.44
91.42
1.23
0.56
69
Vietnam
6.15
87.28
112.72
88.00
78.65
68.30
146.95
-0.10
0.53
70
Pap. New Guinea
6.87
6.73
32.06
108.00
57.12
57.93
115.06
0.90
0.50
71
Paraguay
6.55
6.35
29.11
105.00
51.60
46.53
98.13
0.90
0.48
72
Kazakhstan
7.06
15.89
50.27
74.00
33.79
42.01
75.80
-1.15
0.42
73
Azerbaijan
6.36
8.78
19.63
55.00
24.77
52.49
77.27
-0.62
0.39
74
Honduras
7.26
7.47
52.59
128.00
60.77
42.10
102.87
-0.10
0.34
75
42
Country
Economic
Freedom
Index
Population
in millions
Financial
Depth
Ease of
Doing
Business
Imports
Exports
Trade
openness
Sri Lanka
6.03
20.30
24.79
102.00
27.87
21.36
49.24
Albania
7.18
3.16
37.01
81.00
54.38
28.65
Fiji
6.69
0.85
49.94
61.00
61.73
Namibia
6.85
2.17
46.79
68.00
Pakistan
5.84
169.71
23.54
75.00
Philippines
6.77
91.98
30.29
Ghana
6.83
23.84
Bolivia
6.16
Belize
ChinnIto
Index
TOTAL
RANK
0.10
0.33
76
83.03
-1.15
0.33
77
47.08
108.82
-1.15
0.33
78
59.89
46.62
106.51
-1.15
0.32
79
20.37
12.84
33.22
-1.15
0.30
80
146.00
30.80
31.66
62.46
0.10
0.28
81
15.88
77.00
41.35
30.50
71.85
-1.15
0.25
82
9.86
37.02
148.00
32.90
35.72
68.63
0.63
0.22
83
6.93
0.33
65.94
93.00
70.04
62.09
132.13
-1.15
0.20
84
Bangladesh
6.01
162.22
41.51
111.00
26.55
19.43
45.98
-1.15
0.17
85
Morocco
6.20
31.99
64.41
114.00
39.49
28.59
68.08
-1.15
0.12
86
Moldova
6.51
3.60
36.23
87.00
73.40
36.83
110.23
-1.15
0.10
87
Argentina
5.99
40.28
13.53
113.00
16.00
21.35
37.35
-0.79
0.06
88
Nepal
5.54
29.33
59.44
112.00
37.42
15.70
53.12
-1.15
0.02
89
Madagascar
6.18
19.63
11.46
138.00
52.20
28.48
80.68
-0.10
-0.01
90
Ethiopia
5.19
82.82
17.82
103.00
28.85
10.56
39.40
-1.15
-0.08
91
Mozambique
5.74
22.89
25.06
130.00
43.79
25.07
68.86
-1.15
-0.21
92
Malawi
6.12
15.26
14.24
132.00
37.71
30.05
67.76
-1.84
-0.35
93
Senegal
5.62
12.53
24.71
151.00
43.97
24.04
68.01
-1.15
-0.36
94
Benin
5.91
8.93
22.23
172.00
28.17
13.85
42.02
-1.15
-0.36
95
Lesotho
6.33
2.07
13.52
137.00
111.74
51.22
162.96
-1.15
-0.43
96
Algeria
5.00
34.90
16.21
136.00
36.12
40.40
76.52
-1.15
-0.43
97
Cameroon
5.83
19.52
11.34
173.00
30.90
26.58
57.48
-1.15
-0.46
98
Gabon
5.83
1.47
10.08
158.00
33.31
52.19
85.50
-1.15
-0.46
99
Venezuela
4.33
28.38
21.70
170.00
20.47
18.25
38.72
-1.58
-0.74
100
Chad
5.05
11.21
5.18
183.00
70.10
42.10
112.20
-1.15
-0.83
101
Congo, Rep. Of
4.75
3.68
4.81
177.00
50.90
71.86
122.76
-1.15
-0.89
102
Angola
3.89
18.50
21.15
164.00
46.23
52.23
98.46
-1.84
-1.01
103
43
APPENDIX B. Regression analysis
Variables in matrix “scatter-plot”
44
Regression model with Economic Freedom
Coefficients
a
Standardized
Unstandardized Coefficients
Model
1
B
(Constant)
Std. Error
Beta
-242851.720
83775.655
76.993
6.735
.187
Population
Economic Freedom Index
Financial Depth
Trade Openness
Coefficients
Collinearity Statistics
t
Sig.
Tolerance
VIF
-2.899
.006
.549
11.431
.000
.315
3.177
.062
.182
3.011
.005
.199
5.035
35376.792
13840.286
.208
2.556
.015
.110
9.124
21867.824
13422.169
.120
1.629
.112
.134
7.477
a. Dependent Variable: GDP per capita
45
Organized Standardized Residual Histogram
Organized Standardized Residual Histogram
46