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models with varying degrees of capital and labour mobility. Furthermore, we
subject these models to the kinds of shocks that we believe to have been
important in driving the Irish boom.
While based on the exogenous growth model, the analysis in our paper also
draws inspiration from what Barry (2002a) has characterised as the major
competing hypothesis to that of delayed convergence. The alternative
interpretation, as initially proposed by Krugman (1997), is that of “regional
boom”.1 Regional wages are largely determined by rates available in the wider
encompassing economy with which the region shares an open labour market.
Employment levels are determined therefore by labour demand, rather than,
as in a typical national economy with a closed labour market, by the
interaction of labour demand and supply. Labour demand is determined
primarily by the region’s export base (with non-tradable employment - both
public and private - arising largely to service that base). In modelling Ireland,
the export base can be thought of as the multinational sector.
Regional boom models have been developed by Dascher (2000) and Barry
(2002b) to elucidate aspects of the Irish experience, though not in a growth-
theory context.
Capital and labour inflows stimulate each other in the regional models,
generating substantial “extensive growth” as well as the “intensive growth” in
income-per-head terms that is the focus of convergence theory. In these models
the boom ultimately comes to an end when labour inflows dry up through
housing and infrastructure congestion, while dramatic growth can easily turn
into dramatic decline in the event of adverse shocks. This regional perspective
seems to us to be close in spirit to the model that Blanchard proposes.2
The model we present here represents a half-way house between the
delayed-convergence and regional-boom perspectives. Since ours is an
exogenous rather than endogenous growth model, there is indeed convergence
to an exogenous steady state.3 We allow for highly elastic supplies of capital
1An important distinction between the perspectives is that the first approach proposes that
convergence will follow if Ireland follows the same policies as the rest of the EU. The second
suggests that non-orthodox policies such as lower corporation tax rates may be required to
surmount the core-periphery gap; see e.g., Borck and Pflueger (2004), which builds on Baldwin
and Krugman (2004).
2Though Blanchard (2000) does not devote much attention to foreign direct investment (FDI), he
does mention a third feature - besides the openness of capital and labour markets - that may
make the Irish economy function more like the AK model: the shift towards the production of more
capital intensive goods. This is associated with the FDI-intensity of the economy.
3This does not necessarily imply that the convergence process should stop when Ireland has
reached average Western European living standards. GDP per head may continue to converge on
the US; Krugman (1979).