Prospects look better than a year ago but we will be waiting for fruits of recovery
Opinion: Growth is likely to be more at the level of the 90s than that of the bubble years
We should be careful about regarding a revival of house prices as an indication of economic recovery.
The Irish economy has provided plenty of positive news for the Government of late. Employment figures and confidence indicators suggest growth is accelerating and the successful sale of the Bank of Ireland preference shares will sugar coat Ireland’s bailout exit. But there may be a disconnect between global investors eyeing up the State’s remaining stakes in the financial sector and many households that have yet to see any tangible improvement in their own circumstances.
Strong jobs growth makes weak GDP performance puzzling.
Typically, the concern during the early stages of economic recovery is of “jobless growth”. Productivity gains limit companies’ need to hire workers as output picks up initially. Indeed, during the 1990s it took several years of the Celtic Tiger before the unemployment rate fell below double-digit levels.
But this time around Ireland has had the unique experience of a “jobs-rich recession”. The unemployment rate has fallen steeply to 12.5 per cent, its lowest since 2009, but with GDP falling in three of the last four quarters. The latest data shows employment up by 58,000 and indicators also suggest the recovery is already sufficiently mature that companies are adding jobs. This confusing configuration of job creation but falling GDP means labour productivity has suffered its sharpest annual decline since at least 1960. In the past such productivity puzzles have often served as a warning light that the GDP data may be giving an unreliable signal on the health of the economy.
However, the answer to Ireland’s productivity puzzle is relatively straightforward. The entire drop in GDP over the past year has been accounted for by the pharmaceutical sector. The patent cliff affecting up to €200 billion of global pharmaceutical sales has hurt Irish goods exports. Multinational profits have been hit badly, but the job cuts in pharmaceutical companies so far pale in comparison with economy-wide job creation. This means GNP is likely to expand by about 2 per cent in 2013, a far better picture of the underlying favourable trends in the economy.
Nonetheless, it will be some time before the recovery becomes tangible for many households. Consumer spending, employment and disposable incomes are still well down on peak levels and will only recover slowly. The burden of household debt is exceptionally high, close to 200 per cent of disposable incomes and skewed towards older age groups who will remain squeezed by repayments. One threat here is that many indebted households are still vulnerable should ECB rates eventually rise to more normal levels. Instead, the future for the Irish consumer will largely rest with younger age groups free of debt.
Commentators have focused on the return of house price inflation as the key metric to assess Ireland’s prospects. But even in Dublin, house prices are still down 50 per cent from peak, so negative equity will persist. Concerns that Dublin house prices are being protected by an illiquid market starved of supply may seem academic to homeowners. But first-time buyers are increasingly failing to bring mortgage approvals to fruition, and are struggling to find suitable homes. The lack of supply is somewhat artificial, reflecting slow progress by banks in dealing with delinquent mortgage loans. Even repossessions and voluntary sales of buy-to-let investors remain negligible, preventing first-time buyers from getting into the market.
It is often asserted the economy cannot truly recover without a functioning property market, confusing cause and effect, as if encouraging people to sell houses to one another should be a key tenet of industrial development strategy. This view seems to regard economic development as a chain of housing bubbles and busts – perhaps closer to the truth than we would like to admit. Thankfully, the IDA is focused on attracting foreign direct investment, particularly in the IT sector, while weathering the storm of the pharmaceutical patent cliff. In the near term Ireland’s growth prospects will comprise an element of bounce-back in the domestic economy, facilitated by smaller budgetary adjustments, with the export sector growing as global demand picks up. So the configuration of growth should be closer to the more sedate 1990s than the the noughties housing bubble.
Overall, economic prospects look far more encouraging than 12 months ago. The euro area is emerging from recession and the global economy is picking up. The Government now has a fighting chance of implementing just one more austerity budget before the next election in 2016 – good news for households hit repeatedly by revenue measures such as hikes in VAT and incomes taxes. Indeed, the revenue adjustments under the EU-IMF programme, such as the new property tax, have been applied almost seamlessly.
But progress on structural spending reform has been far more problematic. The Department of Health is set to exceed its spending limits for a second year running. Efficiency savings envisaged have not been realised, necessitating an additional round of pay cuts under the Haddington Road agreement. Finally, IMF proposals to target social spending at vulnerable groups have not materialised, with blunderbuss universal payments such as child benefit maintained.
Ireland’s marginal income tax rates are exceptionally high, but are rarely portrayed as the inevitable consequence of a costly, inefficient public health service and bloated universal benefits. Beating EU-IMF deficit targets has clearly been the winning strategy in securing Ireland’s access to global funding markets. But the absence of bond market vigilantes has limited the pressure to address structural spending problems.
So for now, substantive income tax cuts to help a broad swathe of Irish households join in the recovery still seem a distant prospect.
Conall Mac Coille is chief economist with Davy