Rebuilding our economy BRIC by brick

Fri, Mar 30, 2012, 01:00

2030 ECONOMICS:SOME PROPHETS of doom believe the ancient Aztec prediction that the world will come to an end this year. In case that forecast proves wrong, let us explore how things may pan out in Ireland over the next 30 years or so.

It seems an impossible task. There could be another oil crisis, or indeed the opposite – a technological breakthrough in renewable energy. Nanotechnology may revolutionise the production process. Over that timespan virtually anything can happen – for good or ill. Nevertheless, we can at least look at some important issues likely to arise over that period and see how they might be dealt with.

Perhaps the most important development will be the continuing strong growth of the BRIC and other countries. Some commentators call this the “Great Reconvergence” or the “Rest vs the West”. The latter tag implies that it will be something of a zero-sum game, meaning that progress by the “Rest” can only be at the expense of the “West”. This does not have to be the case but it might turn out that way. It is in any case a development of historical importance – a megatrend.

Even if China falters – from a property crash, say – it is unlikely to slow down the overall forward thrust of that enormous country. Anyone who visits a large city in China is immediately impressed by the ceaseless activity of people going about their daily business. The energy is palpable. Manufacturing processes are migrating to countries such as China, where wages are still very low compared to those in the West. At some point wage costs in China will be bid up towards Western levels but this will take several decades. In the meantime job losses will occur in the West. Whether these can be replaced by job creation in more upmarket activities remains to be seen. It seems unlikely, however, because higher-tech activities tend not to be labour-intensive.

The West may also suffer from a declining world demand for financial services which probably had become too complicated and exotic and were riddled with hidden risks. In any case, tighter regulation is likely to clip the wings of the more buccaneering financial institutions. The largest economy in the world, the US, could possibly be in structural decline. It is extraordinary that it continues to suffer from large fiscal and balance-of-payments deficits, depreciating infrastructure and frightful inequality. Real wages in the US have remained static for 15 years. Military expenditure remains a cause of serious resource misallocation. Heavy dependence on borrowing from China is a source of amazement to many observers. While the US still has a lead in technological innovation, one wonders how long this may last.

There are now doubts about the so-called new economy, based on information technology, and about the capitalist system generally. The questioning of old certainties may slow down the growth process for some years.

Ireland will not be immune from these global trends and has serious problems of its own, for example the drag-anchor of debt caused by the fiscal situation and by the bank bailout. This anchor will slow down domestic demand for many years to come, even if some restructuring of bank debt is permitted. We will have no option but to vote for the EU fiscal pact – the alternative would be worse – and that will build in austerity for a long time to come. We will probably need a second Troika programme in any case.

Will our low corporate profits tax last for another 30 years? Pressure to remove that important incentive will increasingly come from Europe and also the US. Remember Obama’s pledge to stop shipping American jobs overseas? A Europe-wide common basis for assessing corporate taxation could also damage the foreign direct investment that Ireland has come to rely on for exports and growth. A Tobin tax on financial services, of the sort favoured by France, would be an added complication.

If the worst should happen and new foreign direct investment slows down, will our own entrepreneurs be able to take up the slack? The answer must be in the negative. This is because new, homegrown entrepreneurs could not be expected to be as effective as those who have already built up large, successful US multinationals. Moreover, our dependence on foreign companies has, over the years, provided growth without any hard entrepreneurial graft on our part. There was no pressing need to develop our own enterprise culture. Whether there is something the Government can do now to improve this situation is a moot point.

Recent large-scale lending by the ECB has not opened the credit lines from Europe’s banks. Despite having access to liquidity from the ECB and cleaner balance sheets courtesy of Nama, Irish banks are, and will continue to be, slow to lend, especially to start-up companies.

We should not be surprised by this because, even during the boom, Irish banks did not have a good record in productive lending to SMEs. Foreign banks which may take over the shattered remnants of our banking system will also be cautious for several years until they acquire knowledge of the Irish credit market.

As mentioned earlier, the worst-case scenario would be that the West is not just in recession, but also in secular decline. If this gloomy prospect is not mitigated by some major positive development such as nuclear fusion and cheap renewable energy, then it is difficult to see Ireland growing by more than about 2 per cent a year. This would be about half the rate of long-term growth that most observers envisaged during the boom period.

Real living standards would still improve, of course, but rather slowly. There would be a need to lower expectations all round regarding health services, education, law enforcement and so on. Government would be faced with a harsh choice between lowering the rate of welfare benefits or increasing taxation. If they choose the latter, this may prompt emigration of skilled labour. Most unskilled people will not emigrate but remain on the dole. We know that unemployment feeds on itself so the unemployment rate, despite emigration, could edge up towards 18 per cent. Not only will this result in weak consumer spending but it may also contribute to a rise in crime.

Because of high long-term unemployment and reduced social protection we may witness a return to the extended family in which one or two people with jobs will have to house and support several relatives. The need for continuing austerity to balance the books will lead to political instability, which will not help the reputation of the country abroad. This could well inhibit inward direct investment and access to capital markets.

It is to be hoped that not all of these depressing scenarios come to pass – but it is important to consider them as contingencies, with a view to remedial action. We should not forget that it was the delirious ignoring of contingencies that led to the collapse of our economy and banking system in the first place.

The bright spot on the horizon is the good performance of the agricultural and food sectors. For years, as we aspired to become an information economy (and a cringe-making “innovation island”), little attention was paid to these sectors. We had outgrown agriculture, hadn’t we? The conventional wisdom of the time was that the consumption of food in the West had a satiation level, so that the demand for food products would not increase pro rata with the growth of incomes. Indeed, for many years we had embarrassing food surpluses in Europe – beef and butter mountains. The development of China and other BRIC countries changes all that.

As these countries grow, and as they develop middle classes, the demand for food from countries such as Ireland is bound to increase. The recent visit of the vice-president of China is no coincidence. China has a special empathy with this country. We must build on this relationship in every way possible. The restoration of agriculture would help to revitalise this country – and not just in commercial terms. It does not have to be at the expense of high-tech aspirations. If the “West” is beginning a secular slow-down it is all the more important for Ireland to gain a foothold in the “Rest”.