SMEs and global recovery are best hopes
As a small player, Ireland is subject to vagaries. But enterprise, banks and less austerity are good tools
The British and the US economies are each vying for the top spot in global growth league tables.
That simple statement represents a major stroke of luck for the Irish economy: two of our greatest sources of inward investment and two of our largest trading partners are showing signs of self-sustaining growth for the first time since the financial crisis.
Forecasts for economic growth in 2014 are being nudged up on both sides of the Atlantic. The news from the euro area is less promising. The only country with any signs of economic vitality is Germany. The rest of the zone is flatlining at best.
In thinking about domestic economic prospects, we always begin in this way, with the overseas outlook, for obvious reasons: most of the time, swings in the global economy determine what happens at home.
We are the epitome of the small, open economy. It has been this way for many years, although the composition of our trade with the rest of the world has altered dramatically since the days when our biggest export was cows.
But it is not just about being open, domestic policies can make a big difference, for good or ill. But the major policy levers are, for the most part, pre-set, either by the European Central Bank or by those who watch over our spending and taxation decisions. Until recently, of course, this was the troika; from now on it will be the bond market. Either way, our room for manoeuvre is limited.
As if we didn’t need reminding, the financial crisis delivered a double shock: as well as a severe hit to global trade – and hence our exports – our home-grown bubble burst, leading to a collapse in construction output and employment.
While the recent fall in unemployment is welcome, and looks set to continue, all those lost construction jobs are most unlikely to return. To get back to anything like full employment, we have to imagine a different engine of job growth. That’s not impossible, just difficult and likely to take a long time. It throws into sharp relief the SME sector: in most countries this is where job growth typically comes from.
While the jobs created by multinationals are vital, we cannot rely on this sector to make a material dent in the unemployment numbers. The growth of smaller, probably indigenous, companies will determine how quickly we can solve this problem. This is why the debate over the flow of credit, or lack of it, to SMEs is so important.
More generally, we need to press on with micro measures that foster the growth of smaller companies. More people need to form more companies: that’s the debate over whether or not we have an entrepreneurial culture.
The Tiger years did leave us with one or two favourable legacies. The fact that Ireland has been a welcoming place for immigrants is a big positive. The more people we can bring to this country the better: it is no coincidence that those two successful economies, Britain and the US, are also countries to which people from all over the world try to move.
Economic success attracts immigrants and all the evidence suggests that the process is self-reinforcing: they bring success with them in the form of skills, entrepreneurship and energy. It will stand to us if we can avoid the ugly and statistically irrelevant argument over “welfare benefit tourism” that is taking place in Britain and elsewhere.
Best guesses about growth in 2014 suggest an expansion in gross domestic product of about 2 per cent. In the wider scheme of things that doesn’t amount to much. A “normal” recovery would typically see initial growth rates well in excess of this number.
A sluggish recovery is proving typical around the world, even in those countries where we are getting quite excited about the growth numbers. The headwinds to growth are still strong, particularly in Europe, but less so in the US. Risks from the euro area remain constant. Bailouts of countries could destabilise things again: Slovenia is thought to be a possible candidate, with Portugal and Greece also sources of more trouble.
But Europe’s lack of growth is also a problem for many of the larger countries, particularly Italy, an economy that hasn’t had growth since the turn of the century.
Interest rates, at least those set by the ECB, are close to zero. Conventional monetary stimulus has now reached its limit. If euro zone growth does not resume, all eyes will be on the possibility of an unorthodox move: will the ECB embrace quantitative easing, as practised over the last few years in Britain and the US?
Given the hostility of the Bundesbank to what has been done already, we can conclude that any unconventional steps will be extremely controversial and fiercely resisted. The potential inability of the ECB to prevent deflation, or at least to achieve its inflation target, is one reason to fear prolonged European stagnation.
On the other side of the Atlantic, the flipside to better economic growth could be an end, or the beginning of the end, of the Federal Reserve’s monetary stimulus. I think this is likely to be less of a big deal than many market commentators seem to believe but it is another source of potential financial instability.
Europe’s slow march towards a banking union will continue. The argument will remain the same: who pays? When a bank gets into trouble, where will the needed money come from? We may, or may not, achieve clarity on this in 2014.
Decisiveness will not be helped by prolonged stasis in Brussels: next year will see European elections and a lot of European commissioners are expected to move on. Olli Rehn, well-known to us, has announced he is running for parliament, perhaps with an eye on a move, ultimately, into the presidency.
Running parallel, we hope, with moves to form a banking union are the ECB bank stress tests, an exercise designed for the most part to get the banking system ready for that union, even if the details have yet to be made clear.
One detail of interest to us, of course, is whether or not any or all of the Irish banks will be required to raise more capital. And if so, where will it come from?
How stressed our banks turn out to be depends in part on how our domestic “loan resolution process” evolves – how quickly mortgage arrears are dealt with.
Another problem that will take a very long time to sort out is the lack of competition in Irish banking. We are being squeezed by the few banks that remain – just look at net interest margins, a measure of underlying profitability. That’s a headwind for the economy.
Weight of austerity
If the Irish economy does achieve two or more percentage points of growth, the fiscal arithmetic will improve, perhaps rapidly. Technically, another chunky adjustment is due in the next budget, another dose of austerity. The arrival of economic growth could give the Coalition the opportunity to fudge this. The authorities should need no reminding that the right time to do austerity is when things are going well. Given all of the risks that are out there, they should take every opportunity to reduce the country’s vulnerability.
If the euro zone manages to generate another crisis, it would help if we were in a position of not having to ask the bond markets for too much. For the first time in a while, we have some tailwinds; let’s acknowledge how fickle these can be and not squander them.