ANALYSIS:Green shoots! Really? Or maybe the sort of self-serving nonsense that got us into this mess in the first place.
IT WAS remarkable that some green shoots of recovery were discovered two days before the recent election. They didn’t make much difference to the outcome, but then people are much wiser than politicians give them credit for.
The principal green shoot was that in May total tax receipts had fallen “only” by 11.1 per cent compared with the previous May. Because this was less than other falls which occurred in earlier months it was suggested that our problems were bottoming out. This was a very thin straw to clutch at.
In the first place receipts of corporate profits were brought forward, thus distorting the data. If allowance is made for that fact, the underlying fall in total tax receipts comes to about 17 per cent, not 11.1 per cent.
Second, one swallow does not a summer make. The idea that some trend or turning point can be read into one observation does not stand up. Such information is regarded
as “noise” by statisticians; it contains no meaningful information. God help us all if this straw-clutching is what passes for analysis in the present administration. It is precisely this kind of self-serving mania that got us into our present crisis in the first place.
Even if the fall in tax revenue in May did suggest that a floor had been reached, it tells us nothing about how long we might remain on the floor before recovery sets in. Nobel prize-winning economist Paul Krugman seems to believe that recovery will take five years in Ireland – much longer than any other country in recession. Let’s hope he’s wrong. But at the present time the data support his belief just as much as any more optimistic view.
The second green shoot that was widely embraced before the election, was the Economic and Social Research Institute (ESRI) view which suggested that economic growth could bounce back to 5 per cent in 2011.
On the face of it this sounds pretty good, but the important assumptions and caveats made by the ESRI were, unfortunately, not alluded to. The first point to make is that even a dead cat will bounce if it falls far enough, so a 5 per cent recovery has to be viewed by reference to the extraordinary fall in gross domestic product (GDP) which has already occurred.
The ESRI makes a number of assumptions, the principal ones being that we will have regained cost competitiveness, that the banks will have been fixed and that normal credit will be flowing again. Despite the enormous logistical and administrative difficulties which will beset the National Asset Management Agency (Nama) as it tries to fix the banks, it is possible that the assumption regarding competitiveness will prove to be the most heroic. It is true that there is a reasonable degree of wage and price flexibility in the economy at present at least in the private sector, but it has to be remembered that this applies in other countries as well.
Private-sector wages and other costs of production have fallen in most of our trading partners by as much if not more than here. This does not augur well for a rapid recovery of competitiveness and neither does the cumbersome machinery of social partnership which seems incapable of coping with its first real challenge.
Then there is the awkward question of the exchange rate. If China reduces its investments in US dollar securities then it is likely that the euro will rise, putting further pressure on our competitive position.
The really important message from the ESRI is that the long-run potential growth rate of the Irish economy has fallen to 3 per cent per annum. This must come as a shock to the Department of Finance and other analysts who had estimated this to be in the region of 5 to 6 per cent per annum. What the ESRI estimate really means is that for every year the Irish economy grows by 5 per cent there will be another year when it will grow by only 1 per cent (to give the average of 3 per cent).
The potential growth could be even less than 3 per cent if the “normal” flow of foreign direct investment is not maintained. In any case a 3 per cent potential growth rate is unlikely to yield full employment or to stabilise the public finances. The unemployment rate could remain in double digits while it would prove very difficult to get the general government deficit down below 3 per cent of GDP. With a lower potential growth rate the threat of inflation would never be far away.
We really do need a detailed plan to work out the implications of this kind of scenario over the long term and to formulate appropriate policies. No such plan exists and, despite abundant economic talent in the ESRI, Central Bank and the universities, it seems unlikely that any such plan will be drawn up. This is a shameful and inexplicable waste of resources.
Contingency planning is also required to deal with major unknowns following the collapse of financial markets around the world. It is almost certain that regulation will be strengthened in most countries. This may be confined to the financial markets, but it could be extended to other markets as well. In general, state intervention is likely to increase.
Well designed regulation will be necessary to prevent appalling collapses and the excesses of crony capitalism such as we have witnessed in the last year.
However, the burden of regulation is likely to reduce productivity to some extent in all developed countries. This will be deemed a necessary price to pay but the reduction in productivity will have secondary effects which need to be examined. One such effect could be to reduce potential growth rates in major economies.
It is likely that we will see a significant reduction in sophisticated financial products. This may well reduce the size of financial centres in most large economies, and could affect London, Wall Street and even Dublin to some extent.
There could be an effect on the so-called information economy. Skilled workers may move out of financial services into more “old-fashioned” sectors. It is not inconceivable that there could be a return to industrialisation with much less reliance on the service sector generally. How might this affect our Government’s aspiration of becoming a “smart economy”?
It would seem that the emphasis on the Green agenda and the search for energy renewables will not be diminished. However, after a major economic upheaval it is extremely difficult to predict how things may change.
Socialism has failed; now capitalism has failed. Where do we go from here? What forces will inspire and incentivise economic creativity over the next decades?
Whatever new trends emerge, they are likely to originate in the US. Some may play to our strengths; others may not.
It is very important to monitor such trends as closely as possible within a planning framework. We came up lucky in the Celtic Tiger period, but in the future we will have to make our own luck – and this has to involve contingency planning.
Michael Casey is a former chief economist with the Central Bank and a former member of the board of the International Monetary Fund