Economy’s challenge is coping with the fallout of success

The Irish economy appears to be on something of a winning streak in headline terms. It has motored through successive crises – Brexit, the pandemic, war in Ukraine and inflation – relatively unscathed. Growth is strong, there are more people at work than ever before, exports are booming and household consumption, the main driver of domestic activity, continues to surprise on the upside.

The corporate tax boom at the heart of the exchequer also means the Government is projected to generate up to €65 billion in budgetary surpluses over the next three years, money that can be directed at infrastructural deficits in housing, health and transport.

Much of the public debate around the economy now centres on what to do with these windfall taxes – including whether we should have a Norwegian-style wealth fund – a far cry from the narrative of last year, which centred on the possibility of energy blackouts and whether we would experience a snap recession on the back of surging energy prices.

That said, households and businesses remain in the crosshairs of a crippling inflationary surge and the most aggressive rise in borrowing costs since the early 1980s.

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Irish Times consumer correspondent Conor Pope reckons that the final average household bill for the cost-of-living squeeze this year alone could come close to €10,000 per family, a combination of soaring grocery and energy bills, increased mortgage repayments and the additional costs associated with socialising, holidays, clothes and other items.

While incomes are growing in nominal terms, rising prices have ensured the biggest reversal in living standards since the 2008 financial crisis.

The Government and the Central Bank confidently predict inflation will moderate in the coming months – to below 5 per cent – but there remains a significant amount of uncertainty around the precise path for inflation and the extent to which underlying consumer prices, which strips out volatile energy and food prices, will stay elevated. Ironically, stronger-than-expected growth across the euro zone could be one of the factors that keeps inflation above the European Central Bank’s 2 per cent target rate, necessitating interest rates to stay higher for longer.

For households and businesses already struggling with high borrowing costs, that could signal more discomfort to come.

In a recent interview with The Irish Times, Dutch central bank governor and ECB council member Klaas Knot linked the resilience of the euro zone economy to the strength of Government supports rolled out during the pandemic and the energy crisis. He suggested fiscal policy was “doing too much” and would need to be withdrawn before it becomes a driver of inflation itself.

The interaction between inflation, interest rates and growth, a complex matrix, will define the coming year in economic terms.

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“The Irish private sector economy is growing rapidly,” says Ger Brady, chief economist with employers’ group Ibec, noting that, relative to 2019, employment increased by 10 per cent.

The total private sector wage bill over the same period rose by 26 per cent, total household disposable income is up 25 per cent and the income tax and USC (universal social charge) take is up 48 per cent.

“Despite this growing affluence at a macro level, there is a strong sense that not everyone is feeling the benefits,” Brady says. “There are obvious reasons for this. Even as inflation begins to slow materially, as we expect in the second half of this year, a growing economy has not translated to equal access to the things which many regard as the hallmark of an affluent society – like housing or quality public infrastructure,” he says.

“This is important to business. Quality public infrastructure and services are key, not only to our personal quality of life, but in an economy driven by mobile skills, to our overall national competitiveness,” he says.

In its latest spring forecast, the European Commission noted that, while Ireland’s economy remains on a “solid growth path”, the continued “undersupply” of housing poses a distinct risk to labour supply and competitiveness.

“One of the major concerns expressed about using surpluses to build more of the infrastructure and services, to match strong private sector investment, is the question of capacity in the labour market,” Brady says. “Whilst it is important to have some sense of realism, we should not be excessively pessimistic about our ability to find new workers, improve processes and strengthen our capacity to deliver.

“Caution for its own sake is not a virtue and can create unnecessary capacity pressures in the medium term. It is important to note that Ireland first reached unemployment rates below 5 per cent in late 2018 and early 2019. Yet, the economy has been able to add over 275,000 jobs since,” he says.

The growth in Ireland’s working-age population and openness to inward migration “mark us as one of the few countries in Europe where demographics are continuing to add to labour market capacity”, he says.

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Corporate insolvencies in the State rose by 22 per cent in the first quarter of 2023, according to Deloitte. The consultancy said there were 146 business failures recorded in the first three months of the year, up from 120 in the same quarter last year. However, that number was down from 152 reported in the final quarter of 2022, “which means we are not currently experiencing a steep increase in corporate insolvency activity, which many have forecasted”, it said.

Many predicted the removal of Government supports would lead to surge in business failures; so far that hasn’t happened, suggesting businesses weren’t as leveraged as they were in 2008.

“Irish businesses have showed remarkable resilience through a series of crises over recent years,” Goodbody economist Dermot O’Leary says. “Government initiatives such as the wage subsidy schemes, VAT warehousing and the energy support scheme have all helped to minimise the scarring effects of the pandemic and the energy price surge in 2022.”

However, O’Leary cautioned that within the aggregate numbers, there are differences in performance and business health.

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“The most notable difference is between the multinational-dominated FDI sector and domestic industry. As evidenced by the share of employment, taxes and output, Ireland has become more dependent on the multinational sector over recent years,” he says. “This has reaped significant dividends for Ireland and highlights the ongoing attraction of the country for international investment. It is also bringing strains, as Ireland struggles to keep its infrastructure up to the required level and standard. This is most evident in the areas of housing and energy.

“Failure to address deficits in these areas threatens Ireland’s attractiveness in the coming years,” he says.

The European Commission says the main risk to Ireland’s economic outlook is a “potential shock” affecting global and high­ value-added sectors. The price of being a small, open economy, dominated by multinationals, is the exposure to international shocks. An occupational hazard, you might say.

In Ireland’s case, this is combined with a concentration risk. More of the corporate tax bubble comes from just 10 firms. Multinational employees also account for an increasing share of income tax revenue (more than €15 billion in 2020) on account of the high wages paid by the sector, creating a sort of double exposure.

“Ireland’s underlying growth rates look set to slow in the coming decades as it matures, and the population ages, reflecting the tendency for more advanced economies to experience slower increases in productivity,” the Irish Fiscal Advisory Council’s (Ifac) chief economist Eddie Casey says.

“The continued success of the tech and pharma sectors will be important, including how far they choose to stay in Ireland, but is very hard to predict,” he says. “Planning for this future and challenges, such as higher pensions costs, the climate transition and investment needs, is essential.

“The Government will have to manage the corporate tax it takes from a few big multinationals carefully and explore ways to relieve capacity constraints. Saving the excess corporation tax in the proposed pension fund would help address tomorrow’s challenges and avoid further fuelling inflation and rent pressures today,” he says.

Overall, the outlook for the Irish economy has improved significantly since the start of the year but high prices will continue to pose a cost-of-living challenge for households. Turbulence from rising interest rates remains perhaps the biggest uncertainty.