Confusing economic signals from Ireland’s canary in the mine

John FitzGerald: Unexplained surplus on balance of payments needs more study

Grafton Street in January 2021: The current account of the balance of payments  has always been a crucial indicator of dangerous imbalances growing in the domestic economy. Photograph: Patrick Bolger/Bloomberg

Grafton Street in January 2021: The current account of the balance of payments has always been a crucial indicator of dangerous imbalances growing in the domestic economy. Photograph: Patrick Bolger/Bloomberg

 

Last week the CSO published its detailed national accounts for 2020. Attention in Ireland and elsewhere focused mainly on Ireland’s rise in GDP last year, despite the pandemic. However, both the CSO and the Minister for Finance emphasised that measured by GNI, or adjusted national income, national economic welfare fell by 3.5 per cent last year.

That feels closer to the lived experience of economic life under lockdown.

The CSO also publish a figure for the current account of the balance of payments, which measures the difference between what we receive from abroad and what we pay abroad, accounting for trade balances and other net foreign income. The current account of the balance of payments is important as it has always been a crucial indicator of dangerous imbalances growing in the domestic economy, the canary in the mine.

Balance of payments

Since the second World War, a recurring feature of major economic crises has been the large balance of payments deficits, where Ireland was spending more abroad on imports than it was receiving in income from abroad.

Given the need to fund the deficits, these crises were also marked by very extensive borrowing abroad to pay for the gap between national savings and investment.

The CSO’s adjusted measure of the balance of payments shows that, last year, Ireland received more income from abroad than it paid by a very large margin – over 11 per cent of GNI. This follows a surplus of 9.4 per cent in 2019.

If correct, this represents a very strong position.

The counterpart of this excess of external income over expenditure last year, is that Ireland saw a reduction in foreign debt amounting to more than 11 per cent of national income. If the number is correct, while the Government’s debt burden rose by 9 per cent of national income, the net debt burden of households and companies must have fallen by a much greater amount.

While there was a huge increase in private sector savings last year, it is not easy to match the implied level of net debt reduction over recent years, stemming from the balance of payment, with the actual experience of companies and households in relation to debt repayments.

Before relying on movements in the balance of payments in formulating fiscal policy, further research is needed to provide reassurance that this measure is not affected by the unusual behaviour of foreign multinational enterprises.

Borrowing

As with any household or company, borrowing can play an essential role in funding long-term growth through investment. For a country, borrowing abroad to allow higher levels of investment than domestic savings can finance can be sensible – on condition that the investment produces additional output that will pay off the borrowing.

In the late 1940s there was a surge in foreign borrowing to fund an investment boom. On that occasion, the borrowing came from the US government on favourable terms as part of its aid to a European recovery. That funding was guaranteed and the deficit on the current account was sustainable.

However, with the benefit of hindsight, the then government did not use the loans to invest wisely, building up future problems.

In 1955, there was again a large balance of payments deficit, which triggered a period of austerity in 1956 and 1957 to bring domestic demand into line with supply.

However, as Honohan and Ó Gráda have shown in their article – The Irish macroeconomic crisis of 1955–56: How much was due to monetary policy? – those tough budgets were probably an overreaction. The problems in funding the deficit had been aggravated by the government keeping interest rates below London rates, triggering an outflow of capital.

A growing balance of payments deficit through the 1970s culminated in a major economic crisis in 1981 which lasted the decade. On that occasion, the full gravity of the emerging crisis was masked by a serious underestimate of the deficit on the current account, then referred to as a black hole in Ireland’s national accounts.

Crisis

The financial crisis that began in 2008 was also preceded by a rapid rise in the current account deficit.

In that case the unsustainable housing boom was facilitated by large foreign borrowing by Irish banks. When that funding dried up, and property prices crashed, we had a full-blown banking crisis.

This time round the Government would be unwise to rely on the balance of payments surplus being as large as it seems. If abundant foreign inflows are ephemeral or illusory, we can’t use them to guide government borrowing.

We need a better understanding of what lies behind the unusually benign balance of payments figures while the real economy was shrinking. Further analysis by the CSO would be very valuable for policymakers.

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