Grave economic risks fade but gloomy mood persists

 

ANALYSIS:The economy appears to be moving in the right direction

THREE MONTHS ago, dismal scientists at the Economic and Social Research Institute (ESRI), a Dublin-based think tank, looked shaken when they considered the economy’s future at a quarterly press briefing given to explain their freshly unveiled forecasts. Then, they spoke of “grave” risks to the prospects of economic recovery if a €4 billion budgetary adjustment were to be implemented in 2011.

Yesterday, when setting out their new quarterly economic forecasts, published today, the ESRI’s dismalists looked a lot less spooked. Despite the imposition of a much larger budgetary adjustment for 2011 than feared in October – of €6 billion, rather than a mere €4 billion – there was no grave talk. The institute now expects the budgetary measures to dampen growth in 2011, not crush it. Moreover, the institute’s first forecasts for 2012 include an acceleration of economic growth and the first (albeit minuscule) increase in the number of people at work for half a decade.

Even the Government’s disastrous finances are expected to move towards balance, more or less as the outgoing administration expects.

But none of this means that happy days are at hand.

The ESRI folk are gloomier about jobs and emigration. The trough in the number of people working, anticipated to be reached this year, is now expected to be considerably deeper than forecast last October. In 2011, the number of jobs in the Irish economy is expected to fall back to 2003 levels – two years short of a lost jobs decade.

In terms of policy response, the institute singled out for criticism income tax hikes imposed in the Budget. Increasing taxes on work can only harm job creation and hinder wage adjustments, it says.

With 1,826,000 people expected to be at work on average this year, almost one in seven jobs will have disappeared since employment peaked in 2007.

That, incidentally, is the worst jobs record among the Organisation for Economic Co-operation and Development, the club of 34 most developed economies. The ESRI believes that financial services and public sectors will account for most of this year’s contraction in total job numbers.

The fall in the numbers employedis not expected to result in a rise in the numbers unemployed, for the traditional reason – people will up sticks in their tens of thousands to seek their fortunes overseas, the think tank believes.

In recent decades, the largest outflow of people from the State took place in 1989. Then, net emigration hit 44,000. This year, the ESRI expects a haemorrhaging of 60,000, with only a partial staunching in 2012 – 40,000 are expected to depart next year. Back to a grim future.

If this causes dread among parents of the nation’s twentysomethings, fears of mortgage holders will be assuaged somewhat by today’s report. The ESRI believes that Frankfurt’s central bankers will hold fire on raising interest rates until the final months of this year, despite some recent hawkish noises about a stirring of inflationary pressures. In the last quarter of this year, the institute anticipates a hike in base rates of a quarter of a percentage point.

Over the course of 2012, it thinks that Jean Claude Trichet’s successor, who is to take the helm from the Frenchman on Halloween next, will raise rates by a full percentage point. If that happens, official interest rates would stand at 2.25 per cent in 23 months’ time, up from 1 per cent today.

The prospect of price stability should also give cause for relief. The ESRI expects Irish inflation to remain very low in 2011-12, with prices rising in a range of 1 – 2 per cent annually. This follows an unprecedented two consecutive years of falling consumer prices.

One reason for the low rate of price inflation is an expected decline in wages in 2011. If wages do fall this year, it will be the third consecutive year of nominal pay cuts – a previously unthinkable happening.

While contained price inflation and falling wages will boost competitiveness, the latter will be but one factor keeping consumers out of the shops. Others include a stubbornly high savings rate, the previously mentioned weakness in the jobs market and the consumption dampening effects of budgetary measures which are squeezing incomes. As a result of these factors combined, the ESRI believes that consumer spending on goods and services will fall in both 2011 and 2012 in real terms – if that happens it will amount to five consecutive years of decline.

Could things be worse (or better) than the ESRI predicts? Certainly, says Dr Alan Barrett, the lead author of the report.

Yesterday he had no hesitation in conceding the extent of the uncertainties – economic forecasting is even less reliable than usual in times such as these, he acknowledges.

The euro area debt crisis is the biggest risk identified in today’s report. If it deepens, it has the potential to knock the think tank’s forecasts for six. There are other risks, too.

Although today’s report does not repeat the “grave” language used repeatedly in October’s version, Barrett told The Irish Times that he had not changed his views on the threat that very large budgetary adjustments could pose to already feeble economic growth.

The ESRI is surely correct in stressing the downside risks because, alas, negative surprises are greater in number and impact than any possible positive ones.

But despair not. The economy could be stronger than the institute predicts. If a modicum of confidence returns, the percentage of incomes salted away, rather than spent, could be lower than anticipated – resulting in more consumption activity.

Exports could be even stronger than predicted, sucking more foreign cash into the country. The booming export sector might start hiring at a faster clip if it finds it can draw no more from already stretched employees. Hope survives.


Dan O’Brien is Economics Editor

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