Alan Ahearne: Ireland’s remarkable economic recovery tied to global events

Ireland’s remarkable economic recovery continues to gather strength. A few years back economic forecasters were pencilling in growth rates of 2½ per cent for 2015. Some domestic commentators were much more pessimistic about our prospects. With the volume of GDP surging 7 per cent in the first half of this year, following growth of 5 per cent in 2014, these gloomy predictions have fallen very wide of the mark.

An interesting feature of the economy’s recent performance has been the rapid expansion of the value of incomes and spending. Overall income is on track to jump by €20 billion this year compared with 2014. Such fast growth in nominal income is helping to reduce the burden of debt in the country. Public debt, for example, is now expected to fall below 100 per cent of GDP this year.

Levels of household and business indebtedness are also declining relative to the capacity to service these debts.

Net exports, set to grow by €10 billion this year, are a big part of the growth story, though domestic spending is also expanding strongly. Many exporters appear to be pricing their goods and services in sterling and dollars so their revenues measured in euro have soared as these currencies have strengthened.

Ireland’s export sectors are highly competitive, so the prospects for continued robust growth are good so long as global trade continues to expand.

There are, of course, downside risks to this bright outlook. Some threats, such as Brexit, Grexit, an unexpectedly sharp rise in interest rates, and a reversal of recent movements in exchange rates, have been much discussed.

Over the past few weeks, however, developments in China have moved centre stage, and with good reason.

The Chinese economy has served as a key engine of growth for the world economy over the past decade, and developments there will have significant consequences for global growth, including in Ireland.

Most of the recent news stories about China have focused on the turmoil on the Chinese stock market. Having soared by an eye-popping 150 per cent during the 12 months to last June, prices on the Shanghai stock market have plunged nearly 40 per cent over recent weeks.

The boom and bust in the Chinese stock market was largely driven by policy actions by Chinese authorities. As part of a well-intentioned set of policies to encourage heavily-indebted Chinese companies to issue more equity finance, and thereby reduce their dependence on debt, the authorities eased various rules on investing in the stock market.

Restrictions

For example, restrictions on how much investors could borrow to buy stocks were relaxed. With the cost of borrowing at low levels, these policy moves inflated a massive speculative bubble which burst in the summer as the government introduced measures to try to cool the market.

Recent weeks have seen a raft of government interventions to try to halt the slide, including tax breaks to encourage investors to hold on to their shares for the longer term, but so far with only limited success.

The volatility in the Chinese stock market has been dramatic, but in and of itself matters little for economic activity in the world economy. Of far more importance for global economic prospects are developments in the real Chinese economy and the formidable challenge facing Beijing in rebalancing the economy and putting growth on a more sustainable path.

Having enjoyed three decades of rapid export-led growth, the Chinese authorities responded to the slowdown in exports resulting from the global financial crisis in 2008/2009 by introducing policy measures to boost investment spending, construction and credit growth.

The results were all too familiar to people in Ireland.

A massive construction boom fuelled by an unsustainable surge in borrowing pushed China’s overall indebtedness from 140 per cent of GDP in 2008 to 220 per cent in 2013. Non-bank lenders drove the boom, lending to property developers and state-owned firms in sectors which now suffer huge overcapacity.

Policymakers in Beijing rightly introduced measures to slow credit growth, but the associated hit to the construction sector has resulted in a significant slowdown in economic activity. China appears to have the financial fire-power to stave off a full-blown financial crisis, including roughly €3.5 trillion in foreign exchange reserves. The more difficult challenge will be to push ahead with pro-market reforms announced by President Xi Jinping in November 2013 aimed at putting China on a more balanced growth path.

Real risk

The real risk for the global economy is Beijing relying on devaluing its currency to boost exports and curb imports. The reality is that the Chinese economy is now too large to depend on exports for growth. Domestic consumption needs to be the engine.

A large Chinese devaluation would spread China’s woes across the global economy. As a small open economy Ireland would not escape the shock waves.

All this serves as a reminder that, notwithstanding the impressive growth numbers our economy is posting, our fortunes are tied to external developments over which we have no control. Alan Ahearne is professor and head of economics at NUI Galway. Cliff Taylor is on leave