How push came to shove off the cliff
Thanks to SSIAs and credit growth, much of our 'real' economic growth was phoney, writes Marc Coleman
6.4 per cent 5.7 per cent 6.0 per cent -1.0 per cent
That is the extraordinary sequence of economic growth rates in 2005, 2006, 2007 and in the first half of 2008, respectively. The final figure came from a CSO release last Thursday, confirming that the the economy shrank for the first two quarters of this year. With the full force of the global downturn yet to hit us, the one per cent year-on-year decline for the first half of this year is only a foretaste of the full year. A decline of between two and three per cent is possible.
But even if, as is my wont, I assume the best, the rate of economic growth will still have plunged by seven percentage points. In the euro area, a fall in growth rates was forecast a fortnight ago by the EU Commission. But that was from around two-and-a- half to one-and-a-half percentage points. Granted, our growth rates were much higher last year. But our rates of decline will be more savage this year. Growth rates should be like the drumlins of Cavan, gentle undulations that please the eye. Instead we have the Cliffs of Moher.
The figures referred to above are all percentage changes in a national accounts measure called Gross Domestic Product (GDP). GDP is calculated by totting up and netting out the value of goods and services bought by consumers, investors and government as well as the value purchased by those abroad who buy Irish goods and services, less what we buy from abroad (subtracting value increases caused by inflation rather than productive effort then gives us 'real' GDP from which the growth rates above come).
Where does the cliff-like drop in growth between 2007 and 2008 come from? One reason is the profile of investment activity over the last few years. In the first half of the year, investment output -- the production of anything that lasts for longer than a year -- fell annually by a massive 19 per cent. Thanks to the property boom, investment output grew to account for one quarter of economic activity. Because of our young population, we should expect this share to be high. This is also, incidentally, a valid reason why we shouldn't worry so much about Irish banks having such high loan-to-capital ratios compared with banks in other countries.
But even accounting for this, thanks to construction output, and in particular housing construction, investment grew to become an unsustainable chunk of our economy. Now housing construction is down by a whopping 30 per cent a year.
But for this, the Irish economy would be growing slightly. Personal consumption -- about half of the economy -- grew weakly in the first half of the year. Exports less imports, or net external demand as we nerds call it, grew modestly as well -- although any growth here is welcome in these days of euro strength. Government spending was the strongest component of the economy, growing by about four per cent. In a downturn, that's just as it should be. But we can't fully understand the Cliffs of Moher syndrome until we look at the role of government during the boom years.
Between May 2006 and May 2007, about €17bn-worth of SSIAs entered the economy thanks to a deliberate policy of releasing these savings in a one-year period rather than spreading their release over time. About one quarter of this money was spent directly on the economy. This means that about two per cent of real GDP last year was phoney.
It also explains why the year-on-year growth in personal consumption in the first half of this year is so hard to beat. Although not directly controlled by government, the financial regulator's oversight of the banking system during 2006 and 2007 coincided with an increase of €100bn in private sector credit. The precise impact of that on how much we invested and consumed in that two-year period is hard to pin down. But its impact on investment and construction activity is likely to be very big.
Since last autumn, credit supply has tightened drastically, turning off this source of growth. Last but not least, the Government increased its spending by €12bn. This was a rise of 25 per cent in a two-year period when real GDP rose by less than half that amount. It was an increase that resulted in the share of government spending in the economy rising to 42 per cent by the start of this year compared with 36 per cent in 2004. It was a bridge too far.
Real GDP growth rates in 2006 and 2007 were 5.7 and 6 per cent respectively. But adding in inflation, nominal GDP growth rates were 8.9 per cent and 9.3 per cent respectively. So the value of economic output rose by 18 per cent in those two years.
A rise of this size in State spending would have kept the size of government relative to the rest of the economy steady at just under 40 per cent. In a more globalised and competitive world, it's the higher end of what's acceptable.
But much of this economic growth was a mirage. Firstly, inflation was too high and the gap between nominal growth rates and real ones too large. But thanks to SSIAs and credit growth, even the 'real' growth wasn't all real. It is interesting to note that by the final quarter of 2004 -- just before the borrowing and spending began accelerating in 2005 -- GDP growth had slowed to 2.4 per cent.
As the ESRI predicted it would in 1994, the Celtic Tiger was -- before SSIAs and credit growth took off -- beginning to run its natural course exactly a decade after starting. Had SSIAs been rolled into pensions and had private sector credit growth been restrained, then between 2006 and 2007 the real economy would have grown by a respectable two-and-a-half per cent a year, or five per cent over the two years. Had public sector reform and more competition lowered inflation, the price level would have increased by five per cent over the same period. Adding the two would have justified a 10 per cent increase in public spending.
So instead of the €12bn increase we got, a €5bn increase would have been warranted. Had that been done, the Government would be €7bn richer now.
It's an irony that, according to Brian Lenihan's reaction to last Thursday's growth figures, this is exactly by how much government tax revenues will fall short of expectations this year.
And here's another, more personal, irony: at precisely 11am last Thursday, the Central Statistics Office publicly confirmed that Ireland had entered recession. It was the exact moment that the funeral began of a man who not only started the whole business of media economics in this country, but whose academic work helped reduce unemployment here.
He was a professional who cared only about facts and analysis and not a whit about how popular he was with the public. Which is probably why, among his peers at least, he was the most popular economist there was. Paul Tansey -- a kind, generous and avuncular man -- will be sorely missed by all of us.
Marc Coleman is Economics Editor of Newstalk 106-108
