Brendan Keenan: Deflation can be as great a danger as our surging budget deficit
Declining GNP figure suggests a state of collapse in economy
YOU can't beat a fresh eye. The prominent British economics journalist I met last week was fascinated, not by the budget deficit we obsess about, but the deflation, which gets much less attention.
So I looked again at the published figures with a new eye, and, right enough, they are something to behold. The convention in economic statistics is to deduct price changes from the output of goods and services, to get the 'real' change in that output -- usually measured by GDP (gross domestic product).
Almost all the time, the real change in GDP is smaller than the actual figure, because prices go up.
Not so now. With both output and prices falling, the CSO figures for the third quarter of last year showed a 7.4pc drop in real GDP compared with the same period in 2008. But the drop in prices meant the fall in the money ('nominal') value was 10.4pc.
That is a figure which most foreign observers find almost incredible. Nothing like it has been seen in an advanced economy.
Luckily, such observers do not bother much with the other measure -- GNP, or national income. If they did, their eyes would pop at the 11pc fall in real GNP, and the truly staggering drop of 15pc in the nominal value -- from €37.8bn to €32.2bn.
Both measures matter in Ireland because GNP is about 15pc smaller than GDP, once the profits of foreign multi-nationals are deducted.
There is disagreement on what measure is the best guide to use for what; but GDP may be a better guide to employment changes, and GNP to living standards and the resources available for public spending.
Whichever way one wants to looks at it -- whether the contraction is 10pc or 15pc -- such figures suggest an economy in a state of collapse.
Yet that is not quite the case, as financial markets have begun to acknowledge to some extent in recent months. It is not just that things have stabilised since last autumn. Even more curious is that such deflation has been welcomed in much Irish commentary on the economy.
Recent example
The most recent example was this week's outlook from the employers' body IBEC. They happily noted that labour costs per unit of production will have fallen by 6pc in the two years 2009-10; compared with a 2.9pc increase in the rest of the euro area.
A 9pc swing in competitiveness (at least as measured by unit labour costs) in just two years is also quite something for foreign observers. As such, it may even pitch Ireland into a debate which in the end may be much bigger than the one about Greece: the one about Germany.
The debate surfaced unexpectedly in an interview in the 'Financial Times' with Christine Lagarde, finance minister of France. In a fairly unprecedented public disagreement with German policy, she suggested that its attachment to export-driven surpluses could be part of the problem with the single currency.
This came after her German counterpart, Gerhard Schaeuble, said bluntly that countries with persistent trade or budget deficits should leave the euro -- or even be thrown out -- if they cannot achieve balance.
It may be coincidence that Ms Lagarde singled out Ireland's budgetary efforts for praise, but the mathematical fact is that the efforts of deficit countries to deflate will be far more onerous if there is no effort by surplus countries to inflate -- if not in prices, at least in consumption or output.
"It takes two to tango," is how Ms Lagarde put it. Ireland is taking to the dance floor by demonstrating remarkable flexibility in wages, prices and, probably, labour mobility -- otherwise known as emigration.
As such, it is behaving as a region in a monetary union should. The question economists asked in 1999 -- can adjustments be downwards as well as up? -- is being answered, it would seem, with a yes.
A qualified one to be sure. It is too early to say whether it will succeed. The trade unions have always argued against deflation as a policy, and are prepared to fight when it is applied to the public services. They have the support of some economists, who see it as a damaging cul-de-sac.
Reason
One reason they say so is that deflation is particularly bad for two institutions -- banking and government finances. The two most distressed parts of the economy (construction excepted) are also the most threatened by falling nominal GNP.
This is because falling nominal values increase the real value of debt. The work of this unpleasant vice is clear to see in the Department of Finance projections.
Had the cash value of output merely stayed unchanged, December's Budget would have reduced the general government deficit from 11.7pc to 11.3pc of GDP. Instead, the decline, after €4bn in adjustments, was just a 10th of 1pc.
For next year, the Government is relying on a sea change, with nominal GDP rising by 6.25pc, made up of a real increase of more than 4pc and a return of modest inflation. Add another €3bn in tax rises and spending cuts and the deficit falls by 1.6 percentage points, to 10pc.
Still not in single figures. And, of the three elements -- growth, budget corrections and inflation -- one would be confident only about the inflation.
Achieving Irish growth at this pace will require a return to trend growth or better in the US, UK and euro area; or at least in two of the three.
To judge from the German responses to Ms Lagarde, we cannot expect much uplift from the euro area. There is not much reward in being a flexible region of a monetary union if the union in question not only has no fiscal transfers, but little growth prospects either.
In which case, Ireland's limited exposure to the euro area economy -- seen, rightly, as a danger -- could yet be turned to advantage.
Leaving the single currency is not a practical proposition for a country with large debts, large government deficits and a balance of payments gap.
Managing the economy to maintain competitiveness against a basket of our trading currencies is only a little less impractical, but may at least be possible.
- Brendan Keenan
Irish Independent
