Sunday 21 December 2014

Colm McCarthy: Wishful thinking on heroic scale to believe we've reason to celebrate

Need for reform has been obscured by rose-tinted view of the economy, writes Colm McCarthy

Published 02/03/2014 | 02:30

Shopping on Grafton Street: Some trade union sources are suggesting that economic recovery needs a retail spending boost — increase gross pay, cut some taxes and the public will flock to the shops. The Government should stay a million miles away from any new partnership deal

Employment data released by the Central Statistics Office on Thursday appears to show solid evidence that the Irish economy is recovering. Politicians are beginning to whisper about possible reductions in tax burdens and trade union officials are starting to shout about pay demands. The reform measures universally accepted as necessary to restore economic health a few years back have been shelved or long-fingered.

The December exit from the Troika emergency lending programme has been followed by a series of second-order political controversies about misdemeanours in the charities sector, garda whistle-blowers and the teething problems at the new Irish Water organisation. The big picture issue has disappeared from view.

This country now has a gross State debt equal roughly to 150 per cent of its annual national income, a figure which will continue to grow until the deficit is brought under control. Unemployment is at around 12 per cent of the labour force; the household sector has debts around double the annual level of household income. Tens of thousands of mortgage holders carry debts which they cannot realistically expect to repay. A new generation sees emigration as the best career option. The banking system continues to contract with mortgage lending for 2013 below the modest level of the previous year. There has been no proper banking inquiry, six years after the crisis began to emerge. The improving employment figures are not a sign of a broad-based economic recovery and the country remains locked in a dysfunctional European common currency area which has yet to show a decisive commitment to reform. It is wishful thinking on a heroic scale to pretend that the Irish economy is headed for the sunny uplands.

Yet the recent economic news is dominated by strike threats, demands for tax reductions and a kind of national pretence that the worst of the economic crisis is past and the Good Times are about to roll. The sense of urgency about economic reform has all but vanished.

The CSO conducts a quarterly household survey which provides the most comprehensive picture of trends in the labour market. Unfortunately, the figures for employment in agriculture have been distorted by methodology changes and they are making the overall picture look better than it really is. Over the last two years total employment has grown by just under 60,000. But 37,000 of this increase is supposed to have occurred in farming. Farm output has changed little over that period but on-farm employment appears to have grown by no less than 46 per cent. Non-farm employment over the last two years has performed as indicated in the accompanying table below.

Aside from accommodation and hospitality and the professional and scientific sector, the figures are simply not strong enough to justify any premature celebrations. There are more people at work in hotels and restaurants, and the hi-tech firms have experienced a strong couple of years. But most of the Irish labour market remains in the doldrums and the absence of any improvement in the industrial sector is particularly disappointing. While the unemployment rate has fallen to 12 per cent, some of this is due to the resumption of emigration as well as to the uneven improvement in job creation.

By the end of the twin bubbles in 2008, excesses in bank credit and in public spending had rendered the Irish economy fundamentally uncompetitive. Bank credit collapsed and the problems of debt overhang in both public and private sectors will constrain economic performance for many years to come. If debt burdens are to prove sustainable it is necessary that all of the exporting sectors regain competitiveness quickly. The employment figures suggest that this may be happening in tourism and in export services. There is no evidence that it is happening in manufacturing, the sector most likely to provide job opportunities for those permanently dislodged from a construction industry which will never regain the employment levels of the bubble peak. Creating jobs for tech-savvy graduates is fine (there is evidence of some inward migration filling some of these jobs recently) but the Government has yet to lay out a credible programme designed to recreate the basis for an expansion in manufacturing. Non-pay costs, including energy costs, are high relative to our European competitors and there is increasing pressure for some kind of national pay deal that could damage competitiveness further.

The Social Partnership formula that sealed the fate of so many Irish manufacturing jobs during the bubble imposed unaffordable across-the-board pay norms on the traded sector of the economy, which contracted, while the sheltered sector blossomed. This time round it needs to be recognised that the State is in no position to offer any relaxation in pay policy to its own employees and should refrain from putting cost-increasing pressures on the traded sector.

Two versions of Partnership-speak have been gaining currency in recent weeks. One is the notion that the public finances can somehow accommodate reductions in tax rates. With the deficit still stuck at around 5 per cent of GDP this implies either large new expenditure cuts or an abandonment of the fiscal targets. Tax burdens have increased and may have to increase again. Politicians should come clean with the electorate on this score.

The second piece of Partnership-speak comes from trade union sources. The line is that economic recovery needs a retail spending boost and that this can be engineered through a deliberate policy of across-the-board pay increases. Remarkably, no other country in the world appears to have twigged this brilliant wheeze. The formula is simplicity itself: increase everybody's gross pay, maybe cut some taxes as well, the public will flock to the shops, buy more stuff, and Bob's your uncle. What could possibly go wrong? More jobs, more tax revenue, doubles all round.

The Government should stay a million miles away from any new national partnership deal. Stick to its pay policy for its own employees and let private sector employers cut whatever deals they can afford. In the traded sector of the economy they will expand employment if the cost base is competitive and will contract Irish operations if it is not. There is plenty of useful work for Government in cutting non-pay costs of doing business in Ireland, many of which are under its direct control.

In line with several other financially distressed eurozone countries, Ireland has experienced consumer price inflation close to zero in recent years. This is a mixed blessing when both public and private sectors are heavily indebted – the burden of debt falls gently with a little bit of inflation. But the restoration of competitiveness requires that inflation stays low, preferably zero, for many years to come. If tax revenue is to rise in order to bridge the deficit gap, the real volume of activity needs to improve, without benefit of rising prices and incomes.

A rate of economic growth at 1 per cent or 2 per cent will not do the trick if inflation is low or zero. Whatever improvement in the external environment comes along must be exploited through sustaining the improvement in competitiveness that seems to have started in certain sectors. It could easily be thrown away through backsliding on reform.

Servicing the enormous public and private debt burden that is the legacy of the bust requires a strong recovery in output and employment. It will be derailed if recovery is weak, or if it is squandered in another consumer or public spending bubble. There is one decisive contribution yet to emerge from the Irish political system. That is a factual and thorough explanation of the banking collapse. How did it happen, who screwed up, and where, at a personal level, does responsibility lie? How come every other country that has endured a banking disaster on this scale has had the benefit of a proper public narrative of what went wrong?

Sunday Independent

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