Saturday 22 October 2016

Inflation is still too high in protected sectors

Published 14/02/2016 | 02:30

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Rising prices have not been talked about much so far during this election campaign. And that makes this election different from others.

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Over the decades, inflation was a stick with which opposition parties beat incumbents. In the Seventies and Eighties - the decades of very high inflation - it was among the hottest topics on the doorsteps.

There are fewer complaints about the galloping cost of living now because inflation has been next to non-existent for so long - partly reflecting domestic factors, but mostly as a result of international deflationary trends.

Central bankers and economists around the world have been fretting for some about a downward price cycle taking hold.

Not in living memory in Ireland has there been such a protracted period of consumer price stability. Between 2008 and last year, the price level of a basket of consumer goods increased by just 0.6pc. As the first chart shows, no other country in the EU has had lower inflation since 2008.

Why has Ireland been at the extreme end of the price change spectrum over the past eight years?

The most obvious reason is that we had one of the deepest crashes. Another is that pre-crisis inflation over a decade was well above the EU average.

The boom mentality made consumers less price-conscious. Indeed, it often seemed that paying more for something in those years was a vulgar and unsubtle attempt to signal one's own prosperity.

Digging into the detail of comparative price developments between Ireland and our peers provides further interesting insights into why inflation has been so unusually low in Ireland over the past eight years.

One area that has experienced low inflation is the Irish grocery market. Prices of food and non-alcoholic beverages are approximately the same as they were a decade ago, with inflation well below the European average since 2008.

The containment of inflation here is probably partly explained by increased competition in the sector, along with the return of price consciousness.

Many consumer goods have also recorded downward price trends. The category with the steepest fall is clothing and footwear. That sector has faced increased competition from discounters and online operators. Whereas clothing and footwear prices are largely unchanged over the decade across the Eurozone on average, they were 40pc lower in Ireland in 2015 compared to 2005.

Below-European-average inflation was also observed in prices for culture and recreation services, as well as in the hospitality sector. Inflation in Irish transport prices, which rose by 26pc over the period, was just below the EU average rate.

Belt-tightening by households and government is, doubtless, a main factor. And one would expect lower prices when demand falls. Yet the fall or moderation in the cost of living in the above areas may well have made the past few years a little bit easier for those coping with economic hardship.

But falling prices and below-European- average inflation did not stretch to every sector. The cost of housing has been a recent addition to sectors experiencing above-EU-average inflation. The primary reason is the spike in rents over the past three years, which are now back at their pre-crisis peaks.

Electricity and fuel prices increased throughout the recession - although they moved in line with trends elsewhere in Europe (as one would expect, given the manner in which commodity prices are much the same across the world).

Two notable stand-outs when it comes to inflation in recent years are education and health.

As the second chart shows, prices of health services in Ireland have risen by almost one quarter over a decade - twice the eurozone average. If there is any positive aspect to the trend in healthcare prices, it is that the rate of inflation has eased in recent years.

But it is in education that Ireland stands out even more. Prices have risen a massive two-thirds since 2005 - not far off three times the euro area average. Worse still, they show no signs of slowing.

Some of this has to do with the nature of services provision. While goods can be manufactured and sold anywhere in the world, services are often labour-intensive and, usually, less likely to be traded across national borders.

But Ireland's inflation rate in education and health has been far out of line with peer countries. It is very hard to avoid the conclusion that the rent-seeking activities of vested interests in these sectors, and an unwillingness by government to challenge them, are having a big influence on prices.

Inflation indices only measure the change in prices from one period to another. The overall price level reflects cumulative changes in prices over the long term.

During Ireland's bubble era, high inflation pushed the overall price level far above the average in Europe. There were, as a result, valid grumblings of a 'Rip-off Republic' and apocryphal tales of foreign retail executives praising 'Treasure Ireland'.

Indeed, so comparatively high was Irish inflation that the price moved towards the highest of any EU member country. Despite having the lowest inflation since 2008, Ireland's price level remains the joint third highest (alongside Finland) in the EU-28.

Very large price premiums in a number of areas in Ireland account for a large part of the high overall price level. Alcohol and tobacco prices stand out, owing to the very high taxes placed on them over the years. Alcohol is 78pc more expensive than the average in the 15 richer, long-term EU members, something to bear in mind when further price controls are argued for.

The price level when it comes to health is 42pc above EU-15 average. Further proof, if that were needed, that our health service failings cannot solely be blamed on a lack of money.

As noted before, there are different dynamics at play in price developments in goods markets compared to services markets. Ireland's price level for goods is similar to the European average. It is higher in services.

More worrying, trends are diverging. Last year, goods prices fell close to 4pc. Services prices rose by the same amount.

If global goods and commodities prices were to stabilise, Ireland's overall inflation would jump sharply, owing to high services price inflation. And that is an issue that the next government would do well to address.

Sunday Indo Business

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