Sunday 20 May 2018

Dermot O'Leary: We must plan for worst as we weigh difficult Brexit forecast

Gina Miller, co-founder of investment fund SCM Private (2R) is escorted by police officers as she leaves the Supreme Court in central London on January 24, 2017, following the judgement in a case to decide whether or not parliamentary approval is needed b
Gina Miller, co-founder of investment fund SCM Private (2R) is escorted by police officers as she leaves the Supreme Court in central London on January 24, 2017, following the judgement in a case to decide whether or not parliamentary approval is needed b

Dermot O'Leary

THE quote "prediction is very difficult, especially if it's about the future", or variants of it, is often wrongly attributed to the great US baseball coach Yogi Berra. In fact, it was first uttered by the Danish physicist Niels Bohr, who received the Nobel Prize for his work on the structure of atoms in 1922.

It serves to highlight the pitfalls for science in using statistical models, based on historical observations, to predict what may happen in the future. If this was indeed the view of a 'hard' scientist like Bohr, the observation is even more significant for a 'soft' science such as economics.

As is custom, the opening weeks of the year have seen a flurry of prognostications from various quarters (including yours truly) about the prospects for the year ahead. While many in the economics profession may claim to have the powers of clairvoyance, honest predictions must always recognise the range of possibilities around a certain outcome.

After the seismic events of the past 12 months, this caveat has never been as important. Having a view about the balance of risks around future events, as well as the events themselves, has important implications for how governments, businesses, investors and individuals think about planning for the future.

Take Donald Trump's presidency. Although it is now a reality, it was considered a very low probability event for a long time, dismissed by so-called political experts. When 'The Donald' first announced his candidacy back in June 2015, bookmakers put the probability of him succeeding Barack Obama at 150/1.

To put such odds in perspective, it is worth looking at the prices that are on offer at the bookies now for future events. In this context, you can get shorter odds on Kanye West being the next US President or Bono being beatified in 2017. Both of these outcomes are available at 100/1 at your local bookmakers.

The point is that low probability events appear to have become more common, making the job of forecasting even more hazardous. It is no surprise that "uncertain" has become the most overused word among all types of policymakers of late. Central bankers are a good example. At the most recent ECB Governing Council meeting in December, "uncertain" is mentioned no fewer than 14 times in the account of the meeting. Minutes of the latest Federal Reserve meeting included "uncertain" on 15 occasions.

Much of this relates to the heightened risks around policy development. US policy uncertainty presents the most prominent risks on a global scale and relates to much more than just economic policy. Decades-old foreign policy relationships may yet be remoulded for instance.

On the economy, a casual glance at the performance of financial markets in the 10-week period following the election result would suggest that they have bought into the view that Mr Trump's policies will bring about a period of stronger US economic growth. A good thing, one might say, following the slump seen in the aftermath of the Great Financial Crisis. But the slump is over in the USA, even if not in the euro area. The US economy is already close to full capacity, with the unemployment rate comfortably below 5pc. Throwing stimulus at it will surely increase inflation risks, and this has also been priced into markets.

None of this would have been expected, even when Mr Trump became a serious contender in the opinion polls. As a result, it now appears that the Federal Reserve is behind the curve and will need to raise interest rates at a faster pace to remove these inflation risks. The problem here is that it does not yet have sufficient detail on the stimulus plans to contemplate such a response. One key element of the stimulus plan is wholesale changes to corporate tax, which has potentially massive ramifications for US investment flows into Ireland.

On this side of the Atlantic, it has been said that last week's speech by UK Prime Minister Theresa May reduced some of the ambiguity about the position of the UK in a post-Brexit world. This is true, but it was just the opening negotiating position of the UK ahead of what promises to be fraught discussions with the EU.

The range of potential outcomes remains extremely large. The EU is highly unlikely to agree to some of the wishes of the UK around the flow of goods and services given its hard-line stance on migration. A clash between the two sides seems inevitable. The EU will be careful about setting a precedent for successful exits from the EU lest it encourage, if more encouragement was needed, other countries to follow suit, leading to a quick disintegration of the EU overall.

While Ireland will have a small say, at least among the 27 member states negotiating with the UK on Brexit, by and large these major events lie outside Ireland's control.

In this environment, how should Irish policymakers contemplate the future?

Standing still is not an option. How Ireland fares in this challenging environment will depend on what it does now. Taking Brexit first, Ireland was among the first to release well-coordinated policy statements on the day of the result on June 24 last year. It followed these up with a statement within the "Brexit-proof" Budget 2017 in October.

However, this document was largely focused on coping with the downside risks to the UK leaving the EU. While this is of course necessary, there are also opportunities, but Ireland needs to be more ambitious about putting the conditions in place to coax UK-based businesses, which rely on EU market access, to come to Ireland.

While there should be enough offices to house these firms, there remains an ongoing shortage of transport, housing, water and educational infrastructure.

These policy proposals also apply when planning for a future where our corporate tax advantage over the US is much reduced. Ireland has been remarkably successful in attracting US companies to Ireland over the course of decades, with one in every 13 workers in Ireland now directly employed by a US company.

Many ingredients are necessary in attracting these firms, including a skilled labour force, EU market access, the English language, ease of doing business, and tax. If Trump's plans are introduced, tax will largely fall off this list.

Ireland still ranks highly in the other components, but we have been complacent on the skills element. Indeed, in the fast-growing area of IT, firms based in Ireland have had to tap into foreign pools of labour, with more than one in three being non-Irish.

Given these global challenges, setting out a long-term blueprint that encompasses a renewed focus on both social and physical capital is vital. While we do not know for sure what the future may hold, it has never been as important to hope for the best but plan for the worst.

Dermot O'Leary is chief economist with Goodbody Stockbrokers

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