Tuesday 21 November 2017

Dan O'Brien: GDP data shows investment is up - and Brexit is starting to hit

From peak in 2007 to trough in 2010 there was a 43pc decline in quarterly capital spending. In inflation-adjusted money terms, that amounted to a fall from just under €13bn to just over €7bn (Stock picture)
From peak in 2007 to trough in 2010 there was a 43pc decline in quarterly capital spending. In inflation-adjusted money terms, that amounted to a fall from just under €13bn to just over €7bn (Stock picture)
Dan O'Brien

Dan O'Brien

The publication last week of second quarter GDP numbers passed without much comment. Compared to the publication of the first quarter figures in June, when huge revisions led to the revelation that growth had hit 26pc last year, not an eye was batted.

One reason for this was because the latest GDP numbers were perhaps the hardest to interpret yet, and that's saying something. The headline quarterly rate of growth - at 0.6pc - was about the most normal thing in the numbers. Such a rate of growth by comparative standards is good, if not spectacular.

But like looking at the calm surface of a very deep ocean, the headline figure tells little about what is going on beneath. To get a better handle on that, one needs to look deep down into the individual component parts of the numbers.

Overall, and with some difficulty and many caveats, the numbers do not give any real cause for concern about the state of the economy, even if there were a few surprises, most notably the weak private consumption figure.

Perhaps of most interest to readers of this column is the capital investment component, illustrated in the chart below.

It was this expenditure component of GDP that fell more than any other in the crash (the other main components are private consumption, public consumption and net exports). To a large extent that was related to the collapse in housing and construction investment.

From peak in 2007 to trough in 2010 there was a 43pc decline in quarterly capital spending. In inflation-adjusted money terms, that amounted to a fall from just under €13bn to just over €7bn.

Those three years of contraction were followed by three years of stagnation.

But since 2013, there has been a very sharp upswing in business investment. The chart below illustrates both that trend and the fact that the second quarter of this year marked an all-time high in investment spending, coming in at just over €16bn (this does include public capital spending, but it is dominated by corporate activity).

Statisticians break down investment spending, also known as fixed-capital formation, into a number of subcomponents.

Traditionally, the most important from an economic and business perspective has been spending on machinery and equipment. Arguably, it remains the most important component, even in today's hi-tech world which is dominated by services rather than the manufacture of widgets.

Through boom, bubble, bust and recovery, spending on plant has been the most stable part of the investment picture. Happily, it has recovered strongly since 2010 and last year was running at all-time record levels, at around €4bn per quarter.

Of mild concern is the fact that it has contracted for two consecutive quarters in 2016. In the second quarter of this year it stood at €3.5bn, the lowest level in two years. It would be in no way surprising if the uncertainty around domestic politics and Brexit had a negative impact. That said, even if this component is less volatile than others, it is quite jerky, and it would be wrong to read too much into the slowdown in the first half of the year at this juncture.

Investment in the built environment has long been the second major component of fixed-capital formation. In Ireland it grew rapidly in the late 1990s, more moderately in the early naughties and then went into a frenzy for the five years up to 2008. Over the following four years it was in a state of almost constant collapse, declining by more than two-thirds.

Very much reflecting conditions and the wider economy, the bottom was reached in 2012 and growth has been solid since. Indeed, in the first half of 2016, the rate of expansion accelerated somewhat, growing by just under 3pc quarter on quarter in the first three months of the year and just under 5pc in the second.

While there is no prospect of a return to the levels of bubble-era investment, nor should there be, there is little doubt that more construction investment is needed now - as of the second quarter of this year, the inflation-adjusted €3.5bn that was spent on buildings and physical infrastructure was the same as in the late 1990s.

Finally, we come to the third component of fixed-capital formation - intangible assets. These include non-physical assets such as software and patents. In Ireland, this component of investment spending has long been very much dominated by the second, which is classified by number crunchers as "research and development", or R&D.

From 2004, quarterly investment in intangible assets was relatively steady at around €2bn, and it actually picked up a little after the crash.

On a comparative basis, the EU statistical agency has figures only up to 2013. In that year, R&D assets accounted for 7.5pc of the total net fixed-asset stock. That was the highest share of any EU member state.

Ireland is now likely to be off the chart as an outlier. Since 2015, intangible investment has gone through the roof and been the driver of overall capital-formation growth, as the chart shows clearly. In the second quarter of this year alone, it reached almost €9bn.

There is little doubt that this involves multinational subsidiaries here purchasing research and development assets from sister subsidiaries in other countries. Nor is there much doubt that this is mostly an accounting exercise rather than a meaningful addition to the economy in capital stock.

* * * * *

ALSO published last week were goods exports data for the month of July. They showed a marked Brexit effect. The value of goods shipped to the UK in the first full month after the referendum fell by 7.5pc on the same month last year. That is a continuation of a trend in evidence since late last year when sterling started to fall in value vis a vis the euro.

There have been year-on-year contractions in export values in five of the seven months of this year for which data are available. With the effects of the post-referendum decline in sterling yet to feed through fully, there is worse to come for Irish exporters to Britain in the short term.

Sunday Indo Business

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