Friday 17 August 2018

Brendan Keenan: Focus on house-price hikes obscures the real dangers facing the economy

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Brendan Keenan

Brendan Keenan

OVERHEATING? Economists, trying to be helpful, will tell you that, while there is a business cycle, it is not possible to say where it is at any particular time. In the case of a small, open, distorted economy like Ireland's, it is really, really not possible.

So there is no answer to the current top saloon bar question: "Is the economy overheating?" What one can say is that, if it is, it is not doing so in the same way as 2006. The differences are well-known, but were neatly summarised last week by ratings agency DBRS.

The saloon-bar talk is, as always, about property prices. While these are rising at a rate similar to that in the bubble, it is from a 60pc lower base. Besides, even if houses were over-valued in 2006, does that make the same price an over-valuation in 2018?

It is a nice calculation, and anyway, prices in general are not back to the levels of 12 years ago. In truth, the housing market could not be more different from the one we had then, which was characterised by rapid credit growth, mounting household debt and too much building.

Now, credit is constrained by Central Bank rules, households are saving rather than borrowing, and there is an acute shortage of construction. DBRS is in the majority in seeing no evidence of a real estate bubble. There is a housing problem - arguably a crisis - but not a bubble.

That is not the end of the matter. It may be hard to believe after the Noughties, but it is possible for the economy to overheat irrespective of what is happening in the housing market. If demand exceeds the supply of goods and services for too long, prices and wages will rise, eventually snuffing out the excess growth, and then some, and damaging competitiveness along the way.

This is particularly dangerous in a common currency area like the eurozone where balance cannot be restored by devaluation. So many other things have happened to the Irish economy since 1979 that we have tended to forget this particular risk.

The late 1990s, when the Celtic Tiger began to morph into the credit elephant, would have been more damaging than they were, had it not been for the big, last devaluation against the German mark in 1992.

By the nature of things, the loss of cost competitiveness is likely to arise again as an issue, perhaps all the more difficult to identify and correct because unaccompanied by excessive credit or budget deficits. But probably not right now.

Still, we must be somewhere on that invisible cycle and it can hardly be on the down slope. The surmise is whether we have passed the natural peak and, instead of easing off, are heading on upwards to where supply limits, especially of labour, begin to spell danger.

The figures suggest not, but they are odd. Unemployment is down to 5pc, which is pretty close to past estimates of "full employment" before shortages drive up wages. Most gratifying is that long-term unemployment (out of work for more than a year) was just 2pc in the first three months of the year.

However welcome such figures are, they suggest there is no great pool of unused labour to call upon. Ireland does have a pool of new entrants to the labour market and employment continues to increase at around 3pc a year, with most of the jobs for full-time employees. Despite this, there was no overall increase in hourly earnings until last year, when they went up 1.7pc.

As the trade-union sponsored NERI economic institute argued in its review last week, such a rise seems well overdue and can hardly be called inflationary in an economy growing as this one appears to be.

Part of the automatic stabilisers in an economy which drive that cycle involve higher wages reducing firms' demand for workers and helping to slow things down. With NERI projecting wage rises of 3pc this year and next, and interesting data on growth, some see tentative signs that a necessary correction may be happening.

The new CSO figures for the economy in 2017 were littered, as they have to be, with different measures of output. The GDP estimate of 7pc growth is completely discredited, and the most conservative measure found a figure of only 3pc.

This measure does not yet include rises in the cost of the output of goods and services, so "real" growth, as usually presented, would be less than 3pc. Another useful measure of what is happening, the Exchequer returns, were on target for the first half of the year. But the tax revenues of €20bn were based on fairly modest assumptions of growth of around 4pc this year and had been behind target for much of the first-half of the year.

The automatic pilot may be working, so it is the non-automatic stuff which has people wondering and worrying. House prices may be the saloon bar favourite but corporation tax revenues seem to be the topic of choice in the common room and think tank.

In its annual report last month, the National Competitiveness Council warned of the dangers of future rises in labour costs and highlighted the consistent Irish weaknesses in governance and infrastructure where the problem, of course, is that they do not change. The major competitive threat the council saw was a reduction in multinational activities in response to global and European tax changes.

That is a danger of a different kind. The big question is to what extent the Government should try to prevent it happening. Past inducements to keep the tech giants became so bizarre that they left Ireland in an untenable position when it comes to defending the system.

The irony is that those inducements may yet play a major role in chasing the IP companies from our shores. Accepting that may be the only way of preventing even more draconian EU incursions into the tax system.

It is not particularly helpful to call this a competitiveness issue. The net effect of the multinationals on Irish competitiveness is not clear. Alongside GDP, their activities rocket the country up the global "competitive" indices but they crowd out native companies when it comes to wages, the attraction of skilled staff and even accommodation.

It is certainly, however, a fiscal issue, but one where the threat may also present an opportunity. Even if the Commission abandoned its tax plans, it is impossible to believe that the corporation tax revenues can continue at the present €6bn a year - double the figure of a few years ago.

There is therefore every good excuse for setting aside half of that, say, so that the public finances do not depend on its continuation. It would dwarf the paltry rainy day fund but, since it would take several budgets to extract it from the public finances, it is already too late for a Brexit crisis.

If that is avoided, it is not too late for such funds to help in the post-Brexit world of the late 2020s when the final deal is struck and years of adjustment lie ahead.

At the very least, the money could be used for well-chosen, once-off capital investments, with any resulting increase in current spending, such as more teachers, properly accounted for in the current budget. That might not slow the economy, but it would make it more secure in the long term.

As of now, laden with debt, it looks cruelly exposed.

Indo Business

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