Business Irish

Wednesday 22 November 2017

David McNamara: Domestic economy not yet up to offsetting weakening exports

But it's not all doom and gloom with consumer spending recovering well during the second half of last year

David McNamara

Thursday's GDP numbers were a disappointment. Hopes of a new year bounce were dashed with the news that the economy contracted by 0.6 per cent over the quarter.

However, headlines pronouncing Ireland is back in recession are old news – the economy had already fallen back into technical recession through the second half of 2012.

Cutting through the volatility of the quarterly numbers is difficult but the broad picture is one of sharp declines in output through 2008, 2009 and 2010 followed by broad stagnation since 2011.

Quarterly GDP has fluctuated within a narrow band between €40bn and €41bn since the beginning of 2011.

The Irish recovery story is certainly not the miracle our leaders like to portray at international level, but we have performed immeasurably better than our other bailout countries.

The reason for this is exports. Between 2008 and 2012 exports rose 7.8 per cent; while the domestic economy, measured by domestic demand, contracted by a massive 19.6 per cent.

Export growth has come on the goods side through pharmaceuticals – a non-cyclical sector shielded from the worst of the global downturn, and on the services side through the explosion in foreign direct investment in the IT sector.

The concern in recent GDP numbers is the slowdown in exports. The reasons for this fall in exports are twofold. Firstly, sluggish growth in our two main trading partners, the Eurozone and UK has weighed on the demand for Irish goods and services.

Secondly, a number of blockbuster drugs produced in Ireland such a Lipitor and Viagra have come off patent in recent months, pushing down the market price pharmaceutical firms can demand globally.

This has implications for our exports given that pharma account for more than half of the goods we export. Buoyant services exports focused in the IT sector have been enough to offset the fall on the goods side thus far but even these slowed over the quarter in Q1, adding up to a 3.2 per cent fall in overall exports.

In the long run, the effect on GDP from the so-called "pharma-cliff" may be negligible, as a decrease in pharma exports should be accompanied by an equivalent decrease in services imports. This relates to the royalties and licence fees Irish-based firms pay intellectual property held abroad.

In the short run, however, the sharp fall in exports exposes the lopsided nature of the Irish economy.

The good news is that global demand is expected to pick up this year, which should yield a recovery in exports. The bad news is the domestic economy may be too fragile to take up the slack in the meantime.

Exports have provided a welcome floor to GDP but there is very little traction to the real economy from much of the exporting sector.

Take the pharmaceuticals sector again, for example. While companies based here provide much needed employment, in aggregate the sector employs one per cent of the workforce despite accounting for over half of all goods exports.

In comparison, the mainly domestic-facing SME sector accounts for more than 70 per cent of employment and continues to struggle in the face of weak demand.

Many SMEs hold unsustainable debts on their balance sheet relating to the property crash, limiting their ability to access the finance needed to expand their businesses. The High Street is one of the hardest hit sectors. Retailers have gone under, not just under the strain of weak demand, but through the inflexibility of local council rates and upward-only rent clauses in their leases.

But there are also reasons to be cheerful about the prospects for the economy.

The Irish consumer has shown remarkable resilience in recent times, with consumer spending recovering well through the second half of 2012. The Budget 2013 spending cuts and tax rises are worth more than two per cent of household disposable income, coming predominately in the first half of the year. These cuts will inevitably dent spending in the domestic economy. However, following the expected slump in consumer spending in Q1, retail sales picked up again in April and May to provide a positive steer for consumer spending in Q2.

Tourism numbers were up 7.4 per cent in the first quarter on the same period last year. This is good news, particularly for hotels and restaurants. Employment in that sector rose by 4.1 per cent year-on-year in Q1.

The foreign direct investment announcements in recent months have also been positive, bringing new investment projects on stream in 2013 and 2014 and boosting employment, particularly in the IT and business services space.

These developments mean employment has started to grow again, registering three consecutive quarters of growth in the first quarter. Unemployment has fallen from a peak of 15 per cent to 13.7 per cent.

But much of this growth in employment is in part-time work. Of the 422,000 claimants on the Live Register, nearly half are out of work for a year or more. Countless studies show the longer an individual is out of work the harder it becomes for them to find a job.

These statistics illustrate the scale of the challenge still facing the domestic economy before we can call it anything like a real recovery.

David McNamara is an economist at Davy Stockbrokers

Irish Independent

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