Saturday 24 August 2019

As Europe's economic giants stumble, what harm will Ireland face?

Friday Insight

Troubled waters: The Samuel Beckett Bridge in Dublin. How will Ireland adapt to changing economic realities?
Troubled waters: The Samuel Beckett Bridge in Dublin. How will Ireland adapt to changing economic realities?

David Chance

Economic data this week and last painted a gloomy picture for the two largest economies in the European Union, as output in both Germany and Britain contracted in the second quarter of the year.

The first has seen its 'heavy metal' export model hit the buffers after a decade that delivered prosperity to its manufacturing sector and built the world's largest current account surplus at $294bn (€265bn) last year.

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Britain, whose economy grew 61pc in real terms between 1995 and 2018 as it benefited more from the EU than the bloc's average rate of 49pc, is now haemorrhaging growth, thanks to the self-inflicted wound of Brexit.

The humbling of two of the most successful economies in the world, in Germany's case built around its envied engineering sector and, in Britain, the world's largest financial sector, poses the question: can Ireland thrive if these two countries are going to hell in a hand basket?

At first glance, the Irish economy appears to have a toxic mix that combines the export dependency of Germany with all the risks of Brexit, and then multiplied for some added effect.

According to four out of seven in-depth economic studies, Brexit will cause more economic damage here than it will in the UK, thanks to the State's higher dependence on overseas markets than Britain, with the food and agriculture sectors most at risk.

Germany's economy contracted by 0.1pc in the quarter, bringing to an end a decade of post-crisis success, and the flaws in its cars and engineering export mix are now out in the open.

The auto industry makes up 17pc of German manufacturing output but only 5pc of real gross domestic product, a surprisingly small number given the country's marque names in the industry from VW to Porsche, although it has huge effects beyond that in industries such as steel, plastic, rubber and electronic components.

Take BMW, whose CEO stepped down on Friday. The car company's operating margins have halved to 6pc since 2011, according to the 'Economist' newspaper. And it is likely to face further pressure as not only Tesla, but the likes of Uber and Waymo, formerly the Google self-driving car project, also seek a chunk of a transport market that is adjusting to shared ownership and electric power.

A drop in infrastructure spending in China to just 4pc a year compared with the 10pc average of the past is also not good for German manufacturing either.

In other words, the magic sauce that powered Germany from 2010 onwards, cheap money from the world's central banks, a weak euro that underpinned exports and seemingly never-ending Chinese demand, will not work this time, as the issues are of a fundamental nature.

"Germany needs a two-pillar stimulus package: a short-term stimulus and an increase in the long-run growth potential. The buzzwords are well-known: digitisation, climate protection, energy transition, infrastructure and education," said ING's Germany economist Carsten Brzeski.

Compare that with Ireland's exports where, despite a lacklustre June performance which saw a near €500m hit from the volatile aircraft leasing industry, the overall picture for the first six months of this year was more positive.

Amid the noisy data, exports to the United States from Ireland actually grew in June and, despite concerns over its economic health, the US is still by far the biggest market in the world and the strongest-growing of all the developed nations.

Data from the Central Statistics Office issued yesterday showed that between January and June, exports of goods rose 1.8pc to €42.73bn.

If there is vulnerability in Ireland's export model that ties it directly to the global economic downturn, it is probably aircraft leasing. The airline industry is highly geared to economic cycles and there is a structural issue here with the grounding of the Boeing 737 Max.

The economy expanded by 6.3pc year-on-year in the first quarter of this year and net exports contributed 4.1 percentage points to real GDP growth.

Total trade with the rest of the world is 212pc of gross domestic product for Ireland, a figure that is distorted by multinationals to be sure, but one which compares with 87pc for Germany, which of course is a much larger economy on its own, with a much bigger domestic market.

Ireland's exports tend to be very high-tech and the sector accounts for 35pc of total exports, according to European Union data, by far the largest proportion in the EU and far in excess of Germany's 15.1pc.

Those readings suggests that Ireland has, thanks to its taxation and foreign direct investment model, hit on a more 'modern' export mix than Germany currently has, and one which does not need to be dramatically "re-engineered" for success.

While Germany's economic woes do illustrate some of the issues of industrial concentration that have been identified as a weakness for Ireland too, thanks to the State's reliance on a small number of American multinationals for everything from exports to jobs and taxes, there is at least a case to be made that Ireland is relying on significant companies like Apple, Facebook and Google.

Apple and Google alone have cash reserves between them of more than €200bn, and that is more than enough to see them through several economic downturns. That means the Irish development model, in which these high-tech US companies account for 40pc of gross value added in the economy and 70pc of the corporate tax base, may not be under as much of a threat as the German one is as the likes of BMW and VW face challenges to their whole manufacturing model.

As for Brexit, it is a 'known unknown'. The Central Bank of Ireland forecasts that if the UK crashes out come October 31, economic growth here will come to a juddering halt in 2020 compared with a forecast of 4.1pc if the trading relationship were left unchanged. But even in the event of a hard Brexit, the effects will be to slow, rather than derail, the economy.

For example, 34,000 of the new jobs the Bank estimates would have been created by the end of 2020 will not in fact materialise due to the shock. But that number needs to be set against the Central Bank's base forecast, which sees the number of people in work rising to 2.36 million by the end of 2020, from 2.26 million at the end of 2018. By the end of the first three months of this year, the economy had added 81,200 jobs over 12 months, the largest rise since 2007.

To be sure, if there is a synchronised global downturn, there will be no hiding anywhere and Ireland's debt mountain will come into play.

It is the stellar rates of economic growth of the post-crisis era that have made the debt more sustainable and put its ratio on a firm downward path, in terms of its affordability and size relative to the economy.

But just at the moment, Ireland does not appear to be in as much trouble as either Germany or Britain, and there are some valid reasons to believe our economy may prove more robust.

Irish Independent

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