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Sunday 18 February 2018

'The economy has signs of continuing life'


Over the past year, Ireland has become "interesting" to the outside world and, as a result, a string of foreign journalists, ratings agencies, international agencies and even the odd potential investor have passed through the capital. One visitor, commenting on the rather predatory nature of some of these visits, explained that "even vultures have a place in the food chain". Hopefully our interest for foreign journalists and their ilk will be a passing phase and we will return to boring normality over the coming years.

What strikes many of these visitors to Ireland is that the real economy shows every sign of continuing life. While all the citizens they meet are angry and worried, life goes on in what is still a country with a high standard of living, albeit significantly reduced from the heady days of 2007. This perception of continuing economic life is real. While there has been a dramatic reversal of economic fortunes, with a particularly severe impact on the labour market, the real economy continues to show some of the vigour of the past. If the serious problems that remain are addressed effectively in the next two years, a return to reasonable growth can be achieved within two or three years.

The economy faces two immediate problems. One of these remains difficult to quantify with any certainty -- the hole in the banking system -- and the other is all too easily quantified: the hole in the public finances. In order to get Ireland back to work, both of these problems must be addressed effectively by the incoming Government.

The task of reducing the deficit to manageable proportions over the coming four years has not changed with a change of Government. This requirement is necessary for the future wellbeing of the economy and not because of any outside imperative. The IMF/EU package will allow Ireland to make this adjustment in an orderly fashion over a much longer time scale than would have been the case without such assistance. The self-imposed requirement to put our national finances on a sound footing means that there will be further very tough Budgets for 2012 and 2013, which together must aim to reduce borrowing by between €6.5bn and €7bn.

This very painful medicine will substantially reduce growth in domestic demand -- consumption and investment -- below the level that would normally be expected. Because domestic demand tends to be relatively job-intensive, this will mean that employment growth over the next two years will be anaemic, leaving unemployment still at an unacceptably high level in 2012. A return to normal growth in domestic demand will not be possible until the bulk of the fiscal adjustment is clearly completed.

While households are unclear about whether they will still have a job next year and what their after-tax income will be, they will remain extremely cautious. However, once it becomes clear that the worst is truly over and that individual households feel secure about their future, they will begin to spend again, whether it is visiting the local pub or restaurant or even buying a house. Because this kind of expenditure is quite job-intensive, it will signal a rapid drop in unemployment.

While this painful adjustment is still under way in domestic demand, that large part of the Irish economy that produces goods and services for export is doing very well. The success of exports is not confined to foreign-owned firms but is also being experienced by Irish firms. This was brought home to me on a visit to Hanoi in Vietnam for work a year ago. Sitting in a cafe, I was approached by someone who asked if I was Irish. It turned out that he was an Irish businessman also in Vietnam on a sales mission. That evening, I had dinner with him and representatives of 11 other Irish-owned firms on a similar mission facilitated by Enterprise Ireland. I learned more about the real Irish economy that evening than I did about Vietnam!

The success of exporters is now apparent from the data, with a rapid growth in volumes, not just of the normal hi-tech exports such as pharmaceuticals and IT services, but also of food processing and other more traditional goods and services. The related growth in output is slowly being turned into jobs.

The effect of this boom in exports is that Ireland will run a balance of payments surplus this year and an even larger surplus next year. This means that, while the Government will still be borrowing a frightening amount of money on our behalf, the private sector, households and companies will be saving heavily and repaying an even larger amount of foreign debt than the Government is acquiring. This growing balance of payments surplus is the promise that Ireland will exit from the financial crisis as it means that Ireland's foreign indebtedness is beginning to fall in absolute terms and, as growth returns, it will fall even more rapidly as a share of GDP.

The major remaining source of uncertainty is the banking system. By the end of March, we will have a revised estimate of the hole in the banking system. This will determine how much additional funding the Government will have to put into the banks to ensure that they are more than adequately capitalised to meet any future liabilities and, more importantly, to provide credit to facilitate the economic recovery.

There are significant pressures from the ECB and the EU to put in further funding over and above this recapitalisation. Such an additional injection over and above that needed for prudential reasons would be unnecessary and it would saddle the taxpayer with an even bigger burden of adjustment.

Provided that the injection of capital into the banking system is confined to meeting the banks' identified capital needs, it is likely that the debt/GDP ratio will peak at between 100pc and 105pc of GDP over the next three years. This level of debt would be painful but sustainable. It would be significantly less than the levels achieved in the late 1980s and would be fully consistent with the pattern of economic recovery I have painted earlier.

However, if the full €35bn provided in the EU/IMF package for the banking system had to be used, it would push this ratio up to 120pc of GDP. While this would still be sustainable, it would make the exit from the crisis even more painful.

While citizens are angry, life goes on in what is still a country with a high standard of living, albeit reduced from 2007

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