Saturday 25 January 2020

Brendan Keenan: Economy may yet deliver a pleasant surprise to many

Brendan Keenan

Brendan Keenan

ABOUT the only thing you can say with certainty about the Irish economy is that it tends to do surprising things, both good and bad. It may surprise us again.

Indeed, if it's still the same little economy, a lot of people could be in for a pleasant surprise. Right now, few give much for its chances, at home or abroad. But a continued global recovery, and the kind of response we got from business in the past, could see those attitudes confounded very quickly.

That would be in what the Economic and Social Research Institute (ESRI) calls the "high-growth scenario" in its latest medium-term look at the economy. (Its regular quarterly commentaries look just one year ahead).

In this favourable scenario, strong export-led growth would see unemployment back to 5pc by 2015, the national debt at a manageable 90pc of output (GDP) and the budget deficit within the EU limits -- not counting the cost of the bank rescue.

Ah yes, the banks. This optimistic scenario is achieved despite a cost of €25bn for saving the banks. It is an enormous sum, and the ESRI reckons it will directly cost up to 2pc of GDP forever, and considerably more indirectly.

Yet it would be bearable if the economy did absorb the loss and stage the kind of recovery seen in the optimistic scenario. The catch is that one of the conditions for achieving that is that the banks provide credit to fund the recovery.

The ESRI's senior research professor, John FitzGerald, clearly believes they will not. From a bank's perspective, building up capital and reducing lending risk makes more sense in present conditions than providing credit. But if they won't lend, they should be made to lend, Mr Fitzgerald says.

It is an unusual position for a liberal economist to call for such direct government action, but the stakes could not be higher. Like many, he has been persuaded by the number of business people complaining that even expansion plans backed by healthy order books are being refused bank finance.

The other scenario -- where the economy does not respond to global conditions as in the past -- makes grim reading. It is a striking example of the power of compound growth that an average of 4.5pc a year in one outlook, as compared with 3pc a year in the other, makes the difference between success and failure.

If the lower figure -- not bad in itself -- should turn out to be right, unemployment will still be 7pc in 2015, and 200,000 people will have emigrated. Government debt will have topped 100pc of GDP and be on a rising trend. In practice, such an outcome would surely trigger a debt crisis and even more budget cuts imposed from outside.

The ESRI will not be drawn on which forecast it thinks is more likely to be correct. So far, the Irish economy has behaved as its models say it should. But the test will come when steady growth does resume, which ought to be next year.

Will it be in line with the high-growth forecast or the low? It could be 2012 before the trend becomes clear.

A lot of it is in the lap of the gods. The productive economy has suffered severe damage in the Great Recession. Quite apart from credit, it remains to be seen what capacity it now has to deliver growth. A closed factory or shop can make no contribution.

We also need the global recovery to be sustained, especially in the EU and the US. A "double-dip" international recession would put the optimistic scenario out of reach.

One thing that is theoretically under our control is dealing with the budget crisis. Here, the ESRI's approach may prove more controversial. It says the remaining €7.5bn in tax rises and spending cuts must be implemented in full, and perhaps more quickly than the Government plans.

It does not dispute the arguments of trade unions and opposition politicians (and even the odd Green) that this is deflationary. Highly deflationary. It is knocking two percentage points off growth, and will cost over 60,000 jobs, with a 40,000 reduction in the public sector headcount.

But it is still the right policy, the ESRI says, because of what would happen to interest rates if there were any slippage. Yesterday, the National Treasury Management Agency had to pay over 5.5pc to borrow for 10 years.

That is an unbearable cost for an economy that is not growing. Luckily, the amounts are small and no large sums are needed before next year. The ESRI suggests that taking even more than the planned €3bn out of the economy in the December Budget might produce some reduction in interest rates, and reduce fears of backsliding before the 2012 General Election.

Labour market policies are also in our own hands and the training regimes need urgent attention, the report says. It is important that tax and welfare changes are applied so as not to create the "poverty traps" of the 1980s, when getting a job meant a fall in income.

If we can learn from the mistakes of 1982, in other words, we may yet find that 1987 can come round again.

Irish Independent

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