Tuesday 11 December 2018

A Precarious backdrop to Paschal's Budget

The economy is not back on a boom-bust roller coaster, but there is little fiscal leeway if big external risks materialise

PRESSURE: Finance Minister Paschal Donohoe must contend with uncertainly over Brexit, a trade war between Europe and the US and Italian economic strife, ahead of Tuesday’s Budget. Photo: AFP/Getty
PRESSURE: Finance Minister Paschal Donohoe must contend with uncertainly over Brexit, a trade war between Europe and the US and Italian economic strife, ahead of Tuesday’s Budget. Photo: AFP/Getty
Dan O'Brien

Dan O'Brien

The boom is back. The good times are rolling again. Ireland is the fastest growing economy in Europe: this year, last year, and, according to some predictions, next year. One hears this a lot, with the latter point repeated frequently by ministers.

This talk perplexes many people. They ask: why, if the economy is roaring as it was in the Celtic Tiger years, do I not feel as flush as I did then? Why, they ponder, is the Government not doing more to solve problems that result in, among other things, ministers and TDs being flayed in the media on a daily basis?

The main reason people don't feel as prosperous as in the past, and why the Government isn't increasing spending as it did back in the halcyon days, is that the economy is doing well, but it is not growing nearly as fast as it did during the Celtic Tiger period (1996-2001). It is growing considerably more slowly than during the property bubble period (2002-07).

The standard measure of economic growth - GDP - is the basis for much of the "fastest growth in Europe" guff. It needs to be ignored. GDP is a worthless indicator in Ireland, for all intents and purposes, owing to the distortions caused by the highly internationalised nature of the economy.

A much better measure of how the economy is doing, and one that is highly relevant as we enter Budget week, is the amount of cash that is flowing into the State's coffers. In recent years, total revenue - taxes, social insurance and non-tax revenues - have been growing at 4-5pc annually.

These are solid increases. They are not the highest in Europe. They are not anything like the increases recorded in the past. During the Celtic Tiger years, revenues were growing three times faster, at around 15pc each year. During the bubble era, they rose twice as fast as they are rising now.

In those two previous periods ,governments had greater resources to fund crowd-pleasing announcements, Budget day after Budget day. Nor did they have to contend with European budgetary rules put in place since the Great Recession which are designed to prevent national self-harm.

Last week's fiscal figures for the first nine months of the year showed that Government revenues were up 5pc on the same period last year - in line with recent years. This reflects a continuation of the solid, but not spectacular economic expansion over the past half decade. It means that there is some leeway to increase spending and cut taxes in Tuesday's Budget, but not very much. The amount of debt the Government has run up over the past decade - currently, the third highest in the world per person - narrows choices even further.

The Government has been among its own worst enemies in raising expectations even though its leeway is so limited. Ministers have frequently cited the "fastest growing economy in Europe" statistics, based on the flawed GDP numbers.

In truth, and despite talk of the Irish economy being back on a boom-and-bust roller coaster, most of the economic indicators point to solid, steady and well-balanced growth. Before discussing this happy state of affairs, consider the big exception - property prices.

That they have been rising strongly in recent years, and at rates far above consumer price inflation, is probably the main reason so many people feel that we have gone back to the pre-2007 period.

But the dynamics driving rising property prices now are very different to the dynamics operating when the bubble was inflating. Then, bank lending to developers and people taking out mortgages was going through the roof. Now, lending growth is moderate, to both individuals and business. Repayments of outstanding loans are more or less equal to the issuance of new ones.

If lending is not fuelling home prices, another factor is, and again its dynamics are very different from the past. In the decade to 2007, hundreds of thousands of new homes were built. In the decade since, new supply has collapsed. Last year, fewer than 15,000 new homes were built.

Today, insufficient supply combined with a fast-growing population is driving property prices. The fact that credit is playing only a limited role makes any kind of reversal much less likely than if banks were fuelling the fire. All of this means that the property market is not in bubble territory, even if affordability in some urban areas is a growing problem.

Now for the better news: of a good, but not roller-coastering economy.

Jobs growth remains strong, if less strong than pre-2007. Unemployment and dole queues continue to shrink. Pay growth over the past couple of years has accelerated nicely, but not to a point where competitiveness is a concern. That, in turn, is to be seen in still-strong export growth, the lifeblood of a small open economy.

This solid and well-balanced growth is reflected in sentiment. Recent surveys of consumers and small businesses certainly do not point to the sort of excessive optimism that leads people to lose the run of themselves.

So, with the economy simmering nicely but not about to boil over, does Finance Minister Paschal Donohoe have nothing to worry about as he puts the finishing touches to his Budget plans? Far from it.

The Irish economy faces three huge risks. The first is much discussed: a hard Brexit next March, made worse from an Irish export perspective by the likelihood that sterling would move to parity (or beyond) with the euro in a no-deal scenario.

The second big risk is a Trump-caused trade war between Europe and the US.

Although a ceasefire has been called between the two sides, it may not hold. A re-ignition is just a tweet away. As Ireland does more trade with the US than any other individual country, new trade barriers in the Atlantic could be enough to tip the Irish economy into recession.

The third major risk - and one that gets surprisingly little attention - is Italy. It is close to going Greek economically. Since elections earlier this year, it has had Trumpians in charge. This toxic political and economic brew is becoming ever more unstable.

Last week, more investors fled the country. The cost of government borrowing ratcheted up - yet again - reaching its highest level since last spring's election. It will take only a half dozen more weeks like last week for Italy to move into the critical zone. When Greece, a tiny economy, entered that zone, the entire eurozone went into panic and the single currency had a near-death experience. Italy's economic dimensions by every measure are many times greater than Greece's.

Financial markets across much of the world are looking fragile. Prices of everything, from commercial property to government bonds, are high after years on the rise. Debt levels globally are even higher than they were a decade ago. A panic over Italy - one of the 10 biggest economies in the world - could be the trigger for a wider global panic.

With such major risks on the near horizon, the Government's budgetary arithmetic would be in a precarious position if any of them were to materialise. Where many other peer countries have given themselves much more fiscal leeway to face into a period of low economic growth or recession, Ireland has none.

It is to be hoped that the forces far beyond the control of any Irish government do not push the country off the tightrope it is walking over the next 12 months.

Sunday Independent

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