Monday 21 October 2019

Dan O'Brien: 'Budget preparations bedevilled by unprecedented uncertainty'

The world should avoid recession but swerving from Brexit will be impossible for Ireland, writes Dan O'Brien

(stock photo)
(stock photo)
Dan O'Brien

Dan O'Brien

The Irish economy is still in a sweet spot. It is neither too hot nor too cold. This is about as good as it gets.

The economy is still competitive even after seven years of expansion. Despite all the uncertainties and headwinds, growth remains remarkably strong.

The bad news is that Brexit could change all that within weeks. A no-deal exit, which has been the most likely outcome for well over a year, could stop the economy in its tracks. The only question is how big the impact would be, and how long the effects would last.

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Brexit is coming to a head. In the coming weeks, this column will return to it again and again. But in the meantime, there is an opportunity to look beyond Brexit and consider how other developments elsewhere could impact the economy and the Budget arithmetic Paschal Donohoe is finalising this weekend.

Consider first the global context, which is ever more relevant to an economy that is among the most globalised in the world.

The world economy, and those regions to which Ireland exports most, are vital to Ireland's outlook as one the most trade-dependent countries on the planet.

In Europe, America and beyond there has been a lot of talk lately about recession. The concerns are based on factors that are genuinely concerning, such as trade wars, and others that are less so.

At the broadest level, the global economy has been growing more slowly since the end of last year than it did in the previous half decade or so. More precisely, growth in global GDP over the nine-month period to the middle of this year was the weakest period for the global economy since 2012. Other indicators from around the world suggest that the quarter which ended last week (July-September) was similarly weak.

What is the outlook for the world economy as the final quarter of 2019 begins?

Let's say frankly that economists are not good at forecasting under any circumstances, and that the most difficult moment to forecast is during a soft patch: is lower growth the early stages of a recession or is it merely a transient soft patch?

The bad news from the global picture over the past year is that growth has been sluggish. The not-so-bad news is that it has been consistently sluggish since the end of 2018. In other words, there has not been a continued deceleration in growth pointing to a slide towards recession. That is not to say that a global recession will not happen, merely to say that the balance of evidence to date does not point in that direction right now.

The reason the world is not sliding towards recession is because the main source of the current period of weakness - the manufacturing sector - is not infecting other sectors to any great extent. In part, that is because while making things still matters a lot in almost all economies, the services sector is now many times bigger than manufacturing. That means that production lines can churn out fewer widgets and employ fewer people without causing entire economies to slump.

We saw this just last week with new figures from the Eurozone. While earlier data had been showing a manufacturing recession across the continent, last Monday's numbers from Eurostat showed that unemployment in the single currency bloc continued to fall over the course of the summer. In August it was down to 7.4pc, only a smidgen above the lowest level of joblessness in the two decades since the currency was launched.

Figures on how much Europeans are spending in the shops were also published last week. The trend in retail sales remains positive, too.

A similar pattern of weakness in manufacturing, but strength in other sectors, is in evidence in the American economy, still the world's largest and Ireland's single biggest export market. The main difference between Europe and the US right now is that American economic growth is well above that on this side of the Atlantic.

At this junction, a political point on commentary around the US economy is worth making. Many analysts believe that the US president's chances of a second four-year term will tank if the American economy tanks. Just as Donald Trump polarises political analysts, he has had a similarly polarising effect on economic analysts.

Those who support him tend stress the American economy's strengths and downplay its risks and weaknesses. Those who don't like him do the opposite, and one has to wonder if some of those who dread a second Trump term believe that a US recession over the next 12 months might be a price worth paying to avoid another four years of demagogic harangues and policy being made on the hoof.

As of right now, the US economy looks as if its decade-long run of recession-free growth will continue.

Ireland is into its seventh year of uninterrupted expansion and the underlying economy is solid in most regards. Continued strong economic growth has been remarkable given the headwinds.

The performance of the export side of the economy in the first half of 2019 has been even more remarkable than that of the domestic economy. Exports of goods and services both grew in double digits despite the aforementioned slowdown in most markets. Every indication points to foreign investment still coming in quantity.

Brexit uncertainty could have been expected to dampen activity among consumers and businesses. Both groups tell confidence surveyors that they feel wary. Consumer may be feeling nervous, but the figures show they continue to increase their spending. Unusually, the feelings and actions of consumers have decoupled.

That is less the case among companies. Business caution is more evident in the data on investment. Spending on plant, machinery, offices, hardware and software has stopped growing over the past year or so. One of the few discernible negative effects of Brexit uncertainty has been on business investment.

Last week's figures on the public finances reflected the continued overall momentum in the economy. In September, cash going into the Government's coffers surged compared to the same month last year. As has been the pattern in recent times, companies are handing over more tax on their seemingly ever-growing profits. Corporation tax is the gift that keeps giving.

All the other main sources of government revenue - income tax, social insurance contributions and VAT, in that order - clocked growth of 6-8pc in the first nine months of the year compared to the same period in 2018.

The extra cash in September, and over the other eight months of 2019, makes the arithmetic underpinning Budget 2020 more favourable.

The Government's decision to assume growth will come to a halt next year as a result of Brexit is prudent. Making a no-deal Brexit the basis upon which the Government's Budget projections are based is also politically canny. It helps dampen expectations among interest groups while allowing everyone blame the dastardly Boris Johnson.

But other Government projections appear less prudent and less plausible, most notably the expectation that the public finances will only dip a little into the red if the economy comes to a halt. A more plausible scenario is the opening up of a bigger deficit in the Government's finances. This could quickly bring Ireland into the debt danger zone.

Irish public debt remains among the highest in the world by most meaningful metrics. Nor has there been any progress in paying down that debt. On the contrary, whether measured in gross or net terms, the pile of Government debt has actually increased over the past couple of years.

Last week the public finances watchdog rightly okayed the Government's economic (as opposed to its budgetary) projections. But the Irish Fiscal Advisory Council also rightly included this important and ominous coda: "Although the Department of Finance has taken on board the impacts of a disorderly Brexit in its forecasts, the potential impacts from such a scenario could be more severe, especially in the short run."

This is as true for the public finances as it is for the economy.

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