Is Austerity Working in Ireland or Not?
During its descent into a financial crisis Ireland has found itself being a poster boy for austerity and then for some an example of why you should not impose it and now perhaps a poster boy again for some! If that sounds unclear and muddled you would be right in my view as Ireland finds itself set up as an example or test case with so much of the story still to run. However there are some interesting lessons from what has happened there.
The extent of her decline
Back in 2007 much seemed healthy in what was called the “Celtic Tiger”. In both 2006 and 2007 economic growth as measured by Gross Domestic Product was over 5% and measured by Gross National Product was 6.3% and 3.9%. Her national debt was less than 25% of her GDP nad had been falling for some years as the boom in her banking and housing sectors led to a boom in tax revenues which was used at least partly to pay down debt. So far so good and at this point fiscally conservative.
However when trouble hit the housing and banking sectors her political leaders panicked and in September 2008 they offered an absolute guarantee from Irish taxpayers to the debts of the Irish banking sector for two years. Either they did not realise that this was a move which was virtually impossible to reverse or even more seriously they were in effect in the pocket of the bankers. So Ireland ended up guaranteeing bank assets that were nearly three times her GNP and became a banking sector with a population rather than an economy with a banking sector.
Why are you distinguishing between GDP and GNP?
Regular readers will be aware that I have several criticisms of the use of GDP as a measure for economic growth and only yesterday I discussed some of them with reference to the UK. However a feature of Ireland's economy is that she has a low corporation tax rate (12.5%) and by measures sucha s the tax-free financial business district in Dublin has encouraged overseas businesses to base themselves there. If you like the businesses are the corporate equivalent of what is called non-domiciled or non-dom for an individual.
So if they have come to Ireland for cheap and in some cases virtually no corporate taxes (Google) then if you try to tax them they will start to leave. It is this that GNP measures as it excludes the effect of such foreign businesses. To give you an idea of the scale real GDP in 2007 was 178 billion Euros and real GNP was 151 billion Euros so the difference is substantial and economic output is suddenly potentially some 15% lower.
What is the situation right now?
Some have been arguing that austerity is working on the basis that GDP rose by 1.6% in the second quarter of this year. Even if we put aside the weaknesses of basing your view on a preliminary estimate I think that one needs to compare the seasonally adjusted figure of 40.4 billion Euros with the 2007 number divided by 4 which is 44.5 billion Euros. As you can see Ireland has a very long way to go.
I would suggest that as GNP is as important for Ireland that the 1.1% growth rate in the second quarter is as important and we can do the same maths by comparing 32.1 billion Euros with 37.8 billion (2007 divided by 4). You may have spotted that the gap is wider with a smaller number and here is an interesting statistic for you the gap between GDP and GNP appears to be widening in 2011. Internationally mobile businesses are doing much better than domestic ones.
Her Housing Market
This is followed closely by the Nama Wine Lake blog which tells us the following. Irish commercial property prices fell by around 5% in the second quarter of 2011 and Irish residential prices dropped by between 3 and 5% in the third quarter depending on which measure you use. This means that residential prices have fallen by 14-17% in the last year and between 42-58% in the last year.
Irsih property law looks like it will be changed vis a vis rent agreements which he expects to reduce commercial prices by another 10% or so. And with Ireland strewn with “Ghost Estates” the outlook for residential prices still looks week with vacant properties being around 100,000 more than normal.
One cause of this is that Irish mortgage rates have been rising partly due to the rise in the ECB's interest-rate and partly due to the distressed state her banking sector is in.
Her Banking Sector
If you read the output of her central bank you see that loans for all purposes are still falling and that in spite of offering relatively good interest-rates her banks are still losing deposits. This did show signs of stopping in July but August returned to a loss. If we look at money supply let me quote for the latest central bank quarterly bulletin.
On an annual basis Irish resident M1 and M2 continues to fall. The pace of decline has increased in recent months
Whilst the exact numbers have varied the Irish banking system remains entirely dependent on central bank funding as at the end of August the ECB was providing some 98 billion euros of funding and the Irish central bank providing 56 billion. I will leave you to mull over claims that the ECB is the “lender of last resort” when in practice the Central Bank of Ireland was. Ooops.
Other Economic statistics
Whilst it has levelled out recently Irish unemployment has more than doubled since September 2008 from 7.1% to 14.5%. If we look at inflation we do actually see that the disinflation which began in March 2009 has ended but with the European/UK CPI measure at only 1% it is a weak rise when we consider the commodity and oil price boom and one has to question whether Ireland might return to disinflation.
The National Treasury Manegement Agency estimates that Ireland will have a Eurostat standard debt of 173 billion Euros at the end of 2011 which will be 111% of GDP and the fiscal or budget deficit will be 25 billion Euros. As it has slipped their mind to use the more important GNP ratio let me point out that it will be around 135% and remind you that as it represents what Ireland can tax it is at least as important as GDP.
There are dangers here going forwards too as Ireland's projections show her debt rising but that economic growth will help to get it under control. Her projections were always on the optimistic side and with the current outlook are now very optimistic.
Government bond interest-rates
Here there has been a considerable improvement as her benchmark ten-year yield has dropped from 14.1% on July 18th to 7.63% now for a considerable improvement. For her the 21st of July agreement has had some success although she may be rueing the talk of international bank recapitalisations as she paid for much of her own!
However care is needed as if she had to issue bonds at current interest-rates she would still be insolvent and she is the recipient still of an extraordinary amount of central bank liquidity.
The statistics tell us that Ireland has had some of this. Care is needed as Greece has shown as that improvements in net exports can be at least partly because imports are falling. However Ireland's improvement in net exports of 1.9 billion Euros over the past year is mostly an improvement in exports.
Going forwards even a relatively small economy like Ireland may face probelms from their being a European economic slowdown.
Domestic Demand: Retail Sales
Here we have a much more patchy picture. After falling heavily in 2008 (6%) and 2009 (13.8%) the postion stabilised somewhat in 2010. unfortunately the latest figures for August 2011 showed numbers which were down by 3.6% compared with a year earlier and 0.4% down on the month before. If we use 2005 as the benchmark of 100 the current absolute level is 87.1.
This has done better than you might think and appears to have benefitted from the increase in exports as compared to 2005 it is at 97.2 which is much better than that for the UK for example and industrial production is at 107.2 which is far better. However the more recent numbers do indicate a slowdown as manufacturing is down 1% over the past year and industrial production is down 5.4%.
So as you can see there are some flickers of light in Ireland's situation but in my opinion they are a very long way away from declaring a success for austerity. Her housing and banking sectors remain mired in crisis and her national debt could easily slip out of control if the current Europe wide economic slowdown continues. Also the repayment of bank bonds some of which should have been wiped out continues and Ireland cannot afford this to continue in my view. So her political class remain in thrall to the banks.
Also a fair bit of her government's austerity programme has still to bite. Mind you there is a way as I have pointed out before…
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