Monday, November 21, 2011

21/11/2011: Sunday Times 20/11/2011 - Exporting our way out of recession

Here's the unedited version of my article for Sunday Times (November 20, 2011).

The latest trade statistics, released this week were, as usual, greeted with enthusiasm by the growing media tired of the adverse newsflows. From the headline figures, preliminary data shows that seasonally adjusted exports of goods rose 2% to €7.9 billion in September, and the trade surplus jumped 11% to €4.1 billion. This makes September trade surplus second highest on record.

Trade in goods in general has been going through a boom, rising from the annual trade surplus of €25.7 billion at the bottom of the peak of the Celtic Tiger era in 2007 to €43.4 billion last year. Data through the first nine months of this year suggests that our annual trade surplus will post another record in 2011, finishing the year at some €43.8 billion.

For years we have been told by two successive governments that Ireland’s recovery will be exports-led. The latest data appears to be supportive of this. Except, appearances can be deceiving.

Consider closer the monthly goods trade data. September increase in trade surplus was, in fact, driven as much by rising exports (up €193 million month-on-month), as by shrinking imports (down €208 million).

Given deep cuts in consumption goods imports in 2008-2010, any recent reductions in imports are primarily reflective of the changes in demand for intermediate inputs into production of our exports. In other words, trade surpluses based on imports reductions are not sustainable in the medium term. This is evident from the longer-term statistics. In H1 2011, Irish trade surplus in goods was up only 3.4% year on year. In H2 2011, based on latest data, trade surplus might actually fall some 2% year on year. Back in November 2010 4 year programme, the Government projected that in 2011 exports will increase 5% and imports will rise just 2.75%, which would have implied an annual goods trade balance of €47 billion this year. It looks now that this projection might be undershot by over €3 billion. Not exactly an optimistic picture.

This performance is worrisome for another reason. The above data, cited most often as the core driver of our economic ‘recovery’ relates solely to trade in goods. Yet, the overall balance of trade for the country includes net exports of services. We have to rely on the Quarterly National Accounts data to gauge overall trade balance in both goods and services.

Full trade data we have covers only the first half of 2011 – the period before the latest slowdown in Euro area, UK and US economies became pronounced. Despite this, the data shows some emerging strains on the side of Ireland’s full trade surplus. Year on year, exports of goods and service through H1 2011 were up 5.8%, but imports increased 6.1%, which means that the trade surplus expanded by just under 4.7%.

Exports-led recovery may be starting to falter. In 2009, trade balance for goods and services grew at a massive 52.5% year on year. Last year it expanded by 19.7%. This year, so far, annualized rate of growth is just under 4.7% and that was under more benign global growth conditions that prevailed through June 2011. Budgetary projections were for a 14.7% expansion on total trade surplus for 2011 – 3 times the current rate.

If ‘exports-led recovery’ was really able to carry us out of the economic doldrums, much of the external trade growth now appears to be behind us in 2009-2010. It didn’t happen. Why? Exports growth is good, creates jobs and huge value added in our economy. But exports are not enough, because Ireland is not an exports-intensive economy. It is a multinationals-intensive economy.

Let’s take a look at the National Accounts. In Q2 2011, Net Factor Income outflows from Ireland – largely multinational profits – accounted for 21.4% of our GDP, 20.3% of all our exports and equal to 100% of the entire trade balance in goods and services. In other words, in national accounts terms, trade basically pays for itself, plus small employment pool of workers. And that’s about it.

This is not surprising. In 2010, one category of trade: Organic Chemicals, Medicinal and Pharmaceutical Products accounted for 86.1% of our entire trade surplus. Between 2000 and 2009, the same sector average contribution to trade surplus was 84.1%. Total food and live animals – the indigenous companies-dominated exporting sector – combined trade surplus in 2010 was just €2.4 billion or some 16 times smaller than the trade surplus from the Organic Chemicals, Medicinal and Pharmaceutical Products category.

This reliance on MNCs-dominated sectors presents significant risks to our trade flows going forward.

Firstly, Ireland-based MNCs face the risk of the much-feared ‘patent cliff’ threatening the pharma sector. Various estimates put the effect of the blockbuster drug going off-patent at a staggering up to 80% reduction in revenues within the first 3 months after patent expiration. In the next 3 years, according to some estimates, this fate awaits approximately 30-35% of our MNCs sales. This can see our trade balance dropping by almost €6 billion in the first year of impact.

Secondly, lack of diversification in sectoral patterns of trade – further reinforced by the fact that computer equipment exports are now down 11% year on year in the first 8 months of 2011 – is paralleled by the decline of regional diversification of our exports. In 8 moths through August 2011, 18.7% of our exports went to the countries outside the EU and US. A year ago, the same number was 19.1%. Ireland’s trade with the largest emerging and middle income economies, such as the BRIC countries, remains virtually static and minor year on year at just €2.2 billion or less than 3.7% of our exports. Our trade balance with the BRIC countries stood at unimpressive €80.2 million in January-August 2010 and has fallen to €70.3 million in the same period of 2011. You get the picture: Ireland is missing out on booming trade markets.

Thirdly, recent proposals in Washington – combining a potential reduction in the US corporate tax rate with a tax holiday for repatriation of US MNCs’ profits back into the US can have profound effects here. Just a 25% acceleration in repatriation of profits by the US multinationals can result in GDP/GNP gap rising to 22.5% by 2016 against current 17%. This, in effect, will mean that Irish economy will be sending abroad more funds in repatriated profits than the entire trade surplus brings into the country.

The risks we face on our exporting sectors’ side point to the reasons why exports-led recoveries are rare in general.

Historical evidence, across the euro area states, taken over the period of 1990-2010 clearly shows that, in general, countries do not reverse external imbalances overnight. Only two out of 17 euro area countries, Austria and Germany, have managed to switch from persistent current account deficits in the 1990s to current account surpluses in 2000-2010. Evidence also shows that between 1990 and 2009, no country in the Euro area was able to achieve average current account surpluses in excess of 5% annually and only one country – the Netherlands – was able to deliver average surpluses of over 4% of GDP. Given Ireland’s Government debt overhang, we would have to run over 4% average surplus for a good part of the next two decades if exports-led growth were to be the engine for our economic recovery.

Ireland’s exporters are doing a stellar job trying to break out of the globally-driven patterns of trade and generate growth well in excess of that delivered by other countries around the world. The real problem is the unreasonable expectations for the exports-led recovery that are bestowed upon them by the Government. If Ireland is to develop an indigenously anchored robust export-driven economy, we need serious policy reforms to facilitate domestic investment and entrepreneurship, know-how and skills acquisition and ease access to trade for our services and goods exporters. So far, the Government has been talking the talk on some of these reforms. It is yet to put its words into action.


The continued turmoil in the Euro area sovereign bond markets presents an interesting sort of a dilemma for investors around the world. By all possible debt metrics, Japan is more insolvent than Italy or all of the PIIGS combined. In addition, barring the latest quarter uplift, Japan had not seen appreciable economic growth in ages. And yet, Japanese Government bonds yields are falling and the country is perceived to be a sort of safe-haven for investors fleeing the beleaguered Euro area. Why? The short answer to this question is – investment risks. There are tree basic investment risks when it comes to bonds. The first risk is that of future interest rates increases. If interest rates were to rise, currently trading bonds will see their price drop, devaluing the investment. Japan is less likely to rise interest rates any time in the near future than the ECB, as it faces significant costs of rebuilding its economy and its high debt levels require lower interest rates financing. The second risk is of high inflation. Once again, Japan wins here, as the country had sustained periods of near-zero to deflationary price changes in its recent past. In addition, the country is no more susceptible to importing inflation from the global commodities markets than Europe. Lastly, there is the set of re-investment, credit and default risks, which in the nutshell boil down to the risk that the issuing sovereign will not be able to roll over current bonds for new ones at maturity. Of course, in the case of Japan this can happen only if investors refuse to accept new bonds in a swap for old bonds. But in the case of European states, this can happen also if the euro were to break up between now and maturity period (in which case the swap will not be like-for-like) or if the collective entity – the EU – were to compel sovereign bond holders to accept haircuts at some future date. With both these possibilities being open in the case of, say, Italy, Japan – as sick as its economy might be – presents a potentially lower risk bet for many investors today.
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