Thursday, August 21, 2014

21/8/2014: Economy in a 'Not me, but maybe you?..' recovery


This is an unedited version of my column for the Village Magazine, June-July 2014 (date of filing: May 24, 2014)


There has been a uniformly singular analysis of the fallout from the European and local elections last week, the leitmotif of which is the view that the voters have vented their frustration and disappointment with the policies the coalition government. Majority of these policies, relate to the economy. Going into elections, candidate after candidate insisted on recounting the successes of the Fine Gael and Labour in reversing the pains of economic crisis: tens of thousands of jobs created, economy stabilised, property markets and investment on the upside and households finally facing into the prospect of tax cuts in the Budget 2015. Save for the contracting pharma sector – suffering from ills of the patent cliff unrelated to Ireland and the Government – things are getting brighter by the minute.

The voters bought none of these claims. Still, the question remains unanswered: has the economic decline been reversed during the years of coalition management?

It is a difficult question to tackle. So let us try and face up to the core facts with a measure of cold statistics.

In very broad terms, the economy can be broken into private consumption, Government consumption, private investment, public investment, and net exports (exports less imports) of goods and services. Everything, excluding net exports, taken together is known as the Final Domestic Demand. Adding to the demand net exports provides for the Gross Domestic Product. Adding to GDP inflows of payments on Irish investments abroad net of outflows of payments on foreign investments in Ireland gives the Gross National Product.

In the economy severely distorted by MNCs tax arbitrage and where foreign companies account for the entire trade surplus (the positive measure of net exports), the Domestic Demand is the measure of economic activity that most accurately measures what takes place in the country. It excludes the pharma sector and the ICT services exporters who are pushing massive accounting revenues and profits into our national balancesheet.

The simple statistical fact is that final domestic demand rose in Q4 2013 by EUR630 million compared to Q4 2012, although for the full year 2013 it was down EUR366 million, once we adjust for inflation. This means that 2013 was the sixth consecutive year of declines in domestic demand, but it also means that toward the year end things started to look a little sunnier.

Looking at the composition of our demand, both public and private consumption fell in 2013. These declines were moderated by a rise in gross domestic capital formation (or in more simple terms, investment), which rose EUR710 million year-on-year. Much of this ‘upside’ was Nama and IDA attracting foreign investors to Dublin. In other words, it had little to do with our real economy.

While on the topic of property investments: house prices and commercial real estate valuations did rise through 2013 in Dublin and trended down in the rest of the country. But since the on-set of 2014, things have gone slightly off the rails. National property prices index peaked at 70.0 in December 2013 and have slipped to 69.1 by March 2014. In Dublin, this decline was even more pronounced - from the local peak of 68.5 at the end of 2013 to 67.2 in February and March 2014. Building and construction activity picked up in 2013, with index of activity by value of construction up from 94.3 in Q4 2012 to 105.4 in Q4 2013 and volume up from 95.7 to 106.2 over the same period.

Here's the kicker, however: much of the above growth related to completions of already started projects and retrofits. Planning permissions for new construction, stripping out alterations, conversions and renovations fell year on year in Q4 2013 and were down over the full year. The pipeline of building permissions into the near future looks dire.

In contrast, contribution of industry, excluding building and construction to GDP was down EUR1.1 billion in 2013. Overall, of the five broad sectors of the economy contributing to our GDP, three posted decreases in activity compared to 2012 and two recorded increases.

Here's an interesting comparative. As Chart 1 below clearly shows, since the current Government came to power in Q1 2011, our real GDP in constant factor cost terms grew on average by less than 0.76% per annum. In the recovery of the 1990s this rate of growth was around 14 times faster. Agriculture, Forestry and Fishing; Industry; Distribution, Transport Software and Communication; and Public Administration and Defence – four out of five broad sectors of the economy are down over 3 years of Government tenure. Only Other Services (including Rent) sector was up. No prizes for guessing which sector is dominated by internet giants pumping tens of billions of revenues and profits earned elsewhere around the world into Ireland to be recycled to tax havens.



Things are even worse when we consider domestic economy excluding external trade. Personal Expenditure on Consumer Goods and Services shrunk 3% in the tenure of this Coalition, falling at an annual rate of 1%, Net Expenditure by Central and Local Government on Current Goods and Services is down at an annual rate of decline of 2.4%, while Gross Domestic Fixed Capital Formation fell at an average annual rate of almost 2.3%.

So by all metrics, save the one that covers Google & Co, the Coalition record to-date is hardly impressive.

Which leads us to another question: what is there to look forward to in the economy between now and the next general election?

Assuming the current Coalition remains in power through its term, there are some positive signs on the led-grey economic horizon. The data on these positives is not exactly convincing, but still, some signs are better than none.

Little as they matter in current environment with no established economy-wide trend and a lot of volatility, the Purchasing Manager Indices for Manufacturing and Services continue to move deep in the growth territory. Investment remains sluggish, with credit in the economy continuing to shrink and cost of loans continuing to rise gradually. But non-traditional sources of funding are showing signs of growth: investment funds, private equity and even some direct peer-to-peer lending.

As banks shift defaulting mortgages into 'restructured' portfolios of loans, numbers of new mortgages approvals, although volatile, are on a gentle upward slope. However, average value of mortgages approved continues to trend down.

Retail sales are faring much worse: value of retail sales in Q1 2014 remained static on Q4 2013 and is up only 0.6% y/y. Volume is up 0.2% q/q and is now 2.6% above Q1 2013 levels. Which means that deflation is still cutting into retail sector earnings, and with this trend, new hiring is still off the agenda of Irish retailers. However, encouragingly, retail sales have finally started to move in line with consumer confidence in recent months, although gains in retail sales still severely lag behind the confidence indicator, as the chart below shows.



Meanwhile, on the exports side, external demand for Irish goods and services might be improving at last, although you won't be able to tell this from the hard data, for now. The growth in global demand is yet to translate into indigenous exports growth for a number of reasons. Chiefly, growth in global trade volumes has shifted toward trade between middle income and emerging economies, away from advanced economies. This pattern of trade dis-favours Ireland. MNCs based here predominantly service the US and Europe, with the rest of the world being supplied from other countries. Our own exporters are having hard time getting a strong foothold in the merging markets. In 12 years since 2002, Irish exports to markets outside the EU and North America stagnated, as a share of our total exports at a miserably low 15-17%, as the chart below illustrates.



Growing our indigenous exports will require serious rebalancing of our sales and marketing efforts toward the markets outside our familiar geographies. The good news is that we have a ready base for such a push. Our competitive advantages are in the sectors where proximity to MNCs resulted in Irish indigenous startups gaining experience, intellectual property and access to early stage supply contracts, e.g. auxiliary services in international finance, ICT and biotech. The challenge, however, is to continue generating exports-oriented startups, while forcing more indigenously firms to export. The former requires financing and business development supports that are very scarce on the ground, especially for companies not clients of the Enterprise Ireland. The latter is a challenge no one has been able to tackle to-date.

Majority of companies operating in the Irish economy are engaged in reselling foreign goods and services without any serious value added to them. In order to push these firms into exporting, they need to identify potential ways for adding value to imported goods and services and then identify the markets and the path for entering these markets, where this value-added can generate sales. Parallel to this, Irish firms are facing an uphill battle to increase productivity of their capital and workforce to make certain that any value added is not consumed by the internal inefficiencies. While during the crisis, Irish economy regained some share of its competitiveness lost during the Celtic Garfield years of 2001-2008, these gains were achieved predominantly through two channels: productivity growth due to on-shoring of large-scale ICT services providers (Google, Amazon, etc), and due to massive jobs destruction in less-productive sectors, such as construction and retail, and other domestic services. Which, incidentally, shows that our Government’s claims of competitiveness gains are barely scratching the surface in terms of revealing the underlying trends in this economy. Stripping out the MNCs with their tax arbitrage, Irish economy is more competitive today than it was in 2004-2006 only because we are no longer employing builders and not adding more convenience shops to every street corner of every town. This is hardly a form of productivity gains that can make our products more competitive on supermarkets’ shelves in Canada or our services supplied to an Indonesian investment bank.

The final drag on the prospects for exports-led growth relates to skill sets required. These skills rest predominantly outside the current vast pool of the unemployed. Despite the claims of 70,000 new jobs created by the Government, data from CSO shows that in Q1 2014, there were only 49,500 fewer unemployed in Ireland than in Q1 2010, of which 14,314 came from higher numbers in state training programmes, such as JobBridge. Meanwhile, numbers of those in unemployment for over 1 year – the period commonly associated with long-term losses in skills and employability – declined by only 20,800 in 3 years of the current Coalition rule. If in Q1 2011 when this Government came to power, 57.5% of all unemployed were jobless for longer than 12 months, in Q1 2014 this proportion rose to 60.5%. Demographically, numbers of older workers (age 45 and older) without jobs rose by 5,900 during the tenure of the Coalition, and number of older workers out of jobs for more than 12 months is now up by 7,000.



While the Government has been successful in reversing the trend in rising unemployment, the progress to-date has been relatively weak compared to the enormous task at hand. Irish economy has been creating new jobs that suit skills and career progression of the younger workers – jobs that require excellent command of foreign languages, coding, technical services that cannot be easily taught to those of older age. Majority of new jobs being created are at the earlier stage of careers, meaning that they are basically of no use to mortgaged and indebted middle-age households with children and ageing parents. In addition, these starter-level jobs are not likely to improve pensions prospects for those currently unemployed, especially those of age above 45, when savings for retirement must be ramped up aggressively.


All of the above problems as well as opportunities are closely interlinked and reach across all groups and segments of our society and all sectors of our real economy. They require not just a policy response, but a coherent, long-term and comprehensive strategy. So far, such a strategy remains wanting. The Coalition might deserve credit for doing the hard thing over the last three years, but it still an open question whether it deserves the credit for doing the right thing.

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