Economics 17/12/2009: End of recession in Ireland?

Is Ireland technically out of the recession? Well, I don't know. And for several reasons.

First, it takes two consecutive quarters to get into a recession. Should one quarter of positive growth mean you get out of a recession? Me thinks not.

Second, what measure do you go by? In a large diversified economy, GDP does the job. In the case of Ireland - GNP. Just as we should not count transfer prices by multinationals as our income, we should not count GDP as our measure of economic well-being. And here is a sticky point for today's QNA data: Q3 2009 saw GDP rise by 0.3%, but GNP fall by 1.4%. So this economy's income/output is falling still.

Third, consider why the GDP expanded in Q3 2009.

In the case of Q3 2009, every category of domestic expenditure fell on Q2 2009:

• Spending by consumers down by 0.7%qoq;
• Government expenditure down 0.9% qoq (good news given the deficit);
• Investment down some 10%
• Spending on Irish exports down 0.6% relative to Q2 2009.

So how did the economy grow? Imports fell a whooping 4.5%. Fewer BMWs and Mercs and flat screen TVs imported into the country and, magic happens – we are now richer by 0.3% than we were in June 2009. Right… North Korean model of growth indeedanyone?..

GDP expenditure components, % qoq
Now, in comparison, the US – economy on public spending (err stimulus) steroids – grew by 0.7% increase in GDP Q3 2009 and this growth was broadly present across all categories of expenditure.

The only net positive is that GNP contracted only 1.4%, which is much slower rate of collapse than 5.2% decline in Q1 2009 and even slightly slower than Q2 2009 fall of 1.7%. Nonetheless, the fall is still significant.

Thus, overall, GDP/GNP gap grew wider once again as the real domestic economy is still deeply in the recessionary dynamic. The GDP / GNP gap is accounted for by the “Net Factor Income from Abroad” or NFIa. As MNCs export more and more profits from Ireland, driven by increased transfer pricing through our off-shore accounting zone, NFIa rises. NFIa also increases as Government debt financing rises – and we know where that is coming from. And it does so as a proportion of the overall value added in the economy. Aptly, Q3 saw NFIa reaching record levels.

How important is the transfer pricing effect in Ireland? Chart below updates the earlier data on the GDP/GNP gap. But figures for sector activity show that while modern manufacturing sectors (Chemicals, Pharma, ICT – all dominated to the tune of over 90% by the foreign companies) grew in output by 6.5% in 2009, traditional sectors (dominated by domestic firms) collapsed in output by some 15%. Did anyone notice new factories supported by MNCs mushrooming over this year? Not really, So 6.5% ‘output’ increase is the MNCs booking higher value added to their Irish operations, assigning accounting value to the same products they manufactured here last year and booking more profits in Ireland at our 12.5% tax rate.

This is cool – it supports jobs here. But do not confuse this with Irish output. Or with Irish income. Or with the end of Irish recession. Lest you want to be that one-time invitee to a cool party who imagines himself to be the owner of a lavish host’s estate.

Now, let me update some charts.
GDP at constant prices - all components are down. Even those that were showing improvement in Q2 2009 (Agriculture, Forestry & Fishing) or stabilization (e.g Industry) are now turning negative. Except for Other Services & Rents (gotta be Nama offices at the banks renting new facilities).
GDP is down in all measures at constant market prices, and GDP relation to GNP is fairly evident (more on this below).

Now, contributions to GDP:
Again, no improvements on Q2 above.

And GDP/GNP gap visualization:
Yes, an end to a recession indeed. We've breached 20% for the gap - a full 1/5 of the so-called Irish income has absolutely nothing to do with Ireland except for the accounting ledger in MNCs offices. If this is growth - well, set up an imaginary ledger in DofF and start entering zeros to our GDP figure on a monthly basis.

Now on to value added in Irish economy:
Things are now worse than they were in Q2 2009 in all sectors, save 'Other' and Agriculture.

This not an end to a recession. It is a recession running at pretty much the same rate as in Q2 2009.

QED

Economics 27/10/2009: Recessions, Busts and Crunches

I am back from a very enjoyable (as always) trip to Paris and some 150km beyond. Superb retrospective of Pierre Soulages' work in Pompidou - a real master of true dynamism. A mouthwatering Hans Hartung print (some examples here) and two lovely Soulages' prints as well - all in my favorite gallery Paul Proute SA - were hard to resist, but given we are in a depression, while the French art market seems to be only in a recession, judging by prices, resistance was a-must.

One telling tale - at a lovely dinner with a small group of friends in the countryside, conversation took a quick turn to corrupt politics. Our French hosts were lamenting about the state of their country politics by pointing to a scandal surrounding Nicolas Sarkozy's plans to appoint his failed-lawyer son to head the Epad, the development corporation of La Défense (see a note here). Epad is a state-sponsored body and the French nation was literally lifted to its feet when nepotist Sarko tried to push his baby-faced offspring into the CEO seat. In return, I recalled for our friends the story of Bertie Ahearne arrogantly telling the nation that he gave state jobs to his cronies not because they provided him with money but because they were his friends. My French hosts couldn't believe that such a statement did not cost Bertie his job leading to years of public investigations and pursuits through courts. Nor could they believe that Bertie's friends are still, mostly, in their places of power.


Now, a couple quick notes relating our own troubles.

Stijn Claessens, M. Ayhan Kose and Marco E. Terro have published their excellent paper "What Happens During Recessions, Crunches and Busts?" (I wrote on it before based on the working paper version here) in Economic Policy, Vol. 24, Issue 60, pp. 653-700, October 2009. Here are couple interesting illustrations:
So per above, combined duration of contractionary segment of the credit crunch and housing price bust can be expected (on average) to last approximately 30 quarters (timing the current Irish crisis to last from Q1 2008 through Q2 2015 if the rate of house price bust and credit contraction here in Ireland was close to an average of the countries surveyed by the paper).

The latter 'if' is a serious assumption to make. Claessens, Kose and Terro show that the average bust/contraction is associated with a roughly 18% fall in credit supply and 29% decline in house prices. Of course, in Ireland, we are already seeing a 70% decline in credit supply and a 40-50% decline in house prices. So make a small adjustment - back of the envelope - to account for these and you get expected the current contraction/bust crisis to last more than 52 quarters, taking us well into the beginning of 2020 before the recovery truly takes hold.

And this dynamic is seemingly also in line with Claessens, Kose and Terro data on the impact of crises on GDP. 2008-2010 Irish GDP is expected to fall by some 13.5-15%. This is approximately 2.5 times the depth of the average adjustment associated with credit crisis and house price bust per Claessens, Kose and Terro, as illustrated in their chart reproduced below:
Oh, and for those 'advisers' who are telling Minister Lenihan that Ireland will recover from this crisis along the same trajectory as the 'average' OECD economy (the same advisers who are talking of 8-year cycles in property prices), here is how average Irish crisis is compared to the rest of the modern world history:
Only 4 countries so far have experienced a combination of Asset Price Bust + House Price Bust + Credit Crunch.


My second note of the day is about the effectiveness of fiscal spending as 'get-us-out-of-recession' stimulus. Given that the Government is now pre-committing itself to not cutting public sector pay, it is worth quickly mentioning that the Unions-supported idea that cutting public expenditure is only going to make our recession worse is simply untrue. A recent (July 2009) note by Fabrizio Perri of University of Minnesota, Federal Reserve Bank of Minneapolis titled "Comment on: Planning to cheat: EU fiscal policy in real time by Roel Beetsma, Massimo Giuliodori and Peter Wierts" provides an estimate of the fiscal expenditure multiplier for European economies. The number is 0.85... or, significantly less than 1. This suggests that cutting public spending will lead to a proportionately smaller reduction in GDP than the savings to be generated.

Here is an additional (excellent) note on the whole mess of fiscal multipliers. Adding to this, one has to recognise that Irish public spending is far less effective as a stimulus to the economy, as it is accounted for (to the tune of 70% of the total expenditure) by social welfare and wages - i.e. non-productive components. Thus, one can expect the above 0.85 multiplier estimated for Europe as a whole to be around 0.26-0.0.29. Which, in turn, means that any fiscal contraction in today's Ireland will likely result in a medium-term expansion of our economy. Then again, we already know this much from the 1980s experiences, don't we?

In reality, of course, taxing private economy amidst credit and asst price crises to continue wasting money on the current public expenditure is a sure way to extend and to deepen the recession, as:

• Our public expenditure level was not sustainable for this economy even at the times of growth, let alone at the time of a severe recession;
• Ireland is now likely to be on a path of permanently lower post-crisis potential GDP/GNP growth, so the cuts in public spending will have to take place no matter what delay in public expenditure adjustment the unions will force onto this Government;
• We are facing the fastest and the longest increase in public debt (ex-Nama) in the OECD over the next 5 years and an additional open ended liability under Nama, both of which make it virtually certain that Ireland will emerge from this crisis as a fully insolvent nation.