17/6/2012: Services Value Index for Ireland - May 2012

Some good news for a change:


Per CSO: "The seasonally adjusted monthly services value index increased by 5.5% in May 2012 when compared with April 2012 and there was an annual increase of 8.0%." Some notable mom changes were:

• Information and Communication (+12.1%), 
• Business Services (+6.3%), 
• Wholesale and Retail Trade (+4.5%), 
• Other Services (+2.3%) 
• Accommodation and Food Service Activities (+0.3%) 
• Transportation and Storage showed a monthly decrease of 1.4%.

Some larger yoy moves were:

• Information and Communication (+20.0%), 
• Transportation and Storage (+8.7%),
• Wholesale and Retail Trade (+8.3%), 
• Other Services (+0.8%) 
• Business Services (+0.2%) 
• Accommodation and Food Service Activities showed an annual decrease of 2.5%.

24/6/2012: Irish Services: April 2012

For a shocker, folks - a positive set of news.

The experimental time series from the CSO on services sectors performance shows some relatively robust activity in the services sectors.

Here's the headline chart:

Now, to some figures:

• Overall index of activity (value) in Irish Services sectors stood at 101.0 in April 2012, down slightly on 101.2 in March 2012, but up 4.0% on same period last year. 
• This confirms a robust growth trend in the series.
• 3mo MA in April was at 101.2 against 100.9 in March and at the highest level reading since data series began in October 2010.
• Activity is now 1% ahead of 2009 average levels - sounds like not much, but when one considers that it was at 97.3 back in Q4 2010, there is some progress.
• Notice - these are value indices, so not free from price changes variations and inflation in services does increase index performance.

Sub-indices are shown below:

• 3moMA through April 2012 for Wholesale & Retail trade sub-sector stood at 107.7 down on 108.6 in 3mo through January 2012. The sub-index fell 1.4% m/m in April but was up 2.7% up y/y.
• 3moMA through April 2012 for Information & Communication sub-sector stood at 108.4 up on 105.0 in 3mo through January 2012. The sub-index fell 1.6% m/m in April but was up 9.1% up y/y.
• 3moMA through April 2012 for Business Services sub-sector stood at 97.2 down on 98.9 in 3mo through January 2012. The sub-index rose 0.7% m/m in April but was down -0.5% up y/y.
• 3moMA through April 2012 for Transport & Storage sub-sector stood at 105.0 up strongly on 96.7% in 3mo through January 2012. The sub-index rose 3.2% m/m in April and was up 14.4% up y/y.
• 3moMA through April 2012 for Accommodation & Food Services sub-sector stood at 86.9 down on 87.1% in 3mo through January 2012. The sub-index fell -0.1% m/m in April and was down -2.9% up y/y.
• 3moMA through April 2012 for Other Services sub-sector stood at 71.9 up on 69.1% in 3mo through January 2012. The sub-index rose 4.2% m/m in April but was down -0.5% up y/y.

Although a mixed bag overall, the index continues to show expansion in the sector accounting for a large share of our overall economic activity.

7/5/2012: Analysis of April Irish PMIs (4): Profitability

This is the last post on April 2012 PMIs. In the first and the second posts, I covered headline index readings forManufacturing PMI and Services PMI for April 2012. In the third post, I looked at the Employment sub-indices for both sectors. This post will focus on profitability conditions, an index I derived from the PMI data.


April 2012 saw profit margins conditions deterioration slowing down in Services from -15.06 in march to -11.96 in April. 12mo MA is now at -15.9, shallower than the average deterioration in profit margins during the pre-crisis period (-17.8), but deeper than -14.7 average reading for the period since January 2008. Overall, -11.96 April 2012 reading is the slowest pace of profit margins deterioration recored since October 2010. 3mo MA is now at -13.8 and this marks a significant improvement on -19.8 deterioration for 3mo MA a year ago.

Manufacturing profitability index has moved from -24.84 in March 2012 to -22.86 in April 2012, marking the second sharpest decline since March 2011. 12mo MA is now at -17.1, while 3mo MA is at -23.3. This compares against pre-crisis average reading of -11.6 and January 2008-present average of -14.55.

So on the net, profitability conditions continue to deteriorate, but deterioration in Services is less pronounced and de-accelerating continuously compared to historic trends. Deterioration in Manufacturing profit margins continues unabated and is running well beyond historical averages.


The above suggests that while some positive momentum is possible for employment in Services sector, it is unlikely that profits conditions will support much of an employment uptick in Manufacturing.

7/5/2012: Analysis of April Irish PMIs (3): Employment

In the last two posts I covered headline index readings for Manufacturing PMI and Services PMI for April 2012. In this post, I am looking at the Employment sub-indices for both sectors.

Employment index rose to 52.9 in Manufacturing from 51.2 in March. The move is against 49.5 12mo MA and 50.0 average for Q1 2012, suggesting some expansion in Manufacturing employment. The change comes coincident with a decline in the rate of growth in overall sector PMI to 50.1 from 51.5 in March.

In Services, employment index declined to 50 from 51.9 in March 2012. The index 12mo MA is at 47.9 and Q1 average was 48.1. In contrast to Manufacturing, decline in Employment growth rate came against an improvement in PMI from 52.1 in March to 52.2 in April.

Short-term changes in the series, however, are pretty volatile. Chart below shows the counter-moves in the two sectors:

and the chart below plots relationship between Employment and Exports:

The good news is, March and April 2012 mark two consecutive months when exports expansions in both sectors led to above 50 readings in employment as well. Last time that happened on a monthly basis was in April 2011 and last time it happened in two consecutive months was in October 2007.

If sustained over the next 2-3 months, the trend might shift firmly to the upside.

7/5/2012: Analysis of April Irish PMIs (2): Core Services

Previous post dealt with the high level trends in Manufacturing PMI for Ireland. In this post we look at the core data for Services PMI.

Back in March, markit - the agency releasing Irish PMI data for NCB - headlined the changes in the Services index with a rather bombastic "Growth of Activity Sustained in March, and Optimism Hits a 22-month High". Of course, such was the booming time in Irish economy a month ago.

Fast forward one month to April and the headline remains bombastic: "Activity Growth Maintained in April as New Business Rises for Third Month Running"... Ok... so...

Headline PMI in Services (Business Activity index) improved from 52.1 in March to 52.2 in April, which is good news nominally, but statistically still indistinguishable from 50. Good thing is, the moving averages are a bit stronger along the just-above-50 trendline. 3mo MA is at 52.5, 12mo MA at 51.3, and 3mo MAs for 2011 and 2010 are all below the current running at 52.1 and 49.8 respectively. So business activity is indeed somewhat on the rise, albeit a very shallow rise.

Overall, headline Services Activity has been running on average above 50 since June 2009. Anyone noticed the boom, yet?

New Business Activity firmed up to 52.7 in April, from 52.1 in March, marking the third consecutive month of above 50 readings. 12mo MA is at 50.0 and 3mo MA is at 52.8, ahead of same period 3mo average in 2010 and 2011 (49.1 and 51.9, respectively). All, however, remain statistically indistinguishable from 50.

Again, trend pattern in New Business sub-index is identical to the pattern in overall Business Activity index - flat just above 50 since, roughly Q2 2011. The snapshot of more recent data illustrates, next.

Input-output prices are both moderating in trend, but input prices continue to expand, while output prices continue to post significant deflation. Profit margins, therefore, are shrinking more and more - the pattern that is running solidly since August 2009. More on this in future posts, however.

On core components of PMI: New Export Business growth moderated, but remained above waterline at 54.3 in April, down from 55.5 in March 2012. Both monthly readings were statistically significantly above 50, the same as in February. 12mo MA is now at 52.7 - barely statistically significantly above 50, while 3mo MA is at 55.0 - strong reading, ahead of 54.6 in 3mo through April 2011 and 52.8 reading for the same period of 2010.

As mentioned earlier, Profitability remained in the contraction territory, posting a reading of 47.5 in April, worse than 47.9 in March. Last time Profitability sub-index posted a reading above 50 was in December 2007.

Employment sub-index declined to 50.0 in April 2012, down from 51.9 in March 2012. 12mo MA is at 47.9 and 3mo average through April 2012 is at 49.9. This is virtually identical to 3mo MA through April 2011 which came in at 49.8 and is better than a rapid contraction-signaling 43.7 for the sub-index 3mo MA through April 2010.

Confidence slipped to 64.1in April 2012  from 70.4 in March. The series reading is now at 3mo low, but ahead of 12mo MA of 62.5. 3mo MA through April is very strong 67.1, while 3mo average through April 2011 was 66.5 and for 2010 period it was at 64.2. Overall, business confidence is relatively inflated indicator, as shown in the chart below. The indicator has relatively strong coincidental connection - in historical data - to the same period Business Activity index.

Overall, Services PMIs are showing stronger performance in the sector than in Manufacturing, but the numbers are more volatile and trending along the flatline. Business expectations continue to out-perform actual activity and exports orders, although this is hardly a new trend. With profitability severely constrained and actually deteriorating, I wonder if the 50+ readings in the last two months in Employment sub-index are credible.

2/1/2012: Sunday Times January 1 - 2012 Economy Forecast

This is an unedited version of my Sunday Times article for January 1, 2012.

Happy New Year and the best wishes to all of you fond of reading up on economics this morning.

Having just closed the book on the fourth year of the crisis, one can only hope that 2012 will be the year of the return of the global and Irish economic fortunes.

I wish I could tell you that this will be so with some sort of certainty. That ‘exports-led growth’ will open the way for reduced unemployment and that ‘real reforms’ will take place to the benefit of those of us living here and restore the confidence of the proverbial international investors. Alas, the only reality we can glimpse from the road we travelled since 2008 is that this year will be marked by the same fiscal uncertainty, growth volatility and markets psychosis that were the hallmarks of the years past.

So in line with the New Year’s Day tradition for forecasts, lets take a look at the crystal ball and ask two questions.

Question number one: Where are we today on the road of the global economic and financial crises resolution?

At the macroeconomy level, the US has completed some two-thirds of the required private sector deleveraging. This means that by the very end of 2012 we might see some signs of life in the US consumer demand and household investment, assuming the credit system globally does not experience another seizure. Until this takes place, corporate balance sheets will remain focused on hoarding cash and capex is unlikely to re-start. The US economy is likely to bounce around the growth rates just above zero, with moderate risk of a recession in the first half of 2012.

The three black swans for the global economy are: the risk of the deficit blowout and the lack of Congressional consensus on dealing with the US debt mountain that can destabilize the Treasury market; China’s economy teetering on the brink of an asset crisis and growth slowdown; and the euro area hurtling toward a disorderly collapse. Should any one of these materialising, there will be an unprecedented shift in global investment portfolia with gold and a handful of international blue chip corporates becoming the only stores of value. Unlikely as it might seem, such a scenario will cause a new Great Depression worldwide.

Barring the catastrophe identified above, global demand will most likely remain subdued in 2012, with previous pockets of growth – e.g. the emerging markets, the beneficiaries of exceptionally low cost of carry-trade finance from QE funds in the US in 2009-2010 – becoming mired in a significant growth slowdown.

Europe is likely to be on the receiving end of the poor global growth newsflows.

Germany was the driver of European growth in 2011 and its exports performance (up 13.4% in 2010 and 8.5% in 2011) looks set for a severe test in 2012. In months ahead, the ECB will drive down key interest rates to 0.5-0.25 percent from the current 1.0 percent to accommodate the default-bound euro area sovereigns. However, in the climate of deleveraging banking sector, this move will fail to stimulate private demand. Government spending in Germany is also set to fall in 2012, by 0.4-0.5 percent. As the result, we can expect German GDP to contract in Q4 2011 and Q1 2012. Annual rate of growth is likely to fall from 2.9% in 2011 to 0.2-0.4% in 2012.

France is now forecast to enter a shallow recession between Q4 2011 and Q1 2012 with annual growth falling from 1.6% in 2011 to zero percent in 2012. The downside risk for the second largest euro area economy is that fiscal adjustments planned to-date can be derailed by lower growth. In this case, France can remain in a shallow recession through 2012.

Overall, euro area growth looks set for some negative downgrades in months ahead. We can expect GDP to remain flat in 2012, having shown expansion of 1.5 percent in 2011. Personal consumption will be static, investment will shrink by 1.2 percent and Government spending will contract 0.3 percent. Exports growth will fall 10-fold, from 2011 annual rate of 6.3 percent.

This provides the backdrop to the second question of the day: What will 2012 bring to Ireland?

We are all familiar with the fact that Irish economy is highly volatile and subject to a number of push and pull factors ranging from global demand for Irish exports, to foreign conditions for debt crisis resolution in the common currency area.

Assuming no major disruptions to the current global environment, we can look at two possible scenarios.

Scenario 1 involves benign assumptions of continued growth in agricultural output, modest resilience in exports, moderating contraction in construction sector, and only slightly deeper reduction in public spending compared to 2011. Crucially, this scenario assumes virtually no nominal change in the services sector activity, a moderate rise in net taxes and a slight decrease in profits by the multinational enterprises expatriated abroad. All in, Scenario 1 yields estimated rate of growth in real GDP of 0.8% and GNP growth of 0.7%.

Less benign Scenario 2 with shallower growth in agricultural and exporting sectors activity, as well as services sectors contraction, yields growth forecast of -0.6% for real GDP and -0.9% for GNP. In this adverse scenario, Irish economy is likely to end 2012 with real GNP 13% below the peak 2007 levels.

These small differences in forecasts are, however, compounded year on year, as illustrated by the historical divergences between previous Department of Finance forecasts and realised rates of growth in the chart.

The range of risks we face is a daunting one, but there is also a narrow range of potential outcomes that present an upside for the battered economy.

In terms of the sovereign risk, recent discontent with the Budget 2012 has translated into dramatically reduced approval ratings for both Fine Gael and Labor. These are likely to persist on the back of higher taxes and a potential increases in unemployment in the retail sector and other services, post-January sales. By mid-2012, lower growth and overly optimistic projections on tax revenues and expenditure reductions will mean that the Coalition will face a stark choice of either further reducing capital expenditure, or levying some sort of a new revenue raising measure. Discontent of the backbenchers will only increase as time moves closer to the Budget 2013, possibly forcing the Government to adopt some structural reforms on the expenditure side and rethink its policy on future tax increases.

The latest projections by the Economist Intelligence Unit put peak Government debt/GDP ratio at 120-125% in 2013. At this stage, there will be a belated restructuring deal struck with EU that will see debt/GDP ratio falling to below 100%. The pressure for such a deal will be building up throughout 2012 and we might see some positive moves during the year.

Banks will be nursing continued losses, with mortgages showing a more visible trend toward deterioration, while business insolvencies will continue driving significant losses behind the façade. Again, pressure of these losses will become more apparent in late 2012, just around the time banks capital buffers begin to dwindle once again.

With economy bouncing up and down along the generally stagnant growth trend, the Government will continue its search for excuses for avoiding deep reforms. Thus, 2012 will be the year of silent risks build up in Irish economy, culminating in a major blow-out in late 2012 or early 2013. Welcome to the Groundhog Year Number Five.

Box-out:

Most recent data for Ireland’s external accounts shows that in Q3 2011 our balance of payments stood at a surplus of €838 million, comprising a current account surplus of €850 million and a capital account deficit of €12 million. For the nine months of 2011, the current account has registered a deficit of €669 million, an improvement of just €125 million on the deficit in the same period of 2010. Over the same time, balance of payments deficit fell from €771 million in the nine months through September 2010 to €675 million for the first nine months of 2011. Which raises the following question: given that we continue running current account and balance of payments deficits, what external surpluses does the Government foresee for the near future that can possibly make a dent in our public debt overhang? Since the onset of the current exports boom in the beginning of 2010, Ireland’s average quarterly current account surplus has been a meagre €13 million. At this rate, it will take Ireland Inc some 190 years to pay down just €10 billion of debts, even if these debts were costing us nothing to finance.

16/12/2011: QNA for Q3 2011: 'exports-led recovery' myth

In the first post on Q3 Quarterly National Accounts, we looked at the data on real rates of growth in the Irish economy based on sectoral decomposition (linked here). Now, let's take a look at the expenditure-based data. Please keep in mind - Q3 2011 was the record-busting quarter in terms of exports growth for Ireland, with the latest data pointing to falling growth rates in Irish external trade for Q4 2011 (see here). In addition, keep in mind that unlike the DofF that projects Irish GDP growth to be 1.3-1.6% in 2012, most of the euro zone is factoring in contractions for H1 2012 (see details here).

So down to data now.

In nominal terms,

• Personal consumption continued its precipitous fall in Q3 2011, declining €291mln (-1.4%) qoq and €283mln (-1.4%) yoy. Relative to Q3 2007, personal consumption is now down €3,085mln or 13.3%.
• Net expenditure by central and local government, is down €61mln (-1.0%) qoq and €110mln (-1.7%) yoy. Compared to Q3 2007, net government spending is down 12.1% or €869mln.
• Exports of goods and services are up €373mln (+0.9%) qoq and €1,025mln (+2.5%) yoy. Exports are also up on Q3 2007 by some €3,849mln (+10.2%)
• Imports of goods and services are down €192mln (-0.6%) qoq but up €1,033mln (+3.3%) yoy.

Thus, GDP at current market prices is now down €703mln qoq in Q3 2011 (-1.8%) and down €1,011mln (-2.5%) yoy. Compared to Q3 2007, GDP is down €7,030mln (-15.4%) in current market prices.

In current market prices, value of profits expatriated abroad net of profits inflowing from abroad has risen €189mln (+2.4%) qoq and is up €1,076mln (+15.5%) yoy.

As the result, GNP is now down €612mln (-1.9%) qoq and down €2,063mln (-6.3%) yoy. GNP in current market prices is down €9,092mln or 22.8% on Q3 2007.

Personal consumption in nominal terms now stands close to the level of Q3-Q4 2005. Fixed capital formation is at the level roughly 1/3 of the Q1 2005.

Things are pretty dire in constant market prices terms as well:

• Personal consumption fell €182mln (-0.9%) qoq and €822mln (-3.9%) yoy. Relative to Q3 2007, personal consumption is now down €2,744mln or 12.1%.
• Net expenditure by central and local government, is down €88mln (-1.4%) qoq and €259mln (-3.9%) yoy. Compared to Q3 2007, net government spending is down 13.9% or €1,035mln.
• Gross domestic capital formation also continued falling in Q3 2011, with qoq decline of €1,234mln (-27.1%) and yoy fall of €955mln (-22.2%). Relative to pre-crisis level in Q3 2007, Q3 2011 investment in this economy came in at €5,754mln less (a decline of 63.2%).
• Value of stocks of goods and services has contracted €173mln in Q3 2011 qoq (-26.7%). 
• Exports of goods and services are up €786mln (-1.9%) qoq and €947mln (+2.4%) yoy. Exports are also up on Q3 2007 by some €2,650mln (+7.0%)
• Imports of goods and services are down €1,865mln (+5.9%) qoq but up €997mln (+3.3%) yoy.

GDP at constant market prices is now down €836mln qoq in Q3 2011 (-2.0%) and down €57mln (-0.1%) yoy. Compared to Q3 2007, GDP is down €3,318mln (-7.6%) in constant market prices.

Value of profits expatriated abroad net of profits inflowing from abroad has fallen €262mln (-3.1%) qoq but is up €1,347mln (+19.8%) yoy.

As the result, real GNP is now down €574mln (-1.8%) qoq and down €1,404mln (-4.2%) yoy. GNP in current market prices is down €5,398mln or 14.4% on Q3 2007.

So once again, that 'exports-led recovery' is, predictably not enough to keep economy above the waterline. And this is the case for Q3 2011, when "net exports (exports minus imports) grew by

21.8% at constant 2009 prices compared with the same quarter of last year." Record growth in exports before the slowdown hit in Q4 2011, and still recession in the overall economy.

16/12/2011: QNA for Q3 2011 - that R-thing again

Initial estimates for Q3 2011 released by CSO today show that seasonally adjusted, GDP fell 1.9% qoq  and GNP declined 2.2% qoq. Year on year, GDP is down 0.1% and GNP is down a whopping 4.2%.

In constant prices terms, real GDP fell €836mln qoq in Q3 2011 (-2.0%) and €57mln yoy (-0.1%). Relative to the peak in 2007, real GDP is now down €3,318mln or -7.6%. In constant prices terms, real GNP is now down €574mln (-1.8%) qoq and €1,404mln (-4.2%) yoy. Compared to peak 2007, GNP is down €5,398mln (-14.4%).

Output in Agriculture, Forestry and Fishing has fallen (in constant market prices and seasonally adjusted) €348mln (-30.2%) qoq, but is up 15% or €105mln in yoy terms. Relative to pre-crisis 2007 levels, sector output is up €104mln (+14.8%).

Industrial production declined €1,036mln (-8.7%) qoq and is up €419mln (+4%) yoy, while registering an increase of €227mln (+2.1%) on Q3 2007. These figures combine booming exporting sectors and collapsing building and construction sector. In building & construction, output grew €16mln (+1.9%) qoq, but is down €224mln (-20.4%) yoy and is down €1,423mln (-62%) on Q3 2007.

Distribution, transport & communications sector - a brighter spot last quarter, shrunk €129mln (-2.4%) qoq and is down €¡37mln (-2.6%) yoy. Compared to Q3 2007, the sector is down €1,064mln (-17.1%).

Other services, including rent are up €225mln (+1.3%) qoq, but down €531mln (-3.0%) yoy. The sector is down €1,889mln (-10%) on Q3 2007.

Chart below shows annualized returns by sector using data for the 11 months through November 2011 annualized using historical trends:

And the chart below shows in more detail the plight of Building & Construction sector:

Overall forecast for real GDP and GNP for 2011 based on data through November 2011 is not encouraging:

In the chart above, analysis of the latests data and historical trends suggests that 2011 GDP can come in at 0.7% growth rate, with GNP declining by -0.7% at the same time.

Net factor income from abroad - aka MNCs profits expatriations - declined in Q3 2011 to €8,136mln - or €262mln less than in Q2 2011. MNC's profits expatriation is now running €1,347mln ahead of Q3 2010 and €2,197mln ahead of Q3 2007 as record exports are fueling transfer pricing. So that 'exports-led recovery' thing... oh, it's dead in the water, folks. As predicted, record exports are not enough to sustain the entire economy. But more on this in a follow up post with detailed analysis of expenditure-based QNA.

5/12/2011: Sunday Times, December 4, 2011

For those of you who missed it - here is an unedited version of my article for Sunday Times, December 4, 2011.


Comes Monday and Tuesday, the Government will announce yet another one of the series of its austerity budgets. Loaded with direct and indirect taxation measures and cuts to middle class benefits, Budget 2012 is unlikely to deliver the reforms required to restore Irish public finances to a sustainable path. Nor will Budget 2012 usher a new area of improved Irish economic competitiveness. Instead, the new Budget is simply going to be a continuation of the failed hit-and-run policies of the past, with no real structural reforms in sight.

Structural reforms, however, are a must, if Ireland were to achieve sustainable growth and stabilize, if not reverse, our massive insolvency problem. And these reforms must be launched through the budgetary process that puts forward an agenda for leadership.

Firstly, Budgetary arithmetic must be based on realistic economic growth assumptions, not the make-believe numbers plucked out of the thin air by the Department for Finance. Secondly, budgetary strategy should aim for hard targets for institutional and systemic improvements in Irish economic competitiveness, not the artificial targets for debt/deficit dynamics.

Let’s take a look at the macroeconomic parameters framing the Budget. The latest ESRI projections for growth – released this week – envision GDP growth of 0.9% and GNP decline of -0.3% in 2012. Exports growth is projected at 4.7% in 2012, consumption to fall 1.5% and investment by 2.3%. Domestic drivers of the economy are forecast to fall much less in 2012 than in 2011 due to unknown supportive forces. This is despite the fact that the ESRI projects deepening contraction in government expenditure from -3% in 2011 to -4% in 2012. ESRI numbers are virtually identical to those from the latest OECD forecasts, which show GDP growing by 1.0% in 2012, but exports of goods and services expanding by 3.3%. OECD is rather less pessimistic on domestic consumption, projecting 2012 decline of just 0.5%, but more pessimistic on investment, predicting gross fixed capital formation to shrink 2.7%.

In my view, both forecasts are erring on optimistic side. Looking at the trends in external demand, my expectation is for exports growing at 2.9-3.2% in 2012, and imports expanding at the same rate. The reason for this is that I expect significant slowdown in public sector purchasing across Europe, impacting adversely ICT, capital goods, and pharmaceutical and medical devices sectors. On consumption and investment side, declines of -1.5-1.75% and -4-4.5% are more likely. Households hit by twin forces of declining disposable incomes, rising VAT and better retail margins North of the border are likely to cut back even more on buying larger ticket items in the Republic. All in, my forecast in the more stressed scenario is for GDP to contract at ca 0.6% and GNP to fall by 1.7% in 2012. Even under most benign forecast assumptions, GDP is unlikely to grow by more that 0.3% next year, with GNP contracting by 0.5%.

Under the four-year plan Troika agreement, the projected average rate of growth for GDP between 2012 and 2015 was assumed to be 3.1% per annum. Under the latest pre-Budget Department of Finance projections, the same rate of growth is assumed to average 2.5% per annum. My forecasts suggest closer to 1.5% annual average growth rate – the same forecast I suggested for the period of 2010-2015 in these same pages back in May 2010.

Using my most benign scenario, 2015 general government deficit is likely to come in at just above 4.0%, assuming the Government sticks to its spending and taxation targets. Meanwhile, General Government Debt to GDP ratio will rise to closer to 120% of GDP in 2015 and including NAMA liabilities still expected to be outstanding at the time, to ca 130% of GDP.

In brief, even short-term forecast changes have a dramatic effect on sustainability of our fiscal path.

Yes, the Irish economy is deteriorating in all short-term growth indicators. The latest retail figures for October, released this week show that relative to pre-crisis peak, core retail sales are now down 16% in volume terms and 21% in value terms. In the first half 2011, nominal gross fixed capital formation in the Irish economy fell 15% on H1 2010 levels and is now down 38% on pre-crisis peak in H1 2007. And exports, though still growing, are slowing down relative to imports. Ireland’s trade balance expanded 5% in H1 2011 on H1 2010, less than one fifth of the rate of growth achieved a year before. More ominously, using data through August this year, Ireland’s exports growth was outpaced by that of Greece and Spain. Ireland’s exporting performance is not as much of a miracle as the EU Commissioners and our own Government paint it to be.

However, longer-term budgetary sustainability rests upon just one thing – a long-term future growth based on comparative advantages in skills, institutions and specialization, as well as entrepreneurship and accumulation of human and physical capital. Sadly, the years of economic policy of hit-and-run budgetary measures are taking their toll when it comes to our institutional competitiveness.

This year, Ireland sunk to a 25^th place in Economic Freedom of the World rankings, down from the average 5-7^th place rankings achieved in 1995-2007. In particular, Ireland ranks poorly in terms of the size of Government in overall economy, and the quality of our legal systems, property rights and regulatory environments. The index is widely used by multinational companies and institutional investors in determining which countries can be the best hosts for FDI and equity investments.

In World Bank Ease of Doing Business rankings, we score on par with African countries in getting access to electricity (90^th place in the world), registering property (81^st in the world), and enforcing contracts (62^nd in the world). We rank 27^th in dealing with construction permits and 21^st ease of trading across borders. Even in the area of entrepreneurship, Ireland is ranked 13^th in the world, down from 9^th last year. This ranking is still the highest in the euro area, but, according to the World Bank data, it takes on average 13 times longer in Ireland to register a functional business than in New Zealand. The cost of registering business here amounts to ca 0.4% of income per capita; in Denmark it is zero. In the majority of the categories surveyed in the World Bank rankings, Ireland shows no institutional quality improvements since 2008, despite the fact that many such improvements can reduce costs to the state.

I wrote on numerous occasions before that despite all the talk about fiscal austerity, Irish Exchequer voted current expenditure continues to rise year on year. Given that this segment of public spending, unlike capital expenditure, exerts a negative drag on future growth potential in the economy, it is clear that Government’s propensity to preserve current expenditure allocations is a strategy that bleeds our economy’s future to pay for short-term benefits and public sector wages and pensions.

Similarly, the new tax policy approach – enacted since the Budget 2009 – amounts to a wholesale destruction of any comparative advantage Ireland had before the crisis in terms of attracting, retaining and incentivising domestic investment in human capital. Continuously rising income taxes on middle class and higher earners, along with escalating cost of living, especially in the areas where the Irish State has control over prices, and a host of complicated charges and levies are now actively contributing to the erosion of our competitiveness. Improvements in labour costs competitiveness are now running into the brick wall of tax-induced deterioration in the households’ ability to pay for basic mortgages and costs of living in Ireland. Year on year, average hourly earnings are now up in Financial, Insurance and Real Estate services (+3.1%) primarily due to IFSC skills crunch, unchanged in Industry, and Information and Communications, and down just 2.6% in Professional, Scientific and Technical categories. In some areas, such as software engineering and development, and biotechnology and high-tech research and consulting, unfilled positions remain open or being filled by foreign workers as skills shortages continue.

By all indications to-date Budget 2012 will be another failed opportunity to start addressing the rapidly widening policy reforms gap. Institutional capital and physical investment neglect is likely to continue for another year, absent serious reforms. In the light of some five years of the Governments sitting on their hands when it comes to improving Ireland’s institutional environments for competitiveness, it is the Coalition set serious targets for 2012-2013 to achieve gains in Ireland’s international rankings in areas relating to entrepreneurship, economic freedom and quality of business regulation.

Box-out:

Amidst the calls for the ECB to become a lender of last resort for the imploding euro zone, it is worth taking some stock as to what ECB balance sheet currently looks like on the assets side. As of this week, ECB’s Securities Market Programme under which the Central Bank buys sovereign bonds in the primary and secondary markets holds some €200 billion worth of sovereign debt from across the euro area. Banks lending is running at €265 billion under the Main Refinancing Operations and €397 billion under the Long-Term Refinancing Operations facilities. Covered Bonds Purchasing Programmes 1 and 2 are now ramped up to €60 billion and climbing. All in, the ECB holds some €922 billion worth of assets – the level of lending into the euro area economy that, combined with EFSF and IMF lending to peripheral states takes emergency funding to the euro system well in excess of €1.5 trillion. Clearly, this level of intervention has not been enough to stop euro monetary system from crumbling. This puts into perspective the task at hand. Based on recently announced emergency IMF lending programmes aimed at euro area member states, IMF capacity to lend to the euro area periphery is capped at around €210 billion. The EFSF agreement, assuming the fund is able to raise cash in the current markets, is likely to see additional €400-450 billion in firepower made available to the governments. That means the last four months of robust haggling over the crisis resolutions measures between all euro zone partners has produced an uplift on the common currency block ‘firepower’ that is less than a half of what already has been deployed by the ECB and IMF. Somewhere, somehow, someone will have to default big time to make the latest numbers work as an effective crisis resolution tool.

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.

Box-out:

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.

07/11/2011: Is Ireland a Poster-Boy for "Austerity & Growth" paradigm?

My article on the real dynamics in Irish economic 'recovery' and 'austerity miracle' is available on LISWire: http://liswires.com/archives/1359. 

24/09/2011: Projected trends in economic growth for 2011

In the previous post I covered the current results for Q2 2011 QNA for Ireland. As promised, here, I will focus on forward-looking signals emerging from H1 2011 data.

Please note, though I do use the term 'forecast' below, the results shown here are really more projections than formal forecasts. The difference is very important. I use data through Q2 2011 to estimate what the economy performance is likely to be, assuming no change on the trends established in H1 2011. Of course, this is subject to significant risks (identified below).


Based on Q2 2011 (preliminary - and I stress this) data, chart below shows my forecast for 2011 growth:
Using simple forward forecast based on Q1 20003 - Q2 2011 data, we can now expect:

• Agriculture, Forestry and Fishing sector real output to grow by ca 5.5-5.6% this year, well in excess of 2010 growth of 0.7%, lifting sector output closer to €3.2bn in 2011 or 3.2% ahead of 2007 (the peak year for GDP and GNP).
  
• Industry, including construction, is expected to expand by 5.0-5.1% this year, slightly below 5.2% growth rate achieved in 2009. This will put sector output in real terms 2,9% ahead of the pre-crisis peak of 2007.
• However, industry performance will come against continued double digit contraction in Building & Construction sub-sector, which is expected to shrink 17-18.5% in 2011, compounding an astonishing 30.1% decline in 2010. Bu the end of this year, the sub-sector output can be 61.3% below the level of pre-crisis peak year of 2007. Note, the peak for the sub-sector was back in 2004 and if things continue on trend, 2011 output will be a whooping 74% below that.
• Distribution, transport & communications sector is likely to post another decline this year - shrinking by some 1.1-1.2% against a decline of 2% in 2010. Relative to economy's pre-crisis peak the sector is likely to be down 16.3% in 2011.
  
• Public administration & defence sector will contract 2.4-2.5% in 2011, based on data through Q2 2011, compounding a 2.7% decline in 2010. The sector is likely to fall compounded 4.9% on 2007 and 9% on peak sector contribution in 2008.
• Other services (including rents) - the sector accounting for 51% of our overall economic acitivity (GNP) is likely to post another contraction of -0.6-0.8% this year, compounding a 2.3% fall in 2010 and down 6.6% on 2007 peak.

Hence, GDP is expected to expand by 1.5-1.6% this year on the constant factor basis if we are to use the data from H1 2011, following 0.1% contraction in 2010. This will put our GDP somewhere around 5.6-5.7% below 2007 peak levels.

Taxes, net of subsidies are continuing to fall with 3.5-3.7% decline in 2010 now expected to be followed by 1.8% contraction in 2011. The end of 2011 taxes net of subsidies will likely come in at 32-33% below 2007 levels. This, of course, is driven by the twin forces of rising social welfare costs and continued presence of other substantial transfers, plus a reduced tax take.

With this, overall GDP (in constant market prices) can be expected to rise ca 1.1-1.3% in 2011, based on preliminary data through Q2 2011 (subject to revisions and also reflective of much more robust global economic conditions pre-July 2011 amplification of the crises). This will follow on a 0.4% decrease in 2010, leaving the gross real income 9% below 2007 levels.

Net factor income outflows to the rest of the world are likely to continue rising in 2011, growing 2.4-2.6% in 2011 (assuming amplified crisis conditions do not trigger signifcant withdrawals of retained profits), leaving factor outflows up 4.3% on 2007 levels.

With that, we can expect GNP to rise 0.8-1.0% in 2011, following on 0.3% growth in 2010 and national income will be 11.2% below 2007 peak levels.

Sectoral decomposition of national income by source, so far, stands at:

• Agriculture, forestry and fishing - the flagship sector by subsidies received and attention paid to it (remember, RTE and Irish Times are so keen covering ploughing championships) - contribution to GNP will be a whooping 2.4% in 2011 a 'massive' jump on 2.3% in 2008 and 2009, but still below 2.8% average annual contribution in 2003-2005.
• Industry (including Building & Construction) will be contributing 34.9% on GNP, up on 33.5% in 2010. If this materialises, 2011 will be the best year for Industry since 2003, which, incidentally, shows just how significant the growth in MNCs-led exports-oriented manufacturing was over recent years. As Building & Construction subsector contribution shrank from 9.9% at the peak in 2004 to 2.6% in 2011, manufacturing picked up the slack, pushing Industry overall contribution from 34.1% in 2004 to 34.9% - a swing of 8.1 percentage points.
• Distribution, transport & communications sector contribution is currently running at 15.7%, behind 16.0% in 2010, and at the lowest levels since 2005.
• Public administration and defence contribution to GNP is running at 4.2%, down from 4.4% in 2010, but still ahead of 3.9% in 2006 and 2007 and ahead of 4.0% annual average for 2003-2005. In 2003-2007 sector contribution average was also 4.0%, so our austerity so far is, in relative terms, seeing an increase in spending on public administration and defence as the share of the total economic pie. Now, these two functions are not front-line vital services, last time I checked, so you would expect a rational policy would be to shrink these sub-sectors at least at the speed of reduction in GNP. So far, this is not happening. Another alternative would be to reduce them at least at the rate of decline in taxes importance in the economy. This too is not happening, as shown below.
  
• Other services are likely to contract in their importance in the economy in 2011 (to ca 51.1% of GNP) following a contraction from 53.5% in 2009 to 52.1% in 2010. Large share of these services are exportables, which highlights the fact that not all of our exporting activities are booming.
• Taxes net of subsidies are likely to come in at 11.3% of GNP in 2011, down from 11.6% in 2010 and reaching the lowest level on the record since 2003. 2003-2007 average here is 14.5%, 2008-2010 average is 12.4%, so current state of taxes net of subsidies is worse than any recorded sub-period.
  

Again, to stress, one metric for sustainability of public spending would be to have public administration and defence spending contracting faster than the rate of contraction in taxes. And again, this is simply not happening. Since 2007 taxes have fallen from 15.0% of domestic economy to 11.3%. In the same period, public administration & defence contributions have increased from 3.9% to 4.2%.

Again, to stress, these 'forecasts' or rather 'projections' are based solely on preliminary figures for H1 2011. They are not strictly speaking forecasts, but rather annualized reflections of performance between January 2011 and June 2011. The risks to these are to the downside:

• Decreasing rate of growth in the US and the euro area materialising since May-June 2011 is not reflected in the projections above
• Signs of significant slowdown in broad leading economic indicators (PMIs, investment etc) are not reflected in the projections above, and
• Preliminary data can see significant revisions in time - in Q1 2011, preliminary estimate for GNP decline was estimated at 4.3% and it was revised to 3.0% decline in the current release, so the swings can be quite significant.
  

23/09/2011: QNA for Q2 2011: decent growth=welcome news

Second quarter national accounts were published today and came in with a surprise (in my case) on the upside across both GDP and GNP. Here are the details:

In terms of constant prices (real variables):

• Irish Q2 GDP came in at €41,080mln - a rise of €829mln qoq or 2.1% - strong showing. Last time GDP stood at above €41bn was in Q4 2008. YOY real GDP is up €936mln or 2.3% - another strong figure. However, we are still €3.158bn below Q2 2007 levels (-7.1%). This is a benchmark to reach since it represents the pre-crisis peak.
• GNP came in at €32.683bn in Q2 2011, up €354mln (+1.1%) qoq - growth, but anemic given previous quarter sharp fall-off. YOY GNP is also up 1.1% (+€368mln), but relative to Q2 2007 we are still down 11.7%.

Due to slower growth in GNP, the GNP/GDP gap has widened in Q2 2011 from 19.7% in Q1 to 20.4% in Q2. We are now at the largest gap point since Q1 2003. Importantly, the gap widening - due to higher outflows of profits expatriated by the MNCs - did not push GNP into negative growth this quarter. This reflects positive activity in non-exporting sectors. Income from the ROW - the category that captures profits expatriation - went from -€7.922bn in Q1 2011 to -€8.397bn in Q2 2011, reaching the highest level since Q1 2003.

Index of sectoral activity shows that:

• Consumption activity declined from 98.5 in Q1 2011 to 97.8 in Q2 2011. Index of consumption activity stood at 100.2 in Q2 2010. Q2 2011 marks the second quarter of index falling below 100 (which marks Q1 2005 level of activity). Prior to the last two quarters, index never dipped below 100 in the series since Q1 2005. In constant prices, Consumption has dropped from Q1 2011 reading of €20.336bn to €20.19bn in Q2 2011. This reflects an 0.7% decline qoq and 2.4% drop yoy. Compared to Q2 2007 we are now spending €4.199bn less on Consumption (-10.7%).
  
• Net Government Expenditure has dropped from €6.708bn in Q1 to €6.484bn in Q2 2011 (-3.3% qoq). Government spending is now 3.3% behind Q2 2010 and 10.7% below Q2 2007 levels. Notice that Government consumption decreases are now catching up with those in private consumption. To see this, consider index movements. Recall that in Q1 2005 the index stood at 100. Current index for Government expenditure reading is 104.3, down from 107.9 in Q1, but still above Q1 2005 levels.
  
• Fixed capital formation improved slightly, in terms of index, rising from 46.5 in Q1 2011 to 46.7 in Q2 2011. However this is the fourth consecutive month that the index is below 50. In absolute terms, Gross fixed capital formation was €4.665bn in Q2 2011, up 0.4% on Q1 2011. Capital investment is, however, still 14.3% below the levels in Q2 2010 and a massive 51% below Q2 2007 levels. My recent research, presented last week at a conference in UCC shows that we are now close to failing to cover amortization and depreciation on existent stock of both private and public capital.
• One of the largest positive contributions to growth in Q2 2011 came from the increases in the value of physical changes in stocks, which rose €760mln qoq and €782mln yoy.
• Exports are booming - as we know, and imports rose much less dramatically than exports Q2 2011, so net trade grew, yielding a net positive contribution to GDP. Exports are now up 5.8% qoq against imports rising 3.4%, while yoy exports are up 4.9% against imports rising just 0.1%. This clearly suggests that we are not running 8%+ growth in exports and also shows that transfer pricing is one of the core drivers of our exports as inputs imports are not exactly dramatic. The 8% growth in exports is what underlies much of the DofF rosy projections for 2011 made back in the Budget 2011 (of course, since then DofF has revised its growth projections down to 0.8% annual rate for 2011 GDP).
  

I will post on detailed breakdown by sectors and annual forecasts for QNA series in my next post.

So to conclude & summarise: we have some good news here - both GDP and GNP expanded, against the backdrop of continued growth in MNCs profits outflows, implying that despite sluggish GNP growth, domestic activity (if only carried out by exporting sectors) is growing. These numbers are, of course, subject to significant uncertainty as preliminary data tends to be revised and sometimes substantially, while overall quarterly series tend to show high volatility. Lastly, there is an ongoing slowdown in all leading indicators for Q3 growth both domestically and internationally. And longer-term view is still bleak - with continued domestic and international crises, dead banking sector, prospect of state-sponsored duopoly in the banking sector in the foreseeable future, forthcoming increases in taxation and further cuts in investment, and importantly, the prospect of rising pressures post-crisis on the interest rates expectations.

Nonetheless, for our battered economy of the last 3 years, we can have a light smile tonight.

04/06/2011: The 'Confidence' trick?

Updated below: In the update below I address one particular point raised by some readers of this blog relating to PMIs and my analysis of these.


As promised in the earlier post, for the fans of the 'If only we were confident in Ireland' school of economic thinking... The school of thought, also known as the 'Green Jerseys', maintains that if confidence is high, then growth and employment will follow, so to get Ireland out of the crisis, positive thinking is needed.

Let's take a look at the data.

Keep in mind that we only have data for the period of May 2000-present and only for Services sector. Of course, Services is the largest sector in the Irish economy and it is more labour intensive, so the conclusions drawn from these observations should be expected to remain broadly valid for Manufacturing as well.

If the 'Confidence' thesis holds, we should expect some strong relationship between Confidence reading in PMIs and employment sub-index of the very same PMIs as well as PMIs main index which captures activity. This relationship might be subject to lags, of course, as Confidence sub-index is self-assessment of the future some 12-mo in advance, while Employment sub-index reflects current staffing levels, and the core PMI reflects current activity. Now, keep in mind that the 12-mo in advance expectations is for a continuum, not spot, in other words, growing confidence means expectations for improving business over the 12 months horizon.

First, consider whether there is a coincident relationship between Confidence and PMIs and Employment sub-indices:
Yes, there is a strong positive relationship between expansion signaling readings of confidence today the future and current levels of economic activity as measured by employment and PMIs. In other words, things tend to be optimistic (pessimistic) when PMIs are booming (shrinking) and employment is rising (falling).

Sounds like the 'Confidence' theory working? Not really - what's happening here is that when things are great, we expect them to stay great, on average. Alternatively, when things are bad, we expect them to stay bad for some time ahead. Which, of course is consistent with the fact that data we have covers 2000-present - two periods of pretty much persistent boom and then bust.

So let's take a look at change from month to month.

• Does change in confidence imply change in current PMIs and employment? (If the 'Confidence' theory is right - it should, as future expected changes in activity should have a positive growth effect on current activity)
• Does change in confidence today imply a change in future PMIs and employment? (If the theory is correct, then it should, with some lag kick in in terms of positive real outcomes)

Sorry, but it appears that a change to higher Confidence in the future in any given month relative to previous month has virtually no relation to either present or future Employment changes or future PMIs. It has a tiny positive connection to present PMIs, however, but barely enough to be called 'significant' from statistical point of view. In other words, we might get all giddy chirpy about the great future we have, and yet it will be unlikely (highly unlikely) - according to the PMIs data - to translate into significant gains in either services activities or employment, neither today, nor in the near future (I tested longer lags up to 12mo and the results do not change by much).

This of course does not mean that positive sentiment is not a good thing for the economy. If positive sentiment is backed by something more tangible - reforms, improved exports, growth in consumer or investor confidence - some real productive fundamentals, then of course it will matter. But that is not the 'Confidence' theory. The 'Confidence' theory says 'negativity hurts economy'. No, folks - it doesn't. You can't talk yourself into a recession. And the 'Confidence' theory claims that if we get 'positive' about the future, things will improve (presumably improve significantly, otherwise, what's the point). This is not what the data is showing.

So what's going on, then? We know that Confidence is associated with performance, but we also now know that at least in Ireland, over the period looked at, changes in confidence are not associated with changes in performance either today or in the future.

Of course, Ireland is a small open economy. Which means it is volatile and is subject to constantly shifting external 'winds' of change. May it be the case that 'Confidence' theory doesn't work in Ireland because our real economy is subject to external forces and shocks? Ok, let's test this proposition. Let's control for contemporaneous backlog of orders, leaving only that component of Confidence that is not influenced by these backlogs. In other words, let's consider that part of our self-assessed optimism (pessimism) that is unrelated to the actual observed increases in new orders (decline in these orders). Furthermore, let's slightly smooth the series tor educe volatility by using a 2mo moving average on all variables.
An interesting result above. The link between confidence and contemporaneous PMI and Employment is now virtually gone (compare the results with Chart 1 above), which exactly supports my conclusions made following Chart 1. What matters to the turning of the economy, folks, is the real economic activity - rising backlogs, new orders, new export orders. What doesn't matter much at all, it appears, is 'Confidence'. So, please, go on, feel great - it might improve your smile, your utility, your view on life - all of which are great results. But don't hold much hope that it will improve the economy and reduce unemployment.

In the end, to achieve these two objectives, we need new businesses to be created, new markets to be accessed, new products and services to be developed and marketed, and so on, and new reforms implemented. Unfortunately, the 'Confidence' theory can lead us into complacency of avoiding making hard choice to have such reforms, to support our entrepreneurs, our companies and workers.

Ignoring the rain might make getting wet tolerable or even fun, but it won't make you any less soaked.

Update: Some websites contain references to these series of posts on PMIs. In particular, there is an occasional refrain to my view that (1) I would prefer seeing strong (above 60) readings in some sub-indices, and (2) my insistence that an 'improvement' in the sub-index reading from a number below 50 to another, higher number below 50 is not an improvement. Let me explain my views on these 2 points.

1. Readings above 60 are rare, that is true. But PMIs refer to comparative/relative performance metrics. Now, real recovery is not, I repeat - not - associated with growth returning to a long-term trend, but growth overshooting long-term trend as economy goes from negative growth (contraction) to expansion. Thus, for example in the Services series, near-recession of 2001 is returned to growth by PMIs reaching for 60.8 by April 2002. In Manufacturing series contraction in October 2001 to 46.1 is returned to growth with June 2002 reading of 54.5 (so -3.1 from 50 to +4.5 - a ratio of 1.45), contraction of July 2003 (45.8) is returned to growth with a peak of 55.2 in June 2004 (-4.2 to +5.2 - a ratio of 1.24). Now, bottom of the latest contraction was at 32.6 which should be consistent - if we take the above two episodes averages (ratio of 1.35) - with a rise to above 67. We've gone up to 62 in March 2010, but we have not seen this translate into overall economic growth. Hence, my preference would be to see more episodes of 60+ readings in PMIs. Either way, all of the episodes we have on the record so far are episodes relating to either 'near recessions' or temporary declines in the series not associated with a recession at all. Except for the current crisis, that is. O course, this 60 is not a 'hard' target. Read carefully what I said (here): "Either way, of course, I'd rather see PMIs at above 60 reading, than heading for a downward territory". This is a statement of 'truism' - as in: I'd rather see things improve than get worse. Sadly, some anonymous commentators on some of the forums out there are not getting even this simple concept...
2. When the series read below 50, the series show contraction. Thus, for example, a reading of 44 in one month followed by a reading of 46 in the next month does not mean that economy has improved from month to month. It means that the economy has deteriorated at a slower rate. If you are familiar with compounded effects of recessions (expansions), you would know that having a loss of 10% in month 1 followed by a 5% decline in the other month implies a cumulative decline of 14.5%. An improvement would be if following a 10% drop in on month, economy grows by, say, even 1% in the next month, thereby reducing the original decline to a cumulative decline of 9.1%. Let me quote Brad DeLong on this: "Getting worse more slowly is not the same as getting better".