Investment Remains the Key to a Real Recovery

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The Irish recession which began in the final quarter of 2007 is the most severe in the history of the state. GDP contracted by 12.1% in a little over two years ending in the 4th quarter of 2009. That slump is not over. The latest data shows that the economy still remains 3.4% below its pre-recession peak. In effect it is likely to take 5 years or more simply to recover the output that was lost in the slump.

Even then, the economy will remain way below its previous trend rate of growth. This is illustrated in Fig 1 below, which shows real GDP and real GNP from 1997 to the present. The average annual growth rate of the Irish economy from 1997 to 2007 was approximately 6%. Maintaining the trend rate of growth would have led the economy to be approximately 50% larger than it is currently, and there is a danger that this potential is lost permanently.

Fig.1 Medium-Term GDP & GNP

Fig.1 Medium-Term GDP & GNP

The causes of the slump are very clear. Over the entire period of the crisis the fall in investment more than accounts for the entirety of the decline in aggregate measures of output, either GDP or GNP. GDP in the 2nd quarter of 2014 is still €6.6bn below its late 2007 peak. Investment (Gross Fixed Capital Formation, GFCF) is €14.4bn below its peak. There are other compoents of GDP which have also failed to recover, notably personal consumption and government expenditure. But even taken together, their combined fall of €10.1bn is less than the fall in investment. The only component of GDP which has risen is net exports. The change in components of GDP is shown in Fig.2 below.

Fig.2 GDP & Components In the Slump. Source: CSO

Fig.2 GDP & Components In the Slump. Source: CSO

This data belies the notion that there is an ‘export-led recovery’ under way. Recorded net exports have grown very strongly, up €30.5bn over the period. But only one quarter of this or €7.4bn is a rise in the export of goods. A much larger statistical contribution has arisen from the decline in the imports of goods, down €14.6bn. As both investment and consumption have fallen, this simply suggests that both firms and households have been priced out of world markets by reduced purchasing power. The remainder of the rise in net exports is derived from international trade in services. These are particularly prone to the tax-induced flow of funds that plague the Irish economy and completely distort the economic data. There is little benefit from attempting to unravel them.

More importantly, it is clear that exports have not led a broad-based recovery at all. All the main domestic indicators of activity, consumption, government spending and investment are still far below their pre-recession peaks.

The Recovery

The low-point for the Irish economy was reached in the 4th quarter of 2009. There is not yet a recovery. But there is a rebound from that low-point, which has not always made smooth progress. Every year since 2009 has seen at least one quarter of economic contraction. It is hoped that 2014 will be different.

One reason for this volatility in the data is the activity of multinational corporations. For example one large order for aircraft, none of which are produced in Ireland but are booked in this jurisdiction, can provide a large one-off boost to GFCF and to GDP.

The engine of the recovery is also clear if we take the inflection point from the 4th quarter of 2009 to the most recent data. This is shown in Fig.3 below.

Fig. 3 Change in GDP & Components in the recovery. Source: CSO

Fig. 3 Change in GDP & Components in the recovery. Source: CSO

The rebound in both GDP and GNP since the end-2009 low-point is driven solely by the rise in net exports. Of the €24bn rise in net exports over that period just €8bn is a rise in the net export of goods.

Otherwise there has been no improvement in the other components of GDP even during this phase. Personal consumption and government expenditures have fallen by a combined €2bn. Again, this is exceeded by the fall in investment, down €2.7bn since the end of 2009.

The motor force of the Irish economic slump has been the fall in fixed investment. Ireland’s openness to the world economy (its high degree of participation in the international division of labour) provides a real benefit to the economy, even if that is vastly overstated in the official data.

But for exports to lead the economy investment must grow. Otherwise Irish goods (and genuine services) become priced out of world markets. The investment strike in Ireland has not ended. Until it does there can be no confidence in the sustainability of any eventual recovery.

Image of the Financial Times editorial which claims that recent economic figures for the Irish economy provide an example for Europe and how taking ‘a sharp hit following the downturn is paying off’. Taken from the Irish Independent.

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