Not a Vintage Year

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This is a post by Michael Burke originally posted on Notes on the FrontMichael works as an economic consultant. He was previously senior international economist with Citibank in London. He blogs regularly at Socialist Economic Bulletin.  You can follow Michael at @menburke

2010The publication of the ESRI’s latest Quarterly Economic Commentary follows the recent publication of the national accounts for 2014. But they were both strangely muted affairs given that the headlines were GDP growth of 4.8% in 2014 and GNP growth of 5.2%. The ESRI is forecasting 4.4% and 4.1% respectively for 2015- although it does not have a very good forecasting track record.

Not only are these the strongest actual and projected growth rates since the recession began but they are also the strongest growth rates in both the EU and in the OECD. So why the long face? Why are people still taking to the streets to protest water charges and the government parties getting no bounce in the opinion polls?

One factor is that despite all the talk of recovery, even on the distorted GDP measure of activity the patient is still convalescing. The economy has not returned to its pre-recession peak, as shown in Chart 1 below. GDP contracted by 12% from the end of 2007 to the end of 2009. In the 5 following years about 70% of that shortfall has been recovered.  On that trend it will be 2016 before the economy is finally in recovery.

Chart 1. Real GDP

MB ESRI 1

On most indicators including GDP the level of activity is now back to around the level last seen in 2010, which was hardly a vintage year. Following a deep recession, industrialised economies much more usually bounce back equally sharply. But this is a slow, painful and incomplete recovery from a deep recession.

Stagnation apart from exports

There is another factor in the subdued mood. GDP is a measure of activity. But it is not designed to be a measure of prosperity. It is widely accepted that recorded export activity is hugely distorted by the activities of multinational company operations in Ireland. Yet since the economy stopped contracting at the end of 2009 these highly distorted net exports (exports after imports are deducted) have risen by an annualised €16bn, almost exactly equal to the rise in GDP.  Net exports, many of them purely fictitious, account for the entirety of the partial recovery.

Chart 2 below shows that the key components of domestic activity are either still falling or are stagnating after a sharp fall. Personal consumption is over €7bn below its peak on an annualised basis and is stagnating. Government spending is €5.6bn below its peak and continues to contract. Popular anger is actually inclined to grow the more there is talk of ‘recovery’.

But the most dramatic contraction is in fixed investment which is now €23.6bn below its peak at the beginning of 2007. The decline in investment led the recession and continues to act as the main brake on recovery. The fall in investment now far outstrips the total decline in GDP since the recession began.

Chart 2 Personal Consumption, Government Consumption and Investment

MB ESRI 2

There might be grounds for increased optimism if the ESRI were plausibly making the case for higher consumption, government spendign and investment. But that is not the case. Private consumption and government consumption are projectedf to rise by just 2% and 0.5% respectively in 2015. Investment is forecast to rise by 12.5% following a double-digit increase in 2014. Even if the ESRI’s optimism is borne out, the fall in investment is now 60% from its peak. So it would take another 4 years of growth at that pace to begin a full recovery.

One area that is definitely improving is government finances. This reflects the very deep cuts made to date, off-set in part by the impact of those same multinationals parking profits in Ireland. But the effect is to produce ESRI forecasts of a general government deficit of 2.3% in 2015 and 0.3% in 2016.

There never was any justification for austerity measures as the crisis was caused by a private sector refusal to invest, not over-spending by the public sector.  Any further austerity measures would amount to sadomasochism. Instead, the debate has already switched to the prospects for different forms of tax cuts.

There is certainly a need to improve the living standards of households. But tax cuts are the least effective means of achieving that as they only benefit income tax payers not the very low-paid or those not in work. They also disproportionately benefit high earners. There is a better way, or a number of them.

Exceptional era

The ESRI makes no forecasts for long-term interest rates and, aside from the fall in debt interest payments, they barely feature in ESRI calculations. This is an important omission.

We are living in an exceptional era.  The government can currently borrow for 10 years at an interest rate of just 0.8%. If the ESRI is correct it will also have borrowing head room of approximately €12bn over this year and next while still meeting the Maastricht Treaty criteria on deficits. If there is nothing that this government can invest in with an annual return of 0.8% or more (and so provide a surplus for the public sector), then it should go home. For example, the OECD estimates that the Irish government’s rate of return on its investment in tertiary education is 17.5% per annum.

To lift living standards, improve public services and raise investment a rational economic policy would allocate government resources in the proportion which they have contributed to the current crisis. This would see approximately 15% allocated to current government spending, about 20% to boosting household incomes and the remainder to public investment.

But we seem to be a long way from rational government. So there is no popping of champagne corks just yet. We are still living with the miserable vintage of 2010. It doesn’t have to be that way.

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