Tuesday, June 24, 2008

The Government isn't working

Economists are predicting unemployment of over 7% in 2009, and that Government borrowing will exceed EU limits next year if public spending growth is not reduced to historically low levels. The massive public finance surplus, on which the Government based its election promises, will be all gone by next year. This raises the spectre of a return to net emigration for the first time since the 1980s, with the numbers having to leave the country to find work exceeding those coming here by 20,000 per year. The report includes the ESRI's fifth successive downward revision to its outlook for this year. It says the impact of declining consumption, slower exports, the building slump, and the international credit crisis have been much worse than feared. And it expects the first Irish recession in 20 years.

But speaking on RTÉ Radio's Morning Ireland, report co-author Dr Alan Barrett said the prospects of getting out of this recession were better than those of the 1980s. The ESRI argues that the Government should break European rules and borrow €11bn to run the country next year. It says pay restraint must be imposed in the public sector, and it calls for State agencies to do more to help the unemployed. will experience a recession this year for the first time since 1983, and a return to net emigration next year, the Economic and Social Research Institute (ESRI) forecasts in its latest Quarterly Economic Commentary, published today. It anticipates that the economy will contract in size by 0.4 per cent this year after growing by 4.5 per cent in 2007. This recession reflects a steep decline in domestic demand, according to the ESRI, which calculates that the volume of domestic spending this year will fall by 2.6 per cent. Investment spending is forecast to fall by 14.9 per cent while real consumer spending growth in 2008 has been revised downwards by the ESRI to just 1 per cent from 3 per cent just three months ago. Shares in Irish companies fell heavily as news of the report leaked into the market. Bank shares were particularly badly hit, with Bank of Ireland down 5 per cent.

The ESRI expects economic growth to resume next year, with a forecast expansion rate of 1.9 per cent. However, this will be insufficient to stem a recurrence of net emigration in 2009. The ESRI projects that the outflow of people from the country will reach 20,000 next year, a level of net emigration not seen since 1990. The reappearance of net emigration signals a steep deterioration in domestic labour market conditions. The ESRI projects that the level of unemployment will increase by 60,000 or 60 per cent between 2007 and 2009. The unemployment rate - the number out of work as a percentage of the labour force - is expected to climb from 4.5 per cent in 2007 to 6 per cent this year before increasing again to 7.1 per cent in 2009. The numbers at work in the economy next year are forecast to be smaller than in 2007. Yesterday, the financial services group Hibernian announced plans to move more than 500 jobs to Bangalore in India in the next three years. The recession will also derail the public finances. From an overall budget surplus of €5.2 billion in 2006, the Government is expected to incur a deficit of €7.4 billion in 2009, a turnaround of more than €12.5 billion in the space of three years. Consequently, the overall budget deficit is projected to grow to 3.9 per cent of Gross Domestic Product (GDP) next year - above the Maastricht criteria requiring a deficit of less than 3% of GDP. The large budget deficits projected for this year and next would cause the burden of the national debt to increase by almost 10 percentage points. The ESRI reckons that government debt as a percentage of GDP would rise from 25.4 per cent in 2007 to 34.5 per cent in 2009. Reflecting the recessionary environment, house prices are forecast to decline in both 2008 and 2009. The ESRI projects a 6.3 per cent decline in house prices this year followed by a further 1.5 per cent fall in 2009. From the new house price peak in February 2007 to the expected trough early in 2009, the ESRI estimates that new house prices will fall by 17 per cent in money terms and 24 per cent when adjusted for inflation. However, despite the economy receding into recession, upward pressure on consumer prices remains pronounced. The ESRI has revised its prediction for the rate of consumer price inflation this year to 4.5 per cent from 3.4 per cent three months ago. However, it anticipates that inflation will abate to 3 per cent during 2009.

The recession has not been triggered by the global economic slowdown or even by the surge in world prices for energy and food. Its origins are closer to home. The recession is the result of a fall in domestic demand.Last year, domestic demand - which embraces fixed investment, consumer spending and the day-to-day spending of government - increased by 3 per cent in volume terms. This year, the ESRI anticipates that it will fall by 2.6 per cent when adjusted for inflation.With a helping hand from a resurgent export drive last year, the 3 per cent growth in real domestic demand was transformed into a real growth rate in Gross National Product (GNP) of 4.5 per cent. However, in 2008, even the continuing strong performance forecast from net exports cannot offset the sizeable slide in real domestic spending. Hence, this year's recession is home grown.

The origins of this recession can be traced to the construction sector, and particularly its housing segment. The housing boom saw annual housing completions peak at 88,000 in 2006, an unsustainable level of output. Housing completions declined to 78,000 in 2007. Now, the ESRI has cut its forecast for housing completions to 40,000 in 2008 and just 30,000 in 2009. It has also halved its forecast for the volume growth in other building to 6 per cent this year. As a result, the ESRI now anticipates that the volume of total building and construction output will fall by 21.6 per cent this year. The construction sector accounts for over one-sixth of total domestic demand, with this forecast fall in building output reducing domestic demand by 3.75% in 2008. This fall in construction is there the proximate cause of the fall in domestic demand and hence it is the principal agent of the forecast recession.

The growth in unemployment, much of it stemming directly from the building sector, has prompted fears of job losses elsewhere in the economy, as households control their spending. Employment growth is now at a standstill and this has removed the principal stimulus to real consumer spending growth. With price increases accelerating past pay rises, those at work have little in the way of additional real income with which to finance additional consumer purchases.The combination of these forces has caused the ESRI to revise downwards its forecast for real consumer spending growth to 1 per cent this year from 3 per cent just three months ago. As a result, the power of consumer spending growth to brake the fall in domestic demand occasioned by the collapse of construction investment has been significantly reduced. The impact of increases in the quantum of consumer spending and current public spending, together with some additions to investment in plant and machinery, effectively contain the fall in the forecast volume of domestic demand this year to 2.6 per cent. While net exports are forecast to deliver the equivalent of 2.2 percentage points to the national growth rate this year, this is insufficient to offset the downward drag caused by the fall in domestic demand. As a result, real GNP is forecast to fall by 0.4 per cent this year, the first decline in Irish GNP since 1983.

What this underlines is the sheer wrongheadedness of Government policy on the property-market for the past 10 years - but especially since the slowdown of 2001. A decision appears to have been made to concentrate all our economic eggs in the basket of the property-market. Typical of this approach was the failure to fully implement Part 5 of the Bacon Report requiring property-developers to set aside 20% of land on sites to affordable-housing. Fianna Fáil decided to allow developers to get around Part 5 by paying a fine to local-authorities. Furthermore, as Politically-Incorrect as it may still be, the Government's strategy on opening the labour market to the new EU Accession States in 2004 must also be subjected to critical scrutiny. Non-nationals accounted for 15% of market-demand as of last year, contributing to an already overheating part of the economy. Together with our membership of EMU, with its associated one-size-fits-all monetary policy that suits European rather than Irish inflationary conditions, these 3 issues constitute an unholy trinity within the Governments management of the economy. Now don't get me wrong - I am on balance pro-EU - but taken together with these other factors, what I say is correct. The arrival of a new Finance Minister opens up possibilities in terms of rectifying these mistakes, but given the autocratic nature of the new Fianna Fáil leadership, the prospects for that have to be open to question. Fingers-crossed.

No comments: