ECONOMICS:Believe it or not, history tells us that the good times will roll again. Here's what we can expect, good and bad.
THESE DAYS, there is much talk about recession, economic slow-downs and soft and hard landings. There is even the occasional whisper about the dreaded word depression and, indeed, a few commentators have suggested that the problems in the US could lead to a reprise of the 1930s.
This is scare-mongering, but the fact remains that there is much uncertainty and confusion. And views about the economic feel-good factor tend to be subjective. Someone once pointed out that when your neighbour loses his or her job it's a recession, but when you lose your job it's a depression.
The term depression seems to have disappeared from the language since after the 1950s and was replaced by the term "growth recession" which means that the growth rate of the economy falls. Real Gross Domestic Product (GDP) might still be growing but at a slower rate than normal for the economy in question. Most recessions in the post-war period have been of this type and it is difficult to see the present one being much different, though the growth rate in the US could come close enough to zero for a year or so, instead of its normal growth of 2 per cent to 3 per cent per year. It is very important for Ireland that the US corrects its problems as soon as possible because the spill-over effects here are very strong. The main reasons to worry about our economic future are as follows:
THE LOWS
Recession
A growth recession does seem likely here and in the US. Real GDP in the US has been slowing and the current figures indicate that it is well below its average potential growth of about 3 per cent.
Some commentators think it may be close to zero for 2008. Forecasts for the EU are more up-beat than this and for Ireland a growth rate of about 1.5 per cent seems likely.
While this is better than zero, it is way down on the growth rates of the past - in fact the lowest for 20 years. Because of this we are likely to see a virtual cessation of net job creation and a rise in unemployment. It is also likely that immigration will slow down and we will lose the skills that immigrants have brought with them in the past few years.
Slower growth also means less revenue for the Government and this could be bad for the provision of important services in sectors like, health, law enforcement, and public transport. In fact, the Exchequer was in deficit to the tune of €354 million in the first quarter of this year compared with a surplus of €1.86 billion in 2007.
Construction
The undue reliance on construction in Ireland means that the slow-down in house-building will impact strongly on overall growth. People don't want to buy houses while prices are falling; there is an understandable desire to wait until prices bottom out.
Moreover, banks are much more careful now about approving mortgages. In fact the growth in mortgage-lending is now lower than it has been for 14 years. Builders are reluctant to build more houses while they have unsold units on their books. Difficulties in the construction sector will quickly spread to other related sectors, eg furniture, interior decorating, DIY stores, etc.
Chinese competition
Extremely keen competition from China and other low-wage economies is being felt by Ireland and Western economies generally. This is not going to go away and more job losses here will be inevitable.
Attempts will be made to replace these jobs with more high-skilled ones but this requires a major transformation of the economy which can't be accomplished overnight.
Property and equity
The fall in equity and property markets in Ireland makes people feel poorer, less confident, and more reluctant to spend their hard-earned money.
This hits consumer spending which is a large part of GDP - around 60 per cent. Tax figures show a fall of €600 million in the first quarter of 2008; of this some €253 million relates to VAT which is of course levied on consumer goods. Surveys of pedestrian footfall in Dublin shopping streets indicate falls of up to 10 per cent. This is not unexpected because many people are highly indebted to the banks due to large mortgages and credit card debt.
Lower consumption will lead to lower orders for manufacturers and other producers and is likely to give rise to job losses. If people lose their jobs they will have even less money to spend and a downward spiral could set in.
Bad debt
The banks, especially in the US but to some extent here, don't want to extend more debt because they are afraid of incurring more bad loans. This is sometimes called a credit crunch. In addition, many financial institutions are finding it difficult to borrow money from banks which have a surplus because these banks are afraid they won't get their money back.
They don't know if the borrowing institution is healthy or not; it could have some sub-prime mortgages on its books or other "toxic" products that the financial sector developed in boom periods. The reluctance of banks to lend money among themselves is not so serious here as it is in the US but it is nevertheless a factor in the slowing down of consumer spending in both countries.
Vulnerable sectors
Irish banks are being targeted by outside speculators who seem to believe that their dependence on property lending makes them vulnerable. This is probably grossly exaggerated-indeed, according to the Irish Financial Regulator, rumours may have been deliberately spread. But unfortunately, even wrong perceptions can lead to falling share prices, not just of banks but of other Irish companies as well.
This in turn reduces the value of peoples' pensions and cause them to be even more cautious about consumer spending. In the first quarter of 2008 the value of Irish managed pension funds fell by over 11 per cent.
Oil
As an oil-importing country, Ireland is being hit by the rise in the price of oil which is now above $106 per barrel. Electricity and gas prices have also risen substantially in Ireland. This makes our production costs dearer and less competitive; it also raises the cost of living.
Exports
Sometimes, when consumer spending slows down, it may be compensated for by an increase in foreign spending i.e. on our exports. This offsetting factor, however, is not likely to come into play. High wage and other costs in Ireland, combined with the high value of the Euro in terms of dollars means that Irish firms will find it very difficult to export to the US (and the UK). This difficult climate for Irish exports will be made worse by more sluggish demand conditions in the US.
Foreign direct investment
It is possible that foreign direct investment from the US into Ireland will fall off as the US economy slows down. If this happens to any significant extent it could be far and away the most important negative event.
Over the years, this type of investment has been extremely beneficial to the Irish economy because it "embodies" high-tech research and development. The presence of so many top-name US multinationals in this country (IT, pharmaceuticals, medical products) has boosted our growth and employment in a major way. If this 'engine of growth' were to slow down the effects could be quite serious.
So, that was the bad news. The good news is that it is not the end of the world. Most modern economies are resilient and can adjust to shocks and slow-downs. Some commentators maintain that, like marathon runners, economies actually need to slow-down periodically, to take a breather.
Another way of looking at it is that a growth recession is like a reality check; it brings us back down to earth and we adjust our behaviour accordingly. There are several reasons why there's no reason to panic.
THE HIGHS
The benefit of experience
Policy-makers didn't know how to handle recessions in the 1930s but they do nowadays. The usual remedy is to increase government spending and/or reduce taxation. This puts more spending power into the hands of consumers and producers. As well as that, central banks can reduce interest rates which encourage people to borrow and spend, and helps stock markets to recover. In exceptional circumstances these policies might not work very well but in normal recessionary times they do work.
Recession have a short life
In the US the average length of recession is about 11 months. This is not a very long time. Even without the sort of government intervention mentioned above, the private sector itself can sometimes pull itself out of recession.
When entrepreneurs find that their plant and equipment is deteriorating they tend to reinvest and this can help get the economy moving again. Banks will return to lending
Banks will have to resume trading with each other at some stage. As time passes more information will become available about which banks have sub-prime and other bad products on their books.
Central banks may be able to help in "cleansing" the system and in providing liquidity where necessary. The "good" banks will be able to borrow again and they will start lending to the good-risk borrowers.
Consumers will help themselves
Consumers will improve their own personal balance-sheets in time. Having tightened their belts and increased personal savings to more comfortable levels, consumers will be able to increase spending.
The US Fed can cut rates
The Fed (US central bank) will probably continue to cut interest rates. They could, in extreme circumstances, go to 1 per cent or even lower.
During the recession in Japan interest rates went to zero and below. In the longer-run it might be a mistake to cut interest rates too much since this could cause inflation. To date, however, the Fed has not worried unduly about that aspect.
In Ireland of course we can't cut interest rates because of EMU membership and it is unlikely that the European Central Bank will cut rates much if at all.
Nevertheless, the action of the Fed will help the US economy to recover and this will be to our benefit. It might also be noted that the US Treasury is bringing in a stimulatory package of tax rebates for individuals and tax breaks for businesses.
A weak dollar has an upside
Although dollar weakness was mentioned as one of the factors causing problems for Irish exports, it is likely to have a beneficial effect in the longer term. This is because the low dollar will boost US exports and help the US economy to recover. The rising tide should raise the Irish boat.
America is a safety net too
America's pre-eminence in the information economy and its entrepreneurial flair will provide a safety net. The recession probably won't be that deep.
While the problems in the financial markets are serious there is a possibility that the worst effects will not spill over to the real economy. Several analysts maintain that Wall Street has a limited effect on Main Street. Let us hope so.
Even gold has a top price
Money can't simply disappear or continue to flood into gold and other exotic commodities because the prices of these will reach levels which will not be considered sustainable.
The price of gold is already $900 an ounce. At some point money will find its way back into equities and property, i.e. more normal assets. Recovery in these markets will help restore confidence and increase consumer spending.
Nothing lasts forever
The Irish economy should recover in due course (though there is little prospect of seeing the Celtic Tiger years again).
Direct investment from the US should resume, on the assumption that we maintain a favourable tax regime and have a highly skilled labour force.
We also have good demographics, with half of the population under 35 years.
Many analysts estimate that our potential growth rate is above 4 per cent a year which is high by international standards. The equivalent figure for the US is around 3 per cent and only 2 per cent for the EU as a whole.
But we must adopt good policies in relation to wage settlements and budgetary dispositions to be in good shape for the recovery when it comes.
The Government will no doubt be tempted to borrow money to make good the shortfall in tax revenue.
Some borrowing might be appropriate on condition that the proceeds are used productively but this condition has, unfortunately, not been met in the past. Borrowing, therefore should be kept to a minimum.
In conclusion, there are good reasons to be concerned about the Irish economy for the next year or so.
But a growth recession is not an apocalyptic event and the economy should recover in time. Much of course will depend on correct policies being implemented.
Michael Casey is a former senior official with the Central Bank and a former member of the board of the International Monetary Fund
