A slew of data about the Irish economy published in the past two weeks all points to a remarkable turnaround in the State’s economic fortunes.
Headline growth, at 7.8 per cent, is comfortably the highest in Europe . Employment is growing at a faster-than-expected 3 per cent and is now close to its pre-crash peak. Retail sales, perhaps the strongest indicator of consumer confidence, are growing by 6 per cent despite fears that a weaker sterling may send shoppers across the Border.
However, nagging questions about the relevance of our growth metrics and in particular the contribution of multinationals remain while, on the horizon, Brexit and changes to the global tax environment loom large. One or both could derail the current upswing.
On the multinational question, it may be that Ireland is suffering from a bout of cognitive dissonance. Internationally, we defend their importance to the Irish economy, insisting they provide real “substance” and jobs: at home, we’re busy trying to remove them from our national accounts.
As Ireland seeks to exorcise some sort of national guilt about the preponderance of multinationals here and their aggressive tax stratagems, the Central Statistics Office (CSO) has developed new measures to factor out their transactions.
But measures such as modified domestic demand and modified gross national income (GNI*) – the CSO’s attempts to de-globalise the Irish economy – are unlikely to be anything more than statistical curiosities.
Gross domestic product (GDP) remains the official yardstick and its troubling gyrations are unlikely to go away.
Since 2013, GDP here has grown by 50 per cent, placing Ireland ahead of China in global growth terms. As a result, the value of the Irish economy is now close to €300 billion, 56 per cent higher than it was at the peak of the Celtic Tiger in 2007.
Sluggish wage growth
Needless to say, Irish people are not 50 per cent better off as a result, far from it. Outside of the IT and finance sectors, wage growth has been sluggish, household debt remains elevated, and big-ticket items such as housing continue to erode purchasing power.
Telling people they’re in the midst of a remarkable economic turnaround when they’re not feeling it in their pockets is a dangerous thing, as the Government found to its cost at the last election.
Despite its prevalence, GDP, a metric invented in the 1930s-1940s when the world economy was dominated by manufacturing, has long been a poor indicator of economic wellbeing. It is now also clearly failing to adequately account for the increasingly intangible nature of the global economy.
The most valuable companies in the world – Apple, Google and Facebook – are nearly entirely defined in value terms by their intangible assets, in other words the patents and trademarks that go with their products.
Apple’s decision to move a significant chunk of its intellectual property (IP) here in the wake of a global clampdown on tax avoidance caused a near tidal wave in the national accounts. But it was Ireland, not Apple, that got the blame as the tag “leprechaun economics” indicates even though the CSO was only following obligatory accounting standards.
"We can't go on having asterisks beside everything," economist Dan McLaughlin says. "We either say that we've been phenomenally successful at attracting multinationals and that they produce a lot stuff which, under the new accounting standards, is included in our GDP.
“But we can’t have it both ways. We can’t defend the idea that multinationals are real and then simultaneously start stripping them out of GDP,” he says.
One of the headline indicators that isn’t distorted by globalisation is employment, McLaughlin says. “If you just concentrated on the labour market, it’s very clear there’s been a massive recovery in the economy. You might even say it’s booming again.”
Last year, employment here rose by sharper-than-expected 3 per cent, bringing 66,800 people back into the labour market.
Since the nadir of the crash, the unemployment rate has fallen 10 percentage points from a peak of 16 per cent in December 2011 to 6.1 per cent last month. We’re now on course to hit “full employment” – equivalent to an unemployment rate of 4-5 per cent – early next year.
“I doubt anyone anticipated that,” McLaughlin says.
Former Central Bank governor Patrick Honohan always maintained that employment was the best lens through which to view Ireland's recovery.
Even with this considerable turnaround, total employment is still marginally below pre-crash levels. That contrasts with runaway GDP and reveals that, in employment terms, the effects of the crash are still not entirely a matter of history.
One of the main accusations levelled at the Government and the CSO recently by the Economic and Social Research Institute (ESRI) was that it was next to impossible to estimate sustainable growth for budgetary purposes with the current set of indicators. However, for McLaughlin, consumer spending would be the figure to look at when framing a budget. It rose by a modest 1.8 per cent last year, a figure that’s out of kilter with the numbers for retail sales and employment.
McLaughlin believes that, as currently collated, the measure of consumer spending may be failing to capture the full extent of online spending. Regardless, his point is that the traditional national accounting measures are still the best aggregates for assessing the Irish economy, even if headline GDP is polluted by R&D imports and aircraft leasing.
In any case, the economy’s bounce back to vigour brings with it a new and different set of challenges. Capacity constraints and the risk of overheating are now increasingly the focus.
While most point to bottlenecks in housing and transport, the capacity constraints can be seen in a myriad of areas. It can take up to 28 weeks to get a driving test, for instance, and there’s currently a backlog of some 45,000 applications.
For the ESRI’s Conor O’Toole, however, the three big roadblocks ahead of us are the labour market with the economy converging on full employment; housing; and investment by domestic firms.
“The growth in employment is happening cross-sectorally and across occupations. There are few areas left where we can see spare capacity to be mopped up if there’s further growth,” he says.
“To alleviate this, we will be reliant on inward flows of migration, which may or may not be available.” Stronger growth outside of Ireland may hinder the inward flow of labour here, he notes.
Despite the acceleration in employment, pay growth has been unusually limp, albeit this has been a feature of the global economy since 2008.
Normally when economies tend towards full employment, wages begin to rise as employers chase a shrinking pool of labour. Instead we have a low-wage, jobs-rich recovery. This isn’t easily explained. It might be linked to digitisation, the gig economy and/or the general shift away from industrial-based activities to service ones, which typically command lower wages.
O’Toole speculates that it may be just taking longer than expected for wage pressure to build in the Irish economy and that it will become more pronounced as we get closer to full employment. The ESRI forecasts that unemployment will fall to a near record rate of 4.5 per cent in 2019.
While we’re unlikely to see another credit-stoked boom and bust, O’Toole says a serious hike in wages could erode competitiveness and halt the current momentum.
Another area of constraint, O’Toole says, is investment in domestic enterprises. Recent ESRI research suggests SMEs here are underinvesting in their businesses given the potential for growth.
Housing undersupply
However, the logjam that receives most attention here is the housing market. “We continue to have substantial undersupply in residential accommodation in both the rental and owner-occupier sectors.”
While the ESRI is forecasting 24,000 new home completions this year, and up to 30,000 in 2019, these levels are still thought to be well below the level of structural demand, which the ESRI estimates to be in the region of 35,000.
This is continuing to put pressure on the domestic economy, bidding up rents and house prices, O’Toole says.
Ibec chief Danny McCoy sounded a warning about diminishing competitiveness this week, noting rents on Baggot Street in Dublin 2 where Ibec has its headquarters have risen from €25 per square foot to €62sq ft inside three years. He argues that the erosion of competitiveness in the economy is now moving faster even than during the heady days of the Celtic Tiger.
But, in an address to business leaders, McCoy said the current disquiet over Ireland’s headline growth rates was misplaced.
“GDP is the official, international measure of an economy. If that’s driven by intangibles – as it has been as a result of the OECD work – to deny that is to miss the opportunity,” he said.
Ireland was effectively a resource economy, he said, but instead of the resource being oil, “we’ve found something more valuable, which is intellectual capital”.
However, he warned the State was consuming “this largesse” without investing in infrastructure and the education system necessary to make it sustainable.
The catch-22 for the Government is that if it addresses these capacity constraints too swiftly it will overstimulate the economy. Failing to do so may overheat the economy anyway.
Minister for Finance Paschal Donohoe has said he’ll shelve tax cuts if he feels the economy is starting to overheat. The next budget, however, is also likely to coincide with an election cycle, an event that can blur the objectives of even the most fiscally prudent minister.
Trying to provide tax cuts, the Government's stated aim, and build capacity while delivering a neutral budget is next to impossible, Trinity economist Frank Barry says.
“Any increase in expenditure into the economy now will be pro-cyclical, which is part of what got us into trouble initially.”
Barry also highlights the fragility of the Government’s tax base with its increasing reliance on corporation tax revenue, which accounted for 16 per cent of the Government’s record €50.7 billion tax take last year.
The problem is that nearly two-thirds of this comes from a small number of firms paying in excess of €10 million, and almost 40 per cent from just 10 companies. While playing down the likely impact of US tax changes here, Barry says the over-reliance on a few big firms leaves Ireland uniquely exposed to changes in the global tax environment.
Digital tax
A more pressing issue on the tax front is the European Commission’s plan to introduce a digital tax on internet companies such as Google, Apple and Facebook. While the proposal faces considerable opposition, it’s seen as a serious threat to Ireland as it could diminish the appeal of our 12.5 per cent corporation tax rate.
And then there's Brexit. A recent report commissioned by the Government, Nordic think tank Copenhagen Economics examined four possible Brexit scenarios, all which saw Ireland lose out to varying degrees.
The best option for Ireland saw the UK staying in the European Economic Area – akin to the Norway arrangement. That would see GDP fall 2.8 per cent by 2030 when compared with a no-Brexit scenario.
The worst-case scenario is a reversion to World Trade Organisation rules in the absence of a trade deal – the so-called "hard" Brexit. In this case, GDP here could tumble by 7 per cent by 2030.
The economic threat from rising costs for imports of goods – both to the individual household and the wider economy – were highlighted in a separate ESRI report last week and also by the Department of Finance.
The number of caveats associated with Brexit make forecasting a tricky business and the ESRI was keen to point out that its growth forecasts for Ireland for 2019 assumed a Norwegian-style arrangement, which is a big if.
Overall, it might seem like we’re back to the early part of the boom where growth is being driven by genuine economic activity and not some credit-fuelled binge on housing.
The risk from capacity constraints and international events such as Brexit, however, cloud the outlook. How we cope with the latter will define the next phase of our economic performance.
