With recent evidence pointing unmistakably to an improvement in the Irish economy, three important questions arise.
What is driving the revival in economic growth? Are there grounds for optimism that the recovery can be sustained? And what do improving economic prospects mean for economic policy, especially for the next budget?
The economic recovery that is gathering momentum in Ireland is most visible in the labour market. Gains in employment averaged about 4,000 per month over the past year, corresponding to one of the fastest rates of job creation in Europe. It is worth recalling that the economy lost nearly 8,000 full-time jobs per week in early 2009, as the construction and other property-related sectors collapsed. At the current pace of growth, employment is expected to approach the 2 million mark by the end of next year. The unemployment rate, though still at elevated levels, has fallen more than 1½ percentage points over the past year to 11.6 per cent in June and is down about 3 percentage points from its peak in 2012.
Other indicators are also pointing to recovery. Growth in the volume of retail sales (excluding motor vehicles) averaged nearly 3½ per cent over the first six months of this year and recent surveys have recorded strong increases in consumer confidence. New car sales are booming. Asset prices, including house prices in our main cities, have risen sharply. The export sector continues to expand and is expected to remain the engine of growth for the Irish economy of the next few years.
The recovery is being driven by three main factors.
First, the performance of the Irish economy over the past decade was dominated by the boom and bust in the property market. Other sectors of the economy, where Ireland has long-established real strengths at a global level, were less visible in the economic statistics. With the bottoming out of the construction industry and property market, these underlying economic strengths have come to the fore. Sectors such as Med-tech, Information and Communications Technology, Pharmaceutical, Agri-food, and Tourism are now driving recovery. Generally speaking, these were the export-oriented sectors that propelled the economy during the genuine “Celtic Tiger” era in the second half of the 1990s, before the property bubble and related excesses in banking activities came to dominate. Growth in these sectors has been supported by improvements in Ireland’s international cost competitiveness and by revivals in economic growth in the UK and US. The strengthening of sterling against the euro on foreign exchange markets over the past year has also boosted our exports to Britain.
As always, there is considerable uncertainty surrounding any forecast for growth. Recent geopolitical events abroad remind us of the significant risks to the economic outlook. That said, it is reasonable to project that exports should continue to grow at a solid pace and employment in export sectors should continue to expand. Moreover, the shortage of housing in Dublin (and to a lesser extent in Cork and Galway) creates the potential for an increase in activity in the depressed construction sector.
Second, decisive policy actions at home in response to the economic and financial crisis were critical to putting the economy on the road to recovery. These policies centred on sustained efforts to reduce the budget deficit and rebuild the devastated banking system. Those who argued that the tax increases and spending cuts introduced over the past six years to restore order to the public finances would prove counterproductive have been proved wrong. The budget deficit looks set to decline to comfortably below 3 per cent of GDP next year, compared with double-digit levels at the onset of the crisis. Of course, fiscal consolidation, though necessary, has been painful and has put a drag on domestic demand. The good news is that the vast bulk of budgetary actions are behind us. With moderate wage increases, disposable (that is, after tax) incomes should begin to rise over the next couple of years. Put simply, workers are likely to have more money in their pockets in 2016 than in 2015. This extra cash should give some additional boost to consumer spending.
Given these trends, the Government should resist the temptation to try to stimulate consumer spending by bringing the programme of fiscal adjustment to a premature end in this October’s budget. It is clear that the political system will not be able to tolerate the full €2 billion in adjustments previously pencilled in. A political crisis followed by a general election in the next few months is not in this country’s economic interest. But the Government should strive to get as much of the remaining adjustment over with as quickly as possible so that households can be confident that their disposable income is finally on a sustained upward trajectory.
Third, policy actions abroad have been supportive. The ECB’s bond-buying programme introduced in September 2012 deserves most of the credit for ending the panic that had debilitated European debt markets during much of the crisis. The resulting substantial improvement in investor confidence in the peripheral euro-area economies was a pre-condition for a return to economic growth.
However, inflation is currently too low in Europe and the authorities need to do more to guard against a descent into deflation. Interest rates are expected to remain at very low levels for the next several years – a boon for borrowers with tracker mortgages. Although the Irish economy continues to improve, the recovery is far from complete. Unemployment is falling at far too slow a pace. Household and small business debt levels remain high. Absent large shocks from abroad, however, a return to some semblance of economic normality, where households can reasonably expect incomes to rise each year, looks to be just around the corner.
Professor Alan Ahearne is Head of Economics at the National University of Ireland, Galway
