ECONOMICS:Consumers could boost economic growth. But that will depend on how much they choose to save rather than spend, writes DAN O'BRIEN
WILL YESTERDAY’S new economic growth forecasts, designed to underpin the Government’s budgetary strategy, turn out to be correct? The figures look credible, but the risks are large. Assuming that there is no double dip recession internationally, the greatest risk to the forecasts is if consumers spend less than anticipated next year.
Private consumption – spending by households on non-investment goods and services – accounts for half of gross domestic product (GDP). The Department expects it to stagnate next year. For comparison, the Economic and Social Research Institute is forecasting growth of 1 per cent, the Central Bank 0.4 per cent and the IMF 0.9 per cent (the latter forecast was published in July).
All of these forecasts may be too optimistic. To see why, consider the two factors that are central to determining levels of private consumption: everyone’s total income and how much of this total income is saved and how much spent.
Start with aggregate income. This, in turn, is determined mainly by the numbers in employment and what is happening to wage, salary and benefit levels.
The latest figures show 1,859,100 people at work in Ireland. There is reason to believe that some sectors, particularly those that are export-focused, will hire in greater numbers next year. In addition, an aggressive revamp of labour market policy could help boost numbers at work.
In certain sectors, however, structural change – ongoing and/or to come – will lead to further job losses. These are construction, financial services and the public sector.
A report earlier this week by economic consultants DKM suggested a further 50,000 jobs could be lost in construction and related industries in the year ahead. If this seems a lot, then consider it would bring the total to one-third of the numbers employed at the peak of the building boom. Given that output in the sector is far below one-third of peak, this seems likely rather than merely possible.
The financial services, insurance and real estate sector employs more than 92,000. Remarkably, this has changed little since the financial crisis erupted. Domestically, demand for real estate and banking services is much reduced. With the European Commission’s restructuring plans only starting to be implemented at Bank of Ireland and not finalised for AIB, the downsizing of retail banking remains at an early stage. Internationally, waves of financial reregulation are being implemented, and more is to come. It is very difficult to see the International Financial Services Centre not being negatively affected.
The third area of employment where numbers can only shrink is the public sector. A hiring freeze along with various voluntary exit schemes, such as that which was announced by the Health Service Executive this week, will bring numbers down.
The net effect next year of some job creation in export-focused sectors and structural declines in the sectors discussed above is that economy-wide employment will fall again. The Department expects total numbers at work to decline by about 5,000 on average between this year and next. The ESRI and Central are forecasting a decline of 10,000. It will take very robust rates of job creation in healthier sectors to limit the net change to these projections.
If the numbers at work look set to fall further, what about average incomes?
In the private sector, wage and salary rates may be stabilising. Next year will almost certainly see the stronger sectors – again, the foreign-focused businesses – award increases. But with joblessness staying high, worker bargaining power will be limited.
The outlook for the public sector is seemingly more certain given that the Croke Park deal includes a commitment on behalf of the Government not to cut pay again.
However, tax increases in the forthcoming budget are certain to eat into incomes for public and private sector earners. The outlook for those who depend on welfare payments is bleak – most benefits look set to be cut.
Overall, then, average incomes will fall. As discussed, so will the numbers at work. Total aggregate incomes will therefore decline. In this context, the only way private consumption can grow is if more of total income is spent instead of saved.
Figures published last week show that saving by Irish households soared in 2009. At least some of this very marked shift towards saving is motivated by worries about the future. In general, the greater the level of uncertainty about the future, the more important the “precautionary” savings motive.
If those who are saving for this reason become more assured about the future, they will spend more and save less. There is a possibility that this effect could be large. But it would be wrong to place too much emphasis on it. Irish households need to save to rebuild their balance sheets, as any comparison with other countries demonstrates.
EU-wide figures show that, in 2009, gross savings as a percentage of disposable incomes in Ireland stood at a single percentage point above the euro-zone average. But Irish savings rates need to rise well above EU averages given the state of household balance sheets.
With the debt to income ratio at almost 200 per cent in 2008, compared to 95 per cent in the euro area, the liabilities side of balance sheets is comparatively very large.
As property and equity prices have fallen more in Ireland than in any other euro-zone country, the asset side of household balance sheets has been decimated.
The rational response to this is to increase savings.
Yesterday, the Department if Finance said that it assumes the savings rate will fall from 11 per cent of disposable income now to 8 per cent in 2014. Given that the average rate over the long term rate is 7 per cent, the envisaged change to traditional savings patterns is small relative to the change to balance sheets.
