November 14, 2007
Are we about to enter a winter of discontent? History would suggest that we are. The reason is simple. The end of an economic cycle tends to be characterised by industrial unrest as the workers and company owners try to grab as big a share as possible of the declining spoils.
The strikes at Dublin Bus and Aer Lingus are probably just the start of it.
If we examine economic cycles throughout the past few decades, we see a number of distinct phases.
Initially, as an economy emerges from recession, there are loads of unemployed workers looking to be hired.
Wages are low, so too are expectations and there is a golden opportunity for companies to hire good workers for a song.
Typically, house prices have fallen rapidly in the preceding years, debts have mounted and people are in no mood to borrow. The banks having taken a hit on bad loans in the recession are reticent to lend. But at this stage in the cycle, stock markets are traditionally quite strong as forward looking investors are “pricing in” a strong recovery.
It is crucial to understand how differently investors and workers negotiate. Investors negotiate today based on what is likely to happen tomorrow. Workers negotiate today on what has happened yesterday.
Workers are constantly trying to claw back cash for themselves, while investors are always thinking ahead. As long as the future looks relatively rosy, workers can normally claw back enough to be happy, while investors can factor in these costs and, if they are optimistic, even forecast a profit.
They calculate that as long as demand is buoyant, they can “pass on” these costs to the customer in higher prices.
If we look at our own recent economic history through the prism of the economic cycle, we can see why this week’s industrial unrest might mark the beginning of a process.
Our cycle started some time around the early 1990s when the previously moribund economy began to register a pulse.
Interest rates were low, so that anyone who could get their hands on capital would see a decent profit on an investment.
In the recovery phase, wage costs are typically low and companies will make significant profits as sales grow, but costs are kept down by cheap labour and low interest rates.
As the recovery continues, unemployment falls leading to upward pressure on wages. But employers are doing well and are investing heavily, so the wage demands are given.
Economy-wide, the tolerance of wage demands is dependent on the level of unemployment. The quicker unemployment falls, the smaller the window for higher wages. When unemployment falls to its lowest level, wages tend to pick up strongly.
But in Ireland this did not happen, because mass immigration meant that the supply of labour expanded rapidly.
So, instead of Irish wages rising in the second phase of the recovery, the number of people employed here soared.
Rather than wages rising, tax revenue rose instead, giving the Government a huge windfall which allowed it to expand the public sector enormously.
In economic terms, the “normal” windfall that would have gone to workers in wages as a result of the boom found its way into the coffers of the State.
Typically, as the recovery matures, people start spending and stop saving. This drives up the price of houses and will also push interest rates upwards.
Both these factors, particularly the latter, put brakes on the pace of economic growth. However, in the Irish case, by joining EMU we got interest rates that were priced for a German recession rather than an Irish boom.
So, the economy grew as more and more cheap money was borrowed. This prolonged the boom. German interest rates and mass immigration undermined the built-in, self-regulatory nature of the economic cycle. This implied a longer and more effervescent boom than would normally be the case.
But as Irish workers — and, to an extent, immigrant workers — tried to keep up with a world of rising house prices, they were constantly trying to “claw back”.
What is not clawed back is borrowed, because the average worker tries to keep up. This is why we have seen an explosion in borrowing in recent years as workers try to bridge the gap between the cost of their lifestyle and their restrained income. The huge windfall that goes to the Government as a result of greater tax revenue explains why we have had so many cost overruns on everything from hospitals to roads.
This fiscal incontinence is tolerated in the face of overflowing coffers. As the cycle peaks, however — years after it would have, had we to rely on our own resources — the subsequent and apparent downturn comes as a surprise to many. (It’s worth noting that the same stockbrokers who this week, are falling over themselves to forecast a downturn next year, were suggesting six months ago that all was hunky dory.)
As costs rise, firms can’t pass on the outlays in higher prices and state companies’ budgets are cut by a central government who find that their tax revenues are drying up. And so, a monumental struggle ensues between workers and employers over their slice of the diminishing pie. The workers realise if they don’t “claw back” now, they will never get the cash.
The employers figure that if they “give in” now, they will see a drop in profits and miss budget targets or both.
In good times, such rigidity is rarely a problem because there is always a bit of leeway, now the wriggle room is narrowed.
Both sides harden their positions and a scrap follows. This tends to accelerate the downturn as employers hold off on investment until the strike is over and the industrial problems are sorted. In turn, poor industrial relations knock confidence, denting spending. The isolated strikes become part of a larger picture whereby falling house prices are compounded by these industrial tensions.
Our much-vaunted partnership model is like a marriage in good times — a match made in heaven. It is likely to be reasonably strong initially, but as the interests of employers and workers diverge, the jury on partnership is out.
Ironically, commentators will jump to the conclusion that the boom came to an end because of the strikes. In reality the opposite is the case: the strikes came about because the boom came to a cyclical end.