November 14, 2007

Our winter of discontent tells us boomtown is bust

Posted in Celtic Tiger · 22 comments ·

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.

  1. vince

    Yes, employers and employees are both seeking the same thing, stability or a fair measure of predictability. However as we have seen over the last while, these conditions are not available at the moment. And the hope that the arse falls out of the housing market seem to be the one hope. BTW, how does that once off bankrupt system work in the USA, I suspect that the quicker that or something like it is installed here the better. Something to dress the wound, once the boil is lanced, may be needed.

  2. “(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.)”

    I agree about the onset of a generic U-Turn in the opinions of not just stockbrokers, but corporate Economists too (I have personally experienced several cases of that bi-faceted fraudster in the past three to four years,) and you can bet your bottom Euro that the press will follow suit, but only once the Government has already publically admited that things are on a decline (don’t hold your breath) and the property boom has burst at the seams. It doesn’t take a rocket scientist to know that the newspapers are attached at the hip of politics and business, and only the bravest of journalists (such as yourself) would dare to speak the voice that shall not be named. And by the time it’s all over the papers it will already be too late.

    What I’m wondering now is this: If the bubble is about to burst, when will it happen and when will the property market collapse, or will it just continue to seep as it has been doing for the last year and if that’s the case, when will the market reach rock bottom?

  3. sean

    If it follows the historical pattern in other countries, it will be long, drawn out and gloomy for half a decade at least.

  4. Anto D

    Joe soap,
    The market should bottom about 2013-15.

    There will probably be an attempt for a recovery around 2011-12 (what is currently happening in Japan but they have yet to witness the death blow)
    If we study the Tulip mania in Holland in 1600s, The South Sea Bubble or The 1929 crash (to later become the “great depression 1932 (the rise of Hitler and all that negative and dangerous leadership). We can identify certain things.

    Those manias and busts all had one thing in common!

    Where the booms(or manias) began and eventually ended they all collapsed lower then where they began.

    Back to your question, if we are to repeat a similar outcome we have to look where it began.
    I would say around 1992 the bull market in Ireland began therefore if this mania is to produce a similar outcome we would have to hit 1988-89 lows or there abouts.

    One important caveat, the boom in Ireland is larger both in length and distance than that of the roaring 20s in America. House prices fell 90% in the US and in some cases banks sold them 1% percent of there peak to avoid tax on revenues.

    Could that happen here?

    As a follower of patterns in all form of markets?, I would say yes.
    Dont wet yourself.) Get liquid and get at least financially safe.

    P.S your money is worth a lot more in such environments.
    What cost 10,000 today would generally cost 1.000 in such an environment. Certainly in property and cars and so forth.

    Good article Dave.)

  5. Anto D,

    Thanks for the answer, I appreciate it. I missed getting on the property ladder in the UK n the Eighties, and here I was already chasing a departing train, so I’m looking at this from the point of view of a lot of people that can’t afford to buy property and feel that I’ll never be able to get on the ladder at this rate. Though I can’t see house prices ever dropping by 90%, do you really think that this size of price collapse is a possibility?

  6. Official Announcement

    Bertie Ahern today announced that he is changing our national emblem from a shamrock to a CONDOM because it more accurately reflects the government’s political stance.
    A condom allows for inflation, halts production, destroys the next generation, protects a bunch of pricks, and gives you a sense of security while you’re actually being screwed.

    Damn, it just doesn’t get more accurate than that! 

  7. Observation

    So much for it actually working!

    Ahern is going to be roasted and sliced to pieces being the pig he really is!

    We all saw what happened to Napoleon on “Animal Farm”!

  8. Stephen

    The governments only really have two options: Firstly, they can let the bubble pop, enormous numbers of companies and people would go bankrupt, unemployment would rocket, and the economy would effectively come to a screeching halt. Alternatively, they can inflate, and inflate, and inflate, the effect will be much worse in the long run, but in the short run, people just get poorer in terms of buying power, things get harder for everyone, every year, the deserving, and the undeserving. Those who thought they were rich, find that they aren’t, houses are still worth $2m, but people find that $2m isn’t so much after all, what with a tank full of petrol now $300 (it’s about US$120 in the UK now). The process of inflation brings a slow, lingering, agony, but not the short shock of a crash that would focus attention, and be such unwelcome negative PR. They’ll chose to inflate, I’ll bet you 1 million Zim dollars.

  9. Would it be correct to say that the Irish government surely can’t do that as they have given up control of the treasury, through the back door, to Brussels? Perhaps going into the ERM means it’s less likely you’ll see massive inflation, unless Germany wants interest rates to go up a lot further. And that’s not too likely unless the German public go on a spending spree (which is even less likely.) I would imagine that it’s more likely the market here will collapse under a complete lack of faith.

    “Those who thought they were rich, find that they aren’t”

    Well, if by that you mean the property developers who have all been creaming the paying public for massively over-priced property. I have one word to say to them. Tough!

  10. Stephen

    You’re probably right on the first point given the status quo, I was considering David’s ‘leave the Euro’ argument. Even ignoring that, areas such as banking capital requirements in tthe Euro zone may allow (I really don’t know, although I doubt it) a government to effectively increase the money supply by making it easier for a bank to lend money. I believe that one of the major contributory factors in Japans 15 year depression was caused by the banks being allowed to count as part of their regulatory capital, shares they held in companies to whom they’d lent money. This effectively meant that the more money they lent to companies, the more the companies grew, so the higher their share price went, so the more money the banks had available to lend. A virtuous spiral that turned nasty, and went into reverse, in about 1989.

    I would agree about the developers, like the estate agents, and much of the banking industry, but inflation hits everyone, it spreads the pain pretty evenly, whereas a big property crash obviously hits hardest those who are deepest in property & property finance.

  11. shtove

    If you want to avoid inflation, stick with the ECB because they will keep a strong currency and highish interest rates. If you want to accept inflation, leave the euro – but don’t expect any help from the EU when the trade wars start in the big test of globalisation.

  12. Donal

    When the economy does go bust!

    We need people in this country who we could count on and have a link to this country.

    It’s about time now that we have the calling of the diaspora in place so we can reverse the damage and become even stronger.

    The EU’s days are numbered, no-one supports the way it is going and let’s be realistic the “free movement of people” has screwed up our country because the migrants send back billions to their families at home.

    We’re losing money and they aren’t going to make their lands prosperous this way, so they need to do the same as what david proposed and get their diaspora children to return as well.

  13. While I agree with you Donal, I can’t see the return of ex-pats happening in the foreseeable future. There is no justifiable reason for anyone to want to return to Ireland with the ship sinking at a great rate of knots each day. It would be akin to asking the crew of a passing ship to board the Titanic moments after she hit the fateful iceberg. A suicidal action, if not foolish in extreme. And while it may be an honourable deed, it would only serve to slow the gradient of the decline a fraction (such as the immigration of the Polish has served to slow the impending end to the rental market) and will most likely still end in bitter tears for all concerned.

  14. Fergal

    I’m Irish, I’m part of the diaspora – I was chased out of Ireland by a political and economic system that ensured that I could work in a middle class job, earn a middle class salary, but never have a middle class life – property simply cost too much. I looked around the world and saw better opportunities and the decision was easy – leave Ireland.
    Why would I go back? To support the very people that chased me out? Those who left in the 90′s and have created a life will not return to Ireland until they can get a similar quality of life there.
    I live and work in Manhattan, make a lower end 6 figure salary and have a better quality of life than I could have in Dublin. Also the fall in the dollar means that the assets I hold in USD are not worth in practical terms what they would be if I left here and converted to Euro.
    I’m with Joe Soap here – the diaspora need positive reasons to return. There are none.

  15. Donal

    Points taken fergal & Joe,

    the thing is that the government has relied too much on EU labour and migrants from external to the EU to fill vacancies that we could easily have filled ourselves. We don’t need non-nationals in the Garda because 7,000 applied 2 years ago compared to the 1,000 foreigners who did, the exact same applies in the army where there are more than enough recruits to serve in the UN peacekeeping duties.

    I admit it is sad that the Irish Government has focused more on accomodating strangers who have no sense of loyalty of any link with the nation compared to its children at home and abroad. The dáil should just scrap the Intercultural scheme of accomodating people who’ll probably boot out in the next 20 years and focus on resettling our children that left long ago whom want to return.

    I would rather have that imposed on me than future communal strife that has plagued the rest of europe, it can happen but we need people like David and even Ted Kennedy to push this forward for a god given right to return home.

    I’m sure what problems I have mentioned in this caused you to leave Ireland? We need to focus on ourselves and rely on ourselves for our own future, we can use the japanese model of strict quotas for non-nationals and the rule allowing anyone of irish descent (As long as its over 50%) to return and live & work here.

    You can assimilate but we need someone intelligent running this country and can have foresight into the future, our lack of that has been responsible for the Irish language not be spoken to the extent it should and why infrastructure is not great yet we have the money (at the moment to improve it – until we are bankrupt)!

  16. Donal, I agree with the principle of what you are saying. But the reality is that a returning Irish diaspara is an idealism that won’t happen in any foreseeable future. Any incentive (though there are none) would be considered far too little too late. As far as I can see, the only thing that ‘might’ possibly encourage a very small percentile to return to Ireland is the thing that the wealthy (and unfortunately anyone who bought property in the last three years) dread the most, a massive property crash. Though those wealthy property speculators, developers, landlords, investors, thoroughly deserve to bear those losses too for the most part. Irish homes need to find a true and honest value in a global market and that true value based on current average salaries, is probably a national average price of €120,000 – €150,000. Hard pill to swallow for those who have been creaming the market and fleecing the public for the last 10 years, but they will gain little sympathy from a public who lost faith in the markets future a long time ago.

    The future reads: “Irish property – A market with an over-inflated future behind it.”

  17. Donal

    I understand Joe it is late, but it’s not too late.

    Of course this plan of calling the diaspora would occur once the property market has crashed and rebuilding the economic damage has commenced.

    We do have to try and make this ideal possible by any means hopeful or hopeless, however it’s interpreted but it is possible and we as a people are strong and no matter what adversity we face – we’ll always come out on top!

    We just need to keep the faith…. this is possible but it will take time (5+Yyears) and we can get this right by encouraging our own family in the US, Australia, CAN or NZ to come back.

    Once the economic conditions are right or easy enough for them to come over – The opportunity needs to be seized

  18. Criostor

    I agree with Donal,

    we need to do more by pressurising the government to follow this idea. The Irish American Forum recently criticised the Government for not encouraging the diaspora to come home or provide them opportunities to work and settle here.

    I’m sick of the government trying to promote a scheme of multiculturalism that has only brought ethnic tension and social problems that has rocked europe over the last 50 years.

    It’s only a matter of time before we become like the rest of europe whom really don’t give a crap about minority ethnic groups, the fiasco in balbriggin is an example of all the future screw ups to come but the one’s to come will get much worse.

    At least with the diaspora concept we won’t suffer these social problems because we’ll be welcoming back people whom we have a lot in common with but we’ll only have to make them conscious of what being Irish is truly about & rid them of any ignorance or bad habits they have picked up in their host countries.

  19. RB

    I have been following the Irish Economic madness with great interest for some years now. I am a 31 year old Irish guy returning to college to begin a degree this year. I not only missed the property boat but i also missed the career boat too it seems. What amazes me about Ireland country is the complacency of the Irish people. Bertie Ahern is a gombeen and a sleiveen. The fianna fail dominated politics of the past ten years has shafted my generation. I know people my age who are up to their necks in debt. Some are couples with kids. They work up to four jobs between them, they can’t buy houses near there family or friends due to crazy prices so they have to move further and further away. Some have spent most of their late twenties and early thirties struggling to make ends meet, living on garage sandwiches while they rush about like panicked mice up and down the M50. On the surface it looks like people have a good quality of life in Ireland, but this is not the case for my generation. We are all stressed out, worried and burning out. The sooner the Fianna Fail crooks are out of office the better. Not only have they squandered my generation in a debt-trap but they also plan to tarmac over the cultural heart of Ireland with their motorway through the Tara/Skryne valley in Meath. Ireland today represents all that is wrong with capitalism. Maybe a recession and housing collapse would bring us all back to reality.

  20. Fergal

    Donal, I thought I was pretty clear. Ireland did not offer me the quality of life available. Ireland offered a tiny apartment in the city of Dublin, or a 3 bed house with a 4 hour daily commute. Ireland offered me the opportunity to pay twice over for my health care – through taxation and then paying my VHI or BUPA subscription. I won’t go on.
    The US offered me far more. A higher salary and a lower tax. Yes, I pay for health care, but only once. New York has a public transport system that actually works! Imagine – it has an integrated ticketing system.
    What kind of a program could get me to return? A better job, less traffic, a bigger place to live, better public services…. Can you see that happening in 10 years? The Irish keep electing people with solid corruption records, from Charlie, to Bertie and Bev Flynn. Ireland will never deliver in a 10-year timeframe.

    RB, get your college education here – hopefully you’ll qualify for mature student grants. Then get a job abroad as quickly as you can. New Zealand is pretty open at the moment. Ireland will tie you to the either rabbit hutch living or a lifetime of commuting. There is a much brighter world outside.

  21. I’m starting to wonder the very same thing RB.

    I earned a good degree in an area which is in high-demand by the multinational companies in this country. I’ve worked very hard at my job, but what reward have I? My salary is decent and lets me live comfortably. But, what about my standard of living?

    - I have to go through commuter hell every day to get to work.
    - I am nowhere near buying a place to settle down in.
    - I have the double whammy of PRSI/Health levies and cost of private health care.
    - While my salary is decent, it’s just not a good enough reward compared to compatriots abroad.

    To be honest, I’ve had enough and am ready to leave. I have an offer of a job working in the States. My Visa will be sorted out by the employer. I’ll be earning more money there than here (despite the currency adjustment), my living costs will be lower and I’ll be taxed far less.

    I’m disillusioned with the country. It seems like unless you’re a lawyer, builder, guard, pharmacist, you won’t be rewarded for your effort.

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