September 4, 2014
Two things can be true at the same time. An economy can grow strongly and also be badly managed. The key is what Keynes called “animal spirits” which can’t be suppressed indefinitely. In fact, history suggests that economies can grow despite bad management, which begs the question how much could be achieved if economies were managed properly?
I think the Irish economy might be about to hit a spurt of activity not seen for many years. This view is, in some quarters, about as popular as bringing an electric guitar to a 1960s folk festival, but let us keep an open mind and remember the thing about two things being true at the same time.
In fact, possibly the reason the growth may surprise on the upside could be precisely because there are government bottlenecks everywhere. Government asphyxiation makes the economy fight more to grab a breath. These airwaves need to be cleared – something that could be done quite easily.
However, for now just consider the possibility that the economy is fighting and showing imprudent signs of life.
Could this be a turn?
Well, the queues are back. Dublin airport is jammed. House prices are going up, as are rents. The price of hotel rooms - a very reliable leading indicator of the economy – has also turned upward sharply. On the roads, the traffic is back. The Newland’s Cross overpass couldn’t have come at a worse or better time – worse because the tailbacks in the morning are awful, better because the commuter traffic into the city is building. Tickets for gigs are selling much quicker than last year, restaurants are reporting much better trade and tourism had a better than expected summer.
Something is stirring in the Irish economy. The place looks set to take off. Don’t be surprised if the growth rate hits 4% at some stage in the years ahead. All economies recover at some stage, downturns don’t go on forever and the human spirit’s belief in the future is a redoubtable force. The role of economic policy is to make downturns as short as possible and growth periods as prolonged as prudent. Policy in Ireland has undoubtedly prolonged the slump. If you examine how quickly the UK, with its own exchange rate, or the US, with a massive fiscal expansion, came out of recession, there’s little argument on this point.
Admittedly, I have been in denial this year about what I was seeing around me but now the time has come to say with a certain degree of confidence that the economy is likely to rebound much stronger than most are expecting. Yesterday’s exchequer returns are part of this rapidly improving story. Income tax receipts were up strongly as were VAT receipts. These are crucial areas because unlike corporation tax, they are much more linked into the real economy.
Despite the increases in income tax, the major area that is lagging now is employment and wages, but all indicators point to these turning up too in time. The reason for this is that unemployment is what is called a lagging indicator in economics. It lags the cycle. People who employ others usually wait until the new orders are firm, some old debts are paid down and feel truly confident that there is demand out there.
Companies don’t create jobs. That is the great misunderstanding in the Irish political lexicon. I have never seen a company where the objective is to create jobs. Jobs are a cost to a company and that cost has got to be covered by revenue. What creates revenue? Demand creates revenue and solid revenue, over time, allows the employer to consider taking on more workers. So demand leads to revenue and revenue prompts both new hires and higher wages, in time.
Unemployment will fall and wages will rise if the indicators of the real economy keep going as they are and there is no reason to be pessimistic right now.
What is happening out there and why is it happening now?
The first thing to remember is that Ireland suffered a catastrophic “balance sheet” recession. This means that the balance sheet of the broad middle class in our country was destroyed by the property slump.
On one side of the balance sheet is the asset side, and it is the middle classes who have “assets” – houses, land, apartments. Asset values were eviscerated by the property collapse. In contrast, on the liability side of the balance sheet, these people had the debts they incurred to buy the assets. Not only did the debts not fall in tandem with the assets, the debts actually rose, because interest rates although very low were still positive.
When the balance sheet implodes like this, people panic. Those with a bit of money panic about the future and they save like hell. Those with too much debt try to pay back money as soon as possible.
What is the net effect of both of these moves? People stop spending and savings rise. Demand falls. The evaporation of demand causes revenue to dry up and people are let go because there is no money in the companies and no demand for the goods. In 2009, savings amounted to over 16% of disposable income (against a ratio of only 6% a few years earlier) but gradually, people and companies have stared to spend again. The ratio declined steadily from there and fell back into single figures last year at 9.4%. This decline in savings will continue and this means that when people are faced with the decision to spend or save, they will vouch to spend. Confidence is viral and when you become a bit more confident and spend a bit more too, so too do I.
In addition, since 2012, our major trading partners, the UK and US, have been doing well. America is now growing at 4% and the UK isn’t far behind.
As house prices have risen in Dublin, the balance sheet of people in the capital has started to improve. Rising house prices makes people who have houses “feel’ wealthier, they become less pessimistic and they spend a bit more.
We see that in retail sales buoyancy and also in big-ticket items like new car sales. In June, new car sales were up 24% on the same time last year. 64,031 cars were sold versus 51,556 for the first six months in 2013.
With interest rates to remain low and possibly go lower, consumer credit will become more available and “legacy” debts slightly more manageable. This will underpin local demand. Falling unemployment falls from here, and is likely to reinforce this relative optimism. Also the US and UK should keep motoring along for a few years yet.
Ironically, we need the Eurozone to stay on its knees, mired by deflation and the reverberations of Russia’s invasion of Ukraine because we are more positively affected by lower Euro interest rates than by negative trade demand on the continent.
The economy has turned materially. You mightn’t feel it yet, but I suspect, it has.