October 31, 2016
Why bargains in Newry this Christmas are about so much more than the recent fall in SterlingPosted in Sunday Business Post · 95 comments ·
It has become an article of faith in Official Ireland post Brexit that the dramatic fall in sterling has caused a serious problem for Irish competitiveness. The narrative spun is that the British vote has been disproportionately negative for Ireland because our currency has suddenly risen against the falling sterling, punishing Irish exporters and retailers. This sounds plausible but it is not true.
The truth is that the appreciation of the Irish currency — first the Punt and then the Euro — has been relentless, and has been explicitly the policy of successive Irish governments over the past twenty years. So the appreciation of the Irish currency against sterling isn’t because of some shock associated with Brexit or anything emanating from British politics, rather it is the explicit choice of successive Irish administrations.
In order to show you what has been happening, I’ve done up a chart of the Irish Punt and later the Euro against sterling. Going back to the early 1990s, when we orchestrated a devaluation to cancel out the British devaluation against the Deutschemark, the appreciation of the Irish currency against that of our main import partner has been relentless. Check out the chart.
FIGURE 1 IRISH PUNT VS. POUND STERLING
I remember when business people used to worry about the old Irish Punt going above 80 pence sterling. Today, if we still had the Punt, it would be trading at 1.14 sterling. (As you can see this has been particularly marked since 2000 and the adoption of the Euro) This is a massive silent appreciation. So let’s be clear, far from being the unintended consequences of British policy, the appreciation of the Irish currency against sterling has been the explicit aim of Irish policy! We can’t blame the Brits for this.
Now here is the interesting bit.
In textbook economics if the currency of a small open economy appreciates against that of its major trading partner, particularly a partner that we import 31% of our total imports from, the prices of goods here relative to the UK should be falling, not rising! And as this appreciation has been going on for years! Irish prices should be permanently lower, not higher, than British prices.
But this is not the case.
Even before the 17% fall in sterling post-Brexit, Irish shoppers have always found great value in Newry, Derry and Belfast. The cost of living in Northern Ireland is a fraction of that in the Republic. We are not just talking about the price of slabs of Harp at Sainsbury’s in Newry. We are talking about tradesmen from the North, we are talking about the ridiculous notion that German-made, white goods and cars sourced from within the Eurozone are cheaper in the North – despite sterling’s fall which should make them more expensive! Housing is much cheaper, not only rents, but also the actual cost of buying a house is about half Southern prices. Building materials, private medicine, car insurance as well as groceries are all much cheaper. Even mortgage rates are lower in the North than in the South despite the fact that British base rates are actually higher than Eurozone rates!
How can this be?
Let’s stand back and examine this conundrum because for me if Brexit exposed anything, it’s the lamentable value that we Irish people get in comparison to our British cousins – for almost everything.
Because our currency has been rising against sterling for years, we should be getting a lower cost of living not a higher cost of living.
It is clear that if you are exporting from Ireland (which I do with my small economic consultancy company), the higher Euro against Sterling means that we have to watch our costs to remain competitive. So wages are tighter because if we let wages in Euros rise too much we will price ourselves out of the market to our UK clients.
Therefore, for people who trade with the UK, which is one in six of all exports, the exchange rate has driven down prices and wages over years. Also because exports to the UK are in labour intensive industries, far more people in Ireland work in companies that export to the UK than any other country. So we – those working in the traded sector – can’t be driving up costs in Ireland because if we did we’d go bust.
So why is everything more expensive if the exporting side of the economy is disciplined by the strong exchange rate?
Cost pressures must be coming from that part of the economy that isn’t traded.
The main culprit has to be the government sector, which is the biggest buyer of services in this country. In addition, the second source of inflation must be the banking sector that finances the most expensive of all Irish assets: property. The upward costs can’t come from any other place.
It seems logical to argue that the non-traded sector in Ireland, the public service and the State apparatus in general, is responsible for allowing costs to go out of control and these internally generated cost overruns are seeping into the general price level.
A good example of this is the health service. Ireland spent a massive 12.3% of gross national income on health in 2013. In the rest of the rich world, the average is 9% despite the fact that we have a younger population and should spend less.
The problem is that costs in the public sector are out of control and that every time there is a cost increase, taxes are raised to plug the gap. The rising taxes — particularly indirect taxes — directly push up costs and ultimately this is driving the cost of living upwards.
On top of this, the banks have for the past twenty years expanded lending dramatically — even taking into account the crash. This lending has pumped billions of euro into the economy, causing too much money to chase too few goods, driving up prices again. This is particularly the case for housing.
All this would tend to cause a massive trade and balance of payments crisis in a normal economy as we spent beyond our means. However, on the trade side, the multinationals give a distorted picture of our exports. Multinational exports are not price sensitive. They are part of a global supply chain and any cost increase in Ireland is more than outweighed by the tax holidays they get here in comparison to other countries. Finally, in a monetary union, you can’t run out of hard currency no matter how much you spend because no matter how much we spend, there will still be Euros in the ATMs. So there is no actual balance of payments crisis, despite having balance of payments crisis conditions.
Thus we become progressively less competitive, with a bloated State sector, a squeezed domestic exporting sector and an outsized multinational sector, which massages the figure.
It all looks good on paper but the tailbacks of Hyundais at Newry tells a different story — and it’s a story written by Official Ireland policy.