Economic Opinion: Caught in the Crossfire
Author:
Austin Hughes
The first half of 2005 has provided us with more questions that answers in regard to the outlook for the Irish economy. It should be emphasised that these questions are far less vexed or pressing than those being asked about most Continental European economies or indeed the UK at present. While the Irish economy may continue to out-perform most others in coming years, the likely scale of gains in incomes and employment here is still subject to considerable uncertainty, in large part because of increased downside risks to the global economy.
The most encouraging aspect of the Irish economy’s performance in the first half of this year was the continuing buoyancy of the jobs market. These figures provide good grounds for the belief that the Irish economy can continue to perform well. There were 72,000 more people at work in Ireland in the early months of 2005 than a year earlier. As the diagram below indicates, this scale of job gains is dramatically different to the experience of most other economies. To put it in context, international investors bought the US Dollar and drove US interest rates higher through the first half of 2005 on foot of jobs growth in the ‘States which averaged around 1½ per cent. This was notably better than the main European economies which struggled to deliver even marginal increases in employment. Against this backdrop, a 3.9 per cent rise in numbers at work in Ireland must be regarded as quite extraordinary.
Jobs data send many positive signals
These jobs data say a great deal about the flexibility of the Irish economy. Ireland’s unemployment rate has been around 4.5 per cent for some considerable time. That’s notably lower than the US rate and well under half that prevailing in Continental Europe. However, even in a remarkably strong Irish jobs market it has been possible to increase numbers at work substantially without sparking the sort of acceleration in wage growth that might threaten future competitiveness. Roughly one third of new workers were immigrants. A similar proportion were young workers joining the labour force for the first time and another third were older women re-entering the workforce. This balanced increase sends a number of positive signals in relation to Irish economic prospects.
First of all, continuing inward migration into Ireland, which mirrors a strong pipeline of international investment into this country, bears testimony to the enhanced international standing of the Irish economy. The influx of capital and workers into Ireland also helps restrain costs and increases the economy’s capacity to deliver higher living standards in the future. At the same time, the continuing strong growth in the population of working age underlines the fact that Ireland’s age structure is notably more healthy than most other Western economies. This profile also holds out the prospect of continuing strong demand for housing and across the spectrum of consumer goods and services in coming years. Finally, the continuing increase in the number of women re-entering the workforce reflects among other things the incentives provided by low taxation. Of course, the dynamic growth of the Irish economy poses many challenges, particularly in areas such as infrastructure and childcare but these problems of success are altogether preferable to the problems of virtual stagnation facing other countries at present.
Is strong construction a problem?
Recent employment trends also highlight the central role played by a booming construction sector in Ireland’s current strong economic performance. Of the 72,000 jobs created in the past year, just under 31,000 were in the building industry while there were significant increases in a broad range of businesses related to a buoyant property market. Clearly, the pace of growth in this industry is unsustainable. So, in the future, still healthy levels of activity will contribute far less in statistical terms to the growth rate of the Irish economy. This is one reason why I would tend towards the more cautious end of the range of forecasts for measures such as GDP and GNP. However, I feel the construction industry and the broader property sector will still remain healthy on the back of strong underlying demand and the likely persistence of relatively low interest rates.
The particular buoyancy of construction has allayed another concern as the house-building boom has meant that property inflation eased steadily from the 30 per cent pace of the late 1990’s to a current rate of around 6 – 7 per cent. The capacity of the Irish economy to deliver a ‘soft landing’ for house price inflation without any nasty downturn also underlines the flexibility of the Irish economy.
Interest rates to remain lower for longer
At the beginning of this year, it seemed likely that interest rates would rise over the course of 2005 and might be set on a sharply rising trajectory at the end of the year. However, the picture of the major Eurozone economies that emerged during the Spring was notably poorer than might have been expected. For some time, the particular weakness of the German economy has restrained growth on the continent and ensured interest rates would remain low. More recently there has been some progress in implementing much needed reforms. Unfortunately, this has dented consumer confidence to the extent that in spite of extremely low interest rates German households chose to pay down debt rather than borrow in 2004. Persistently weak growth in the Eurozone has painfully exposed deep-rooted problems in some countries. The particular problems of Italy in adjusting to an environment in which currency devaluation is no longer an option has emerged as an important issue for financial markets in 2005 and seems set to remain a depressing influence on Eurozone growth for some time to come. As a result, as the first half of this year progressed, it became clear that if the European Central Bank were to change interest rates any time soon, it would be to cut rather than increase rates.
From an Irish perspective, the persistence of lacklustre growth in the major Continental European economies means that interest rates will remain much lower for far longer than appeared likely at the beginning of this year. This implies that Irish borrowers will not face any significant increase in their repayment burden for some time. So, strong double-digit rates of credit growth and a solid property market look set to remain prominent features of the Irish economic landscape. Indeed, the likelihood of significant tax concessions in the upcoming budget and the shortening timeframe before SSIA’s begin to mature hold out the prospect of solid increases in household spending in the coming year. That said, the evidence coming from the IIB/ESRI consumer sentiment survey suggests Irish consumers remain cautious about the general economic outlook. Clear evidence of solid economic conditions at home are offset by persistent concerns about global economic trends.
In the face of this economic ‘crossfire’; the combination of subdued wage gains, heavy financial commitments and seemingly relentless increases in a range of public sector charges mean Irish consumers still lack the sort of clear improvement in their own spending power that would allow them set aside worries about the global ‘macro’ climate. Instead, the detailed consumer sentiment survey results point towards a tendency towards increased levels of borrowing in circumstances where current income is falling short of expected future spending power.
Strong domestic conditions offset international concerns
Persistently strong domestic trends bode well for a future in which the global economic backdrop looks set to remain challenging. High oil prices are likely to continue to restrain activity while intense competitive pressures resulting from the expanding productive capacity of countries such a China and India will also ask questions of ‘mature’ Western economies. Importantly, accumulating evidence of a pronounced slowdown in the UK economy implies Ireland’s most important export market may not be as strong as in recent years. This could pose particular problems for a range of Irish businesses.
Increasing evidence of ‘external’ headwinds to Irish economic growth argues for a measure of caution in relation to the likely scale of gains in activity and new jobs in the Irish economy in the next few years. However, this economy has successfully come through a severe ‘stress testing’ in the recent global downturn and the evidence to date in 2005 suggests that domestic fundamentals remain very strong. So, while questions abound about the precise scale of growth likely in Ireland in coming years, there are good grounds for believing that living standards will see a sustained improvement.