Fo­cus on house-price hikes ob­scures the real dan­gers fac­ing the econ­omy

Irish Independent - Business Week - - Brendan Keenan -

OVER­HEAT­ING? Economists, try­ing to be help­ful, will tell you that, while there is a busi­ness cy­cle, it is not pos­si­ble to say where it is at any par­tic­u­lar time. In the case of a small, open, dis­torted econ­omy like Ire­land’s, it is re­ally, re­ally not pos­si­ble. So there is no an­swer to the cur­rent top saloon bar ques­tion: “Is the econ­omy over­heat­ing?” What one can say is that, if it is, it is not do­ing so in the same way as 2006. The dif­fer­ences are well-known, but were neatly sum­marised last week by rat­ings agency DBRS.

The saloon-bar talk is, as al­ways, about prop­erty prices. While these are ris­ing at a rate sim­i­lar to that in the bub­ble, it is from a 60pc lower base. Be­sides, even if houses were over-val­ued in 2006, does that make the same price an over-val­u­a­tion in 2018?

It is a nice cal­cu­la­tion, and any­way, prices in gen­eral are not back to the lev­els of 12 years ago. In truth, the hous­ing mar­ket could not be more dif­fer­ent from the one we had then, which was char­ac­terised by rapid credit growth, mount­ing house­hold debt and too much build­ing.

Now, credit is con­strained by Cen­tral Bank rules, house­holds are sav­ing rather than bor­row­ing, and there is an acute short­age of con­struc­tion. DBRS is in the ma­jor­ity in see­ing no ev­i­dence of a real es­tate bub­ble. There is a hous­ing prob­lem – ar­guably a cri­sis – but not a bub­ble.

That is not the end of the mat­ter. It may be hard to believe af­ter the Noughties, but it is pos­si­ble for the econ­omy to over­heat ir­re­spec­tive of what is hap­pen­ing in the hous­ing mar­ket. If de­mand ex­ceeds the sup­ply of goods and ser­vices for too long, prices and wages will rise, even­tu­ally snuff­ing out the ex­cess growth, and then some, and dam­ag­ing com­pet­i­tive­ness along the way.

This is par­tic­u­larly dan­ger­ous in a com­mon cur­rency area like the eu­ro­zone where balance can­not be re­stored by de­val­u­a­tion. So many other things have hap­pened to the Ir­ish econ­omy since 1979 that we have tended to for­get this par­tic­u­lar risk.

The late 1990s, when the Celtic Tiger be­gan to morph into the credit ele­phant, would have been more dam­ag­ing than they were, had it not been for the big, last de­val­u­a­tion against the Ger­man mark in 1992.

By the na­ture of things, the loss of cost com­pet­i­tive­ness is likely to arise again as an is­sue, per­haps all the more dif­fi­cult to iden­tify and cor­rect be­cause un­ac­com­pa­nied by ex­ces­sive credit or bud­get deficits. But prob­a­bly not right now.

Still, we must be some­where on that in­vis­i­ble cy­cle and it can hardly be on the down slope. The sur­mise is whether we have passed the nat­u­ral peak and, in­stead of eas­ing off, are head­ing on up­wards to where sup­ply lim­its, es­pe­cially of labour, be­gin to spell dan­ger.

The fig­ures sug­gest not, but they are odd. Un­em­ploy­ment is down to 5pc, which is pretty close to past es­ti­mates of “full em­ploy­ment” be­fore short­ages drive up wages. Most grat­i­fy­ing is that long-term un­em­ploy­ment (out of work for more than a year) was just 2pc in the first three months of the year.

How­ever wel­come such fig­ures are, they sug­gest there is no great pool of un­used labour to call upon. Ire­land does have a pool of new en­trants to the labour mar­ket and em­ploy­ment con­tin­ues to in­crease at around 3pc a year, with most of the jobs for full-time em­ploy­ees. De­spite this, there was no over­all in­crease in hourly earn­ings un­til last year, when they went up 1.7pc.

As the trade-union spon­sored NERI eco­nomic in­sti­tute ar­gued in its re­view last week, such a rise seems well over­due and can hardly be called in­fla­tion­ary in an econ­omy grow­ing as this one ap­pears to be.

Part of the au­to­matic sta­bilis­ers in an econ­omy which drive that cy­cle in­volve higher wages re­duc­ing firms’ de­mand for work­ers and help­ing to slow things down. With NERI pro­ject­ing wage rises of 3pc this year and next, and in­ter­est­ing data on growth, some see ten­ta­tive signs that a nec­es­sary cor­rec­tion may be hap­pen­ing.

The new CSO fig­ures for the econ­omy in 2017 were lit­tered, as they have to be, with dif­fer­ent mea­sures of out­put. The GDP es­ti­mate of 7pc growth is com­pletely dis­cred­ited, and the most con­ser­va­tive mea­sure found a fig­ure of only 3pc.

This mea­sure does not yet in­clude rises in the cost of the out­put of goods and ser­vices, so “real” growth, as usu­ally pre­sented, would be less than 3pc. An­other use­ful mea­sure of what is hap­pen­ing, the Ex­che­quer re­turns, were on tar­get for the first half of the year. But the tax rev­enues of €20bn were based on fairly mod­est as­sump­tions of growth of around 4pc this year and had been be­hind tar­get for much of the first-half of the year.

The au­to­matic pi­lot may be work­ing, so it is the non-au­to­matic stuff which has peo­ple won­der­ing and wor­ry­ing. House prices may be the saloon bar favourite but cor­po­ra­tion tax rev­enues seem to be the topic of choice in the com­mon room and think tank.

In its an­nual re­port last month, the Na­tional Com­pet­i­tive­ness Coun­cil warned of the dan­gers of fu­ture rises in labour costs and high­lighted the con­sis­tent Ir­ish weak­nesses in gov­er­nance and in­fra­struc­ture where the prob­lem, of course, is that they do not change. The ma­jor com­pet­i­tive threat the coun­cil saw was a re­duc­tion in multi­na­tional ac­tiv­i­ties in re­sponse to global and Euro­pean tax changes.

That is a dan­ger of a dif­fer­ent kind. The big ques­tion is to what ex­tent the Gov­ern­ment should try to prevent it hap­pen­ing. Past in­duce­ments to keep the tech gi­ants be­came so bizarre that they left Ire­land in an un­ten­able po­si­tion when it comes to de­fend­ing the sys­tem.

The irony is that those in­duce­ments may yet play a ma­jor role in chasing the IP com­pa­nies from our shores. Ac­cept­ing that may be the only way of pre­vent­ing even more dra­co­nian EU in­cur­sions into the tax sys­tem.

It is not par­tic­u­larly help­ful to call this a com­pet­i­tive­ness is­sue. The net ef­fect of the multi­na­tion­als on Ir­ish com­pet­i­tive­ness is not clear. Along­side GDP, their ac­tiv­i­ties rocket the coun­try up the global “com­pet­i­tive” in­dices but they crowd out na­tive com­pa­nies when it comes to wages, the at­trac­tion of skilled staff and even ac­com­mo­da­tion.

It is cer­tainly, how­ever, a fis­cal is­sue, but one where the threat may also present an op­por­tu­nity. Even if the Com­mis­sion aban­doned its tax plans, it is im­pos­si­ble to believe that the cor­po­ra­tion tax rev­enues can con­tinue at the present €6bn a year – dou­ble the fig­ure of a few years ago.

There is there­fore ev­ery good ex­cuse for set­ting aside half of that, say, so that the pub­lic fi­nances do not de­pend on its con­tin­u­a­tion. It would dwarf the pal­try rainy day fund but, since it would take sev­eral bud­gets to ex­tract it from the pub­lic fi­nances, it is al­ready too late for a Brexit cri­sis.

If that is avoided, it is not too late for such funds to help in the post-Brexit world of the late 2020s when the fi­nal deal is struck and years of ad­just­ment lie ahead.

At the very least, the money could be used for well-cho­sen, once-off cap­i­tal in­vest­ments, with any re­sult­ing in­crease in cur­rent spend­ing, such as more teach­ers, prop­erly ac­counted for in the cur­rent bud­get. That might not slow the econ­omy, but it would make it more se­cure in the long term.

As of now, laden with debt, it looks cru­elly ex­posed.

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