Several large risk factors remain from the economic bubble. In particular, debt levels remain elevated. Goodbodys Stockbrokers expect government debt to be 107% of gross domestic product at the end of this year before falling to 101% by the end of 2016.
That debt level far exceeds the upper 60% limit enshrined in the EU’s Fiscal Stability Pact. But as recently as 2013, it was at 123% of GDP here. Government debt may be high. But it has been falling, is falling and is expected to fall further.
Household debt – at about 100% of GDP – is also extremely high. But it too has been falling. In 2009 it was up at 123% of GDP. So it’s another case of “a lot done, more to do.” As with government debt, the really hard work has already been done. Like an oil tanker near treacherous rocks, it’s less the location that matters than the direction in which the shop is moving. And the ship of Irish household debt, while in a dangerous position, is now moving away from the rocks and towards safety.
A less-appreciated (and therefore greater) danger for Ireland is our international cost competitiveness.
The well-known result of a decade-long period of ultra-low Eurozone interest rates from 1997 to 2007 was a massive growth in debt and in the value of property assets largely financed by debt. Another, less obvious, consequence was an artificial stimulation of the economy that elevated our costs and our wages relative to those of our competitors.
The consequence is that today, even after several years of crunching austerity, Ireland still remains an expensive place to shop and to hire labour. A recent report from the National Competitiveness Council (NCC) concluded that “while costs have fallen significantly since 2009, Ireland remains an expensive location in which to do business, relative to some of our key competitors. Ireland is also the 3rd most expensive location in the euro area for consumer goods and services.”
This conclusion confirms data on Ireland’s real effective exchange rate compiled by the Bank of International Settlements. That data shows that between December 1998 (when Ireland’s IR£1.00 = €1.27 exchange rate on entering the Euro was set) and June 2008, our costs rose by a whopping 34% compared to those in Germany. Since 2008 this imbalance has been halved. But relative to late 1998, our costs have still risen by 17% more than in Germany. Unpopular as it may to say to a government planning a smooth glide-path towards election victory, this suggests caution in granting ourselves generous pay increases.
The NCC indicates that caution is already being exercised, reporting that “Irish labour costs increased in 2012 (+2.2%) and 2013 (+0.7%). In the first two quarters of 2014, labour costs grew by 1%. These rates are less than the euro area average.” So, as with high levels of indebtedness, imbalances in our costs are being gradually reduced. This is taking place against a low-inflation backdrop where every CSO measure of consumer prices showed sub-1% increases in 2014.
The gradual healing of Ireland’s biggest problem legacies of the bubble – high debt levels and high cost levels – has been hugely helped by strong economic growth. Goodbodys count on gross national product (GNP) growth of 3.3%, 5.2% and 4.5% in the years 2013, 2014 and 2015 respectively. Even if these measures are inflated somewhat by statistical quirks, this is still a strong performance considering the low-growth malaise afflicting the developed world.
There are two significant risks that might threaten this benign scenario.
The first is that the global economy might face renewed recession and drag Ireland down with it. There is no sign from short-term economic indicators – money supply data and leading indicators of economic activity – of a recession. Indeed might a consequence of low-growth global recovery be an elongation of the business cycle, thus pushing back the date of the next cyclical downturn?
The second – and much more serious – threat facing us is that our neighbours see the massive Foreign Direct Investment (FDI) benefit we get from our low corporation tax rate and they intend to copy it and/or knobble it. The main item on the G8 summit held two years ago in Fermanagh was clamping down on corporate tax avoidance. The United Kingdom has reduced its corporation tax rate to 20% and has introduced a 25% “Google Tax” or diverted profits tax. Northern Ireland wants to introduce its own 12.5% rate. And our European “partners” Germany and France want to introduce a minimum rate of corporation tax across the EU – that would mean the end of our low rate.
But the possible impact of these two big risks (international recession and reduced FDI) lurks well over the horizon. For the next 12 months – which is about as far forward as economic indicators can look forward – the outlook is benign. Fundamental factors lie behind this: low ECB interest rates, quantitative easing, a falling exchange rate, reduced energy prices and fiscal relaxation replacing fiscal austerity.
Cormac Lucey is the Programme Director of the IMI Diploma in Business Finance. Cormac is a Financial Services Consultant and Contractor who has previously worked with PricewaterhouseCoopers, Rabobank Frankfurt and the Department of Justice.