Constantin Gurdgiev: our celtic unicorn economy

Competitiveness, fiscal austerity, skilled labour, capital investment, resilience: all myths. The key, under-recognised factor is private debt

Irish elites, to the right, left and centre of the political spectrum, are completely dependant on the kindness of foreigners. Approval of ‘our European partners’, ‘foreign analysts’ or ‘leading international academics’ and editorial praise from foreign publications are sought as the signs of modernisation of the state, and progress. The latest instalment in this Irish version of Stockholm Syndrome is the idea that Ireland is a European poster boy for austerity-to-growth theory.
In the real world, Ireland is witnessing neither a return to economically (forget environmentally or socially) sustainable growth, nor the real structural fiscal adjustments on the scale needed to achieve public-sector sustainability. Instead, it is an economy slumped at the bottom of the Great Recession with superficial signs of viability provided by the multinationals. Our austerity drive has been nothing more than the ages-old redistribution of pain – the policy of robbing productive Paul to pay largely-unproductive John, an approach that is more economically internecine than any real contraction in public expenditure can ever be.
The latest headline figures for economic growth, referring to Q2 2011 are less than convincing of the case that Ireland’s economy is back on a growth path. Using current market prices, Irish GDP has shrunk, in H1 2011, by 0.84% on 2010 figures; Similarly, GNP has fallen 1.76%. Compared to the first half of 2005 we are now 2.3% worse off in terms of nominal GDP and 8.63% worse off in terms of nominal GNP. Looking at the underlying components of economic activity, year on year, H1 2011 saw a 5.83% increase in exports and a 2.78% increase in corporate profits expatriated abroad. Compared to H1 2005 the same two figures were 27.23% and 33.58%. This really means that the historically-unprecedented rise in exports has done its job of providing at least some growth momentum, but this growth momentum has been erased by the comprehensive collapse of the domestic economy, as well as by the boom in the expatriation of profits by foreign firms.
Almost 4 years into the crisis, Ireland Inc is comatose, while Ireland, as MNC, is powering ahead.
Preliminary Q2 inflation-adjusted GDP growth of 2.3% conceals a number of worrisome facts. Firstly, the largest sector of the economy in terms of both contribution to GDP (41% of total economic activity) and employment (over 60% of the workforce) – Services – continues to contract, posting annual inflation-adjusted rate of growth of -0.7% and a quarterly drop of -1.3%. The second-largest sector – Industry – accounting for 21% of economic activity in the country and only around 15% of employment grew by 7.5% year on year in Q2 2011. However, this growth was concentrated in one sub-sector – pharmaceutical and chemicals. Incidentally, the latest trade statistics show that this sub-sector accounts for 90% of our entire national trade surplus – a number so staggeringly high, that we might just rename Ireland Inc, with its inflated economic ego, Viagra Inc.
Irish growth figures through Q2 2011 show the pattern of an economy consuming itself from inside. Personal consumption is down 1.3% year on year, and gross domestic capital formation has fallen 17.1%. The only two categories of economic activity up are the value of physical stocks of goods, and net exports. Domestic deflation and exchange-rate movements, not more output or higher value added, are driving the inflation-adjusted growth figures cited as the evidence of Ireland’s ‘recovery’.
Similarly, contrary to the assertions made by Irish officials, the unprecedented boom in exports is not being driven by gains in competitiveness or by smart policies. Instead, it is driven by tax arbitrage. The result is amplified recession of the real domestic economy, manifest as follows:
The official unemployment rate is now anchored at 14.2-14.3% (compared with 4.2-4.4% pre-crisis) and conceals youth unemployment running at over 46% for 19 years old and younger, and almost 34% for 20-24 years old, as well as a shrinking labour force, rampant emigration and growing state ‘training’ schemes generating no real uptake in jobs.
The widening gap between GDP and GNP, currently at a historical high of 20.4%, accounted for by transfers of profits abroad by the multinationals.
The extreme dependance of Irish economic activity on pharmaceutical exports that will be subject to severe pressures in months to come, as blockbuster drugs produced in Ireland come off patent, resulting in a rush to book profits by the MNCs today, but threatening a collapse in activity in 2012-2013.
Combined public and private investment in the economy today no longer covers depreciation and amortisation of the capital stock accumulated during the Celtic Tiger years.
The recent gains in competitiveness and cost-of-business reductions, so often cited as the ‘success story’ for Ireland, are mythology.
Firstly, compared to other euro countries, measured by the harmonised competitiveness indicators (HCIs) which are referenced to the unit labour cost, Ireland remains the worst performing core euro-area country. Despite having improved in this metric by 19% relative to the peak, Ireland’s HCI remain 17% less competitive than the euro-area average and 35% behind Germany.
Secondly, many of the gains in competitiveness to-date were not driven by growth in productivity, but by wholesale destruction of two labour-intensive sectors of the Irish economy: retail and construction.
Thirdly, the Irish economy has not been sensitive to competitiveness metrics since at least 2000-2001. Much of the economic growth that we witnessed over the last 20 years was driven by transfer pricing by multinational exporters, or the 1998-2001 or the 2002-2007 property, bubbles. Tax arbitrage and cheap credit were the core ingredients of our past ‘successes’ – not a vaunted smart workforce or great entrepreneurial prowess. This explains why Irish unit labour cost-based HCIs were worse than the euro area average in every year after 1996, And why they were the absolute worst of all core euro area countries from 2004 to 2007. All this while the economy was booming.
This also explains why the major MNC concerns today are shortages of skilled labour and the high cost of basic utilities and services. As of today, there are more than 3,500 unfilled positions in higher-skilled information and communication (ICT) sectors, despite rising wages as ICT sector average earnings rose 5.1% in H1 2011 compared with a 2.5% decline in average industrial wages.. It is the same for financial services – the largest services exporting sector – where earnings rose 2.1% in H1 2011.
Which brings us to the claims that Ireland’s ability to attract multinational corporate investment is a testament to our economic resilience. In reality, this is not true. Despite the well-established exports recovery, the Irish economy missed out on the unprecedented global capital-investment boom of 2009-2010. Our exporting boom also predates improvements in competitiveness, once more showing that productivity metrics have been largely irrelevant to our trading performance.
Last month’s vapid and demoralising show of the Irish elites’ dependency on foreign approval – the Global Irish Economic Forum – is further proof. Incapable of formulating basic leadership of their own, our Irish elites have to crowd-source pearls of policy wisdom from abroad. The pearls gathered were hardly worth the ink dedicated to them by the press. The ‘Gathering’ is aiming to attract 325,000 new visitors to Ireland – a number so pathetically small that it will require 3 years and 6 months worth of these increases to offset just one unsecured unguaranteed bond repayment by Anglo due this November. “The Diaspora Awards” and the “Social Networking website” capped the summit that was the embodiment of Ireland’s post-colonial lack of identity. Our elites desperately scurried to carve out some sort of nationalist exclusivity by appropriating the successes of those foreigners whose forefathers left this island many decades or centuries ago.
Last, but not least, is Irish fiscal austerity. After years of draconian tax increases and cuts to capital spending, the Irish Government continues to run double-digit deficits (excluding banking-sector support measures) relative to GNP.
Voted current spending – the component of current spending controlled by the State – has increased from €30.2bn in the 9 months through September 2009 to €31.2bn in the same period this year. Total current expenditure also increased during this ‘austerity’ period. In other words, due to higher social welfare costs, continued excessive spending on wages and pensions in the public sector and a lack of robust reductions in the largest spending departments such as health and education, Ireland’s austerity drive has been transformed into a hit-and-run on taxpayers’ income and wealth, combined with depletion of the national capital base.
While public-sector wages rose 0.6% in Q2 2011 on average, private-sector wages moderated by 0.5%. In Q2 2011 in ‘austerity’-racked public administration and defence, earnings rose 0.2%, in education by 4.9% and in health by 2.8%. Instead of providing for efficiency increases, the Croke Park deal has led to the destruction of productivity potential in the public sector as younger, less protected employees saw their contracts cut to secure tenure for older workers.
Up to Q3 2011, income tax’s total cumulative share of overall tax revenues was 38.4%, up from 28% for the same period of 2007. Year on year through the 9 months of 2011, total net cumulative spending by the Irish Government has increased 0.6%, not fallen. And this is hardly surprising. For all the verbal bluster about shuddering austerity, the Irish Government budgetary targets for 2011 are set to deliver a 26% decrease in capital expenditure, while providing for a 3% increase in current spending. Even in terms of planned targets, Irish Government total spending in 2011 is set to decline by just 0.8%. One hardly needs an advanced degree in mathematics to understand that Irish Government’s fiscal austerity is the embodiment of the culture of low aspirations: we set shallow targets and fail to achieve them.
Once again, in the public sector, the Irish economy is now consuming its own flesh. Tax increases and capital cuts are being used to fuel continued current-spending excesses.
Remember those environmental charges and the USC, the calls for ‘soaking the rich’, the Social Partnership that sealed the fate of younger workers by protecting public-sector jobs for those with tenure, and the Unions’ push for preservation of the semi-state companies powers. Amid the economic and social collapse that we are witnessing – courtesy of Government policies, and the tax increases cheered on by the official Irish Left – the core malaise afflicting our society, the intolerable levels of private and public debt, continues ravaging Irish households and the economy at large.
“Ireland is not Greece”, shout Irish leaders while conveniently forgetting one simple fact. Combined Government, household and domestic non-financial corporations’ debt in Greece stood at 273% of GDP in January 2011. In Ireland the same figure will be 400% relative to GDP by the end of this year – and 494% relative to GNP. In fact, Ireland’s debt overhang is the most severe in the OECD and our rate of debt accumulation in 2000-2010 was the fastest of all advanced economies. Both of these factors have been shown in the recent paper from the Bank for International Settlements to be the core drivers of dramatic declines in long-term growth potential.
Which, inevitably, brings us to the issue of sustainable growth. Irish growth projections that underlie long-term stabilisation of fiscal imbalances assume long-term average growth rates of 2.5-3.2 percent per annum. Based on OECD evidence, the Irish debt overhang imports long-term growth rates of below 1.5 percent annually.
None of our problems rivals the need for resolving the household debt overhang. Higher taxes to underwrite social welfare and public-sector wages bills are not the answer here. They are, in fact, one of the causes of the disease that consumes us.
In effect, Ireland needs real austerity – deeper than the one being attempted today. We should be aiming to cut current public expenditure by some 30% in 2012-2013 – in line with the GDP/GNP gap differential, plus the last Benchmarking awards. There should be an even split of one third of the cuts accounted for by wage and salary reductions, including through involuntary redundancies and deep pensions reforms; one third through cuts to social welfare and related spending, and one third through rationalisation of spending priorities and privatisation of state-controlled enterprises. The latter, as the first priority, should aim not to raise revenue for the state, but to restructure those sectors where state companies hold dominant positions.
The idea that austerity, through public-spending cuts, will trigger a deeper recession in the short run is irrelevant. Currently, the Irish economy is not on a path to recovery. It suffers from excessive public spending compounded by historically unprecedented private-debt burdens. Only bringing our fiscal targets closer to the reality of the domestic economy can deliver long-term sustainability to our public finances and economy.

Dr Constantin Gurdgiev is lecturer in Finance with Trinity College, Dublin