By Constantin Gurdgiev.
December data on the Irish economy paint a picture of a major slowdown in growth momentum and once more highlight the troubling nature of our national accounts statistics. With that in mind, and given the spectacular tremors rocking the global economy outside the well-insulated doors of our Department of Finance, the Irish economy is set for an eventful 2015.
Let’s take stock of the prospects awaiting our small haven for tax-optimising MNCs and regulations-minimising foreign investors, in the New Year.
On three domestic front, three drivers of economic recovery will be lighting some fireworks over the next 12 months. Here they are, in order of their importance.
The ongoing shift in MNC activities here from profit-booking to cost-based transfer pricing, colloquially known as ‘contract manufacturing’. In simple terms, this means unprofitable low-margin activities are outsourced by MNCs to their subdivisions and other MNCs located abroad, and the resulting revenues are booked, often into Ireland. Official GDP rises here, while our domestic economy stands still. In H1 2014 this game of accounting shells has accounted for 2.5 percent of the 5.8 percent recorded growth in Irish GDP. In other words, some 43 percent of the growth ‘miracle’ that is Ireland Unchained was bogus. We don’t have detailed analysis of the Q3 2014 data to determine the broader impact of ‘contract manufacturing’ yet, but the National Accounts data are not encouraging. The gap between the National Accounts-reported exports of goods and the same exports reported in our Trade Statistics is growing once again. Over Q2 and Q3 2014, this stood at a whopping €7bn more than what the historical average would imply. That is, roughly, 7.65 percent of our entire GDP over the same period. If we correct the National Accounts data for this discrepancy, cumulative Q2-Q3 2014 GDP in Ireland would have posted a 0.4 percent decline year-on-year, not the rise of 5.4 percent recorded in the official statistics.
As the trend accelerates in 2015, the Irish economy is likely to post greater paper gains and lower real and the utility of our economic data will diminish further.
The second driver of boosterism is also MNC-focused. Budget 2015 introduced massive incentives for MNCs to book intellectual property into Ireland. Instead of the notorious Double Irish we now have an even more generous Knowledge Development Box. This reinforces the already absurd change to the National Accounts that re-labels R&D spending into R&D investment. The combined effect of both factors is likely to be more R&D ‘imports’ into Ireland. The latest data show that overseas-originating patents filed in Ireland rose 22.4 percent year on year in Q3 2014. And that is before the ‘Knowledge Development Box’ opened its all-welcoming lid. As 2015 rolls on, expect more GDP supports from the new ‘investment’ products to hit the market here. Just don’t count on new jobs and higher domestic incomes to materialise out of this ‘smart economy’ any time soon.
The third force likely to propel Irish growth to new highs is the ongoing squeeze on the and construction sector imposed by a combination of the credit crunch, Nama’s assets-disposal strategy and the woefully poor regulatory reforms that have cut down the supply of development sites amd the funding for development, and so have blocked up the planning applications pipeline. The result is rising rents (GDP-additive) and prices (the so-called ‘investment’ side of the national accounts) amid the very real deepening misery of rising business costs and an escalating cost of living. Added up, the Irish property sector ‘revival’ is now yet another force that simultaneously transfers money from the households and firms into the pockets of rent-seekers and the Government, and galvanizes with fools’ gold he national accounts.
The domestic bliss of the GDP growth described above will be severely challenged in 2015 by the continued deterioration in global economic conditions. Here we have some serious flash points of risk, trailing back from 2013-2014, and some circling new ones that are likely to emerge in 2015 in their own right.
Back at the beginning of 2014, expectations for a global growth recovery in 2015 were driven by rosy forecasts for North America and the Emerging Markets.
The Euro area was expected to post a rather sluggish, but nonetheless above one percent, recovery in 2014 and rise to close to two percent annual growth in 2015. Fast forward to today. Latest forecasts suggest near-zero growth in 2014, followed by one percent growth in 2015. So Europe’s prospects are bleak. That’s roughly 35 percent of our indigenous exports trade in the bin. But at least low growth is likely to delay the inevitable rise in interest rates, giving our heavily indebted households another stay on execution.
The US miracle of economic recovery is heavily dependent on interest rates policy not reverting back to elevated rates and, in all likelihood, the US Fed might just oblige. Should the Fed change its mind, all bets are off: we might see a slowdown in the US recovery and with it a fall-off in the US demand for Irish exports, both indigenous ones and MNCs’.
The UK is a great example of the fragility also present in the US economy. Like the US, the UK is heavily dependent on supportive monetary policy. And, ahead of the US, its economy is starting to hit serious bumps. Latest data show continued declines in house prices, while demand is stagnating and inflation is slipping to long-term lows. The last time we saw UK inflation at current levels was in 2002 – amid the dot.com-bubble-induced recession.
Taking both the U.S. and UK markets together we see over 50 percent of demand for Irish indigenous exports put under rising risk.
Which leaves us with the rest of the world. Here, the Emerging Markets are tanking, fast. Brazil is in an outright recession. Russia is slipping into one at the speed of a rock falling through the foggy ravine. China is on the brink of a major de-acceleration in growth; and that is under rather rosy predictions. India is enjoying some warm afterglow following applied expansionary monetary policies, but the question is for how long. South Africa is moving sideways: a quarter of contraction is followed by a quarter of anaemic growth.
The Irish Government’s Budget 2015 projections were based on the following assumptions:
– Irish GDP growth of 3.9 percent or 0.85 percentage points above the IMF forecast from October, and 0.6 percentage points below the November forecasts from the OECD
– Euro area growth of 1.1 percent – mirrored by IMF and OECD forecasts, as well as that of the EU Commission, but the risks are still to the downside in all of these forecasts.
– US growth of 3.1 percent – virtually identical to the IMF forecast and the current consensus amongst t economists, but some business surveys suggest growth closer to 2.4-2.5 percent.
– UK growth of 2.8 percent – or 0.1 percentage points above the IMF forecast from October and OECD forecast from November. More recent forecasts published in early December suggest the UK economy might expand by 2.4-2.6 percent in 2015.
Global winds are not favourable to Ireland, although we do have some aces up our sleeve. They are: aggressive tax optimisation and the fact that domestic demand can only rise – two drivers that might, just might, return that 3.9 percent expansion in 2015.
Still, for now, the forecasts suggest that the Government really did miss a major opportunity in Budget 2015. As the Irish Fiscal Advisory Council estimates show, Irish growth at 3.5 percent in 2015 will mean the Government missing the illusive three percent deficit target. As the above forecasts slip back over time, the 3.9 percent growth assumption is likely to be revised closer and closer to that critical point at which the Government risks losing face before the International Markets. And that won’t play too well in the ego-driven Government buildings.
Add to the above some other silly assumptions made in the Budget, such as static current expenditure for 2015-2018 and zero policy change, and you get the idea. Over recent months, the Government has revised its spending plans for Irish Water by some €300m. And over the next twelve months it will have to revise its agreements with the Trade Unions on public-sector costs moderation. Thenthere is the political cycle that simply commands that the Government unleash a torrent of budgetary giveaways over electorate itching to send the FG/Labour coalition into the recycling bin of history.
All told, the real economy is likely to continue underperforming into 2015, just as it did in 2014. In the first three quarters of this year total domestic demand (the sum of private and public consumption and investment, plus changes in the stocks of goods and services in the economy) was up just 2.18 percent year on year in real terms. Over the last three years, coincident with the term of the current Government and its policies, total domestic economic activity has expanded by a miserly 0.29 percent in real terms. That is less than half the rate of growth in GDP over the same period. And the latest quarter has been even less impressive, with domestic demand falling 0.3 percent year on year, same as in Q3 2013.
So tighten those belts for one more year of pain: the slimming down of the Irish economy is not over yet. [December 2014]