Wednesday, 30 June 2010

No recovery yet - and debt deflation

Michael Burke: The Q1 real GDP figures show the economy expanding by 2.7%. No doubt these will be hailed as a turning-point, and even a vindication of policy. If only that were true.

As everyone knows, this is a twin-track or two-speed economy. Organisations such as the ESRI, OECD, IMF and EU Commission all forecast that the export sector would recover reflecting the rebound in global demand following the recession, but that the domestic economy would remain mired in recession. That's what is happening. GNP, the domestic sector of the economy contracted again in Q1 by 0.5%, for the ninth consecutive quarter, far longer than in any other Euro Area economy.

But even this is to understate the true picture. Usually, growth data is presented in real terms, so that it is real activity that is captured not just inflation. But Ireland is experiencing deflation, a generalised fall in prices. So, concentrating on the 'real' numbers means not extracting the effects of deflation. To do that, we have to go to the nominal numbers, the actual Euros produced or spent in each category of national income.

Then the picture is more accurate. Just much worse. On this measure, GDP grew by just 0.1% in Q1 (€38.752bn compared to €38.715bn in Q4 2009- that's just ¤37mn) and GNP contracted by a massive 6.8% in the quarter. Nominal GDP fell 4.4% year-on-year and is now 20.2% below its end-2007 peak. GNP fell 8.6% from a year ago and is now 27.6% below its peak. This is an Irish Depression.

If we take the components of growth the data are as follows: personal consumption is down 4.6% year-on-year, -19.6% from the peak; current govt. spending down 8.9%, -11.2% from peak, and investment remains the biggest single contributor to the slump with gross fixed capital formation falling 7.6%, -66.4% from its peak. The decline in investment actually exceeds the decline in GDP, and accounts for 93% of the decline in GNP. Exports are the only bright spot, up 3.5% from a year ago, belying the idea that the economy is uncompetitive, they are 5.1% below their peak. But the improvement in net exports is actually greater as import demand continues to decline.

Unsurprisingly, given the litany of declines in all other sectors, net exports more than accounts for the entirety of quarterly GDP growth, €2,137bn of a total improvement of just €37mn. Taken together, personal consumption, government current spending and investment fell by more than ¤2bn in the quarter. Because this is on export-only recovery and the sector is capital-intensive, dependent on imports and has ultra-low taxes, this 'recovery' will actually lead to increased joblessness, bankruptcies and a widening of the deficit. Even worse, rampant deflation will increase the real debt for all households, businesses and of course the government, making interest payments and debt repayment more burdensome from shrinking national incomes.


paul sweeney said...

An excellent commentary on what is really occurring in the Irish economy, as usual Michael. Pity the contrarian view is so swamped, nay, utterly overwhelmed, by the orthodox one, as it was too during the Bubble. It is especially disappointing that the Governor of the Irish Central Bank, Mr Patrick Honahan does not read these blogs. Is this why he is so secure in the ignorance that “no one” is critical of the deflationary policies being pursued by the Govt? So he claimed to the New York Times yesterday! There is no alternative! Where have we heard this before? These policies will of course prolong the recession here. And hit the poorest hardest.

Anonymous said...

Yes thanks for the excellent analysis. The budget is just as misleading - the improvement in the 1H fiscal deficit is simply due to two factors: no pension fund transfer this year (3bn) and no bailout of anglo irish in the budget yet (3bn also). Adjust for those two and the budget deficit is right where it was last year, despite the austerity. Then you show GNP fell (or GDP if we count the foreigners) so the deficit is actually rising as % of GDP/GNP. Say 56bn expenditures this year, 36bn revenues - a 20bn euro deficit meaning 16% of GNP. We may be in a depression now, but it will be a lot worse when we lose financing for our deficit [and none of this adds in the costs of bailing out banks....] Meanwhile the government will tell us that the budget deficit is down, GDP is growing, and we are all ok....