Thursday, 8 July 2010

GDP Growth and Government Policy

Nat O'Connor: The Minister for Finance is celebrating GDP growth of 2.7 per cent in the first quarter of 2010 as evidence of the success of Government's policies (Irish Times). This is based on the latest CSO Quarterly National Accounts figures (30 June 2010). The Minister is reported to have said "our plan is working" and "we must stick to it" (RTÉ). However, there is a lot of evidence that this growth is happening despite, not because of Government policy. And in fact, the more common comparison made between GDP with the same quarter of the previous year shows that GDP has gone down by 0.7 per cent (which is the headline statistic used by the CSO in 2008 and 2009).

In the CSO's Quarterly National Accounts (QNA), when you compare GDP in the first quarters of 2009 and 2010, the 2010 figure is €300 million lower (a decrease of 0.7 per cent year-on-year). In fairness to the CSO, the comparison of Q1 2010 with Q4 2009 is relevant to the question of whether Ireland has technically come out of recession (i.e. quarter-on-quarter growth for two quarters in a row) and it is used internationally. But we should be cautious about switching too much attention away from the continuing (albeit slowing) year-on-year decline of GDP. Likewise, more attention should be paid to the significant fall in GNP of 4.2 per cent, compared to Q1 2009.

But to return to the composition of GDP? Where is 'growth' happening? Let's look at Table 5 in the QNA, which compares Q1 2010 with Q4 2009 (which is where the 2.7 per cent growth figures arises):
Personal consumption is down: -1.1 per cent.
Government current expenditure is down: -0.9 per cent.
Capital formation is down: -11.0 per cent.
Exports are up: 9.0 per cent.
Imports are also up: 3.6 per cent.

We can match up certain Government policies with some of these factors. Personal consumption is down because of jobs losses, pay cuts and increased taxes; i.e. people have less money to spend and have less confidence in the economy. This may also increase imports, as people turn to cheaper imported goods. Imports were boosted by the Government's car scrappage scheme, which must have led to leakage, since we don't make cars in Ireland (in fact, we imported €422 million in road vehicles in Q1 2010 compared to €325 million in Q1 2009).

Government current expenditure is down through cuts. Some of this may be inevitable given the crisis in tax revenue. However, the massive decrease in capital formation (i.e. investment in the physical stuff like roads, factories, etc. that will lead to future economic development) can be parked at the Government's door through the massive cutting of capital investment programmes, whereas the social partners are united in calling for state-led investment (e.g. IBEC, ICTU and others).

But what about exports?

The Government's claim is that wage cuts are making Ireland's exports more competitive. This has already be dealt with comprehensively on this blog here, here and here. At any rate, Government policy can only take credit for cutting public sector wages, which lowered consumption and raised personal debt relative to incomes, while having negligible impact on exports.

Ireland's exports in Q1 2010 are composed of €20.4 billion in merchandise and €16.6 billion in services (CSO, Balance of International Payments).

The CSO's External Trade figures gives a breakdown of Ireland's trade for Q1 2010 compared to Q1 2009. (We don't have the same detailed data available for just Q1 2010 v Q4 2009, so we are again looking at the year-on-year picture).

The top four account for 90% of exported commodities:
- Chemicals and related products (€12.2 billion, 59% of exported commodities) down over €450 million
- Machinery and transport equipment (€2.6 billion, 12%) down €1,200 million (includes nearly €800 less exports of office machines and computers)
- Misc manufactured articles (€2.4 billion, 12%) up €120 million
- Food and live animals (€1.5 billion, 7%) up €31 million

There is no clear evidence here to suggest the Government's plan is "working". Exports are still down by 5 per cent (over €1.1 billion) year-on-year. Deflation may have benefitted miscellaneous manufacturing, yet even within this sector only four out of nine sub-headings are up (Table 3, Section 8).

As for service exports, the CSO figures show that the biggest ones are: computer services (€6.3 billion), business services (€5.1 billion), insurance (€2.1 billion) and financial services (€1.4 billion). About a third of all service exports are IFSC. Overall, services are up €1.1 billion compared to Q1 2009. Computer services seems to be the most important sector here as we have relatively low imports, whereas we imported €2 billion more in business services than we exported.

What exactly is the Government's "plan" to boost services? Many of the big players in computer services, like Google and Microsoft, are concerned with quality infrastructure and quality of life to attract high-end staff. Wage deflation does not help them.

For example, the American Chamber of Commerce in Ireland stated in its Pre-Budget Submission that "Ireland continues to face increasing competition from lower cost economies for FDI. However, its sustained commitment to investment in knowledge and physical infrastructure is successfully transforming our economic aspiration to develop a credible base of industry that is underpinned by research excellence and innovation, and is supported by world class infrastructure."

Similarly in its May 2010 statement: "the decision by EA Games [to locate in Galway] is a testament to the educated and skilled workforce in Ireland's western region. Galway offers a readily available pool of talent, global market access and vastly improved physical infrastructure. EA's arrival will act as a boost to the local economy".

Intel's general manager in Ireland has also spoken about the need for digital infrastructure "right around the country" and Government policy that supports "a strong base of well-educated young people".

Undoubtedly, Ireland's tax policies are attractive to some of our major exporters. But where is the Government's "sustained commitment to investment in knowledge and physical infrastructure"?  The Government's current policy of disinvestment in infrastructure and public services, without any plan for how we will develop them in the medium-term, is a major disincentive to knowledge-based companies, like computer services.

Where is Ireland's "educated and skilled workforce"? They are emigrating, if they are among those people identified by the OECD when it stated that "Ireland's recovery will not be vigorous enough to re-employ the 174,000 people who have lost their jobs." (RTÉ)

In the high emigration era of the 1980s, the Minister for Finance's late father, then Minister for Foreign Affairs, remarked that "We can't all live on a small island". There can be no doubt that emigration is still being used as some kind of 'safety valve' for the sake of GDP growth. As people emigrate, this lessens the pressure on social welfare payments, plus it artificially lowers the number of people counted on the live register, despite that fact that it is at its highest level ever at 444,900 in June (277,400 unemployed, the remainder working part-time).

Yet there is plenty of room on the island for a lot more people to live in prosperity. Ireland has a total population of 4.3 million, living on c. 70,000 sq km (island total: 6.1 million people on 85,000 sq km). For comparison, the island of Sri Lanka, in the Indian Ocean, has a population of 21.5 million on less than 66,000 sq km.

In order to develop a social and economic infrastructure that supports more people to live in Ireland, this requires a strategy to build up the physical and knowledge infrastructure in a way that will boost sustainable jobs. However, the Government's plan offers nothing to the tens of thousands of our best-educated young people who are likely to emigrate, despite the preference of many to build their lives here. The Government could have stimulated growth and softened the landing for some people working in construction by a targetted investment in vital infrastructure, which in turn would have incentivised private investment in Ireland, but they chose not to.

All governments need to face the fact that many factors in the economy are outside of their control, including a number of the reasons for Ireland's economic growth. Our current policy-makers have to go further and recognise that their "plan" is part of the problem, not the solution.

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