The Irish Economy: Before and After the Boom

1
The Irish Economy Before and After the Boom

• Jim OLeary
• Dept of Economics, NUI-Maynooth
• Beverage Council of Ireland Annual Conference
• Galway, 8th December 2006

2
Ouline of Presentation

• Review of economic performance
• How the growth dynamic has changed
• Prospects for 2007 and beyond
• The policy agenda for government
• Population trends review and outlook

3
Irish Economic Growth, 1972-2005

• Through the 1960s and 1970s growth averaged about
  4.5
• The 1980s were an aberration from this on the
  downside
• The last decade or so represents an aberration on
  the upside
• Viewed this way, the extraordinary performance of
  recent times looks like a rebound from previous
  underperformance, or what some economists have
  called delayed catch-up.

Graph shows 12-year moving average
4
Irish GDP Growth vs EU 15, 1993-2005

• No other economy comes close to matching
  Irelands recent performance, not even those
  (like Portugal, Spain and Greece) that had plenty
  of catching up to do.
• Amongst the countries comprising the EU 15, the
  nearest to Ireland in terms of GDP growth has
  been Luxembourg
• but Luxembourg is not a comparable economy now
  is it?

5
GDP Per Head vs EU Average

• Virtually no progress made until the late 1980s
  1961 (63.8) 1986 (65.9)
• Since then the rise has been meteoric reached
  100 of EU average in 1997 and registered 127.9
  in 2005
• Measured in terms of GNP per capita (110 by
  2005), some of the lustre comes off Irelands
  performance but the trend remains broadly the
  same.

EU average 100
6
The 2000 Watershed

• Significant changes in pace and composition of
  growth from 2000
• Overall growth rate has slowed, dampened by steep
  deceleration of export growth
• Housing output has continued to grow at robust
  pace
• Note also the decline in productivity growth

7
The Main Drivers of Growth

• 1993-2000
• The international high-tech boom
• Large inflows of FDI
• Big gains in cost competitiveness
• facilitated by favourable exchange rate
  movements
• Plentiful labour supply, mostly from domestic
  sources

• 2000-2006
• Ultra-low interest rates
• Rapid credit growth driving consumer spending
• and very strong demand for housing
• Plentiful labour supply, increasingly from
  external sources
• Immigration reinforces housing demand

8
The 2000 Watershed Employment Trends

• Employment in manufacturing has fallen since 2000
• Pace of increase in private services employment
  has slowed sharply
• Construction and public sector together have
  accounted for almost two-thirds of overall gain
• Construction now accounts for more than
  one-in-eight of non-farm employment

9
Employment in Construction ( of total
employment) Ireland vs EU15

• Proportion of total employment accounted for by
  construction is greater in Ireland than in any
  other EU member state
• Even amongst the new accession states, the
  proportions are significantly lower than in
  Ireland
• EU25 average 7.9 US 5.5

10
Prospects for the Economy 2006-2007

• Very strong tailwinds population growth SSIA
  maturation public finances
• Buoyant consumer spending and construction
  activity likely to continue
• Overall GNP growth rate of 5-6 p.a. (at upper
  end of post-2000 range)
• Will sustain healthy employment gains, low
  unemployment and continued improvement in public
  finances
• Inflation should subside towards 2-3 range

11
Threats and Prospects Beyond 2007

• Rising interest rates
• House price correction
• Decline in residential investment
• Pressure on public finances
• Slowdown in main trading partners
• Sharp decline in the dollar

The problem is that the internationally trading
sectors may not be able to offset a drop in
housing output should that occur, because of the
deterioration in their cost competitiveness.
12
Ireland International Competitiveness

• All these measures indicate a significant
  deterioration in Irelands cost competitiveness
  since 2000
• Depending on the index, the deterioration has
  been of the order of 20
• Some measures show that the improvements of the
  1990s have been fully reversed
• The picture shown here is corroborated by other
  evidence

13
Possible Causes of a House Price Correction

• Possible causes interest rate shock employment
  shock shift in sentiment
• Interest rates would need to increase more
  sharply than expected to prompt sharp price fall
• Shift in sentiment increases in probability the
  more prices rise above level justified by
  fundamentals

Almost all studies indicate that Irish house
prices are significantly above the level
warranted by fundamental factors
14
Some Possible Consequences of a House Price
Correction

• 1. Wealth effect decline in household net worth
  dampens consumer spending. May not be as
  significant as generally supposed given recent
  behaviour of household saving rate
• 2. Credit effect lending institutions adopt more
  stringent credit policies. Prudent underwriting
  practices in upswing should limit the scale of
  this effect.
• 3. Expectations effect undermines demand for
  housing ? reduced output. Could be important. In
  any event, output at current levels not
  sustainable.
• 4. Fiscal effect tax revenues reduced ? tax
  rates raised public spending cut. Could be very
  important since tax receipts are highly geared to
  housing market.

15
What Needs to be Done?

• Costs and competition continue to pursue the
  competition agenda in order to reduce the
  economys cost base
• Public service reform accelerate the pace of
  reform in relation to the VFM agenda
• Education declare war on complacency! Must work
  much harder to get to where we need to be
• Infrastructure there is still a yawning gap to
  be filled

Policies in these areas will yield results in the
medium- to long-term. The only policy instrument
the government has to deal with short-term
fluctuations is budgetary policy (see next slide).
16
Cumulative Increase in Tax Revenues, 2002-2005

• The fastest growing tax heads in recent years
  have been those for which the property market is
  a key driver
• Capital tax receipts rose from 0.8bn to 2.2bn
  over this period
• Stamp duty receipts grew from 1.2bn to 2.7bn
• Activity in the construction sector has also
  greatly boosted revenues from VAT and income tax

17
Analysis of Tax Overshoots, 2003-05

• In each of the years 2003 through 2005, tax
  receipts exceeded the budget projection
• Over this three-year period, the cumulative
  overshoot was 5.5bn
• Of this, the greater part was due to tax
  categories with high degrees of exposure to the
  property market

18
Budgetary Policy

• Maintain practice of conservative tax revenue
  forecasts
• Budget for substantial surpluses for so long as
  building boom continues
• Avoid giveaway budgets limit tax cuts to
  indexation-plus restrain spending growth
• ESRI is right state capital spend may be too
  ambitious in current circumstances

It is critical to recognise that a substantial
proportion of the current flow of tax revenues is
unlikely to be sustained. Budgetary policy should
avoid exacerbating inflationary pressures during
periods of rapid growth and create scope to
offset weakness in private sector activity when
the cycle turns
19
Population Trend, 1960-2006

• The population has risen from 2.8m to 4.2m since
  1960
• Since the early 1990s, the pace of increase has
  been accelerating
• Annual average growth 1996-2001 1.2 2001-2006
  2.4
• The recent growth rate implies a doubling every
  30 years!

20
The Changing Population Structure, 2001-2006

• Since 2001, the total population has increased by
  2.4 p.a.
• But the number of adults has risen more quickly
  by 3.2 pa
• The fastest growing age-groups have been 55-64
  (4.6) and 25-34 (4.3)
• The fastest growing in absolute terms have been
  the 25-34 year-olds (up 110,000)
• The number of children has been growing
  relatively slowly

21
Immigration, 2002-2006

• Immigration since 2002 amounts to about 80 of
  the population increase over the same period
• The number of immigrants since 2002 is equivalent
  to 6 of the 2006 population
• The table is likely to significantly understate
  the number of immigrants from the EU10
• A significant proportion of immigrants from the
  UK and US would have been returned emigrants or
  people of Irish descent

22
Changes in Settlement Patterns, 2002-2006

• Provincial growth rates evenly distributed around
  national average (2.0), ranging from Munster
  (1.6) to Leinster (2.2)
• Growth in Greater Dublin Area right in line with
  national average
• At the county level, Fingal and Meath lead the
  table by a wide margin
• Welcome regeneration evident in previously
  forgotten counties like Cavan and Leitrim
• All cities (except Galway) characterised by
  population decline or stagnation

23
Population Projections

• Population projections are subject to large
  errors
• The key assumptions pertain to fertility,
  mortality and migration
• The assumption to which the greatest degree of
  uncertainty applies is the migration assumption
• This is also the assumption which is the source
  of greatest potential error in the overall
  population projection
• These points apply with particular force to
  Ireland, given the countrys short record of
  significant immigration

24
CSO Projections to 2016

• Implied population growth of 1-1.5 pa depending
  on assumptions
• Projections much more sensitive to migration
  assumption than fertility assumption projected
  adult population independent of fertility
• M1 Net migration of 30,000 per annum throughout
  M2 Net migration of 20,000 pa to 2011 and 10,000
  thereafter.
• Note net migration averaged 47,000 pa between
  2002 and 2006
• Note 2006 population estimate underpinning these
  projections (4.165m) has already been overtaken
  by events

25
CSO Projections to 2016 by Age Cohort

• The most sensitive age group to migration is
  25-34
• The 35-44 cohort is also sensitive on this score,
  but will grow strongly under a wide range of
  migration assumptions
• The older age cohorts display decreasing
  sensitivity to migration assumptions number of
  retirees virtually independent of assumption
• Note big fall in 15-24 year-olds

26
Polulation Projections What We Can Be Sure About

• The average age of the population will increase
• The number of retired persons will rise
• The number of school leavers will fall
• The number of indigenous labour force entrants
  will fall
• There will be a big increase in early middle-aged
  (35-44 year-olds) the baby boomers