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Ireland’s recovery from
crIsIs
John fItzgerald^1
Introduction
The economic crisis that hit Ireland in 2008 stemmed from an uncontrolled real estate bubble that had de veloped over the previous five years, and the resulting collapse in the domestic financial system, which was heavily exposed to the property market. The collapse had an immediate and very severe impact on all as pects of the economy. The very large fiscal adjustment that was necessary to restore order to the public fi nances began in 2009 and it has continued to this day. However, there are clear signs that the economy began to grow again in 2012 and this recovery has continued through 2013 and into 2014.
This paper discusses the measures taken to turn the economy around: the domestic policy actions and their role in the adjustment. However, what is clear to day is that the tradable sector of the economy was less damaged by the crisis than may have initially been thought and it has led a recovery. The growth of the tradable sector has occurred in spite of the fiscal ad justment that is still under way. While this recovery still has a long way to go, it is, by now, reasonably well established. Nonetheless there remain concerns about the robustness of the recovery elsewhere in Europe, which is crucial in underpinning the return to growth in Ireland, and there are also concerns about the abil ity of the domestic financial system to fund the ongo ing recovery.
This paper first considers the nature of the crisis in Ireland since 2008 and the policy measures imple mented to tackle it. It then considers the evidence of economic recovery, paying particular attention to the problems in interpreting data due to the exceptional (^1) College Dublin. (^) The Economic and Social Research Institute, Dublin and Trinity
openness of the economy. Finally, it considers how the recovery may proceed over the next few years.
The nature of the crisis The crisis that broke in the Irish economy in 2008 was rather similar to that in Spain. A major property bub ble had developed over the previous five years, which was financed by inflows of capital into the domestic banking system. The high expected returns from in vestment in housing in Ireland had evoked a huge sup ply response. The number of dwellings built in Ireland at the height of the boom was approximately 100,000. Today the number being built is less than 10,000. This meant that a very substantial part of the economy was devoted to building and construction in 2007 (Fi gure 1). To provide the necessary resources, including labour, the rest of the economy, especially the tradable sector, had to be squeezed through a high rate of wage inflation, which reduced competitiveness. In turn, this was reflected in a move into deficit on the current ac count of the balance of payments in 2003, a deficit which deteriorated rapidly thereafter. When the crisis hit, the building and construction sec tor collapsed resulting in a fall in GDP from peak to trough of just under 10 percent and a fall in GNP of over 15 percent.^2 The unemployment rate rose very rap idly. Between 2007 and 2012 it had increased by 10 per centage points. As discussed in Fitzgerald (2012), the current account adjustment was particularly rapid in countries, such as Ireland, where there was a collapse in the construction sector, whereas in economies, such as Portugal and Greece, where there was no real estate bubble, the adjustment in the current account was slow er, being driven by the fall in domestic consumption rather than the very rapid fall in domestic investment. The real estate sector in Ireland was tax rich and em ployment rich so that its implosion had a very severe (^2) of foreign firms and also national debt interest paid abroad. Here we (^) GNP is a better measure of living standards as it excludes profits have adjusted GNP, as described below, to exclude the additional in come of some foreign owned firms that is not captured properly in the current account of the balance of payments.
effect on the public finances. Having run a general government surplus in 2007, the deficit reached 11.3 percent of GDP by 2009 (in spite of significant cuts in the 2009 Budget). In addition, the crisis saw the government having to pump over 40 percent of GDP into the banking system to cover its losses and to re capitalise the remaining banks. The result was that the gross debt to GDP ratio, which was under 25 percent in 2007, peaked in 2013 at over 120 percent of GDP.
Policy response
Because the severity of the impending crisis was real ised in the late autumn of 2008, urgent measures were taken to deal with the deterioration in the public financ es in the Budget for 2009. However, these measures were only a beginning and they did not prevent the pub lic finance from continuing to deteriorate. Table 1 sum marises the ex ante^3 fiscal policy measures taken over the course of the crisis, including the measures pen cilled in for 2015. Together, the cumulative ex ante ad justment amounts to just under 20 percent of GDP. (^3) these measures to government revenue and expenditure. (^) This is the effect of the measures taken assuming no feedback from
When the adjustment began in 2009, the full gravity of the prob lem with the banking system was not realised. It was not till the au tumn of 2010 that this became ap parent. The revelation of these problems in 2010 saw Ireland’s ac cess to funding drying up and the result was the recourse to the sup port of the Troika in late Novem ber 2010. However, before assis tance was sought from the Troika, the government had put in place an adjustment programme de signed to bring government bor rowing below 3 percent by 2015. The adjustment programme pre viously agreed with the EU Commission in 2009 had planned to reach this borrowing target by 2014 but, be cause of the additional burden of funding the banking sector losses, the time scale for meeting the borrowing target was extended to 2015. The adjustment programme set out by the government in early November 2010 was accepted by the Troika in December 2010 without significant change. Thus it was the Irish government’s plan, rather than a plan imposed from outside, that formed the basis for the ongoing fiscal adjustment. Up to that point the fore casts for the public finances in the government’s pro gramme had consistently proved to be pessimistic. However, in drawing up the programme in late 2010 the then government aimed to underpromise. This policy stance by the outgoing government was unusual as they were facing into an election within three months. (It is more usual for governments to overpromise in a run up to an election.) However, in this case the outgoing government anticipated a disas trous election result and, instead, of overpromising,
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Investment in housing
Source: EU AMECO Database.
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2012
Figure 1
Table 1 Summary of actual and planned austerity measures over period 2008–2015 (billion euros) 2008–2010 2011 2012 2013 2014 2015 2008– Revenue Expenditure 5.6 1.4 1.6 1.3 0,9 0,7 11. Capital^ of which
Total 14.7 5.3 3.8 3.5 2.5 2.0 31. Share of GDP 9.2% 3.3% 2.3% 2.1% 1.5% 1.1% 19.5% Source: Department of Finance Budgets. GDP figures revised based on CSO: National Income and Expenditure,2011 and Duffy et al. (2012).
Table 1
the support of its EU partners and the IMF, Ireland would not have been able to deal with the situation in the way it did.
The banking system has been very slow to deal with the problem of the debts that had been recognised in the 2011 stress tests and for which provision had been made in the recapitalisation. As a result, as a recovery in the wider economy is underway, there are concerns wheth er the banking system will be able to fund a prospective significant increase in investment (Duffy et al. 2013). While the evidence to date is that finance has not been a constraint on growth (O’Toole 2013), it could well prove to be a greater obstacle in late 2014 and 2015.
The recovery
While economists are not good at identifying econom ic turning points in real time, after the event it is more straightforward to use national accounting data to date recessions and recoveries. However, in the current Irish case, because of the extreme openness of the economy, it is difficult to interpret standard economic data to assess trends in the recent past. While it is rea sonably clear from the data for GDP that the economy peaked in 2007 and that output (and employment) lev els fell precipitously in 2009, it is much less clear when the recovery actually began.
There are two obvious problems in interpreting the data: one problem relates to the effects on the data of the ending of pharmaceutical patents and the second relates to the operation of some investment vehicles located in Ireland.
Because of the major importance of the pharmaceuti cals sector in Ireland, the ending of patents on certain key drugs has had a major impact on national account ing aggregates in recent years. For example, one par ticular drug manufactured in Ireland, Lipitor, dropped out of patent in the United States at the end of 2011 and in Europe in 2012 (Fitzgerald 2013a; Dalton and Enright 2013). The effect of this change was a loss of revenue for the owner of the drug, Pfizer, of 5.5 billion US dollars in 2012.^5 Even though the pharmaceutical compound continued to be manufactured in Ireland af ter the end of the patent, all of this loss of revenue is classified as a fall in volume of exports and of industri al output. To the extent that this fall in revenue resulted (^5) Over 2.5 percent of the value of exports and of GDP.
in a fall in profits earned in Ireland, it also represented a fall in the volume of GDP. However, it had only a minimal impact on GNP. As this was only one of a number of drugs produced in Ireland that are falling out of patent, and because the precise accounting treatment used by individual com panies is confidential, it is difficult to unravel the full effects of these developments on GDP. In an economy, such as Ireland’s, a better measure of real activity, in so far as it affects the domestic econo my, is the development of GNP. This is because of the very large and profitable multinational sector in Ire land. The large profits that these firms earn are remit ted to the firms’ owners and this outflow is included in net factor income paid abroad; this is subtracted from GDP to arrive at GNP. Thus GNP is largely unaffected by the loss of patent revenue as that loss of revenue only affects the profits of the multi nationals.^6 However, even with GNP there have been significant distortions arising from unusual behaviour by foreign firms located in Ireland, which affect the interpretation of the data. Between 2009 and 2012 approximately a dozen financial firms, largely UK in origin, relocated to Ireland. These firms, referred to as ‘redomiciled plcs.’, are liable for tax in Britain and have no domestic presence in Ireland (no employees) (Fitzgerald 2013b). They earn investment income in Ireland, which is cred ited as a net factor inflow, raising GNP and the meas ured current account surplus. However, because they do not pay dividends, their income does not flow back out to the beneficiaries on the current account. As a re sult, it increases GNP and Gross National Income (GNI)^7 and the current account surplus of the balance of payments by a significant amount. The increase in the value of the firms’ assets arising from the inflow of dividends shows up in the Net Foreign Liabilities of the state. Clearly this addition to GNP, which properly belongs to the foreign owners of the investment funds, does not represent an increase in Irish welfare. To deal with this problem we exclude these inflows from the published GNP figure shown in Figure 2. As shown in Figure 2, in the case of GDP the trough was in 2010 and there was very slow growth in 2012 and 2013. While GNP, unadjusted for redomiciled (^6) the lower profits there would be an effect on GNP. (^) To the extent that there is a loss of corporation tax as a result of (^7) spite of the fact that there is no domestic value added arising from (^) The rise in GNI raises Ireland’s contribution to the EU Budget in these firms’ activities.
plcs., stabilised in 2010, it only returned to significant growth in 2012. Probably the best measure of domes tic welfare is GNP, adjusted to exclude the redomi ciled plcs. This aggregate suggests that the recession in Ireland continued through 2010 and 2011, with recov ery only beginning in 2012.
The clearest signal of what is happening in the econo my is probably the growth in employment (Figure 3). Beginning with the last quarter of 2012, there have been five consecutive quarters where seasonally adjusted em ployment grew, quarteronquarter, by over 0.6 percent. This suggests a very similar turning point to the GNP data – some time in 2012. Since late 2012, there has also been a significant increase in hours worked.
When considering the impact of the crisis on the distri bution of income, the single biggest driver of change was the dramatic rise in the numbers unemployed.
However, there has also been a big impact on the incomes of a signif icant number of really high earn ers, many of whom were depend ent on the property bubble for their livelihoods and the bursting of the bubble has seen a dramatic decline in their fortunes. Between 2007 and 2010 the numbers earn ing over 100,000 euros fell by al most 15 percent and, in addition, the average income of those who were still earning over 100,000 eu ros fell by around 8 percent. While the underlying driver of change in the distribution of in come (and in the numbers at risk of poverty) has been the changes in economic fortunes, public policy has also played a mildly progressive role in modifying the impact of the crisis on households. Callan et al. (2013) show that the effects of changes in the tax and welfare systems over the period 2009–2014 have reduced the incomes of the richest 10 percent of the population by 15.5 percent, while the decline in the incomes of the poorest 10 percent of the population was 12.5 percent. However, while changes in public policy did not have a major impact on the distribution of income, the oper ation of the existing welfare system, interacting with the wider changes in the economy, shielded an increas ing number of people from the risk of falling into pov erty. While the ‘at risk of poverty’ rate in 2011 was 16 percent, official data indicate that, without welfare transfers, it would have been close to 50 percent. By contrast, in the boom years it would have been under 30 percent without transfers. The resulting increase in welfare pay ments has contributed to the problems in the public finances. The data for Ireland for 2011 sug gest that the distribution of in come was rather similar to what it was in 2007 and 2008. For 2009, the first full year of the crisis, the distribution of income, measured in this way, was the most equal that it has been since the 1980s. This contrasts with Spain where the Gini coefficient has risen sig nificantly in recent years.
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Source: Central Statistics Office, Natonal Income and Expenditure (2012); Fitzgerald (2013b).
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Figure 2
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Source: Central Statistics Office, Quarterly National Household Survey.
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