Irish Household incomes and pay

The plunge in support for the sitting Government in the local and European elections has been attributed to a number of factors but a general theme is the view that Irish households are not seeing any improvement in their incomes, despite the much talked about economic recovery. Irish GDP has indeed picked up somewhat but the increase has been very modest, at just over 2% from the low in late 2009 , and extremely uneven, with any quarterly gains often followed by contractions, as per the most recent figures for the final quarter of 2013.The labour market has been an unambiguous positive, with surprisingly strong job creation through last year, but the available data from the CSO  shows that household incomes still fell in 2013, for the fifth year in succession, and that trend is clearly dominating  many people’s perception as to the general health of the economy.

Gross household disposable income in Ireland grew very rapidly in the first half of the noughties, sometimes at a double digit annual pace, and peaked in 2008 at just under €102bn. Wage income is the major driver of total household incomes (the product of average pay and the numbers in employment) and during the boom both components were rising at around 5% per annum, with other gains from rents, profits and rising transfers from the State.  The scale of the fall since then has been extraordinary;gross income is now back under €87bn, a level last seen in mid-2006, following a cumulative 15% fall over the past five years. The plunge in employment has been a key factor, but the other components also fell , offsetting higher transfers, and the tax burden has also risen, although it is worth noting that two thirds of the total €30bn fiscal adjustment occurred between 2009 and 2011.The hit to nominal incomes has been cushioned to some degree by low inflation (in fact negative at times) but the CPI is currently around the same level as in 2008 so that 15% decline translates into a similar fall in real incomes.

The pace of income decline is slowing however, with the initial data showing only a 0.5% fall in 2013, and the latest figures on pay point to some potential improvement. Weekly earnings did fall in the first quarter of 2014 but the  annual decline was a very modest 0.4% and included a 0.7% increase in private sector earnings. The quarterly data can be very volatile but the private sector did record marginal pay increases in both 2012 and 2013 , albeit with a very broad distribution, including strong gains in the  professional and scientific area and in information and communication, with more modest rises in retail alongside further falls in  other industries. The pay increases seen in the first quarter were broadly based,  nonetheless, with 7 of the 10 private sector industry groups recording wage gains, including a double digit annual increase in construction, over 4% in industry and over 5% in the hospitality sector. Pay in the public sector is still falling however and so a significant rise in overall earnings is unlikely this year, but the downward trend may at least be coming to an end.

Any rise in average pay will of course boost household incomes, as will a further increase in employment, although  job creation slowed to a halt in the first quarter and the rise in 2014 is now likely to be lower than most forecasts had envisaged.Rents, too, are rising again, offering further support to household incomes, but disposable incomes will be affected by a rise in tax receipts .Overall, then,the big falls in household incomes are hopefully  behind us but it is difficult to see a period of strong increases in incomes in the near term particularly if employment growth slows further.

Irish Consumer Confidence is a puzzle

Irish consumer confidence , as measured monthly by the ESRI/KBC index,  has risen sharply over the past year and is now back at levels last seen in early 2007,  i.e. before the financial crisis and subsequent plunge in Irish employment and economic activity. The economic situation in Ireland has  certainly improved of late but the scale of the change appears at odds with the buoyant confidence readings and is difficult to explain.

The index is compiled from a telephone survey of households and is based on a number of questions involving the respondents own economic situation and perceptions of the broader economic backdrop. The series is volatile and is best viewed as a three-month moving average and on that basis  over the past  decade  has ranged from over 100  (during 2004 and 2005) to around 40, the low recorded in mid- 2008. Confidence subsequently picked up to a high of 66 in mid-2010 before plunging back below 50 around the bail-out and  entry of the Troika later that year. A slow and uneven recovery ensued but the past twelve months has seen a marked acceleration, with the index currently standing at 85 from around 60 in the spring of last year.

As noted, this is now at levels last seen some seven years ago but the economic backdrop then was very different. The economy was at full employment, for example, with the unemployment rate at 4.5% against 11.7% now, although the latter has fallen from a peak of over 15%. Inflation was much higher back then, at around 5%, as against the current 0.3%, but the Misery index (the sum of the unemployment rate and the inflation rate) was still lower , at 9.6 versus 12 today. Wages were also growing strongly in 2007, by 5% per annum, in contrast to the falls recorded in recent years ,and of course disposable income has also been hit by tax increases since 2008.

The index is thought to have  a close relationship with retail sales and consumer spending but again the picture is very different in the two periods; real personal consumption was growing at an annual rate of some 7% in the first quarter of 2007 but the most recent figure, for the final quarter of 2013, showed a 1.1% fall in consumption. Spending probably turned positive again in the first quarter but most forecasters envisage a 2% rise in 2014 at best,  far from the pace recorded when confidence was  last at similar levels.

It may well be that the index is responding in an exaggerated manner to specific variables, such as the rise in house prices ( which is not positive for everyone), or simply reflecting relief that the economic situation is not as dire as was the case in 2008-2010, and that the economic outlook, although still cloudy, is at least somewhat clearer than  appeared at the worst of the crisis. It is also possible that the consensus is wrong and that spending will surprise to the upside so supporting the confidence index as a useful forward indicator of spending. Time will tell on that issue but it does seem clearer that another observed relationship involving the index has indeed broken down, at least for now- the correlation between consumer confidence and support for the government. In general, strong readings in confidence tended to go hand in hand with strong support for the sitting government, as captured by opinion polls, but that relationship appears to have well and truly splintered of late , as the confidence surge over the past year has not translated into a  boost for the  government in the polls.

Irish Austerity Budgets: why more may be needed

The 2014 Irish Budget was the eighth in succession since 2008 (there were two  in 2009) which cut government spending or raised taxes with the total fiscal adjustment amounting to €30bn, including around €11bn in tax measures. These austerity Budgets were undertaken in order to reduce Ireland’s fiscal deficit and  therefore  comply with strictures under the EU excessive deficit procedure , with the State required to reduce the deficit to under 3% of GDP by  the end of 2015( last year’ it was 7.2%). The Troika may have gone but that requirement remains and Ireland, like others in the same predicament, has to produce a Stability Programme Update (SPU) each April, which sets out medium term forecasts for the economy, the fiscal outlook and the debt situation.

The latest SPU, just published, revealed that the  Government expects this year’s cash deficit to emerge €0.9bn below that initially forecast but that the General Government deficit ( the preferred EU budget measure) will still be about €8bn or 4.8% of forecast GDP, as per the original projection. Real growth in the economy is expected to be marginally stronger than envisaged last October , at 2.1%, although the Department of Finance is now much more upbeat about domestic spending, including a 2% rise in personal consumption and a 15% surge in investment spending, and now expects the external sector to have a negative impact on GDP, with export growth of only 2% offset by over 3% growth in imports.

The main change to the outlook relates to inflation, however, with price pressures across the economy now projected to be much weaker following the trend in 2013. Consequently nominal GDP  is now forecast follow a lower trajectory  in the medium term than previously thought; the 2014 forecast is for GDP of €168.4bn instead of the original €170.6bn , with similar shortfalls over the following few years That  change affects the debt dynamics and although the burden is still expected to fall from last year’s 123.7% of GDP the decline is now slower; the 2014 debt ratio is now forecast at 121.4% instead of the original 120%.

The growth forecast also envisages the economy gathering momentum into 2015 and beyond (although previous projections were too optimistic in that regard) and further strong gains in employment, a combination that might imply less need for further austerity measures. The Minister for Finance has signaled otherwise and to understand  why that may be  the case it is  necessary to delve a little deeper into the SPU document. The Irish economy, according to the EU, is actually operating very close to capacity and to full employment, a view which would surprise many and one that has met with some opposition, most recently from the ESRI in its latest ‘Quarterly Economic Commentary’. That debate may seem arcane but, unfortunately, it has serious implications for Irish households because on the EU view the Irish deficit is virtually all structural and therefore will not disappear with stronger growth. The actual deficit will shrink but if one adjusts for the economic cycle the structural deficit would still remain, requiring policy measures to reduce government spending and/or increase tax revenue. Moreover, Ireland is charged with reducing the structural deficit to zero  by 2019 from last year’s 6.2% of GDP, which implies the post-2015 fiscal landscape will not be as sunlit as some expect. A given economy’s position in the economic cycle is not observable and estimates are just that,so convincing the EU that far more of the  Irish deficit is cyclical would have a big impact on the perceived scale of  the fiscal adjustment required.

Irish household savings ratio continues it decline

The household savings ratio, the percentage of disposable income not spent on personal consumption, can be seen as a residual in the national accounts and in Ireland’s case is subject to sizeable revisions. Consequently it is not a robust  base for an economic projection yet many  forecasts are in part predicated on changes in the ratio and the widely held expectation that Irish consumer spending will pick up this year and next  explicitly or implicitly assumes a fall in the ratio i.e. that households will make a conscious decision to spend more from a given income. In fact, as the latest CSO figures reveal, the ratio has been falling steadily since 2009, and that against a backdrop of a declining trend in consumer spending.

The CSO figures refer to gross savings which are defined as that fraction of gross disposable income not spent, so it does not equate directly with a flow of money into savings products. The use of income to repay debt, for example, would class as saving on that definition, and we know from other sources that households have in fact been deleveraging for some time. The decision to save is also likely to be influenced by a host of other factors including interest rates, changes in the tax system, inflation and the state of the economy, with high and rising unemployment often seen as a catalyst for higher savings as households react to uncertainty. Similarly, an improvement in the economic climate and a decline in unemployment is viewed by forecasters as likely to precipitate a fall in the savings ratio and hence generate a rise in consumer spending above that indicated by the change in disposable income.

Gross savings fell in Ireland  at the peak of the boom, declining to under €6bn in 2007, but rose sharply over the following two years following the onset of the economic and financial crisis, exceeding €15bn by 2009. Savings in that year amounted to over 16% of disposable income (against a ratio of only 6% a few year earlier) but  the ratio declined steadily from there and fell back into single figures last year, at 9.4%.

The actual amount saved annually has also fallen steadily, to just over €8bn last year, but Irish households have also seen a significant decline in disposable income , which fell again marginally in 2013 to under €87bn from a peak of €102bn in 2008. Consumer spending has also fallen since the peak of the boom and the decline is therefore not driven by a rise in household saving- the weakness in consumption over recent years clearly reflects pressure on household incomes rather than any surge in precautionary savings. Indeed, the  fall in the savings ratio can be seen as households seeking to contain the fall in consumption by dipping in to savings.The savings ratio is still higher than it was prior to the crash, it must be said,  but is probably not the font for additional spending envisaged by many forecasters, including the IMF. The scale of data revisions also cautions against hanging any projection for an upturn in consumption on a change in the ratio.

Irish Consumer Spending continues to Disappoint

According to the CSO’s first estimate, the Irish economy, as measured by real GDP, contracted by 0.3% in 2013. This was well below the consensus , which envisaged modest growth, largely reflecting an unexpected plunge in activity in the final quarter, which left real GDP in q4 0.7% below the figure a year earlier. This in turn now makes it less likely that average growth in 2014 will be above 2% as the current consensus expects.

Much has been made of the impact from the Patent Cliff on Irish merchandise exports and hence GDP ( the corollary, a fall in multinational profits, helped to boost GNP, the income of Irish residents, by 3.4%) but a key concern for the Government must be the continued weakness of consumer spending. Personal consumption in volume terms fell by 1.1% last year against a Department of Finance expectation of -0.2%. Moreover, consumption fell in the final quarter and the annual change in q4 was also -1.1% which makes the Department’s forecast of 1.8% average growth in consumption this year look a little optimistic.

A number of indicators would point to stronger consumption than has emerged. Consumer confidence, for example, has risen sharply and is currently back at levels last seen in early 2007. Employment is also rising strongly, by  2.4% on average last year, which offset a 0.7% decline in average wage earnings implying a net increase in total wage income. The retail sales data has also been positive, with a volume  rise of 0.7% in 2013 or 0.8% if one excludes cars.

The value of retail sales fell last year, however, implying that retailers have to cut prices to boost sales, and spending by tourists is excluded from the personal consumption figure as it is meant to capture expenditure by Irish residents. In addition spending on services accounts for over half of personal consumption and that remains weak. One factor may relate to the nature of the employment gains, with some half due to a growth in self employment, and there is no guarantee that the self employed will make money. Indeed, income tax receipts are flat on the year, and weak self employed earnings may be responsible, at least in part. The CSO also believes that the disposable income of Irish households fell over the first nine months of last year (that measure includes transfers and other sources of income alongside wages and adjusts for taxes on income). Households are also continuing with the deleveraging trend evident since 2008, with the repayment of another €5bn  of  debt in the first three quarters of 2013 bringing the total over the five years to €35bn. We do not have figures for recent months but net lending by banks and outstanding credit card debt is still falling, with  a decline of €416bn in net mortgage lending in January the highest monthly fall on record.

The trend in employment. if maintained, does provide the main argument supporting the expected pick up in consumer spending and buoyant car sales have given retail sales a strong start to the year but the trend in wages and deleveraging may also continue as drags on spending and hence GDP, with household’s attitude to debt a particular area of uncertainty.

 

Irish Household debt, Deleveraging and Wealth

Consumer spending in Ireland accounts for around half of GDP and in 2013 probably amounted to some €83bn or €11bn below the peak year of 2008. Consumption is largely driven by  real household income  which has fallen sharply in recent years, but household wealth also plays a role and so the housing collapse has also had an impact, with households deleveraging in order to rebuild net wealth. Annual consumption appears to have fallen again in 2013 but picked up through the year after a very weak first quarter and the  latest retail sales data showed a strong end to the year in term of High street spending, with sales excluding cars rising by 2.8% in volume terms over November  and December. The consensus view sees that upturn translate into a rise in real consumption this year (the Budget is predicated on a 1.8% increase), largely driven by a recovery in household income, and the latest data from the Central Bank is also  potentially supportive in terms of the trend in household wealth although deleveraging is still very much in evidence, adding downside risks.

Household wealth comprises financial assets and housing, with the latter dominating in Ireland. Net wealth (i.e. the value of assets minus debt) peaked at well over €700bn in 2008  and then plunged to less than €450bn largely as a result of the collapse in house prices. Indeed, the net financial worth of the household sector bottomed in late 2009 and has been on a rising trend since, increasing to €148bn in the third quarter of 2013 ( on a 4-quarter moving average, the measure preferred by the Central bank), which is a new high. Around a half of gross financial wealth is in the form of equity reserves in pension  and insurance funds and the recovery in stock markets  has had a big influence as the amount held by households in cash and bank deposits has not greatly changed of late. The pick up in house prices is also significant as it has boosted housing wealth with the result that total net wealth is now some €50bn higher than it was a year ago, rising to €490bn in the third quarter.

The improvement in the net worth position also reflects a significant decline in household debt. That peaked in the final quarter of 2008 at €204bn (total liabilities were and still are around €10bn higher but the Central bank concentrates on loans owed to financial institutions) and has fallen by €35bn since then, to €169bn in the third quarter of 2013. Deleveraging on that scale has also resulted in a fall in the debt burden (debt relative to disposable income) but the decline in the latter has been slower reflecting falls in the denominator, with the latest reading at 196% of income from a peak of 214%, recorded as recently as the second quarter of 2011. The debt ratio is still very high by international standards and  although the rise in net wealth is a positive for the economy and will have some influence on the future pace of deleveraging no one really knows when the latter will come to an end and that adds to the degrees of uncertainty surrounding any consumption forecast.