Irish labour data another indicator of capacity issues.

Ireland’s GDP, the international standard for measuring economic activity, may cause puzzlement to many and amusement to a few but it is difficult to argue with the labour market data as provided in the Quarterly Household Survey, and that continues to point to a buoyant economy. Indeed, it supports our view that Ireland is currently facing capacity constraints on many fronts,  stemming from years of under investment coupled with very strong growth in the population – the latter has risen by half a million over the last decade and double that in less than twenty years, a fact perhaps obscured by the emphasis in some quarters on emigration alone.

Employment bottomed in the autumn of 2012 on a seasonally adjusted basis  and has since risen by 212,000 . The numbers in work grew by an annual 65,000 in the fourth quarter of 2016, or by 3.3% , with the gains spread across all economic sectors. The Labour force is also growing again, albeit modestly, rising by an annual 25.000, with the result that unemployment fell by an annual  40,000 in Q4, taking the total to under 150,000  for the first time since mid-2008.

The unemployment rate peaked at 15.1%  a full five years ago, and  has been falling since , with the pace of decline accelerating of late,  from 7.9% in August to 6.9% in December, while January has now been revised to 6.8%. It is difficult to say what unemployment rate is consistent with full employment ( the rate fell below 5% during the last boom) but it is now likely that some sectors are experiencing labour shortages. Experience in other countries with low unemployment rates ( notably the US and the UK)  suggests that we may not see a generalised accleration in wage growth , although sectoral differences are already apparent.

The tightening labour market is another indicator of the constraints existing in the economy, as evidenced by the shortage of housing, overcrowded hospitals and clogged roads. Yet official policy appears to remain focused on attracting FDI at all times, irrespective of whether the economy can absorb such flows.

Hard to see Brexit as positive for Ireland

The polls pointed to a close run thing in terms of the Brexit vote, albeit with Remain pulling marginally ahead , but the markets had convinced themselves that the probability of a Leave vote was virtually zero. Behavioural economists talk of  Narrative Fallacy and Confirmation bias ( we convince ourselves that our interpretation of events is true and ignore any conflicting evidence) and those concepts seem to capture what developed in the FX and equity markets in the days before the referendum. Consequently, the subsequent carnage in markets  can in part be explained by traders and investors scrambling to exit positions that had gone horribly wrong.

Any short term bounce from oversold readings may be short lived, however, as it seems fairly clear that the uncertainty of Brexit alone will hit economic activity, not just in the UK but across Europe and beyond; consumers are likely to become more cautious, resulting in higher saving and reduced spending, with firms  postponing or even abandoning  investment plans. The plunge in equities has hit household wealth and house prices are also likely to be adversely affected. Bond yields have fallen again and we may well see lower short term rates as well, so further reducing the income of savers and putting an additional squeeze on bank margins.

Any  change in UK activity impacts Ireland ( some studies suggest a 1% reduction in UK GDP reduces Irish GDP by 0.25%) and the export sector would obviously also  be impacted by weaker euro zone growth. Domestic demand in Ireland  may also take a hit, as consumers and firms react to the uncertainty caused by this seismic event. Short term FX moves may not have a huge impact but it appears likely that sterling may be marked down for a long period, so putting margin pressures on Irish SME’s trading with the UK.That uncertainty may well last some time, even if market volatility settles down;  it is up to the UK to trigger Article 50 and the exit negotiations, with the latter taking two years at least, so this is not a short-term event.

On the positive side some argue that Brexit is an opportunity for this country, in that firms may leave London and other parts of the UK and move to EU States in order to secure access to the single market. Financial services, in particular, is seen as ripe for such a  migration.

That belief ignores the reality of the current economic situation in Ireland; there are huge capacity constraints in a host of areas, including housing, commercial property, education, hospitals and infrastructure, particularly in and around the Capital. Consequently it is hard to see how Dublin could absorb a swathe of large financial institutions locating here-  residential rents are already at record highs, for example, so the influx of highly paid financial professionals  is likely to put further pressure on accommodation in Dublin.

Over time, capacity can be increased, of course, but Public capital spending under the Government’s latest plan is set to rise to only 2.7% of GDP by 2021, which is very low by EU standards and woefully inadequate given years of spending cuts. Ireland can therefore not absorb large numbers of firms even if they did wish to relocate here and if one adds the other short term negatives discussed above  it is hard to make the case that Brexit is good for Ireland in any economic sense.

 

The Irish Economy has some serious Capacity Issues.

The Irish recession was long and extremely steep but it ended over six years ago and the economy is now growing rapidly; real GDP has risen by 25% from the cycle low and is now over 10% above the previous peak. Indeed, according to the Department of Finance, Ireland is now operating above full capacity. Others, including the ESRI and the Irish Fiscal Advisory Council have queried this but all agree that the degree of spare capacity in the aggregate has  diminished. It is also true that one does not have to look hard to observe capacity issues in specific sectors of the economy, particularly in and around the capital.

Take tourism, which is booming; last year the number of visitors to Ireland exceeded 8.6mn, having grown by 13.7%, and on the evidence of the first quarter the figure for 2016 will exceed 9.5mn. That has put pressure on accommodation, and the price of a hotel room rose by over 5% in May alone and is 9% up on the previous year. One could not give a hotel away not so long ago but now rooms are scarce and are 22% more expensive than in 2012. Housing in general is also scarce , of course, particularly in Dublin. Rents, nationally, are at record highs and on the CSO data there is no evidence of any significant change in trend, with the latest figure for May showing a 9.7% annual rise.

Irish residents are taking more foreign trips too ( up an annual 13% in the first quarter of 2016) and it is not surprising that Dublin Airport is now seeing record passenger numbers, with 2.5mn in  May alone , an 11% rise on the previous year, implying the 2016 figure will be well in excess of last year’s 25 million. The Airport is building a new runway to help cater for the increased demand, and it is instructive that the planning permission was initially granted in 2007 and then put on hold.

Car ownership is also growing strongly again, with sales up 31% last year following a 29% increase in 2014. The latest data for this year points to a 25% rise which would take the annual figure to over 150k for the first time since 2007. Hardly surprising then that record numbers are using the M50, with gridlock at peak times not uncommon.

The growth in the population as a whole is also putting pressure on schools and hospitals, although one could be forgiven for thinking the population is falling given some media coverage of emigration. The reality is that the population surged by over half a million in the six years to 2009, reaching 4.53mn, and by 2015 had risen to 4.64mn, as net migration has slowed to virtually zero and is anyway offset by the natural increase.

The conclusion has to be that Ireland needs to embark on a huge programme of capital investment in order to tackle capacity issues, particularly in and around Dublin. Borrowing costs for both corporates and Governments are at historically low levels and there has been some increase in building, both residential and commercial, although the former is still well below the annual demand, so exacerbating  the existing supply/demand imbalance. Unfortunately it is  a mark of the absurdity of the current fiscal rules imposed on euro members that capital spending  by the State  is not excluded from the expenditure constraint (  only some incremental spending is allowed) and so any amelioration in these capacity issues is unlikely to occur any time soon.