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.

Irish growth surge begs questions about upcoming Budget

The Irish economy is now growing at a very rapid pace, both in real and nominal terms, and much faster than envisaged by consensus forecasts or by the Irish Government when framing the 2015  or indeed  the 2016 Budget.  Real GDP grew by 1.9% in the second quarter,  leaving the annual increase at 6.7%, while  first quarter growth was revised up to 2.1% and the annual change to 7.2%. That means that  growth averaged 7.0% over the first half of 2015  so forecasts for the year as a whole are likely to move up to at least  6% or higher. Moreover, nominal GDP is soaring, rising by an average  12.5% in the first half of the year, and GDP for 2015 may exceed €210bn,  implying a General Government debt ratio below 100%, from 107.6% last year.

The initial recovery in the Irish economy was driven by exports but of late domestic demand, which is more labour intensive, has moved to the fore. The external trade data  is still extremely strong,  albeit affected by recent Balance of Payments  (BoP) changes, and while exports  still greatly exceed imports in absolute terms,  import growth is now outpacing, so reducing or even eliminating the positive  contribution of trade to GDP. In q2 imports rose by 6.3%  so  exactly offsetting the impact of  a  5.4% increase in exports. Looking at the annual change in q2, export growth of 13.6% was dwarfed by a 16.9% rise in imports, resulting in a  negative (-0.4%) contribution to GDP.

Domestic demand was generally expected to pick up in 2015 but  the data has also  surprised, with the second quarter seeing a 4.8% rise, leaving the annual increase at an extraordinary 10.1%. Investment spending was the main driver, rising by over 19% in the quarter and by 34% over the year. Construction output is growing but the main factor was a surge in spending on machinery and equipment, although this is very volatile, particularly given the influence of aircraft orders. One puzzling feature in terms of the other components of demand is the performance of consumer spending, which has also picked up but at a slower pace than indicated by retail sales; consumption rose by just 0.4% in q2  and the annual increase slowed to 2.8% from 3.7% in q1.

Commentary on the national accounts often includes caveats about the GDP numbers, with some preferring GNP , the income of Irish residents, as a better measure. Yet growth is also extremely strong using that metric, averaging 6.7% over the first half of the year, although multinational profit outflows did pick up in q2 and the differential between the two measures may widen over the rest of the year.

Irish GDP is now  5.7 % above the previous peak but the unexpected strength of activity in 2015 raises a number of policy issues. On the face of it the economy is growing at a rapid clip and  employment is rising strongly , which would not signal the need for a further boost  to demand from fiscal policy in 2016, particularly as monetary policy is extraordinarily easy and the exchange rate has depreciated. The Government has already received advice from a variety of quarters urging little or no stimulus and the GDP  figures might serve to reinforce such views. Against that, CPI inflation is around zero, wages are only beginning to rise, credit is still contracting and Ireland ran a BoP surplus of  €4.3bn over the first half of the year, a picture hardly consistent with an overheating economy.

There is also an election due within six months, of course, but times have changed in that the Government is now constrained by EU fiscal rules, including one which limits the growth in real exchequer spending to the growth in potential GDP. The latter figure  is determined by the European Commission (EC), using a 10-year average ( including estimates of the current year and forecasts four year ahead) and as it currently stands it means virtually  zero growth in real spending in the 2016 Budget. This  real limit is translated into a cash figure by using the EC’s forecast for price rises across the economy ( the GDP deflator) which is currently  1.6%,  giving a permitted  expenditure figure of €1.3bn to allocate between spending increases and tax cuts.

Yet the GDP deflator is currently rising at an annual 5.2%, so the 1.6%  forecast for 2016 looks too low. Moreover, the potential growth rate  forecast also looks less credible, given the 2015 data. For example, Ireland’s potential growth rate for the year  was put at 2.8% , which implies that the economy may currently be operating 3-4% above capacity, given that the EC assumed  the economy was around full employment in 2014, which  is not consistent with the  observed wage and price behaviour.

There is now little more than a month to the 2016 Budget, so interesting times ahead, although whatever transpires, a buoyant economy can no longer translate into the tax and spending package we might have seen in the past.

 

 

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 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.