Full Employment in Ireland-are we there yet?

The Irish unemployment rate fell to a fresh cycle low of 5.1% in June, from 5.6% in March and 6.6% a year earlier. The monthly estimate is subject to revision but on the face of it implies that  employment growth has accelerated from an already strong pace and that Ireland is approaching full employment. The  speed of the decline has  certainly surprised most analysts; the Department of Finance   anticipated unemployment bottoming out next year at 5.3% from an average 5.8% in 2018. In fact, Government budgetary projections are predicated on the view that the economy is already operating above is potential, although one rarely hears that articulated by Ministers.

Full employment does not mean a zero unemployment rate; there will always be churn in the labour market (frictional unemployment) and some workers may not have the skills, education or aptitude to take up the available jobs (structural unemployment). The scale of the latter, in particualr, is hard to gauge so estimates of what unemployment rate is consistent with full employment often vary and can change over time; the unemployment rate has surprised to the downside of late in both the US and the UK, for example. Ireland has also experienced  lower unemployment in the past, with a rate under 4% in the early noughties and a sub 5% reading  in the years before the 2008 crash.

That perhaps argues that the unemployment rate could certainly fall further, and particularly as the participation rate ( that proportion of the population over 15 in the labour force) is still much lower than it was a decade ago, averaging 62% over the past year as against well over 66% in 2007. A return to the latter level would equate to an additional 170,000 joining the labour force, equivalent to three years  employment growth given the current pace of job gains.

That kind of a move in the participation rate seems highly unlikely, however, given the modest level of net immigration currently seen relative to the pre-crash period. Nonetheless, the pool of available labour is bigger than captured in the labour force data, as the figures also record those who are seeking work , but not immediately, as well as those available for work but not yet seeking it. The CSO defines these two groups as the Potential Additional Labour Force (PALF) and this figure is sizeable, amounting to 120,000 in the first quarter. The unemployment rate adjusted for the PALF is therefore much higher, at 10%, although it is problematical to compare this with the historical experience as there was a step jump following the switch to a new survey methodology in the latter part of 2017.

Employment is now marginally above the pre-crash peak  and if labour is getting scarcer one might expect to see an acceleration in wage growth as firms bid for workers. That has not been evident, however, at least as yet. Average weekly earnings in the private sector rose by an annual  1.8% in the first quarter of 2018 following a 1.7% rise in 2017, but that followed  a 2.3% increase in 2016. Low consumer price inflation may be a factor but wage inflation is surprisingly soft in some areas where there is perceived to be a scarcity premium, notably construction, with average earnings growth of 1.1 % in the first quarter and only  0.3% last year.

It is also worth noting that although total employment is again  around the pre-crash peak  the composition  is more evenly distributed across sectors. Then, 10.5% of jobs were in construction alone but that proportion in 2018 is only 6%, with the total employed some 100,000 below the peak. Employment in industry too is 20,000 below the pre-crash level  and also lower in retail (36,000) and financial services (4,000) Indeed, although some private sector areas have seen job gains, notably Hotels and Restaurants (30,000 ) and Professional and Scientific (12,000), most of the increase has occurred in areas dominatd by the public sector, including Education (30,000) and Health (40,000).

Ultimately, the clearest sign that the economy has reached full employment is when the unemployment rate stops falling and that is only observed ex-post. However, the current distribution of employment, the absence of aggregate pay pressure and the relatively low participation rate all point to the likelihood of unemployment falling further in the absence of a demand shock. The latter is always a risk, of course, be it from Brexit or from a broader global slowdown.

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.

Is Ireland in recession?

With all the hullabaloo surrounding Ireland’s 2015 national accounts the data for the first quarter of the year received less attention than normal. To recap, Irish GDP fell by 2.1% in q1,with large falls in exports, investment, imports and inventories, offsetting increases in personal consumption and government spending. A recession is generally defined in terms of two successive quarterly contractions in GDP, and the available data raises the possibility that Irish GDP may  indeed have fallen again in q2, although as we know the national accounts can throw up the strangest results  so it is impossible to be definitive.

What is clear is that absent revisions the volume of retail sales fell in the second quarter and by a chunky 2.7%. Core sales rose, by 1%, so the decline was  strongly affected by a fall-off in car sales ahead of the new registrations in July, but  it is the total that impacts overall consumption, which in general has been weaker  than indicated by  the trend in retail sales.

It is also noteworthy that VAT receipts have been weaker than expected in recent months; the latest exchequer figures, to end-July, showed annual growth in VAT at 4.2%, against an end-year target of 7.7%. Relative to profile, VAT receipts are €292mn behind, or 3.5%. Income tax is exactly on target and although total receipts are still ahead of profile, the €650mn excess largely reflects a €483mn overshoot in corporation tax , which is not reflective of anything going on in the Irish economy. If one excludes corporation tax, receipts are €164mn ahead of profile, or 0.7%.

There also appears to be something unusual happening in the labour market. The Irish unemployment rate has been on a steady downward trend for the past four years, declining from over 15% to below 8%, but in the three months to July the rate was unchanged at 7.8%, with July alone seeing the actual numbers unemployed unchanged. Again, data revisions can change that picture and the labour force may be growing more rapidly than thought but on the face of it the steady fall in unemployment has stalled.

The GDP figure in the national accounts is dominated by external trade and we do not know what will emerge when the estimates are released in September. The available merchandise data shows exports weakening, with annual growth turning negative in the three months to May. The decline in imports is even more pronounced, implying that investment spending has also continued to fall. The industrial production figures available to May also point to a fall in output in q2 while the CSO’s index of services output was flat in the second quarter.

The Brexit vote is generally seen to be negative for Ireland in the short term but the above raises the possibility that the economy may have contracted in q2 anyway and is therefore  already in recession.

Irish pay picking up as labour market tightens

It may come as a surprise to many but according to the Department of Finance the Irish economy is operating well above capacity. The economy’s potential output is determined by the available labour force and the productivity of that labour but output in the economy can be below that potential (a negative output gap, which can be large in a recession) or above it ( a positive output gap, which will lead to inflationary pressures ). The output gap is not observable and estimates can vary widely, particularly for Ireland given that migration has such a significant impact on the labour force, but the official view , from Finance, is that the gap turned positive in 2014 and rose to 2.3% in 2015 with a further increase forecast  in 2016, to 2.5%.

The corollary is that unemployment is now deemed to be below the rate consistent with stable inflation, again not a view one often hears articulated from official circles; that  unemployment rate ,of 10.3%, compares with the latest  actual reading of 8.9%. Consumer prices are flat and Ireland’s Balance of Payments position is not deteriorating, neither of which is consistent with a large  positive output gap, but the tightening of the labour market is beginning to have an impact on pay pressures in the economy.

The CSO had just published data on average weekly earnings, showing an annual increase of 2.7% in the third quarter and a more rapid increase of 3.6% for the private sector. The quarterly figures can be volatile but the average rise year to date is also strongly positive, supporting the view that labour is in higher demand , with a resultant upward pressure on earnings as the pool of unemployed workers shrinks.

That demand/ supply balance differs across industries of course and as a result there is a wide variation in earnings growth across sectors. Pay is rising very strongly in some industries, including Transport (5.6%), Information and Communication (4.6%), Administration (7.6%) and Finance (4.0%), while in others the increase is modest , such as Hotels and restaurants (1.9%) and Manufacturing (0.6%).  A  few are still experiencing falling pay, including Construction (-1.2%) although that sector did experience strong earnings growth in the early years of the recovery.

Price inflation is around zero so the pick up in earnings equates to  a strong rise in real incomes, which in turn is likely to support household spending. The consensus forecast envisages further strong employment growth over the next few years and a concomitant fall in unemployment. It will be interesting to see the kind of pay growth that results  as a feature of labour markets elsewhere , such as the UK and the US,  is that falling unemployment rates have been associated with unusually weak wage growth  in this recovery.

Irish employment growth accelerates

The latest  Irish Household Survey, covering the second quarter of 2015, shows that the labour market continues to tighten and that job creation has accelerated again. Employment  ( on a seasonally adjusted basis) bottomed in the autumn of 2012 and picked up strongly in  the following year, averaging an increase of 15k a quarter, but then slowed sharply in the first half of 2014, with only 4k net jobs created. Employment growth  did pick up in the second six months, with a rise of 24k, and 2015 has seen a further acceleration: the numbers in work rose by over 15k in q1 and by 19k in q2, the latter the strongest quarterly increase since early 2007. Employment has therefore grown by some 57k over the past year, or 3%, and by 130k from the cycle low, although  still nearly 200k below the pre-crash high.

Virtually all sectors of the economy have generated additional jobs over the past year. The largest increase was in Construction ( 20k) , followed by Manufacturing (10k) with Financial services (6k) also showing notable growth. Education and Administration saw marginal falls, as did the Accommodation sector, perhaps surprisingly given the strength of tourism, although the decline followed a very strong rise in 2013.

The plunge in Irish employment from 2008-2012 also precipitated  a sharp decline in the labour force, fuelled by net emigration and a decline in the participation rate. That trend appears to be ending, with the rise in employment now prompting a rise in participation , particularly from those over 45, and a rebound in the labour force, which grew by 9k in the second quarter and by 14k on an annual basis.

The recovery in the Irish economy is also impacting migrant flows. The number of emigrants is still high , at 80k  in the year to April  from 81k the previous year, but immigration picked up, rising to 69k from 61k. As a result  net emigration slowed further, to under 12k from 21k in 2014 and a peak of 34k in 2012. The number of Irish nationals leaving fell to 35k from 41k, and to a net 23k (i.e. adjusting for Irish nationals returning). Only 10k of total emigrants classed themselves as unemployed with the majority having jobs, implying the decision to leave may have more to do with the rewards of employment in Ireland or quality of life issues. Yet  Ireland continues to attract migrants, with most now coming from outside the EU and leaving a job abroad.

The pick up in the labour force in q2 also resulted in a slowdown in the pace at which unemployment fell, to 7k , leaving a total of 207k. That decline was greater than indicated by the monthly data, which has been revised, as has the unemployment rate , which averaged 9.6% in the quarter from a peak of 15.1% in 2012. The unemployment rate for July is now put at 9.5%. This is below what the EU deem to be full employment in Ireland, which seems unlikely but if true, would imply some upward pressure on wages, which  are staring to rise, albeit modestly in the aggregate. The unemployment rate in Dublin is lower still, at 8.8%, which again would point to the prospect of some wage pressure in the capital.

Overall, a clear picture of strong job growth, falling net migration and a tightening labour market and one consistent with the pace of growth in domestic demand recorded in the national accounts.

Ireland now has jobless growth instead of growth-less jobs

The relationship between Ireland’s reported GDP and employment has been a puzzle of late. Output in the economy barely grew last year yet employment soared and this year has seen GDP growth pick up but employment effectively stagnate; growth-less jobs has given way to jobless growth. The unemployment rate is still falling, it has to be said, but the explanation for that is more to do with a decline in the labour force rather than any strength in labour demand. Average pay is also declining and so the picture painted by the recent labour market data is certainly at odds with the recovery narrative currently holding sway.

The main source of information on Irish employment is the Quarterly National Household Survey (QNHS), which means that sampling errors are always present. That aside, the data shows that employment bottomed in the third quarter of 2012, having fallen by a seasonally adjusted 327k (or 15%) and  then rose sharply in 2013, with the annual increase in the final quarter at 61k or over 3%. Not all industries participated and agriculture saw by far the biggest increase in employment, but on the face of it the pace of job creation was extraordinary, and one usually associated with a booming economy. Yet the recorded GDP data, which measures the output of the economy, initially showed a fall in 2013, and although subsequent revisions have been positive, the latest vintage still has real GDP growth last year of only 0.2%.Nonethelss the strength of job creation precipitated a substantial fall in the unemployment rate, to 12.2% at end 2013 from 14.2% a year earlier, despite a rise in the participation rate. The implied tightening of the labour market was not evident in terms of pay, however, as average weekly earnings fell by 0.7% last year.

The data revisions to the national accounts had left exports stronger than previously thought and a positive contribution from external trade was the main driver of the 2.7% rise in Irish GDP reported for the first quarter this year, offsetting another fall in domestic demand. The data left the annual growth rate in q1 at 4.1% and, as we expected, has prompted a substantial upward revision to the consensus growth projection for 2014 as a whole, with many private sector forecasts now  well over 3%. Many analysts are also anticipating a pick up in personal consumption, in part predicated on a strong employment figure, but the latest QNHS data, for q2, is very disappointing in terms of job creation; employment rose by 4.3k on a seasonally adjusted basis in the quarter bringing the increase in employment in the first half of the year to just 5.5k. Coverage of the figures tended to emphasise  the annual increase in employment of 37k but  the quarterly flow implies that  the annual rise will slow sharply by the end of the year .

The unemployment rate fell further in the quarter, to an average 11.5%, despite the weak employment figures, reflecting a fall in the labour force and a decline in the participation rate. The decline in the latter was particularly acute for those  over 16 and under 24, with more staying on at school or entering third-level. Emigration is a factor too, although the net figure fell  to 21k in  the year to April 2014, with an increased inflow of  61k partially offsetting a reduced outflow of 82k.

The surprisingly weak employment figures should also be set against the data on average earnings, showing an annual fall of 1.1% in the second quarter, which again would not indicate a tightening labour market overall, although some industries did see strong annual pay growth including construction (6%), the hospitality sector (5.3%) and manufacturing (4.2%). Some have pointed to the strength of income tax receipts as being inconsistent with the pay and jobs data, which is worth noting, although it should be remembered that the 2014 Budget did include measures to boost income tax by over €200mn as well as strong carryover effects from 2013.

As is often the case with Irish data we are left with a confusing picture- is the economy growing very strongly, as indicated by the GDP figures, or is it much weaker  as implied by the employment figures?. The latter does seem to suggest that domestic demand, and particularly the domestic service economy, where most jobs are located, remains in the doldrums. This does not preclude 3.5% GDP growth but it does mean that growth will again be driven by the multinantional export sector, which is not labour intensive.