The end of the Irish boom

By: Marc Coleman

It howls around the walls, rattles windows and isn’t very comfortable. But as far as macroeconomy effects are concerned, the financial storm has blown any walls down yet. Outside the US, there is one European economy where you suspect it might. Economically as well as geographically (and probably socially), Ireland is as close as you’ll get in Europe to the United States.

            One fifth of the US population hails descent from Irish emigrants. Ireland is now repaying the complement: US Multinational investment accounts for 5 per cent of the workforce and the US is by far Ireland’s biggest export destination. The links don’t stop there. When it comes to the structure of its economy, Ireland is definitely closer to Boston than Berlin.

Compared to an EU average of 7 per cent, 14 per cent of Ireland’s workforce is employed in the construction sector. One quarter of Irish GDP is directly or indirectly linked to the construction sector and one fifth of all government revenues depend on it. The reason rhymes with history. In previous decades ambitious Irish young people had to emigrate to the US (or other destinations). Now they can find jobs at home. Since the early 1990s, an explosion in the age cohort between 20 and 40 created and demographically driven boom in housing demand. A certain lack of spatial planning and an Irish dislike of high rise has kept the skyline of most Irish towns and cities low. Between 1996 and 2004 these fundamentals led to house prices more than doubling.

            But what has really Americanised the Irish economy are developments since 2004. With euro zone interest rates historically low and the economy growing strongly, banks considerably loosened credit conditions. Borrowers were offered 100 per cent mortgages, higher income multiples for loans and maximum mortgage repayment periods went from thirty to forty years. Fundamental drivers of house prices were replaced with monetary ones. Private sector credit rose from 200 billion at the end of 2004 to 350 billion now, one third of this being increased mortgage credit. Housing construction rose to 90,000 units per year: a remarkable figure for a country of just 4 million people.

            Now it's payback time. Predicting a fall in housing output to 65,000 next year, the country’s leading research institute, the Economic and Social Research Institute (ESRI) now predicts GDP growth will fall by 2 full percentage points, from 4.7 per cent to 2.7 per cent. House prices will fall by 15 per cent, it predicts and unemployment will rise from 4.8 per cent this year to 5.6 per cent next year. These are – it points out – still good metrics by EU standards. But complacency has been shaken.

            There has been no Irish northern rock. Nor is sub-prime lending a problem in Ireland. What is a problem is that the economy has had interest rates that are too low for its booming economy and demography. Rising asset prices – the other side of this – are eroding the Irish economy’s once famous competitiveness. Having risen to unsustainable heights, construction activity and consumption related to high house prices will have to unwind. Similar to Germany 15 years ago, Ireland will face a few years in which high growth is hard to achieve.

            Unlike the US sub-prime lending is not a problem. Rather than a sharp and brief crisis, Ireland faces a two or three year correction across entire sectors of its economy. By EU standards, the country will be doing fine. Even if they haven’t been seen in Ireland since the early 1990s, GDP growth rates between 2 and 3 per cent are no disgrace. Neither is an unemployment rate between 5 and 6 per cent. But coming down from a 14 year high of 4 per cent plus can be painful.

            But Ireland is not called the lucky country for nothing. A recent ESRI paper by Vincent Hogan and Pat O’Sullivan suggests the consumption impact of falling house prices will be limited. Housing equity withdrawal – a major feature of US and UK housing markets – is not a big driver of consumption growth in Ireland. For an economy driven largely by consumption, that is merciful news: If Hogan and O’Sullivan are right, house price falls should have limited impact on the domestic economy.

If one sector feels pain it will be government. With one of the most sensitive electoral systems in the world, Ireland suffers from chronic fiscal policy procylicality. Government spending rose by 25 per cent in the two years up to last June’s general election.

Failing to see it – or pretending not to notice it – the government assumed before that election that the economy would grow in real terms by 4.5 per cent and in nominal terms by 7 per cent. Assuming on top that that tax revenues would grow by 1.1 times nominal growth gave it an average tax revenue growth forecast of 7.7 per cent over the five year term of the new government. According to the ESRI, that growth will be 4.2 per cent next year and possibly lower after that, punching a 12 billion euro hole in the government’s accounts.

That Ireland’s boom is ending and things are returning to normal is nothing for Irish people to worry about. It’s their politicians who need to worry. Having convinced Ireland’s that the boom would continue when productivity was declining, they now have to explain why their generous election promises won’t be implemented.

 

Marc Coleman is Economics Editor of Newstalk 106 to 108 and a regular columnist with the Sunday Independent, Ireland’s largest circulation quality newspaper. An excerpt and an outline of his forthcoming book “The Best is Yet to Come can be seen at at www.blackhallpublishing.com/lifeissues/bestisyettocome.shtml

 

---