Belfast Telegraph

Beware of the false dawn of RoI economy

In assessing the RoI’s economy, Brian Keenan warns that hopes of a recovery need to be tempered with the realisation that 2007 income levels are at least a decade off

As a general rule, the first step to solving a problem is to identify the problem. The world seems to be getting closer to agreeing what has gone wrong, but not what to do about it.

The same applies to the Irish Republic, but with a few complications. More things have gone wrong, and more badly, than in most places; and the range of possible responses is limited.

In the wider world, the recent alarming terrifying statistics have led to wide agreement that this is, indeed, a depression.

It seems to have dawned on several UK analysts simultaneously that they ought to look at the actual level of output (GDP), rather than the annual change which is the subject of attention in more normal terms.

The Financial Times and The Economist, have examined, not just the fall in output, but the fall compared with what it might have been if none of this had happened.

Scary

That is truly scary. The conventional measures of depression themselves are bad enough. The downturn began in 2008 and UK output per person is still 7pc below that level. There has been growth since then, but not enough to get back to the previous peak.

It is a similar story in other large economies, with US output per person down 4pc and only Germany in positive territory compared with four years ago.

As for what might have happened, the analysis in The Economist tries to look at the full costs of the depression by asking the question; suppose it had never occurred? To do this, they compared the downturn with “trend” growth — the assumed sustainable growth rate and something which varies from one economy to another. On that basis, the costs are staggering. Britons are 13pc “poorer,” as measured by lost output, than they would have been had growth continued at its estimated trend of just over 2pc a year. Even Germans are 4pc worse off.

But wait for the figure for the Republic! CSO figures show a loss of 19pc in real national income since 2007 but, had the economy continued to grow at trend, output would be a full 25pc higher than it is. Not only is the decline greater here than in other developed economies, but trend growth is higher than most, at something around 3pc per annum, so the two reinforce each other.

Those London articles are not the first to look at things in this disturbing way. The Economic and Social Research Institute (ESRI) produced similar estimates for the loss of output and income in its medium-term.

On a “low-growth” scenario, it calculated that the permanent loss of output compared to what might have been is around 20pc. In its analysis of national debt this week, the ESRI took “low growth” more or less as the baseline assumption.

As the medium-term review put it: “It will be the end of 2011 or 2012 before there will be sufficient evidence to establish with any certainty which of these two scenarios for potential output is likely to be correct.”

Now, with the end of 2011 fast approaching, in its short-term forecast, the ESRI expects output to be growing by less than 2pc next year. The optimistic “high-growth” scenario is fading fast.

With the rest of the world not able to maintain trend growth either, this is hardly surprising. The forecast 20pc loss of income is now more of an estimate of reality than a forecast.

I am not quite sure what to make of this way of looking at things. It certainly seems gloomy, and gloom for its own sake serves no purpose.

On the other hand, the crash happened because banking and government practices allowed output and incomes to grow far faster than was sustainable.

Scale back and write in trend growth from, say, 1997 and assume no crash, and 2011 output is about 20pc less anyway. The lost income should never have been ours in the first place.

Of course, that would have been a far nicer way to get to where we are. From time to time various commentators — and even some economists — have tried to look at things in this more positive way.

Real incomes are still at 2002 levels. There are around half a million more people at work than in 1997. Exports are worth four times more.

As a consolation, it is not entirely convincing. The trouble, of course, is that the disruption and dislocation caused by a bubble and burst are far worse than steady growth even to the same, post-crash, level of income.

Had there been no bubble, unemployment would probably never have fallen below 6pc, even with significant net emigration during the 2000s, money incomes would have risen by just 5pc a year, and we would all have complained mightily. We would have never known how much worse it could be. But we know now.

The question is not whether it makes us feel better or worse but whether we understand the implications.

Many people, including those in business and politics, understandably assume that recovery means a return to the incomes of 2007. It doesn't.

Even on optimistic forecasts, it will be more than a decade before those levels are regained.

Unions

Producers, planners and public representatives — including trade unions — have to recognise that we start all over again from here — and maybe a bit worse than here — not from regained heights of four years ago.

It is important to get started. The longer recovery is delayed, the more plant that becomes obsolete and the more skills that are lost in the workforce. Future trend growth itself is reduced.

The argument rages over whether, to avoid this dire outcome, governments and central banks should keep borrowing and printing money to preserve output while the private sector adjusts to its new, lower incomes.

The argument rages here too, but is of limited relevance in a country which can neither borrow nor print, and which, because of its size, would have limited options to do so under any regime.

The argument here should not be about the size of the deficit, so much as the nature of the measures taken to reduce it.

The central question is which measures will do least damage to the economy's potential output, so as to preserve it for the day when potential can start to become reality.

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