Prospects of global recovery to assist ailing Irish economy
Trying to guide the Irish economy back to growth in the current economic environment is akin to being a coxswain in a four-man rowing boat where two of the oarsmen are out of your control (interest rate and exchange rate), one is going in the opposite direction (fiscal policy), thus leaving you with one reliable oarsman (competitiveness adjustment via wages and costs).
The competitive devaluation that the Irish economy is undertaking, primarily via wage cuts, although painful, is the best option. By becoming more competitive, Irish goods and services should become cheaper, giving a boost to exports and the economy.
Having gone down the competitive devaluation route, it is encouraging to note that the global recovery has begun. If there were no prospect of a global recovery, the Irish economy would be stuck.
In France, Germany and Japan economic growth expanded in Q2 2009, with growth expected to resume in Q3 in the UK and US. While in emerging markets, Indian and Chinese growth remained more resilient than expected.
Global growth is expected to continue improving in the second half of 2009. The Irish economy will lag behind, but it too will emerge from this recession and begin growing again in 2010.
The competitive devaluation should see net exports make up for sluggish domestic demand. The real benefit from net exports comes from the pass-through to the rest of the economy and this will be dependent on the level of exports. This in turn will be dependent on the global recovery.
The predicted recovery in developed economies is primarily accounted for by fiscal policy (car- scrappage schemes, direct Government spending) and inventory restocking. Sooner or later the fiscal stimuli and the inventory boost will fade away. This leads to the golden question: how sustainable will the recovery be once these temporary features recede?
International economists' favourite pastime is no longer gardening — green shoots, brown weeds — but coming up with shapes to describe the economic recovery — V, U, W, L, square root, inverted square root, to name but a few. The V shaped recovery is based on the view that following recessions economies rebound vigorously as a result of the monetary stimulus, fiscal stimulus and large amount of spare capacity (labour and capital) in the economy. The lower than normal growth during the recession gives way to higher than normal growth for some time, until the economy has returned to normal.
We must bear in mind though, this is no ordinary recession. Economies take longer to recover from recession when the recession is global in nature.
Of course, the current recession is global in nature with many economies affected by financial crises. Not an ideal mix — and it leads to the conclusion of a sluggish or U-shaped recovery.
The W recovery, or double-dip recession, is based on the view that policymakers may pull in the reins before underlying demand is strong enough, thus pushing the economy back into recession.
On the fiscal side, worries about growing deficits and debt could see spending cuts and tax hikes phased in even if the recovery has not taken a hold, while on the monetary side, worries about inflation could see liquidity mopped up and interest rates hiked.
A sustainable recovery in the US would make the W recovery less likely and a V recovery more plausible. However, with unemployment rising, the savings ratio correcting, financial deleveraging, construction investment set to remain subdued, and public finance constraints, US domestic demand is unlikely to be vigorous once the fiscal stimulus and inventory cycle unwinds. A more sustainable increase in US demand would come from an increase in exports relative to imports, in other words, the current account deficit would decrease. A current deficit implies that an economy is consuming more than it is producing. If the US is to shrink its deficit, reduce its consumption, and world growth is not to falter, there needs to be a corresponding increase in consumption.
The ideal candidates to fill the hole are those economies which produce more than they consume, ie those with account surpluses.
Japan and Germany both have current account surpluses. Fiscal policy could be used to stimulate consumption in these economies but fiscal debts are already high, especially in Japan, and the demographics for servicing these debts are not favourable.
This leaves the emerging markets, and in particular China. To date, Chinese domestic demand has been pumped up by government spending and increased bank lending at the behest of the government. Programmes have created employment and boosted consumption mainly by shifting resources into investment.
While Chinese consumption has increased, it has done so by increasing future production even faster; in other words, there will be little change in their current account surplus.
If there is to be a structural shift in the Chinese current account surplus, the high savings rate will have to be lowered and imports relative to exports will have to increase. The savings rate is mainly precautionary due to the lack of social safety nets; in this regard a robust retirement system and the provision of health cover have been alluded to as factors which could lower the rate.
Allowing the renminbi, the currency of China, to appreciate, is the quickest way to increase the demand for imports but the lowering of tariffs and barriers would also be beneficial — this would be a reversal of the export-led strategy with which the Chinese have enjoyed so much success and, hence, politically sensitive.
It is hard to see how the adjustment in the Chinese current account surplus is going to be anything but gradual. This fact, combined with a sluggish recovery in developed economies domestic demand, points to a U shaped recovery once the brief period of rapid growth fuelled by government spending and inventory restocking has passed.
The structural shake out from the collapse of the property market, the changed face of banking and fiscal contraction point to subdued domestic demand in Ireland. Given these weaknesses and Ireland's leverage to the world economy, a U-shaped recovery in the Irish economy seems most probable.
Brian Devine is an economist with NCB Stockbrokers