Responsible fiscal policy is only popular during tough times

Responsible fiscal policy is only popular during tough times

Once again, the official GDP data have overstated the strength of Ireland’s economic performance in 2018, says Conall Mac Coille.

The news that GDP grew by 9% in the first half of the year was too good to be true, artificially inflated by distortions in the multinational sector.

Specifically, the burgeoning profits of technology companies and a surge in pharmaceutical exports was pushed up by accounting practices such as contract manufacturing, or the movement of intellectual property across borders.

However, there is no denying the improvement that was apparent in a range of indicators.

Retail sales volumes were up 4% in 2018; goods exports were up by 12%; and tax revenues by 7%.

When the numbers come through, employment looks set to have grown by 3% in 2018.

And the unemployment rate had fallen to 5.3%, for November.

Moreover, the latest data show that net inward migration was 34,000 in the 12 months to April 2018 with past emigrants returning home to take up employment.

The population now stands at a modern-era high of 4.9 million, growing by 64,500 in the past year.

According to the Census data, the last time the population was this high was in 1851, at 5.1 million.

The obvious cloud on the horizon this year is Brexit.

It remains uncertain whether UK prime minister Theresa May will be able to pass the withdrawal bill through the UK parliament.

Time is now counting down quickly to the UK’s exit date on March 29.

One way or the other, some clarity on the UK’s future is likely to be thrashed out in the coming weeks and months.

Irrespective of the political theatre, whoever is UK prime minister by March 29 will probably be forced to maintain the status quo either by extending Article 50 or moving into the transition period within Ms May’s Brexit deal. A no-deal Brexit is not a realistic option.

The UK has yet to establish its own single country membership of the World Trade Organisation.

Also, the UK government has not rolled over existing EU trade agreements with the rest of the world.

So the UK’s entire export sector would be at risk, not only trade with EU countries.

It is too late for the UK parliament to pass legislation that would mitigate the worst effects of a no-deal Brexit.

The UK government had indicated it would legislate to recognise EU standards in a range of sectors, reducing the disruption from a cliff-edge Brexit, and seek reciprocal action from the EU.

However, it is now too late for these steps to be taken ahead of the March 29 deadline.

So the only alternative would be to either accept Ms May’s deal or extend Article 50. Once the uncertainty has passed, it should benefit Irish companies.

Many have put off or cancelled their expansion plans because of the uncertainty surrounding the UK.

Similarly, several share sale plans by Irish companies were put off or cancelled because of Brexit.

When will the Irish Government run a surplus?

The Government received harsh criticism from the Irish Fiscal Advisory Council late last year.

This was despite the fact the budget balance will probably be in surplus in 2018 for the first time in over a decade.

However, the council and the Central Bank of Ireland among other institutions, have argued that Ireland should now be running substantial budget surpluses; not only to provide insurance against the next downturn but also to help Ireland’s still strained government debt position.

It is sometimes forgotten that Ireland actually held a referendum to enshrine EU rules in our own constitution, in an effort to enforce fiscal discipline.

However, responsible fiscal policy only seems to be popular during tough times when households are suffering tax rises and cuts in government spending.

Now that the economy is doing well, there has been little restraint.

Public sector unions have called on the Government to restore public sector pay to Celtic Tiger era levels.

Few politicians of any colour argued for a more sedate budget for 2019.

They didn’t call for the reining in of spending to reduce Ireland’s still high level of public debt, which still exceeds €200bn.

The controversy on raising the Vat rate in the hospitality sector demonstrated the difficulties Finance Minister Paschal Donohoe faces in implementing any measure that hurts any business group.

Responsible fiscal policy is only popular during tough times

It is also worth remembering the improvement in Ireland’s budget balance has been largely due to buoyant corporation tax receipts.

These are a potentially unstable platform to launch sharp rises in spending.

They are reliant on a relatively small number of multinational companies in the technology and pharmaceutical sectors.

Concern has grown that expenditure discipline is being eroded, especially on health spending where the budget overrun in 2018 will be close to €700m.

The Government may like to characterise its Budget 2019 as prudent. However, the planned 6% increase in spending can hardly be described as cautious.

House-price inflation in October had slowed to 8% nationally and 6% in Dublin.

It is clear that stretched affordability, coupled with the Central Bank mortgage lending rules, is starting to cool the housing market.

During the summer, the average mortgage for house purchase was €227,500, the highest level since 2009, but up only 2.9% on the year.

Clearly, housebuyers are now being prevented from reacting to the lack of housing supply by taking out ever higher levels of mortgage debt.

Looking ahead to 2019, Irish banks will have fresh exemptions to the 3.5 times loan-to-income threshold that the Central Bank mortgage rules allow house buyers.

So we would expect the housing market regain some momentum, as long as the uncertainties from Brexit are resolved early in the year.

However, the debate on the lending rules masks the real issues holding back supply: Poor planning, a lack of development, and other bottlenecks holding back construction activity.

This can only be solved through difficult political choices, not through expanding tax reliefs, extending the help-to-buy scheme, or by putting pressure on the Central Bank to relax lending rules.

Such imprudent calls will inevitably grow in 2019 as housebuilding picks-up slowly, but remains well below demand.

Conall Mac Coille is chief economist at Davy

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