Steep fall in domestic spending

THE faltering construction sector and fading consumer confidence meant domestic spending fell more than the European average last year.

According to Bank of Ireland’s latest economic bulletin, the Irish economy contracted by 7.1% in 2009, which was well below the eurozone average of 4.1%.

The bank noted, however, that Ireland was not the worst performance in the euro area or the EU. Finland recorded a 7.8% fall in GDP while across Europe as a whole the Baltic states contracted at more than double the Irish pace – Latvian output fell by 18%, Lithuania by 15% and Estonia recorded a 14% decline.

Bank of Ireland chief economist Dr Dan McLaughlin said the contraction in Ireland was steeper than the euro area for two main reasons.

“First, capital spending generally fell heavily across most developed economies and by 11% in the single currency area, but in Ireland the fall was some 30%, including a 34% fall in building and construction.”

He said this sector was of more significance in the Irish economy than the norm elsewhere, but by the fourth quarter of 2009 had fallen to under 12% of GDP, or half its share of GDP at the peak of the construction boom. House-building alone now accounts for only 2.5% of real GDP, again dramatically lower than the 12% share in 2005.

“Consumer spending also fell across the EU area, by 1.1% on average, reflecting falling employment and slower wage growth. In Ireland employment fell precipitously, by over 8%, and wages also fell on average, which partly explains why the fall in Irish real consumer spending at 7.2% is unusually large.”

Irish households appear to have cut discretionary spending by more than the fall in disposable income.

“In other words the savings ratio went up, and may now be 11%-12%, from under 3% in 2007,” he said.

Ireland, however, outperformed its European neighbours in the external sector, with Irish exports falling by 2.3% in volume terms in 2009, while exports in the euro area fell by over 13%.

“This implies Ireland gained market share which sits uneasily with the widely held perception that the economy has lost competitiveness in recent years.”

Irish hourly earnings in manufacturing have risen by 69% over the past decade, against a 39% rise in its main trading partners, but Irish productivity has also outpaced the competition, with the result that Irish unit labour costs in manufacturing have fallen 14% relative to its trading partners over the past decade, according to Central Bank data.

“This productivity growth has been largely driven by the multinational sector, however, so it would be more precise to say that the indigenous economy has lost competitiveness, but that the multinational sector has certainly not,” said Dr McLaughlin.