Still a long road back to economic normality

The latest European Commission macro forecasts published last week showed that it expects Ireland to be the fastest growing economy in the EU this year, and again in 2015 and 2016. 

The commission expects Irish GDP to grow by 4.6% in 2014, 3.6% next year, and 3.7% in 2016.

On the other hand, it says that GDP growth in mainland Europe struggled to gain momentum in the first half of 2014, leaving the recovery there not only subdued but also fragile. As a result, the commission has downgraded its forecasts for the eurozone. It now sees the eurozone economy growing by just 0.8% in 2014 compared to 1.2% previously. It slashed its growth forecast for next year to 1.1% from 1.7% and says the risks to the economic outlook remain tilted to the downside.

The strong growth performance by the Irish economy is certainly impressive, especially given the backdrop of a weak recovery in the eurozone, its main export market. The commission notes that Ireland is decoupling from the rest of the eurozone as its recovery broadens and gathers momentum.

However, one should not take the strong growth performance by Ireland as a signal that the economy has returned to normal after a long and deep recession. There are still many aspects of the Irish economy which are far from normal.

Take the housing market, which is still operating at a very low ebb. House building remains at depressed levels, well below what is needed to meet demand for new housing.

The result is marked upward pressure on house prices and rents, with Dublin house prices up by over 40% in the past two years. It will probably take at least another two years for new housing supply to rise sufficiently to meet pent-up demand.

The economy is also still very much in deleveraging mode, with private-sector credit contracting by around 8% year-on-year. Lending has picked up but still remains at subdued levels. Debt ratios remain very high, suggesting that deleveraging may well last for another couple of years.

Meanwhile, as labour market conditions have improved with unemployment falling steadily, the jobless rate remains high at 11%. The youth unemployment rate, in particular, remains very high at some 25%. And there are still high levels of emigration by young Irish people.

Improving labour market conditions have not translated into a pick-up in wage growth. We have seen in economies like the UK, US, and Germany that labour earnings are taking some time to respond to better economic conditions and falling unemployment.

It is the same in Ireland. The absence of wage growth is another sign that economic conditions have not yet returned to normal.

One also has to say that the current very high levels of income tax are not normal. Even after the changes announced in the budget, those earning above €33,800 still face a marginal tax rate of 51%. Ireland is unusual in having such a high marginal tax rate on relatively modest incomes.

Overall, then, while growth has picked up strongly and there has been a significant improvement in the economy, there is still some way to go before we see a return to normality. It is no wonder, then, that many households have yet to feel the benefits of the improving economy.

However, it was always likely that this was going to be the case. Given the depth of the recession and the legacy issues that had to be dealt such as high debt levels and weak public finances, housing and labour markets, it was always going to take some time before the economy returned to normal.

Hopefully, expectations that the economy will continue to experience strong growth in the next couple of years prove correct, as it would greatly aid the journey back to economic normality.

Oliver Mangan is chief economist for AIB


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