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Uncertainty and Economic Recovery

Posted on July 14, 2014 by Micheál Collins

Slowly, the Irish economy is recovering; very slowly! Over the weekend, I and other economists contributed to a journal.ie article (see here) on the two-speed nature of the recovery. While the exchequers finances are improving (lower unemployment, higher employment, some increased spending, expenditure cuts and new taxes) the impact on the ground is very different. For those returning to work there have been significant, overdue and welcome benefits from recovery while for those already working the challenges of continuing to absorb further austerity has not dissipated.

At a presentation to the Department of Jobs, Enterprise and Innovation last week (see here) I was asked to reflect on ‘How the economy is doing?’ One theme I focused on is the sustained presence of uncertainty and the negative impact this continues to have on recovery.

Uncertainty is widespread. For households, they are uncertain regarding their family finances in the years to come. How much will water charges be - €240 for an average household, but few live in average households – so how much? How will the scheduled tax changes or public spending changes due for 2015 impact – there will be increases and decreases, but overall? Year on year, since the start of the recession, there has been something unexpected or something new coming along requiring more of finite (often reducing) family finances – what’s next? All of this is reflected in flat consumer spending (see chart in my presentation), the largest part of economic activity, which has bounced along the bottom since 2009.

For businesses uncertainty is similarly an unavoidable reality. Will households spend more or hold tight on their finances –as household don’t know (see above) then neither do businesses. Data suggest that business are investing (for example, see new commercial vehicle sales), probably reflecting improved expectations of the future, a reasonable assumption, and the need to address unavoidable deficits in investment over recent years. Export orientated businesses see good news on the horizon as a slow international recovery takes root. However, the uncertainty is pronounced for domestically focused firms be they big or small.

The situation of the banks and the development of the banking system adds further to the economic uncertainty. Banks remain overly cautious on lending to business, making cash flow management and exploiting any expansion opportunities challenging. Another ‘stress test’ is due – will this be the last and banks can step back from their ultra-conservative stance and become more active again? The challenges for business of accessing lending point strongly towards a wider policy reform on the structure of the banking sector – there is merit in developing a separate investment focuses lender (an Industrial Credit Corporation mark II) – and there is a need to ensure the Irish commercial banking system is not left with just two dominant pillar banks; at least a third major force is needed for a competitive sector with a complementary strengthening of the Post Office network. The latter remains the backbone of the public service obligations of the entire financial sector. However, the lack of progress on all of this fuels uncertainty.

Finally, for the macroeconomy, there is uncertainty regarding the scale of the fiscal adjustment due to be announced in October’s Budget. The NERI, in our recent Quarterly Economic Observer (see here), suggested this should be €800m, the ESRI have suggested both €500m and €2,000m while the Fiscal Council and others have suggested more than €2,000m. Irrespective, the Budget will be contractionary and clarity on its scale would be beneficial all round – we need to move beyond the political games of old where Budget adjustments and their composition are a surprise to be revealed on Budget day. 

Posted in: Government SpendingInvestmentMacroeconomicsTaxation

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