(this blog was composed prior to the recent tragic events in Paris. My thoughts and prayer are with the people of France and all nations suffering from acts of war and terror). Best of Times? was the title of a book published by researchers at the ESRI in the summer of 2007. The book followed on from another work published in 2000 entitled ‘Bust to Boom? The Irish experience of growth and inequality’. One of the memorable sayings associated with the most recent budget in the Republic of Ireland is the following in the Minister for Finance’s speech to the Dáil 
: “This Government has consigned to the history books the days of boom and bust, and the attitude of ‘if I have it, I'll spend it.’” Whatever about the clause ‘if I have it, I’ll spend it’, the reference to the end of ‘boom and bust’ is very unconvincing. That’s not the way capitalism works nowadays and it is not the way that it ever worked. Notions of The End of History (Fukuyama) or The Great Moderation(Bernake) are now distant memories. The promise was that we could enjoy the best of all liberal economic worlds and see much less macro-economic instability than was the case earlier in the last century.
Now, some booms and some busts are larger than others like earthquakes that occur every 50 years or so with minor quakes or tremors in between. But, the notion of ‘this time is different’ fails to convince. Are there dangers and risks right now to the very welcome economic recovery and highly positive outlook for further growth in GDP, employment and living standards? Yes, there are risks both on the domestic front as well as the international as discussed later in this blog.
Humility, perspicacity and historical sensitivity are not virtues readily imbued in economists except when we get forecasts or risk assessments completely wrong. Then, either of two responses issue:
- Oh I told you so in (an obscure reference) on page 219 of my book in 1984; or
- We got it completely wrong but this time it’s different – trust us.
One of Donald Rumsfeld, former US Secretary of Defence, memorable contributions to the English language was the following:
there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know.
The unknown unknowns?
A lot was known about areas of market distortion and governance failure in the years leading up to The Great Recession in 2008-2009. The problem is that few, if any, economists ‘joined up the dots’. No amount of sophisticated modelling and scenario-testing would have predicted the scale and speed of the crash followed by the rebound in the world economy (and the Irish economy). As a general rule, during periods of rapid growth in GDP such as the Republic of Ireland is now experiencing, economists tend to under-estimate the risks of a sudden downturn. On the flip-side during periods of prolonged depression or stagnation such as witnessed in 2008-2010 most economists under-estimated the scale and speed of recovery – when it came eventually. Nobody can predict ‘turning points’ but if you keep saying it is 3 o’clock then eventually you are right (twice every day!).
The English language has been enhanced in the course of recession with the diffusion of terms such as ‘double-dip’ recession. Another term that has spread in the popular discourse is the risk of ‘black swan’ events in human history – unpredictable, random and highly significant developments. When the chain of financial inter-dependency snapped in 2008 the repercussions were dramatic and horrific. Anglo, alone, didn’t crash the Irish economy but it was a very major part of the story and symbolised the combination of poor regulation (or none), rotten corporate governance, political hubris, disastrous fiscal policy and Eurozone dysfunction (which still prevails) all of which made for a perfect Irish storm magnifying the ill-effects of a global downturn. However, the major lesson is that leaving all banks in private ownership is, in the current world of unbridled capital flows, is a risk beyond reasonable. Rather than privitising AIB we should be establishing and resourcing a strategic investment bank to develop a strong exporting enterprise sector.
But this time it is different?
Let’s hope so. But, the signs are not encouraging. For one thing the starting position in 2015/2016 is different to where we were in 2008 when public debt was at a low as a percentage of GDP. The long-term historical failure to create a large, diversified, dynamic, indigenous enterprise sector with capacity to compete on global markets is a key reason for Ireland’s overdependence on footloose inward investment as well as policies that are socially and environmentally unsustainable in the medium-term. Demographic change together with an alarming global environmental context paint a very difficult picture for future fiscal policy. The notion that people ‘deserve’ pay-back through income tax cuts after years of fiscal austerity and loss of incomes and jobs is worrying. It flies in the face of evidence that Ireland is – on the whole – over-taxed or that levels of personal income tax are above what they were in the past (the opposite is the case with much higher average effective tax rates as recently as the late-1990s.)
Wise and prudent fiscal policy should be:
- Ready for the ‘rainy day’
- Active in stimulating the economy when in recession and applying the brakes when it is in danger of over-heating
- Setting the scene for economic progress
- Investing in key infrastructure
- Ensuring policies that promote sustainable development
- Redistributing income in a way that is efficient and effective
- Providing services in a cost-effective way
Rules, legislation and fiscal advisory councils might or might not help. What matters is sustained commitment to clear social goals and strategies.
Every six months the Department of Finance publishes a Statement of Risks and Sensitivity Analysis as part of its periodic budgetary reporting. The most recent statement is contained within Budget 2016: Economic and Fiscal Outlook . The impact of various ‘shocks’ are estimated and presented in the document. As a very rough rule of thumb a 1% fall in world output translates into a 1% fall in the annual rate of growth in GDP in Ireland. The relationship is deemed to be ‘linear’ so that another slump in world output (going from a typical range of 2-3% in our main trading partners to a negative value would make a big dent on the Irish GDP growth rate pulling it down towards zero if not lower. While such an scenario is deemed to be unlikely at this time it is not an impossible scenario by any means at some point in the next 5 to 10 years. A fall in GDP or a major slow-down to under 1% growth would play havoc on Irish public finances including the complex battery of fiscal rules to ensure that Ireland is compliant with measures to reduce public debt and stay within a ‘structural deficit’ of 0.5% of GDP in the medium-term.
Whatever about medium-term economic risks it is highly likely that population will continue to grow as well as age. This will place significant additional pressures on public services not least health and pensions. Add to this the chronically low levels of public investment projected to rise from €4.1bn in 2015 to €4.5bn in 2018 – representing a small reduction as a percentage of GDP at levels that are among the lowest in the EU. Another ‘known’ risk is the impact of an interest rate hike in international capital markets. Interest rates are currently at unprecedented low levels. Were rates to rise, on average, by 1 percentage point that is estimated to reduce the Irish GDP growth rate by 1.4% in 2017 and 2.1% in 2018. A 2 percentage point impact would double these negative impacts.
There is a risk (!) that by looking at external factors as the main or sole sources of risk we overlook the potential for huge risk in domestic policy with its failure to adequately invest in housing in a timely way, to reform banking and to develop alternative longterm sources of enterprise.
But, what of the ‘unknown unknowns’? Nobody foresaw the scale and speed of the migrant crisis resulting from, among other factors, the war in Syria. What other climatic, geo-political and technological risks lie close to hand? A National Risk Assessment 2015 was recently published following public consultation. It makes for interesting and thought-provoking ready. However, history seems to teach us that the unexpected keeps happening and that, very often, what we most feared doesn’t happen but what we never thought of happens. Sometimes!