This weeks blog is by NERI Co-director, Dr Tom McDonnell, it is an article that he wrote for the Irish Examiner on 12 July 2021. The pandemic has changed the future direction of the economy with the speeding up of remote working and digitalisation.
The economy is on the cusp of a rapid and sustained recovery. But formidable challenges and transitions lie ahead.
We are now well over one year into the worst global pandemic in a century. Millions have lost their lives. Covid has caused unprecedented disruption to families, societies and economies. There has been a sharp rise in extreme poverty across the globe, particularly within emerging economies. Tens of millions of jobs have been lost, education has been disrupted, and income levels have fallen.
The measures taken to contain the virus have either interrupted or stopped entire sectors of economic activity. Indeed, the pandemic has permanently changed the future trajectory of the global economy with the acceleration of digitalisation and remote working. The indispensability of public services and the welfare state were brought into sharp focus during the pandemic. The zero carbon transition will further transform the economy in the years ahead. This transition will entail significant disruption for certain sectors and regions but also great opportunity for the economy as a whole. Managing this transition in a just way will be essential.
A brighter outlook in the short-term
The easing of lockdown marked the beginning of what we will be a prolonged economic expansion. The economy should grow by close to 8% this year and somewhere in the region of 6% next year. These rates are very high by historical standards and domestic output should move above its pre-pandemic levels over the next year.
Economic growth will be fuelled by the confluence of a number of factors including increased private investment as business confidence returns and economic uncertainty fades. There will be increased demand for exports as our major trading partners experience strong demand based recoveries supported by the Biden stimulus and the EU’s recovery plan.
The domestic economy will benefit from the realisation of an unprecedented level of pent-up demand for activities constrained during the lockdown such as face-to-face services. The housing savings rate will swiftly decline from its excessive and historically high level as households go out and spend. An unfortunate side effect of this will be to push house prices even higher. Housing demand will continue to greatly outstrip housing supply until the middle of the decade with housing affordability remaining a major issue in the absence of a fundamental policy shift.
Much has been made of the potential for higher levels of price inflation in the coming years. Recent inflation reflects a number of special temporary factors such as the inevitable bounce back in energy prices after their sharp fall in 2020, the return of the economy to normal, and pandemic related bottlenecks for certain goods. The era of sub-1% inflation is probably at an end, and growing demand will certainly fuel inflationary price and wage pressures. However, it is much too early to assert that we are about to enter an era of persistently high inflation. In any event, higher average inflation would make it easier to fight future recessions and would reduce the real value of government debt burdens.
As always there are of course a number of uncertainties. Not least of these is the potential for further Covid induced lockdowns. In addition, savings have been concentrated in higher income households and it may be that the bounce-back in spending will be significantly more muted than we expect. The precise scale of private sector business failures as the government’s supports are unwound remains unclear, and could be significant. The June economic stimulus should ameliorate the damage as the economy transitions away from lock down. A final point is that the level of economic disruption caused by Brexit has been clouded by the impact of the pandemic and could be an impediment to recovery.
Overall, however, the recovery should be much faster and more robust than the recovery from the great financial crash. Household incomes have largely held up, the economy’s productive capacity has broadly been protected, and private sector debt is much lower.
Unemployment
Almost a third of the labour force was either in receipt of the pandemic unemployment payment (PUP) or was benefiting from the employment wage subsidy scheme (EWSS) as recently as May. The extent of structural damage to the labour market remains unclear, although it’s highly unlikely that the labour market scarring will be anywhere as severe as during the great financial crash. There is no equivalent sectoral collapse akin to the structural collapse in construction post-2008.
Labour market conditions should rapidly improve over the next two years with very strong employment growth over the next 18 months. Even so, unemployment levels will still be elevated, at around 7.5% of the labour force (circa 190,000), by the middle of 2022. It is likely to be end-2023 before the labour market is fully or almost fully recovered.
Challenges ahead - Investment not austerity
The cost of borrowing remains extremely low and now is the time to invest in our people, our public services and our public infrastructure. It’s true that the public finances will remain in deficit until at least 2025. The deficit will be an enormous €15 to €20 billion in 2021. Even so, much of this deficit represents once-off costs, interest rates are likely to remain very low thanks to the ECB’s ‘whatever it takes’ support, and there will be no external pressure to return to austerity policies.
Strong employment growth and the removal of once-off Covid-19 supports will see the deficit fall significantly as of 2022, in both nominal as well as per cent of GDP terms. The key to fixing the public finances is to restore employment levels. The economy’s growth potential remains strong and such growth, if realised, will gradually erode the debt burden over time.
Budget 2022 is likely to be somewhat expansionary. However, 2023 will mark the return of the fiscal rules and is also likely to mark the unwinding of the ECB’s financial supports. These processes will need to be very carefully managed.
The formidable challenges lying ahead mean there can be no return to the failed policies of austerity. The housing crisis can only be resolved via massive and direct state intervention amounts to billions of annual investment. The green and digital transitions are also going to require significant annual investment, while our chronic annual underinvestment in childcare, in public R&D and in per pupil spending on education will need to be reversed if we are sustainably grow our economy into the future.
These spending pressures will come in the context of potentially declining corporation tax receipts and a crisis for Ireland’s FDI model. My own view is that the international tax reforms, if they happen, will be the catalyst to force Ireland to finally develop a more rounded economic model based on investment in people’s skills, innovation and knowledge capacity, alongside a greater focus on public services, well-being, job quality, and liveable towns and cities.
It’s clear that there can and should be no going back to the old economic model, but we need a national conversation about what we think the next model should look like and how we can get there.
Article written for the Irish Examiner, Monday, 12 July 2021.