What will 2012 bring us on the economic front?

This post is an expanded and hyperlinked version of an opinion piece published n the Irish Examiner, 24 December 2011

http://www.examiner.ie/business/another-full-blown-euro-crisis-looms-in-2012-178197.html

This has been a pretty horrific economic year, with the European economy stumbling from crisis to chaos and back again, with the change of driver at the wheel of the irish economy but with no discernible deviation from the pre-existing path, with the United States proving even less politically capable than Ireland of achieving economic consensus, and with emerging doubts about the long-term capacity of China to continue its growth path.

So what then will 2012 bring? Is absolutely true that “forecasting is very difficult, especially about the future”, I think it is better to subscribe to the words of the great French mathematician and political philosopher, Henri Poincare, who stated, “”It is far better to foresee even without certainty than not to foresee at all”. Poincare famously left open a conjecture in topology which took decades to solve and was not impressed by the use of overly mathematical concepts in economics. Let us hope that the problems to be solved in economics now do not take as long, and that those who solve them do not end up as disillusioned as Perleman did on solving the Poincare Conjecture.

The outlook for the world economy leaving 2011 is considerably less rosy than it was upon entering it. Predictions for the OECD economies, the largest economies in the world, at for growth in GDP to be less than 2%, with growth in world trade to be less than 5%, both significantly below the 2011 figures. The IMF, with a broader perspective, sees global economic growth somewhat higher, but it is interesting to note that for the most part economies will see lower growth rates in 2012 than 2011, which in most cases was lower again that in 2010, and the outlook is that economies will struggle to reach growth rates in the early years of this decade equal to that of the early years of the previous decade. The world economic engine has slowed. From the context of a country such as Ireland, which is heavily dependent upon the benign international environment, this is not good news. There are a host of downside risk factors which could be identified, instability in the Middle East particularly around Iran, growing signs of a rapid deflation in the Chinese property bubble (with all of the consequences which we are all too familiar with), geopolitical dangers posed by instability in North Korea, and of course the ever present danger of sovereign defaults. 2012 will, I fear, see a further deterioration in global economic conditions. Until the Chinese property bubble is deflated safely, and the US economy with its myriad problems is under the control of a detoxified political system one should bet on the downside.

The chinese issue in particular is one that is worth watching. Nomura published a quite downbeat analysis of China in November. As part of their global economic research analysis they have constructed a China Stress Index, and this plus their other analyses give them a 1/3 chance of a chinese hard landing (defined as growth of less than 5% ) by 2014, predicated on a number of stresses that will be all too familiar to observers of the Irish crash : over investment fuelled by a credit boom, an inappropriate fixed exchange rate, crony capitalism, falling credit standards, and the slowing of the demographic dividend. It will be interesting to see if the Chinese government fare any better in handling these than did the Cowan government. For the Irish diaspora a chinese hard landing would impact severely on Australia, where China is now its third largest export market.

In a European context, where much of our destiny is being laid out, we have seen the most appalling year. The people of Europe have been spectacularly ill served by their political masters. Dithering and insouchant lasitude seem to have replaced action and analysis, with the dyad of Merkel and Sarkozy using the opportunity to strengthe their own relationship, buttress tehir political flanks against domestic enemies, and in the process let the markets take the political leadership which they should, as the leaders of the largest countries in Europe, be giving. Then we have the odious and priapic antics of Silvio and the political gaucheness of Cameron to complete the quartet of political mice. Summit after summit has come and gone with the large grey tusked mammal of sovereign debt being studiously ignored.

Much criticism has been, but correctly, directed at the European Central bank, including from myself. It is however vital to remember that at least the European Central bank has been doing something. We may not have always agreed with it but it has had, reasonably, consistent and from its prospective logical economic reasons for doing that which it has done or not done. Very late in the day the European Central bank has thrown, if not a wall then a few hod loads of bricks, at the sovereign debt markets via a three-year loan facility. It is particularly galling from the perspective of an Irish economic viewpoint that this has taken until now.

Back in July we were told that there was no prospect of such a facility. Much of the subtext around the debate in relation to whether or not we should or should not “ burn the bondholders” was predicated on an unspoken threat that if we were to do so then as Irish banks were dependent on very short-term rolling over liquidity from the ECB going against the wishes of the ECB might result in the cutting off this liquidity, killing the Irish economy stone dead in. If we were ever unclear about our relative unimportance compared to economies such as Italy, the recent about turn by the ECB on the provision of a medium-term liquidity instrument when that country got into trouble should make it abundantly clear. We are truly at the kindness of strangers

However, we should not think that this liquidity is the solution. It is a solution, to a liquidity crisis, but Europe, in particular the peripheral countries, faces a twin crisis of stagnant growth and excessive government (and private) debt. This liquidity will allow banks, although not in any way compelled them, to purchase government bonds, driving down the interest rates, and therefore in theory allowing these countries more rapid re-entry to the international bond markets. It will do nothing, in fact may even be perverse, in relation to enhancing country’s economic growth prospects and certainly will not reduce overall debt levels. 2012 needs to see significant concentrated action at the European level around these two issues.

These issues are recognize as being paramount: the annual growth survey places eduction, training and labour market activation measures at the heart of the required strategy. Absent this labour conditions will worsen, and growth forecasts (see graphic for the EU commission forecasts) will be relentlessly ratcheted down

At the heart of the German problem in Europe is their assumption, whether stated are not, that everybody must be in surplus. On all aggregates. Always. This is the economics of the swabian housewife, a neo mercantilist view that exports are the bee all and end all. This is impossibility in a globalized economy. For those of us of a certain age the eponymous housewife is redolent of the lincolnshire shopkeeper so beloved by Mrs Thatcher. For some economies being surplus others must be in deficit. German imbalances are as much a problem for europe as are Irish or Italian. see here for a discussion of the german imbalances , here for a discussion of why German growth needs to move more towards domestic (import and consumer led) than international perspectives, here for a discussion of why this would be good for germany as well as for other countries , here for a discussion of how the german export competitiveness has acted to drive down german wages further fueling export competitiveness. See here for a discussion on german Imbalances in the context of intra bank claims) The imposition of an austerity compact will in and of itself not solve Europe’s problems but may solve the domestic political concerns of Dr. Merkel. The compact may not survive domestic political scrutiny in other countries, and I suspect that we will be back in full-blown Euro crisis mode and in the first half of 2012.

As it is for Europe so too is it for Ireland. We face into 2012 in the dreary realization that “the beatings will continue until morale improves”. Much of the fiscal consolidation to date has been achieved by snipping at the margins, and in particular by the deferment of planned capital expenditure. And yet we will borrow to €21 billion in 2012… the simply cannot go on. From 2012 onwards it is clear that if the government is to actually achieve even its own modest 3% deficit targets entire program areas will have to be shutdown and significant tax increases will have to be put in place. Ideally increases in tax should come about organically as result of a robust and growing economy.

We are in the terrible position that faced with a weak economy the government perceives no choice other than to increase the tax rates in the hope of increasing tax levels, leaving nothing aside to bolster growth. They are in a red queens race, where they have to run faster (increase tax rates) to stand still ( keep tax levels in nominal terms up). This is the logic that has in the face of collapsing retail sales (yes, even though the november figures came in ok there is still a massive crisis here led to an increase in the level of sales tax. Expect to see more of this.

The most pressing problem the Irish economy faces is the re-emergence of persistent long-term unemployment, and this in the face of tens of thousands emigrating.

As of november 2011 we have 18k males and just under 9k females under the age of 25 who have been unemployed for more than one year. There is very strong evidence that long period of unemployment when youger have a severe effect, reducing lifelong employment prospects, greatly increasing the probability of future unemployment, and generally scarring prospects. Therefore labour market measures should ideally be targeted to these disproportionally one might argue…but of course the young dont vote as much as the older, and when they do they do with their feet. We see a massive outflow of our children, and all the skype chats and cheap-ish flights in the world do not make up for the renewal of what has been our biggest industry, fresh Irish youth on the hoof. At least this time they are more educated and more globalised than the previous generations….

We cannot export our way out of this problem, if only for the reason noted above with world economic growth is slowing. In any case the structure of Irish exports is such that they will not provide job traction. Finally, a very large part of Irish exports (up to 60% of total and closer to 90% of the trade balance) is dependent upon pharmaceutical products that are now coming “ Off patent”. Some estimates are that up to 80% of patent drugs switch to generic within the first year of these drugs coming off patent. Whether the Irish Pharmaceutical industry can effectively negotiate safely down this patent cliff remains open question but apart from the thousands of jobs at risk the potential damage

In any case, 2012 sees the beginning of the 10 years of government cash being borrowed and funneled into the black hole of the Irish bank resolution Corporation, aka Anglo Irish bank. Every year for the next 10 years the Irish taxpayer will borrow €3.1 billion, and rather than use this for targeted job initiatives, to assist in the Roll out of an ultra-high-speed broadband, to incentivize science education, to provide credit and export backup for indigenous SMEs, or even to deliver social services, this will instead be given to a dead bank. There is a growing consensus that while we might in theory get some of this money back upon the eventual windup of Anglo it represents a serious drag on the ongoing financial capacity of the Irish state. An agreement from Europe that takes this fiscal Monkey off the back of the economy should be an absolute prerequisite for the government even entering into contemplation of a referendum on the fiscal compact. Without such an agreement then the fiscal compact will not, should not, survive contact with the Irish population, facing into the 2012 where austerity will really finally began to bite. So, a lot done more to do and no corner left unturned…

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