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National Accounts hide the scale of this recession
On Monday, the Central Statistics Office (CSO) released the Quarterly National Accounts for Q2 of 2020. At first glance, Ireland’s economy appears to have fared better than those of our European colleagues in what was an unprecedented first six months of the year. Ireland is now officially in recession, defined as two consecutive quarters of negative economic 'growth'. (Despite an initial estimate for growth in Q1 2020, the CSO has revised this to esimate a contraction of 2.1 per cent).
The Covid-19 pandemic, the consequent lockdowns across Europe, and the resultant contraction in economic activity across the continent have been severe. However, the CSO's headline numbers suggest a much softer blow to Irish economic capacity than that being experienced on the continent, with GDP falling by 6.1 per cent (€82.3 billion) in Q2 of 2020, and GNP falling by 7.4 per cent (€63 billion) in the same period. This compares with a Euro-area average of a 12 per cent fall in economic output, in spite of what is in many ways a more severe lockdown in Ireland.
The economic contraction was not evenly-spread across industries. Transport & Distribution, and the Hotel & Restaurants sectors recorded a decrease of 30 per cent in Q2 2020 compared with the previous quarter. Professional and Administrative Services contracted 28 per cent over the period. Construction declined by 38 per cent, quarter-on-quarter. Agriculture, Forestry and Fishing fell by 60 per cent, and the Arts and Entertainment industry by 65 per cent. Meanwhile, Information & Communication recorded a 2.3 per cent decrease in real terms in the quarter, while Financial and Insurance activities and Real Estate activities recorded declines of 8 per cent and 5 per cent respectively.
The problem is that the (comparatively) small falls in GDP and GNP do not tell the full story. As the CSO noted in its release earlier this week, Modified Domestic Demand (an indicator of domestic demand that excludes the impact of trade in aircraft by aircraft leasing companies and trade in research and development-related Intellectual Property Product service imports) decreased by 16.4 per cent in Q2 2020 compared to Q1 2020, driven by falls in personal consumption and domestic capital formation of 19 per cent and 28 per cent respectively. That’s worse than most other EU countries. Spain, the worst-hit country in the Euro-zone, saw GDP fall by 18 per cent.
This serves to underline the detachment between Ireland's national accounts and true economic life on the ground.
In fairness to the CSO, they are merely measuring GDP and GNP according to internationally-recognised rules. Ireland's GDP and (to a lesser extent) GNP numbers have long been considered problematic. In 2016, they reached new levels of ridicule when the CSO calculated that Irish GDP had grown by 26.3 per cent in 2015. (This was later revised to an even more incredible 34.4 per cent). The incident caused Nobel prize-winning economist Paul Krugman to coin the term 'Leprechaun Economics'. (It's worth noting that the CSO now periodically calculates an alternative measure of national income called GNI* (different to normal measurements of GNI or Gross National Income) which is an improvement on GDP, removing (as it does) much of the impact of aircraft leasing companies and some other effects of the high concentration of multi-national corporation activity in Ireland.)
There are several repercussions from a situation where economic measurements do not reflect reality, including that policymakers and the public may underestimate the scale of the problems we face. It also might lead policymakers and others to assume that we are doing better as a country than we really are. Remember: Personal Consumption, which accounted for 45 per cent of final domestic demand, decreased by 19 per cent in Q2. If people's consumption is falling by almost a fifth, that has severe effects on general living standards and on the circular flow of income that is so important to maintaining our current economic model.
In the short to medium term, the government should follow the following pieces of advice:
- The primary focus of Budget 2021 (and the two subsequent budgets) should be on increasing employment and delivering infrastructure and services, and not on meeting arbitrary deficit targets
- A significant amount of borrowing will be needed in the next three years, and probably more again. However this borrowing is affordable and is the correct thing to do for the future of the economy and society.
The rationale to borrow to invest was there before the coronavirus crisis, but now has never been stronger. Policies that assist economic recovery and ensure that Ireland’s economic capacity does not contract in a way that could potentially take a decade to rebuild are required. The main goal of investment must be to maintain productive capacity (different from economic growth), and to do so in a targeted way, focusing on greening our economy while extracting environmental concessions from carbon-heavy firms and industries as a condition of any subsidies and support given by taxpayers.
Cheap borrowing for investment always makes good fiscal sense, but it makes sense now more than ever. If we look at this as being a situation to be managed over several years, or maybe even several decades, competent management of the stabilisation phase over the short term will ultimately minimise the long-term economic damage, and therefore minimise any overall fiscal adjustment that might needed.