Regarding the documentation that has been circulated, who took the decision not to circulate this to the committee in advance of today's hearing?
Macroeconomic Forecasting: Discussion with Department of Finance
The Department.
Could the Chairman get clarity on that before we begin? Who within the Department decided the information would be circulated just before the committee began, giving us no opportunity to discuss it? Was the same information provided to the Irish Fiscal Advisory Council, IFAC?
The information has been provided to IFAC.
Did IFAC receive any other narrative? Will we receive the complete presentation provided to IFAC? Did it receive any additional information over and above what we have received today? When and by whom was the decision taken not to allow us access to the information before the group came before us today?
It would be best to ask Mr. John McCarthy those two questions.
Mr. John McCarthy
The Deputy has the exact same presentation that was provided to IFAC on two occasions.
Did IFAC receive any additional information?
Mr. John McCarthy
No, other than what we discussed verbally.
Mr. McCarthy should be very clear on this.
Mr. John McCarthy
It sought additional information on quarterly profiles of growth, such as what happened in the first and second quarters and what that implied for the second half of the year and into next year. We have no problem providing that data to the committee. We do not do quarterly forecasts like most countries. Given the volatility of quarterly data in Ireland there is a trade-off between the quality of the data and-----
Did the Department give IFAC an opportunity to review the document before engaging with the Department?
Mr. John McCarthy
IFAC received tables in advance and the presentation at the meeting.
Who took the decision not to provide us with this information in advance?
Mr. John McCarthy
I do not know if a formal decision was made. We supplied the presentation to the committee secretariat a couple of hours ago.
It was password protected.
Mr. John McCarthy
We followed up and sent the correct version subsequently. There was no ulterior motive. Deputy Dooley may follow up on any questions here. Should this arise again we can undertake to circulate it-----
The budget is this day week, with respect.
Mr. John McCarthy
That is a fair point.
We thought we were into a phase where the Department would engage constructively with parliamentarians who are attempting to do their duties. To be handed a document such as this one a couple of minutes before the witnesses come before us is unsatisfactory. I will not labour the point because everybody wants to get through. It is unacceptable, but for the benefit of brevity, let us move on.
Mr. John McCarthy
Genuinely, it was circulated a few hours in advance. There may have been some IT problems with password protection. It was resolved-----
It was, and we received the document as Mr. McCarthy walked in the door. With respect, Mr. McCarthy has made his point. Could he clarify to the committee later what happened, why it happened, whether a decision was taken by somebody that put us in a position where we did not have the documentation in advance of the meeting and, if so, by whom?
Mr. John McCarthy
Okay.
It is most unsatisfactory that we have the presentation before us only now. We have a bad taste on our mouths from the bankers being before us, trying to bamboozle us with figures and not giving us a chance to see the information beforehand. It is important to look forward. Hopefully in future years we will receive this information at the same time as IFAC. Is there a reason we could not have had this earlier? The tables included require digesting. We have more restrictions on us than IFAC, for example, we have a very strict Chairman, so we do not have much time-----
I will take that as a compliment, and I thank the Deputy.
It is definitely a compliment. Can we confirm that such a presentation can be provided to us at an earlier opportunity for future budgets and at the same time as IFAC receives it, or does the Department have a problem with doing that?
We are here to extract information. When the witnesses are going through the presentation would they take account of the fact that we have only just received the information?
Mr. John McCarthy
Absolutely.
I agree that in future the Department should give us the information in advance. We need to get the presentation under way.
To rule out conspiracy theories, I welcome the witnesses. I originally raised the point about getting access to information at the same time as IFAC. I take on board the earlier points but as this is our first time to do this, we should learn from it, build on it and improve it in years to come. I do not buy into conspiracy theories.
Mr. John McCarthy
I can honestly say there is no conspiracy theory. I apologise; we thought we had put in place a procedure whereby it could be accessed. There were problems and we will undertake to sort them out. I cannot give a guarantee now because I need to go through my superiors. On a personal basis I have no problem supplying the information, although perhaps not at the same time as it is provided to the Irish Fiscal Advisory Council, because we go through an iterative process with the council, but certainly well in advance.
With regard to getting the information at the last minute, if committee members wish to raise questions as we go through each slide in the presentation rather than the end it might be a way to work through the process.
I ask the witnesses to go through the presentation while committee members take notes because otherwise we will end up with no sequence or co-ordination to the meeting.
I told you so.
I will take that as a compliment. We will now discuss matters relating to macroeconomic forecasts with the officials from the Department of Finance. I welcome Mr. John McCarthy, Ms Mary Dalton, Mr. Shane Enright and Mr. Gavin Sweeney. Mr. McCarthy will make opening remarks with a PowerPoint presentation which will be followed by a questions and answers session. I remind members, witnesses and those in the public Gallery that all mobile phones must be switched off.
I advise the witnesses that, by virtue of section 17(2)(l) of the Defamation Act 2009, they are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the committee to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to qualified privilege in respect of their evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given. They are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable. Members are reminded of the long-standing ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person outside the Houses or any official by name or in such a way as to make him or her identifiable.
I call on Mr. McCarthy to make his opening statement.
Mr. John McCarthy
I thank the committee for the invitation to discuss the economic outlook. I am a principal officer in the Department. I am accompanied by some of the team whose job includes macroeconomic analysis as well as the production of the Department's macroeconomic forecasts. The presentation we will go through is exactly the same as was given to the Irish Fiscal Advisory Council on two occasions in recent weeks. It sets out the latest economic trends by way of background and includes the Department's forecasts for this year and next year. The Irish Fiscal Advisory Council has a mandate to endorse forecasts for T and T+1 and nothing beyond this is written into the legislation.
The forecasts for next year are based on the purely technical assumptions of consolidation amounting to €3.1 billion being implemented. The reason for this is it is the latest formally articulated Government policy as set out in the stability programme published last April. On this basis we expect output GDP growth of 1.8% for next year in real terms. By way of clarification, I stress it is our position that we cannot comment on the budgetary situation, the budgetary numbers, or what the composition of consolidation is likely to be. We will update the macroeconomic projections when the amount of consolidation is identified and the type and composition of consolidation is identified on budget day. There will be revised forecasts on budget day which may differ from those endorsed by the council.
Is that 1.8% GDP growth?
Mr. John McCarthy
Yes, this is our projection for next year. It is the headline figure. We will go through some of the details in the presentation. Once we update the forecasts we will publish the full details alongside the budgetary documentation.
We are here because economic governance reforms at euro area level have a major impact. These include the six-pack and the fiscal compact. In particular the two-pack, which has been on the Statute Book since the end of May, provides for forecasts to be outsourced from treasuries within the euro area or endorsed by an independent authority. To the best of my knowledge most, if not all, euro area countries are going down the same route as Ireland, namely, the endorsement route. The Irish Fiscal Advisory Council has been assigned the task of endorsement by way of an amendment to the Fiscal Responsibility Act passed by the Oireachtas over the summer. IFAC is a statutorily independent body with a role in assisting greater fiscal transparency and improved fiscal governance. However, decisions on budgetary policy obviously and clearly remain in the domain of the Oireachtas.
To operationalise the endorsement process we have drawn up a memorandum of understanding between the Department and the Irish Fiscal Advisory Council. It was drawn up over the summer and has been put on the websites of both organisations. I understand the process in many euro area countries is similar. The memorandum of understanding sets out that we provide the council and the secretariat with our provisional economic forecasts. We do not discuss budgetary projections or consolidation; nothing like this enters our discussions with IFAC. It is purely a macroeconomic discussion. Formal presentations were provided by the team to the secretariat of the council on 25 September and to the full council on 30 September as provided for in the memorandum of understanding. On foot of these interactions at a technical level, I can confirm a letter was issued by the chair of the Irish Fiscal Advisory Council last Friday to the Secretary General of the Department confirming the forecasts were in an endorsable range. This letter will be put on our website on the day of the budget.
My team and I will now go through the exact same presentation provided to the Irish Fiscal Advisory Council. Ms Dalton is the specialist on the international side, Mr. Enright works on domestic developments and Mr. Sweeney works on price developers. I will summarise what I see as the key points after every three or four slides. As I stated earlier, we are quite happy to take questions during the presentations given the fact that-----
No. Drive on.
Mr. John McCarthy
I will leave it at that.
Mr. Shane Enright
The first slide shows our last set of forecasts which dates from the end of April, which was the last formal articulation of the Government's fiscal strategy. It also shows a set of macro forecasts which we call the stability programme update, commonly abbreviated to SPU. In the SPU we forecasted GDP growth of 1.3% this year based on a stabilisation in domestic demand and an increase in exports. Since then we have had a number of observations and hard economic data from the CSO which gave us cause to change a little the view we had of the economy for 2013. The first column on the left is the provisional outturn for 2012 released by the CSO in March. The next column is the actual outturn as estimated in June. The CSO revised down the total level of activity or growth in 2012. This brings us to 2012 with less momentum than we thought we had. We also had data for Q1 and Q2 of this year, and it is fair to say these numbers came in a little below expectations not least the contraction in exports we have seen in the first half of the year. It was negative in the first quarter and positive in the second. This has led us to change our assessment of growth prospects for this year.
Obviously, that means pushing into next year as well, which we will touch on in a little while when we get to the outlook. I will pass over to my colleague, Ms Mary Dalton, who will talk about developments in the international economy in the intervening period.
Ms Mary Dalton
To take members through some of the assumptions that underpin our forecasts on the external assumptions slide, looking first to exchange rates, these are purely technical assumptions. What we do is take a ten day moving average, so this is the same presentation we gave to IFAC and these were taken at the end of September. In terms of the difference between the current forecasts and our last set of forecasts from the SPU, we see a slight downward revision in the sterling exchange rate in 2014 but the same for this year. In terms of the US dollar exchange rate, again, we see a slight change from SPU time, with an appreciation of the euro in both 2013 and 2014, but again very marginal.
Looking at Brent crude oil prices, this is a purely technical assumption that we use as we make the assumption that oil prices move in line with future prices. Again, we see a very small difference between our forecast at the time of the SPU in April and our current outlook, so it is €82 and €78 for 2014.
Turning to developments in our key trading partners, we have set out the position for the US, the UK and the euro area, which roughly account for 80% of our exports. The story is broadly similar. We saw that activity in Q2 surprised on the upside. The graph shows that the US is at 0.6%, the UK at 0.7% and the euro area at 0.3%. While this is positive, Q1 was worse than expected so, roughly, for the year as a whole we are where we expected to be in April.
Moving on to the next slide, PMI data is seen as a leading indicator for activity in the economy. Looking at some of our key trading partners, the UK and the euro area, the UK composite PMI - represented by the blue line on the slide - which takes into account activity in the services sector, the manufacturing sector and the construction sector, was 60.4 in-----
Can Ms Dalton give us the full titles instead of abbreviations like PMI?
Ms Mary Dalton
My apologies. PMI is the purchasing managers indices. In the UK in September, this was 60.4. The composite PMI here was driven by the services sector. The green line on the slide represents the euro area. As can be seen, in the last quarter the composite index has moved into positive territory at 52.2 in September.
I would like to briefly mention the world economic outlook which was published this morning by the IMF. Obviously, this did not come out in time for us to include in our forecasts but in terms of where the IMF sees activity in the global economy, growth is quite weak at the moment but, for the advanced economies, it sees growth picking up in the US, the UK and the euro area in 2014. Nevertheless, it is important to point out that economic growth in our key export markets remains fragile. There are short-term risks, which are really tilted to the downside.
Mr. Shane Enright
To touch a little on export performance, as I had mentioned previously, there was a contraction in the first half of this year. To give a sectoral explanation, service exports, which are about equal in the basket to goods exports, are continuing to grow. Goods exports appear to have peaked in late 2011 and have been on a downward path since. Essentially, if we go to the next slide, we see this is being driven by developments in the pharma-chem sector. As members know, Ireland has a high specialisation in pharmaceutical outputs. The patent cliff is essentially sweeping through the sector and that is impacting on measured output from Ireland.
I am conscious this is being broadcast live and people are watching. What do you mean by the patent cliff? Are these patents expiring?
Mr. Shane Enright
That is correct.
To use layman's language.
Mr. Shane Enright
For the blockbuster drugs, as they are known, a lot of the patents were granted in the 1990s and the 20-year period is coming up at the moment. There are charts here which illustrate some of the developments. Exports to the US are leading the decline and we think this is indicative of the patents story, given that patents are generally filed in the US first and expire in the US first as well.
To run through developments in the domestic economy in recent months, we are looking here at core retail sales. We tend to focus on core retail sales, which exclude cars as car purchases are quite volatile and are entirely imported in the Irish context. They have been in positive territory in the first nine months of the year, with some weakness over the early summer, possibly weather related, but there has been reasonable growth of over 1% in the last number of months. The retail sales inform our view in the forecasts of where we think private consumption for the year is going to go.
Mr. John McCarthy
A key point worth emphasising is that while we are all aware of a reasonably strong export performance over the past couple of years and that domestic demand has been very weak given the legacy of the crisis, the charts on view show there is now fairly firm evidence that domestic demand is on a modest recovery. We see a modest improvement in consumption and the chart on view shows this is translating into real tangible improvements in the labour market. I am not getting carried away and, obviously, there is a long way to go, but the employment story is a very good story. Employment in the second quarter was up by 1.8% in year-on-year terms, it is the third consecutive quarter of annual growth and it is broad based across sectors, given the CSO reports on 14 sectors, nine of which had employment growth. The only employment losses were in sectors typically associated with the public sector, so the private demand for employment is moving in the right direction.
Importantly, employment growth was concentrated for the first time since the crisis began in full-time employment. We have seen some modest increases in part-time employment but it is now translating into full-time employment, and so is indicative of an improvement in labour demand. That, in turn, is feeding through into an improvement in the unemployment situation. Unemployment is down by 1.75% since its peak. In the first half of this year the bulk of the decline in unemployment is accounted for by a decline in long-term unemployment - that is, those who are unemployed by over a year - so things are moving in the right direction. I am not getting carried away. Some of it is certainly due to outward migration and so forth but, nonetheless, it is moving in the right direction on the labour market and the employment fronts.
To come back to domestic demand, the next chart shows the household savings rate. Members will know that, since the crisis kicked in, households have ramped up both their rainy day savings - so-called precautionary savings, given the probability of suffering an income shock has increased - but also savings for balance sheet repair. There has been a massive destruction in household net wealth. In Ireland most household wealth is held in the form of housing assets, which have fallen by about 50%. There has been a massive destruction in household net wealth, so households have responded by trying to build up financial assets and reduce financial liabilities, in other words, keeping the savings rate high. Certainly, there is now some evidence that the precautionary element is beginning to ease off as confidence begins to improve. Obviously, the balance sheet repair element is going to be there for the foreseeable future given the high level of public indebtedness.
On wages, to complete the labour market situation, and the time series only begins in 2008, there is no evidence that nominal wage reductions at an aggregate level were a feature of the crisis. Essentially, if we look at the private sector, it pretty much oscillated around €19.50 per hour at an aggregate level right throughout the crisis, and the chart shows it moving around the average for the past four or five years. That pattern has continued into the early part of this year, with very little wage growth and no pressure on that side.
I will hand over to Mr. Enright on the investment front.
Mr. Shane Enright
The next slide shows the growth in investment, which tends to be very volatile on a quarterly basis. We have tried to break it down into its components. The key explanation for the volatility is aircraft. Aircraft imports in the Irish context tend to be large and to fluctuate wildly. There were few aircraft imported in the first two quarters of this year, which depressed aggregate investment, but when one excludes this one can see an underlying recovery. Building and construction activity has begun to show some kind of consistent return to year-on-year growth, and the grey bar represents machinery and equipment, which excludes aircraft. This represents everything physical that businesses need to operate. The return to growth in both of those components of investment is encouraging on the employment side, which we will turn to a little later, but also in terms of the productive capacity of the economy over the medium term.
The final slide on the domestic side illustrates the tourism story. From January to August 2013, we had a 7% year-on-year growth in visitors to Ireland. That surprised everyone involved. It has been broad-based across a number of destinations, but the number of visitors from North America in particular is up quite a bit. My colleague Mr. John McCarthy will now discuss our outlook for this year and 2014.
Mr. John McCarthy
We will now focus on the key chart, which contains our forecasts for the main macro variables on the real side, as well as labour market variables, and on the nominal side also. For this year we are looking at real GDP growth of about 0.2%. We just got the figures this morning and the consensus is that it will be zero for the year as a whole, a minor difference. It must be borne in mind that in an economy like Ireland, where figures are very volatile, there is very little difference between +0.2% and zero. I would not call that a really strong difference. Crucially, in the outlook for 2014, I mentioned at the outset that we are looking at output growth of 1.8%, which is a downward revision, because at the time of the SPU last April we were looking at GDP growth of 2.4%. The main reason for the downward revision is a fall in exports, which was partly due to the very weak international economy in the opening quarter of the year. Another factor is sector-specific issues, particularly the patent cliff, which has been mentioned. We have incorporated downward revisions to the figures for both this year and next year.
Now there is a better story. The employment situation is a great deal better than we thought at SPU time. We are expecting employment growth of 1.6%, which is an upward revision. We have reduced the unemployment projection from 14% at SPU time to about 13.5% now. We expect a percentage point reduction in next year's unemployment figure as well, so there is a good news story.
Members may ask, if GDP is recovering and employment rising, whether that implies negative productivity growth. We have had that once in 50 years. It is an unusual story and it is very difficult to rationalise. We think it is due to the composition of growth. There are productivity puzzles emerging in a number of countries, such as the UK, which also faces this issue. It is an interesting feature of the situation. It is something that cannot continue over the medium term, but we can probably see negative productivity on a once-off basis. We think it is due to the composition of growth - in other words, the pharma-chem issue is decreasing overall GDP, but this is not really having a labour market impact because the labour share of this sector is quite small relative to its profit share. I will hand over to Mr. Enright to speak on the next chart.
Mr. Shane Enright
I mentioned the divergence between goods and services exports. We are expecting a small contraction in exports this year of about 0.6%. We have split that figure into services and goods. In respect of services we were expecting reasonably healthy growth, although not as strong as last year, but goods exports will exert a negative drag on overall exports both this year and next year, primarily due to the contraction in the pharma-chem sector, and there is not enough growth in the rest of our goods exports to compensate for the contraction that we are seeing in that area.
Mr. John McCarthy
The chart showing household income is not as important as some of the others. What we are trying to do is to look at household disposable income and break it down into its individual components. The biggest component of household disposable income is labour income - what we all earn from wages. The key point is that after very sharp falls in disposable income in 2010 and 2011, disposable income now appears to be levelling off in the household sector.
The fiscal council is interested in modelling the labour market. Okun's law relates the unemployment rate to developments in GDP. The fit of the model is reasonably good from the 1960s onwards. There seems to be a little bit of a break in later years - in other words, the elasticity of unemployment with respect to GDP seems to be lower than the historical norm. That is probably explained by the composition of output.
The next chart illustrates what I was alluding to earlier. Negative productivity is very unusual both in Ireland and in many other countries. We are looking at negative productivity of the order of 1.25% to 1.5% for this year.
The following chart compares the unemployment rate projections at the time of the SPU last April with our current projections. As I said earlier, we are moving in the right direction, but an unemployment rate of between 13.5% and 12.5% is still far too high. Our key point is that we are moving in the right direction.
With regard to the labour market, one issue that needs to be borne in mind is what we call the endogeneity of labour supply in Ireland. Essentially, if employment growth picks up, we will typically see in an Irish context that labour supply also picks up. Once the demand for labour picks up, we will see people who have migrated returning to Ireland, as well as non-Irish nationals. We will also see participation rates pick up. We have seen a dramatic fall in participation rates, in layman's terms, during the downturn. During the bubble years, people aged 17 and 18 who did not go to college went straight into construction and the participation rate went up. They are now staying on in college, so the participation rate is going down. Once things begin to stabilise, we will see that the labour supply tends to increase. It is a feature of the Irish labour market and we try to incorporate it into our analysis. The key point is that even if there is employment growth, there will be an increase in labour supply, so we do not expect a dramatic reduction in the unemployment rate.
The next chart may be overly technical, for which I apologise. We try to model exports as a function of export market growth, based on GDP growth in the UK, the US and the eurozone as well as competitiveness variables such as unit labour costs. The model performs reasonably well. I have looked at research in other countries in which there is a better fit. The problem is that Ireland is so small that sector-specific issues can drive a wedge between model-based results and actual results. The model suggests that exports will be very strong in later years, but we know we have an issue in the pharmaceutical sector, which accounts for 25% of our exports, and this is having an impact.
It is just impossible to model that on a short-term basis.
The next chart shows something that we think is important. While we are incorporating downward revisions on the real side, we are also incorporating downward revisions to the deflator. There is less inflation in the system, which means that the overall money amount of GDP is actually lower than previously thought. That has implications for the debt ratio and for fiscal variables expressed as a percentage of GDP. It is something that we keep an eye on and it is important.
The next chart shows the current account and GNP projections. We are looking at GNP growth of about 1% this year. It is better than the GDP forecast. The profit outflows are not as large as in previous years due to some technical factors. We have had a very strong balance of payments surplus over the past couple of years. We have seen a big increase in exports, but we have seen a compression of imports because domestic demand has been so weak, and that has driven a very large current account surplus of 4.5%, which is one of the largest in the EU. Mr. Sweeney would now like to say a bit about inflation.
Mr. Gavin Sweeney
The next chart shows the quarterly composition of the HICP - harmonised index of consumer prices - which is the Europe-wide measure of inflation, allowing comparisons between different eurozone countries. The story in 2013 has been broadly of modest services inflation. We can take services generally as a measure of domestically-driven inflation, whereas goods can be taken as a proxy for imports inflation. Services have recorded modest inflation in the year to date, whereas there has been a drag on the inflation rate of goods exports over the three quarters. This largely reflects bilateral exchange rate movements vis-à-vis sterling in the first quarter of the year, so we see that deflationary effect kick into goods. When we compare 2013 to last year, we see more benign energy price inflation. It has been about 1% in the year to date, whereas it was about 9% last year. We are broadly expecting HICP inflation this year to be somewhere in the region of 0.7%, picking up over the next year based on a number of assumptions, including a fall in the exchange rate impact. The projection of a rise in services inflation is mostly based on an assumption of a reversal of the jobs initiative VAT reduction for tourism, so it is conditional on that. We are expecting a HICP rate of about 1.5% for next year.
When we forecast inflation, we tend to use a bottom-up approach. When we use more granular data we can measure product-specific developments, but we test the robustness of our forecasts by using this top-down approach, and this is broadly in line with what we forecast in the bottom-up approach. This does not take into account budgetary measures such as the VAT increase, so that explains the differential there.
Mr. John McCarthy
I will skip the next slides as they are too detailed. They are to do with modelling export prices and so on.
The overall story is one of a modest, gradual recovery taking hold in the short term, with broadly similar contributions from domestic demand and from net exports. The positive thing we can take from it is that there is very strong evidence of stabilisation of domestic demand and a modest recovery under way in both consumption and investment. The improvements in external demand should support some improvement in export growth next year, but there are some sector-specific issues that are likely to have an impact as well.
We mentioned earlier that a recovery is under way internationally, but that recovery is fragile and subject to downside risk. I believe it is the same in Ireland. As a very small and very open economy - our exports are in excess of 100% of GDP - we are very reliant on what goes on in three regions, so if there were any sort of re-intensification of the eurozone crisis, or if the overall policy mix in the US were to become more problematic, then we could see downward revisions to growth in our major trading partners. Domestically, there is the risk of an intensification of the pharmaceutical patent cliff issue. There is also the issue of household debt restraining consumption growth for the foreseeable future. There could be a flip in the savings rate. Our baseline assumption is that the savings rate comes back gradually, but that is very sensitive to what goes on in the labour market and what goes on internationally. If that were to turn, we could see an increase in the savings rate, with negative implications for consumption and overall GDP. On the upside, there is always the possibility of stronger growth in the UK, the US and in the eurozone, but that is certainly not built into our baseline assumptions.
The next chart shows what the risks mean. We asked our colleagues in the ESRI to use their macroeconomic model, known as HERMES, to simulate a number of scenarios, such as what would happen to growth in Ireland if world growth was weaker. It is typically one for one, so if world growth was 1% weaker that would translate into a 1% reduction in GDP in Ireland. Let us suppose the household savings rate were to increase or even fall - it is broadly symmetrical. A fall would translate to 0.25% growth, or vice versa. The high level of indebtedness in the economy means that we are very exposed to interest rate changes - both market rates and policy rates - so the impact on GDP of any changes there would be fairly stark. We have included those as scenarios. They are not our baseline assumption, but they illustrate some of the risks and try to quantify what would happen if any of these risks were to materialise.
I thank committee members for their attention. I apologise for going through some technical issues quite quickly, but we are happy to answer any questions as best we can and to provide further information if we cannot answer any questions.
I thank the witnesses. While the committee may have had some reservations regarding the timing of the presentation, I believe the content is very detailed, and other members may be of the same view.
The ESRI uses the HERMES models, but I would like to hear what models the Department uses. The ESRI was predicting an unemployment rate of 16% for 2014 about three years ago. That is not the case now and we are witnessing a drop of almost 1%. What differentiates the Department from the ESRI?
Mr. John McCarthy
We use both a bottom-up and a top-down approach. The top-down approach refers to the model that I illustrated earlier called Okun's Law. The actual model tracks the historical data very well. If we get GDP growth, that translates to a reduction in unemployment by a certain amount. The model holds very well over time, but there seems to be a little bit of a breakdown in later years. We also use a bottom-up approach whereby we look at employment growth and labour supply issues. We try to model labour supply. There are three components of labour supply. The first is the natural increase - we know the number of people who are 15, so we know they will enter the 16-64 cohort of the population one year later. We then try to relate our migration to this. Historically there is a strong correlation between migration in Ireland and the Ireland-UK unemployment gap. If that rises, we see outward migration. If it falls, people come home. We then model participation rates as a function of the business cycle, so when GDP is strong, participation rates tend to go up, and vice versa.
Short-term trends will always be a matter of adding judgment to model-type approaches, and that is probably where the difference between ourselves and the ERSI stems from. I do not think we were ever as high as 16%-----
In layperson's terms, what people are focusing on this evening is a drop of 1% in the predicted figure for next year's unemployment. As I mentioned, that is 2.5% below what the ERSI predicted a number of years ago. Where will those estimates come from? In which sectors will we see that increase?
Mr. John McCarthy
I am sorry, but I did not quite hear the Chairman's questions.
In what sectors or occupational fields will employment be created?
Mr. John McCarthy
The CSO report says there are a total of 14 different sectors in the economy. As I have mentioned, there is employment growth in nine of those sectors. We are mainly seeing employment growth in the public sector. I stress there is no sector in the report called the public sector, but there is a sector called health care and the assumption can be made that that is essentially, but not exclusively, the public sector. We are looking at modest employment increases in the manufacturing sector. We are looking at very modest increases in the construction centre - we are never going back to building 90,000 units of housing, so we will never see again the levels of employment that we had in the bubble years. We are probably looking at increases in employment in what we call market services, but we are looking at reductions in non-market services, which are essentially the public sector, given the moratorium on public sector employment. The increases will be essentially private-sector-driven over the next couple of years.
The Chairman is right in saying that people will focus on the unemployment figure. I think we can stand over those figures. If one looks at what happened to the live register over the summer, one is looking at an annual decline in the order of 20,000. If we look at August this year compared with August last year, the number on live register had decreased by around 20,000; ditto in September. The pace of decline in the live register has picked up over the summer. There are positive signs in the labour market, but I stress that we are not getting carried away - we do not see unemployment coming back to single digits any time soon. There are problems with mismatches - the skills of the unemployed need to be better matched with areas where demand for labour is needed.
I want to move on. There is a strong difference between the services we provide and what we export. Exports are dropping because of the patent situation. My constituency and Deputy McGrath's constituency of Cork South Central are in the area in question. I am noting that some goods coming off patent, particularly in generic areas, are being manufactured by the same people who held the patent and in the same plants. I do no know how that will go in the long term. Services are seeing significant growth, but in what fields is that growth?
Mr. John McCarthy
On the Chairman's first point, the Department's intention is to come forward with a working paper on the patent cliff issue and what it might mean. That paper will hopefully be ready in the next couple of weeks. It might be of interest to read it.
IT is the main driver of services exports - they account for about 40% of overall exports of services. They have grown strongly in the first half of this year; the figure is something like 10%. It is positive in the sense that that sector is more labour-intensive than some of the pharmaceutical sectors which are more capital-intensive. It is the biggest sector and employer and the area where the strongest growth is seen. Other sectors, such as business and accounting services, which are traded across borders, are doing reasonably well. Those, too, are reasonably labour intensive as a whole.
I have two final questions before I run out of time. First, what is this year's growth figure?
Mr. John McCarthy
The figure is 0.2%, which is a decline of 1.1% on the projected figure at the time of the SPU, which was 1.3%. The main reason for the downward revision is that we had poor first quarter figures from the CSO, and because we had poor international figures, exports were affected. In addition, the pharma patent cliff issue has intensified. We did not have information at the time of the SPU about the scale of the decline in industrial production, so it is a large downward revision. At the time of the SPU we were close to the consensus - what the troika was saying and, as I mentioned, the market consensus.
I refer the committee to the slide on stabilisation and core retail sales. The graph shows a positive trend. The retail sector employs perhaps 250,000 people in the domestic economy and, although we are hearing a lot of external positivity, the main concern is growth in the domestic economy. What are the growth figures in retail? What products or services have those been in? Is it white goods? What retail is shifting?
Mr. John McCarthy
I defer to my colleague on that question.
Mr. Shane Enright
I do not have the figures in front of me, but I think that the year-on-year trends in August were as a result of declines in bar sales. White goods did not perform particularly well, but there have been increased sales in furniture, lighting and building-related products over the summer months. Food, alcohol and tobacco were down too, which perhaps reflects some of last year's budget measures.
I do not wish to make the witnesses give a tight prediction, but the fact that the beginning of the budget cycle has moved to October has a significant impact on the retail cycle and there is an expectation that consumer sentiment and confidence will grow after the budget, given that we are going into the final quarter which takes us to Christmas, always the best quarter for retail. Is there any prediction or indication about where the figures will go? I imagine there would be an increase.
Mr. John McCarthy
I do not think sentiment would affect the year-on-year comparison because if it is carried out in October every year the comparison will be with what happens in October the following year.
The sector has been lobbying this House for a number of years to move the budget cycle to earlier in the year so that the Christmas sales period is elongated and it is not just something that happens quickly after the budget, after which Christmas arrives and they go into the sales period.
Mr. John McCarthy
The first year of such a cycle would have an impact on the year-on-year figures because that would be compared with last year when the budget was in December, but it would be a level shift, if Members know what I mean, that would not affect year-on-year figures in later years.
I welcome Mr. McCarthy and his colleagues and I thank them for the presentation. As Mr. McCarthy acknowledged, there is a lot to take in, but I will try to cut to the core point, which is what all this means for the budget. I know the witnesses will not talk about the choices the Government has or any related budgetary issue, which is perfectly understandable, but they can tell us, for example, what consolidation package would be required now to give a deficit of 5.1% of GDP?
Mr. John McCarthy
I am afraid I cannot give that information. There are so many things that are works in progress. There are a million and one parts that feed into the budgetary calculations - the general government budget, GGB, calculations. The economy is one issue, but there are many others, including the amount of consolidation and all the below-the-line issues that arise, so I simply cannot give that information at this stage, and neither have I a mandate to do so.
Okay. The witnesses have provided pages and pages of graphs, which are interesting, but they have not provided table 8 in the SPU from the previous April or the updated projections on the fiscal side.
That is something that could be provided, based on static conditions, the assumption being the would be a €3.1 adjustment which we now know is not going to happen. On the basis of that assumption, it is possible to work through the numbers. The model is there and Mr. McCarthy could tell us what it would mean in terms of a deficit next year if was proceeded with.
Mr. John McCarthy
We must come back to the legislation and the MOU. All eurozone countries are required to outsource their macro-economic forecasts, not their budgetary forecasts, or else have them endorsed by an independent authority. We are in the same boat as every other European country. This is because in some countries overly optimistic macro-economic forecasts have been an important source of deficit bias. That is the not case in Ireland, but it is the reason for the two pack legislation. Owing to that legislation, we need to have our economic forecasts endorsed by those whom the Minister chose, the Irish Fiscal Advisory Council. We stated to the council that we would only ask it to endorse the economic forecasts. We did not make any reference in the presentation to it to the budgetary position, budgetary policy or anything along these lines. The only reference on the budgetary side was aimed at emphasising that the working assumption was there would be consolidation to a figure of €3.1 billion. The agreement with the Minister was that we would give the exact same presentation today that was given to the Irish Fiscal Advisory Council. Since we did not discuss issues of a fiscal nature with it, it would not be appropriate for me to discuss them here and I do not have a mandate to discuss them. I am sorry, but I cannot answer the Deputy's question. We are on the macro-economic side of the house. Obviously, we liaise with our colleagues on the budgetary side, but we have a mandate to discuss the macro-economic numbers and nothing else.
Using Mr. McCarthy's definition, he does not have a mandate to answer the question. However, he has the information at his disposal and the competence to tell us what adjustment is required to have a deficit of 5.1% next year, but he cannot tell us. Essentially, he is not allowed to do so.
Mr. John McCarthy
I have some information to hand which suggest what the consolidation figure may be, that is, what the macro-economic position would be, but I stress that there are 101 moving parts in which our colleagues on the budgetary side would be involved. They are moving day to day and I am not familiar with them.
However, Mr. McCarthy is saying nominal GDP next year is forecast to come in at a figure of €170.3 billion. Is that correct?
Mr. John McCarthy
Yes.
Therefore, a deficit figure of 5.1% would give a general government deficit cash balance of about €8.7 billion. In April the SPU forecast that the general government deficit would be about €7.5 billion, but that was to be expressed as a percentage of a greater nominal GDP balance and would have given a deficit of 4.3% of GDP. Mr. McCarthy is prepared to give us as much information as possible on the macro-economic forecasts, but he will not tell us anything at all about what it means for the budget and the fiscal position.
Mr. John McCarthy
I only know a little about what it means for the budget. I must stress that there are many inputs to the budget, only one of which is the macro-economic outlook. I know what that might mean for the budgetary position, but I do not know about the other issues. I do not know the composition, consolidation figure or the full quantum. There are many moving parts below the line which need to be factored in and on which we will not have full information until later in the week or over the weekend. My mandate, as agreed in the letter, was to discuss the macro-economic position as per our discussion with the Irish Fiscal Advisory Council. The budgetary position did not arise in our discussion with the council. Our comparative advantage is on the economic side and that is what we have tried to present.
Mr. McCarthy can sense the frustration from our point of view, although I can only speak for myself. The presentation is entitled, Economic Outlook Underpinning Budget 2014. We are having this discussion in the context of the budget which will be announced next week and Mr. McCarthy is giving us all of the detailed assumptions underpinning his budgetary model, but he is not prepared to tell us anything at all about what it means because he claims this is only part of the picture. I do not accept that he cannot tell us what the proposed adjustment - €2 billion on the spending side and €1.1 billion on the tax side - means on the fiscal side. I do not accept that he cannot tell us this.
Mr. John McCarthy
I do not understand the last statement. The €3.1 billion-----
There is an adjustment of €3.1 billion, of which €2 billion is on the spending side and €1.1 billion on the tax side. The SPU worked its way through what that meant for the fiscal position. I do not understand how Mr. McCarthy cannot put this in the context of the updated macro-economic projections that he has made.
Mr. John McCarthy
We made it quite clear in the letter to the committee that our mandate was to discuss the macro-economic outlook. I can understand the Deputy's frustration, but budgetary policy is a matter for the two Ministers, Deputies Michael Noonan and Brendan Howlin. They will announce it next Tuesday on the basis of an economic forecast. That is the bit where I feed in. That is as far as I go.
Mr. McCarthy is saying the growth rate is projected at 0.2% of GDP. At the time of the last budget, it was 1.5% which was downgraded to 1.3% in the SPU. Mr. McCarthy is now saying it is more or less going to be flat, give or take 0.2%, which is difficult to break down further. For next year, the figure has gone from 2.4% in the SPU to 1.8%. Looking at the numbers, people will be surprised to see that the picture on exports is a lot more mixed than might otherwise have been assumed. We are looking at a decline in exports of 0.6% in the current year. Is that in volume or by value?
Mr. John McCarthy
Volume.
That includes the figure for goods going down by 4% and that for services increasing by 2.7%. On the flip side, the trend in the employment measure is certainly more positive. To whom does all of this go with a view to finalising what will be announced next week? Who else is involved within the Department? Who else is adding variables to Mr. McCarthy's model if he does not have the complete picture? What divisions will be doing this? Who has the master file?
Mr. John McCarthy
There are two questions, the first of which is about the downward revision for this year and next. It is primarily on the export side. Unfortunately, the data had disappointed in the opening part of the year. Exports were down by 1.5% in volume terms in the first half of the year. That, in turn, is related to two factors. As there has been weaker than assumed external demand, projections for the United Kingdom, the United States and the eurozone have disappointed, especially in the first quarter, and that obviously has a direct impact on our exports. There is also the worse than assumed patent cliff position. That will have an affect both this year and next.
The process is based on a consolidation figure of €3.1 billion. As outlined in the SPU, the ratio is two to one between expenditure and taxation. What will happen in the next week or so is that we will get figures from our colleagues on the fiscal side for the actual individual consolidation measures, as well as the quantum of consolidation. We will then apply our own assumptions for various multipliers by looking at the individual consolidation instruments to see what they mean for growth. We will then iterate with the fiscal division in order that we are all on the same page in terms of the macro-economic and fiscal outlook. It is an interative process, whereby information on the consolidation will be the key variable. We do not have it on our side at the moment.
I call Deputy O'Donnell who has ten minutes.
Thank you.
When I say ten minutes, I mean that his session ends in ten minutes. Therefore, the last question cannot be asked at nine minutes and 59 seconds.
I appreciate your guidance, Chairman.
On the figures prepared by Mr. McCarthy, the slide on page 20 is the most important and informative from a general overall viewpoint and shows that GNP will grow by 0.2%. When were these up-to-date figures prepared?
Mr. John McCarthy
They were prepared in mid-September following publication by the CSO of the second quarter GDP and GNP figures.
Therefore, they are based on the figures for two quarters. Mr. McCarthy said 0.2% would be the revised growth rate for GDP in 2013. However, he said earlier that the market consensus at this time was that it would be 0%. Is that correct? Will he elaborate on this?
Mr. John McCarthy
I will correct what I said earlier. Yes, we base it on the figures for the first two quarters, but there were also high frequency data over the summer such as the figures for retail sales and so forth. We also take these into account. What I am talking about in the market consensus is that each month Reuters undertakes a survey of ten to 12 of the domestic financial institutions, that is, the banks, stockbrokers and the ESRI, and produces what is known as a median forecast for seven or eight variables such as GDP, GNP, inflation, employment, unemployment and so forth. It publishes this and provides us with the data. The early October consensus from Reuters was 0% in GDP this year and growth of 1.7% next year.
The Department is projecting a figure of 1.8% in 2014 and Reuters is coming in at around the same figure at 1.7%. In respect of the Department's forecasting, the only areas in which forecasting came in ahead of target were investments, in respect of which the Department forecast a rate of 3.7% and the figure is 4.9%, and unemployment, in respect of which the Department forecast a rate of 14% and the figure is 13.5%. If there has been a reduction in unemployment and an increase in investments, why would the Department foresee a reduction in consumption? It projected a 0.2% increase in consumption and the figure is -0.2%. On Government spending, the Department projected a decrease of 2.1% and the figure is 0.9%. On exports, it projected an increase of 2.3% and the figure is -0.6%. On imports, it projected a decrease of 0.4% and the figure is 1.8%. Even though unemployment has decreased as a percentage, the Department projected an increase in employment of 1.6%, but the figure is 0.4%. The normal experience in economies is jobless growth, whereas the Department appears to have what it calls negative productivity, but it is effectively jobs with very low growth.
Will Mr. McCarthy explain why there are all these different variables which appear to be moving in different directions from what one would expect? What does it mean for the ordinary person? Effectively, we are seeing that the level of unemployment has gone down, while the level of employment has gone up, yet the rate of consumption is down. It was supposed to increase by 0.2%, but it is down by 0.2%. How does that feed into the growth projections? Will Mr. McCarthy give his overall perspective as to where he sees the economy next year? What measures does he believe have worked? Mr. Enright referred to the reduction in the VAT rate for the hospitality sector. Generally, what policy instruments work in creating employment and seeing this reflected in an increase in consumption which feeds directly into growth? What is Mr. McCarthy's overall view?
Mr. John McCarthy
A lot of questions have been asked and if I do not answer them all, the Deputy can refer back to me.
We are getting conflicting messages from the numbers.
Mr. John McCarthy
The answer in general terms is, to use the cliche, that it has been a year of two halves. In the second half of last year there was a deterioration in the external environment which, unfortunately, gained momentum in the opening part of this year, with the result that we had a very negative first quarter figure. We would not have had this at the time of the stability programme. However, consumption has since picked up. It picked up in the second quarter, when there was a quarter on quarter growth rate of 0.7%. Over the summer the retail sale figures indicated a very strong consumer spend. It appears that if one ignores the first quarter, the underlying position is a little better. Obviously, consumption would have been affected by the change in registration regimes which would have affected car sales in the opening quarter but boosted them mechanically in the third quarter. We have to take into account the fact that the figures for the first quarter were a source of disappointment and, on foot of this, we have revised downwards the overall modest growth rate of 0.25% to -0.25%. It is not a massive change, but I believe we are moving in the right direction in consumption.
With regard to the drivers of consumption, the figure for disposable income is flattening out. The savings rate seems to be coming down. There are modest increases in household wealth, although the literature tends to say the margin of propensity to consume from household wealth is fairly small. Nonetheless, it is moving in the right direction.
The Deputy correctly raised the issue of employment growth. Yes, we have seen very strong employment growth without having the activity to explain it.
On a final point, why did the Department project the unemployment rate to remain at 14%, but it decreased to 13.5%?
Mr. John McCarthy
It is now 13.5%.
Yes. The Department projected the level of employment at 1.6%-----
Mr. John McCarthy
It is now 1.6%.
Will Mr. McCarthy explain the term "negative productivity"? Why is it manifesting itself in the economy?
Mr. John McCarthy
It is a puzzle. What we think is happening - nobody can be definitive on this - is that the patent cliff issue, which accounts for nearly one eighth of gross value added which is essentially GDP in the economy, is bringing down the overall GDP growth rate, but it does not really have an impact in the labour market because the labour share of that sector is so small. We believe we are also seeing a modest recovery in domestic demand since the second quarter. That is where one gets jobs. They come from retail spending. Building and construction are moving in the right direction.
The final point concerns the issue of the VAT rate and the hospitality sector, to which Mr. Enright referred. What is Mr. McCarthy's overall view on such measures in terms of job creation and job retention?
Mr. John McCarthy
We published a paper in last year's budget. I do not have the figures to hand, but we undertook an economic analysis of the jobs initiative in the tourism and hospitality sector and concluded that, on balance, it had had very favourable effects on activity and employment in the economy. I do not have the figures to hand, but the paper is available publicly. We can arrange to have it sent to the Deputy.
I thank the delegates for the presentation, despite the challenges in not having adequate time. It was very interesting and informative. As many issues have been discussed by previous speakers, I will focus on some that have not been mentioned.
I understand the delegates cannot delve into budgetary matters or the political world, but it is being reported today that the Minister, Deputy Michael Noonan, has confirmed that the GDP growth rate next year will be 2% as a result of his announcement that the deficit adjustment will be €2.5 billion. The delegates have told the committee that it will be 1.8%, with the caveat that it is based on a €3.1 billion adjustment. I accept the caveat that they do not know how the adjustment will be made, but they did not know how it was going to be made when they were projecting the figure of 1.8%.
Let us assume a number of things. Would an adjustment of less than €600 million result in higher growth rates in the economy - possibly in the order of 0.2%?
Mr. John McCarthy
It would depend on the type of consolidation. I will try to give the Deputy some figures that I stress are purely hypothetical. I do not know whether the figure is €2.5 billion, which would be €600 million lower than the €3.1 billion figure in this hypothetical case. That €600 million amounts to, roughly speaking, 0.3% or 0.4% of GDP. In terms of the impact on the economy one looks at what is called the multiplier effect, the impact on GDP of a 1% change in policy. If consolidation was 0.4% lower, applying what I stress is a central estimate differs in terms of the consolidation instruments but a reasonable central estimate would be 0.4% or 0.5%. Then one would be looking at growth being 0.2% or thereabouts stronger than would otherwise be the case. Again I stress this depends on whether the lower consolidation should be done. That would be a central estimate and it would be difficult to disagree with it at this point without additional information. The answer is "Yes".
I will tease that out a little bit in another direction. Instead of having a set amount less of consolidation, if we had a set amount of additional investment, would there be the same multipliers? Mr. McCarthy spoke of 0.4% or 0.5% as a multiplier. Is the Department not using 0.6% as a multiplier? What would be the figure then? Mr. McCarthy provided hypothetical figures in the last slide, showing 1% growth in world output, inflation and so on, and the effects that would have in terms of GDP. What would a 1% investment in GDP by the State mean? Has the Department considered that?
Mr. John McCarthy
Yes, we certainly have. Again, it depends on the type of investment. As an example, let us talk of examples of reductions. Suppose we were to reduce investment by cutting back on, say, the purchase of trains.
I am not talking about an increase in investment but an injection, or stimulus.
Mr. John McCarthy
Suppose we were to increase investment by €100 million by purchasing trains. That has zero impact on the economy because the margin of propensity to import of trains is 1. We do not produce them in Ireland and import them from Spain, France and so forth. If we were to calculate in terms of the building and construction side the multiplier, by definition, would be higher.
Let us tease that out in terms of a €1 billion investment in the construction industry. It could be for primary health care centres, schools moving from prefabs, whatever works might be construction based and labour intensive. Has any modelling been done on that within the Department?.
Mr. John McCarthy
It would not be unreasonable to assume a higher than average multiplier if that was the consolidation or stimulus instrument chosen. It would be higher than the 0.5% central estimate I mentioned before. That is not an unreasonable assumption.
What are we looking at - is it 0.8%, 0.9% or 1%?
Mr. John McCarthy
Our models do look at this. If a road is being built one does not get as much bang for one's buck as if a school is being built, and so forth. There would be differences in terms of the type of building and construction. That is what we try to get into when we are trying to formulate our forecasts. We look at the individual measures and move them up. We would be looking at perhaps a multiplier of close to 0.7% or 0.8%. That would not be unreasonable but again I stress that it would depend on the type of stimulus being discussed.
I refer again to the modelling. The Department has to do this without knowing what the Government will announce on budget day and must take it from a static policy position that will not be changed by policy. The Government has indicated, for example, the use of the NPPR as an investment tool. Has the Department modelled the use of the €6.4 billion in the discretionary portfolio as an investment tool? Does that factor into the calculations? This figure was announced two years ago and we have not seen much, if any of it being spent. God forbid that the Government should start to use some of that money. Has it been factored in to any of the Department's estimates?
Mr. John McCarthy
All the investment numbers on the public capital front are supplied to us by our colleagues in our sister Department, Public Expenditure and Reform. These are all incorporated into the analysis but I do not have the exact figures in front of me at that micro level of detail. They are, so to speak, exogenous inputs that are supplied to us that we take at face value and input them into the model.
Let us go to forecasting. I appreciate the scrutiny work the Department is doing where forecasters have to second guess how the economy will be the following year. It can be disappointing, however, and must be so. Two years ago we, namely, the Government, the Department or the State, forecasted a 3% growth rate for this year. Today, with the consensus arising from the new information of today, Mr. McCarthy tells us the growth rate will be 0%. It is very hard for people. This is the seventh austerity budget and they have been taking it on the neck, time and time again. We have heard all the positive signals and it is very difficult to be positive at times, although there is some positive data contained in this material about the green shoots and turning the corner. Yet here we are, in 2013, with potentially no growth. Perhaps Mr. McCarthy might take me from that point. The SPU update in April suggested we were going to have a deficit target of 7.4%. That was based on a growth rate of about 1.3% this year but it will now come in at 0%. Will we meet the troika targets of 7.5% this year if we have lost 1.3% of growth? We are obviously cutting it very fine to meet that target.
Mr. John McCarthy
The 2012 figures on the budgetary side are still very much work in progress but I stress that over the long run one can reasonably model nominal GDP growth as opposed to the real figure. For example, taxation revenue will move one for one with nominal GDP growth over the long run. In other words the elasticity is essentially unity. In the short term, however, there can be massive deviations around the long-run trend. There can be very high elasticity and stronger tax growth in spite of the weak GDP growth that occurs for various reasons, for example, it can happen if a small number of firms in the multinational sector are doing well. It is not just the nominal GDP figure that will feed in to the deficit target. One needs to take into account elasticities and the 101 other moving parts that will feed into it.
I am looking back. We are nearly at the end of the year. If Mr. McCarthy can clarify this I will finish. The best estimate from Mr. McCarthy's section of the Department and the other section was what we were going to hit 7.4% in terms of percentage of GDP deficit. Today, however, Mr. McCarthy informs us that GDP growth, based on 1.3% growth, will more than likely be zero. Based on that unless we see a massive upswing in revenue, which we have not seen because we know it is on target, it seems we will not hit the troika target of 7.5%.
Mr. John McCarthy
That is if revenue is on target and expenditure is slightly below target. However, I believe it will catch up later on in the year. Notwithstanding what is going on in the macro economy, the public finances are on track to achieve the deficit for this year. That is explained by-----
Is that the target of 7.5%?
Mr. John McCarthy
So I understand. There can be differences on a year to year basis between the elasticities in terms of what happens to GDP and tax revenue. Tax revenue is pretty much on target up to end September in spite of the fact that GDP growth has been very weak. I mentioned the 101 other moving parts.
Unfortunately, it is not as simple as looking at the GDP figure and extrapolating out what it might mean for the deficit target. All I can say on that front is, as per end-September, we are on track in terms of revenue and slightly behind, if I recall correctly, on spending, although that is a profiling or timing issue. In other words, things look to be on track on the Exchequer side.
I am not referring to the amount of consolidation. I am talking about-----
I am afraid the Deputy is over time.
There are some oddities to the analysis we have heard, as referred to by other speakers. To follow on from the last point, the Fiscal Advisory Council, in its earlier reports - although, perhaps significantly, not in its most recent one - included an interesting graph which showed that if growth were to turn out 1% less or 1% greater than projected, the adjustment necessary to meet the deficit targets would be very significantly higher or lower. As I recall, the difference was in the order of €1 billion per year. We have not met the growth forecasts for this year, the difference being approximately 1%. According to those earlier tables from the Fiscal Advisory Council, this could have very serious implications for the level of adjustment that might be required in future years. Can Mr. McCarthy explain why this is not being reflected in the Department's analysis? Surely there must be an impact if the growth forecasts are not met.
We used to hear a great deal of talk about jobless growth. Now it seems we have growthless jobs, which is an interesting anomaly that requires significant scrutiny. Are there issues in regard to the method of counting or defining unemployment? Are people on internships and back to work schemes, for example, counted as unemployed?
Mr. John McCarthy
Our primary focus in terms of the labour market is the quarterly labour force survey. The first question a surveyor from the Central Statistics Office will ask when he or she arrives at a person's door is whether that person is in or out of employment. If participants in the schemes to which the Deputy referred classify themselves as being in employment, they will be recorded as such. In other words, there is a classification issue. The method employed by the CSO is standard international practice. This survey-based measure, which involves surveying something like 30,000 households every quarter on a rolling basis, is our primary focus.
That is very revealing. One can conclude, therefore, that the supposed increase in employment, which, oddly, is not matched by significant increases in growth, could very well have something to do with how people are being categorised as either employed or unemployed, with people on schemes or internships putting themselves in the latter category.
Mr. John McCarthy
One would need to see a dramatic change in year-on-year terms to reach that conclusion. It is not the case that all the people on those schemes classified themselves as unemployed in the first quarter of last year and subsequently classified themselves as being in employment in the first quarter of this year. There is a level versus rates of change issue here which will not be fully captured. In short, the rate of increase in employment cannot be explained by that particular sampling issue.
I am not so sure. We are not talking about such a dramatic increase.
Mr. John McCarthy
It is a question of scale.
What are the figures?
Mr. John McCarthy
The number is 35,000 for the first half of the year. In percentage terms, this indicates employment growth of some 1.5%. We have not had that since the bubble.
How many people have joined back to education schemes, back to work schemes and so on?
Mr. John McCarthy
I do not have those figures to hand.
I expect they might be very interesting, and I intend to seek them out. There is a very strange contradiction going on here, which Mr. McCarthy has acknowledged is difficult to explain, in that we have jobs but no growth. I accept that he might not have all the answers today, but the issue certainly requires further analysis.
I understand the CSO has estimated that 40,000 people are leaving the country every year.
Mr. John McCarthy
That figure is calculated from April to April. In the year to last April, net outward migration stood at approximately 34,000.
Going on that estimate, if 68,000 people had not left in the past two years, what would the unemployment rate be?
Mr. John McCarthy
We make no bones about the fact that outward migration is one of the factors in the declining rate of unemployment. We are clear and up-front on that point, just as I was clear about it in my presentation. It is factored into our modelling because it is simply a feature of the Irish labour market. I cannot give the Deputy the figures off hand, but it would be a fairly simple calculation. I can come back to him with the number. It is not rocket science, but I do not have a calculator to hand.
I would appreciate if Mr. McCarthy would come back to me with that figure. We need to know what impact the enormous flood of emigration is having on the unemployment statistics. Is it fair to say that if the estimated 68,000 who have left had not done so, we would be looking at a significantly higher unemployment rate than what we have now or even what we had two years ago?
Mr. John McCarthy
That is beyond doubt. I can give the Deputy very rough rules of thumb for quantifying the figure he is seeking. On a survey basis, there are approximately 300,000 unemployed in the country. The labour force is in the region of 1.85 to 1.9 million. Simply adding 68,000 to the numerator would allow one to work out the rate.
Is it not fair to say, therefore, that if we did not have people flooding out of the country, then the story, as Mr. McCarthy described it, would not be so rosy?
Mr. John McCarthy
I am not describing the labour market situation as rosy. I agree that without emigration, it would be worse than the current bad situation.
As regards the jobs that are being created, Mr. McCarthy indicated that they are concentrated in export services.
Mr. John McCarthy
We are seeing job creation right across the board in the private sector, in agriculture, manufacturing, private market services and, in the second quarter, even in construction, which is something of a surprise given the shake-out in that sector. The bulk of the job losses are in areas associated with the public sector.
Did Mr. McCarthy point to one of the tables as showing that exports of goods were down and exports of services up?
Mr. John McCarthy
Yes, but practically all the decline in exports of goods is due to one specific sector which does not have a large labour content. In the year to end-July, merchandise exports are down by €3 billion, of which €2.7 billion is due to a decline in two sectors, namely, pharmaceutical and chemical.
Are financial services making a significant contribution to the increase in services exports?
Mr. John McCarthy
I understand financial services exports have been fairly stable in recent quarters.
Mr. Gavin Sweeney
Exports have been stable but it is not the dominant sector. IT is assuming a far greater weighting in terms of driving the increase, particularly in the second quarter.
What about aviation services?
Mr. John McCarthy
They only give seven or eight sectors.
The witnesses probably cannot answer this question.
The Deputy can ask it anyway.
The witnesses said that they are basing their contribution on the adjustment figure of €3.1 billion originally set out for this year and they cannot tell us what adjustment would be required to meet the deficit. Can the witnesses say anything about the primary surplus or are they barred from answering that? What adjustment would be needed for us to achieve the primary surplus next year, which is an important benchmark?
Mr. John McCarthy
I simply do not know the scale of consolidation needed to move into primary surplus territory. At the time of the stability programme update, on the basis of an adjustment of €3.1 billion and growth of 2.4% in real terms, we were looking at a primary surplus of €400 million or €500 million. I do not know what it is now. There are many moving parts with interest and the NTMA. It is not that I am barred from discussing it but technically I cannot do it right now.
Can we deal with two points before Deputy Twomey contributes? One is a figure that hops off the page but which was not drilled into in the presentation. The other concerns the employment figures. My understanding is that people are still registered as social welfare recipients if they are in the JobBridge programme. Given that it has a 65% success rate in putting people into employment, the figure can be recovered in one envelope. With regard to the investment heading, page 3 of the stability programme update forecasts that investment will increase by 8.2% this year, which amounts to double the 2013 increase of 3.7%. Where is that coming from? What are these investments? Does this mean the agricultural sector buying machinery?
Mr. John McCarthy
Investment has two aggregate components, one of which is building and construction investment; the other is investment in machinery and equipment. In the agricultural sector, this means buying tractors and harvesters. The Chairman is right to draw attention to it because the figure jumps out as a large increase. The main source of the increase is linked to the law of small numbers. For example, new house building is down to such a low level, something like 5,000 units for this year, that if it increases to 6,000 units for next year, which is not a huge absolute increase, it amounts to an increase of 20%. The level is so small that percentage changes become large.
We are almost starting from a stopped position.
Mr. John McCarthy
Another issue is always arising in troika discussions. In terms of modelling investments, in the long run we typically look at investment to GDP ratio or, in other words, overall investment relative to economy-wide activity. For an advanced economy and a euro area country, the norm is an investment to GDP ratio of 18% or 19%. In Ireland's case, it is 10%, which is abnormally low and at some stage it must normalise. A rapid normalisation is not built into our medium-term projections because we would have to build in 15% or 20% growth in investment, which is not plausible. There is some upside risk to the investment component over the medium term, although maybe not next year. The original question is pertinent as the figure jumps out. The law of small numbers explains it.
Most of the points I wanted to raise have already been dealt with. With regard to productivity and how this is related to the patent cliff, is this not really a change in productivity? Is it linked to the way some of these companies, which have manufacturing plants in this country, also have external income that is put down to other companies related to the companies in this country? We are dealing with this issue in respect of global taxation. Is there some connection or am I incorrect in my assumption? Can the witnesses explain the decrease in productivity that does not seem to be real?
Mr. John McCarthy
It is very difficult to explain. My hypothesis involves sectoral composition from the pharmaceutical sector. I am not sure it is correct but it is plausible. I cannot be definitive. If output is falling in the sector, which accounts for 25% of our exports and a large part of our GDP, GDP is falling but the decrease does not really have a labour market impact because the sector does not employ many people relative to the construction sector or the retail sector at the height of the boom. Employment is one component, with 30,000 people employed in the sector, but we have not seen massive lay-offs in the sector. If output is decreasing without a corresponding impact on employment, that depresses productivity in the sector. The sector is very large relative to overall GDP, which drags down productivity across the economy.
Another element is the stabilisation in domestic demand. Domestic demand is more employment rich than export-led growth. If we are seeing a modest recovery in the building and construction and retail sectors, we will see increases in employment without massive increases in output. These are not capital intensive, they are labour-intensive sectors. There is a depression in productivity from that. In the bubble years, we had weak productivity growth because so many people were employed in the construction and retail sectors. Very few people were employed in the traded sector, where there is strong productivity growth.
Is that the real economy to which we refer?
Mr. John McCarthy
Exactly. I am interested in other people's theories and the research that will inevitably emerge in the area. The conundrum can be explained by the composition of output this year. It will not be a feature of the economy for too long as it is very difficult to envisage a scenario of productivity in negative territory for a prolonged period of time. We are not unique in this area. This time last year, questions were being asked about productivity performance in the UK. Deputy Boyd Barrett referred to growth without jobs. It is interesting and we would like to know more about it but it requires further work and more data.
Mr. McCarthy's explanation seems strange when the retail and construction sectors have collapsed in this country.
Mr. John McCarthy
No, they are on a gradual recovery path. Looking at the past three or four quarters, there is a modest improvement in building and construction. Since the second quarter of this year, consumption figures have been strong, up by 0.7% quarter on quarter, and retail sales in the third quarter were very strong, increasing by 1.5% in annual terms. If we include cars, it increases by 3.5%. There is a modest recovery under way in domestic demand.
A few years ago, someone talked about the economy reaching a certain level of stability, leading to pent-up demand in the economy. The idea is that people have a significant amount of money, up to €3 billion or €4 billion, that is not rainy day money or money to reduce debt.
If people saw stability they could start spending this money in the economy and it could lead to growth or certainly contribute to the GDP in a positive way. What are the views of the witnesses on this thinking?
Mr. John McCarthy
There would appear to be some pent-up demand. I suspect it is through this precautionary or rainy day savings. Obviously there would be the wealth impact as well if they have significant amounts of deposits sitting in banks or even under the bed, then one could see an increase in consumption. We look at GDP as a flow variable so it tends to be what happens with the flow of income and how households allocate their disposable income between consumption and savings. Where we would see the scope for consumption improvements is primarily through a reduction in precautionary saving as opposed to the €3 billion that might be lying under the mattress or even in banks.
It is a case of going by what people are spending rather than what they have on deposit.
Mr. John McCarthy
Yes, exactly.
It has been mooted that a 1% increase in income taxation would show a contraction of up to 1.4% in GDP. Are the witnesses familiar with this argument?
Mr. John McCarthy
The multiplier on income tax changes does not jump out at me. I do not have the figures to hand but I can revert to the Deputy with that information.
That information could be very useful. We are very much against increasing income taxation because of its negative effect on growth.
Mr. John McCarthy
As a general comment, research in the area of the OECD hierarchy of taxes tends to suggest that direct taxes have the highest multiplier effects. In other words, without quantifying it, they would be more damaging to the economy than some indirect taxes or property or carbon taxes and so forth. I am unable to quantify it just at this moment.
Our economy is in a unique situation. I find it strange that the part of the country showing the most improvement is the greater Dublin area. House prices and rents are increasing by anything from 4% to 10%. Yet, there has been no significant increase in incomes over the same period. That is not really sustainable over any significant period. How will this impact on the economy? The last thing we need is another bubble bursting just when we are bringing ourselves out of this mess. What is the forecast for the mortgage market? Mortgage costs are increasing to some degree but mortgage arrears and repossessions are bigger issues and it is a question of how these may impact on the economy.
Mr. John McCarthy
On the Deputy's first question, I think he is correct. On a regional basis, rents in the urban areas have been quite strong for some time, perhaps as a result of what the Deputy termed the pent-up demand. We do not produce forecasts on a regional basis as they are based on the economy as a whole. We simply do not have up-to-date regional GDP data. The latest data is from 2010. We look at the economy as a whole. We implicitly try to take into account in our forecasts any developments in the mortgage market. However, it is a case of stop versus flow variable. GDP is a flow concept and therefore, my house does not feature in GDP because has already been built. It featured in GDP back in the mid-1990s. From a forecasting and macro perspective we are only trying to gauge the likely new house build. If there were issues in terms of arrears and repossessions then we would try to feed them in through that channel. It is very implicit; it is not something we explicitly model.
If the patent cliff had not happened what would be our growth rate today? That is the basis of Mr. McCarthy's argument.
Mr. John McCarthy
Roughly speaking, one could add one percentage point to the figure of 0.2%.
That is the basis of the argument.
Mr. John McCarthy
Yes. It was something the fiscal council asked us in the meeting. I did some quick calculations and came up with a figure of broadly 1% higher.
The primary surplus of 3.1%, 0.4% was estimated by the witnesses. This is roughly about €600 million or €700 million of a surplus.
Mr. John McCarthy
Yes. That is in the SPU.
When the SPU figures are being done, why is a range of adjustments not considered as distinct from just looking at the 3.1%?
The Deputy should be brief.
This is a pertinent question.
It is very pertinent but it is not a short question.
I apologise.
Mr. Shane Enright
The 3.1% figure was outlined in the budget prior to the SPU, prior to any promissory note savings. We just carried that through as a technical assumption. We were clear and upfront that this was not a government decision, that it was a pure technical assumption that we continued with the consolidation. As I said at the outset, we do not have a government decision as to whether that is different.
Mr. McCarthy has indicated that he will reply in writing to any further questions from the Deputy.
I have three questions which I will put quickly. The pharmaceutical sector amounts to 25% of our exports and the slide presentation shows that exports have reduced by 4%. This is one of the reasons the Department has downgraded the economic forecast for this year. We all knew that the patent cliff was happening. How did the Department underestimate the size of the patent cliff? I refer to our discussion about the growth in joblessness. The CSO figures show that something could be wrong, that the figures for either economic growth or jobs could be wrong. Mr. McCarthy referred to the volatility of quarter on quarter numbers and these have been adjusted in the past. For example, we thought there was growth last year and it was downgraded but it can work the other way. Is the Department in any way optimistic that we will see an adjustment of previous quarters which will actually show growth in the economy? My final question is linked. I do not think we have ever had the Department ratcheting up the growth outturn. There is an evident pattern which is that growth is downgraded for this year, that modest growth or a reasonable growth for next year is projected. In April it is downgraded a bit and closer to the budget it gets downgraded more. That has happened for the past number of years. There is something wrong. We can blame external forces as much as we wish but there is a problem in terms of economic forecasting and that is not just within the Department. I appreciate all the difficulties and I would not like to change places with the witnesses. In a way, some of this is false hope. If we actually had the real economic growth figures from 2008 to 2013 painted in black and white, we would have taken a different direction. However, we have been fed the notion that next year will be better if we hold on and tighten the belt a wee bit but when next year comes there is no growth.
Mr. John McCarthy
I thank the Deputy for the easy questions. The Deputy mentioned the scope for revisions. He is half right. There is scope for revisions on the GDP but there is no scope for revisions on the employment numbers which are pretty much set in stone and are revised every five years with the census figures.
That is the definitive version, but the revisions tend to be very minor over the quarters. Some economists around town have certainly queried the GDP figures, but we take them at face value and see them as the Central Statistics Office's best estimate at the time.
Is it a wee bit hopeful of a positive adjustment?
Mr. John McCarthy
Looking at the research one can see the probability of an upward revision is pretty much the same as the probability of a downward revision. Let me give an example. The Deputy is right about what happened in the past couple of years. The figure for 2011 has been revised to 2.2%; we indicated at the time that it would be 1.3% or 1.4%, but it came in stronger than we would have thought at one stage. Last year the initial estimate was 0.9%, but it was brought down to 0.2%. That makes our job difficult, but the CSO has a difficult job to do and the quarterly figures are extremely volatile in an Irish context. If the cut-off point for the supply of data by firms is the 15th day of the month and data from a large multinational come in on the 16th day of the month, they cannot be incorporated. It is a very difficult job.
With regard to not achieving the macro forecasts, we are not unique, as the Deputy acknowledges. The International Federation of Accountants has conducted some research and we have been too negative in our outlook for exports, as they have tended to over-perform relative to our forecasts, but this has been more than compensated for by our being too optimistic on the domestic demand. In other words, we assumed domestic demand would recover more rapidly than it has. It is a balance sheet recession problem and there is the question of the turning point which is very difficult to predict. I mentioned that there were tentative signs of a modest recovery in domestic demand. If that occurs, people will feel it on the ground and there will be more tax-rich and employment growth. Trying to predict this is very difficult and we have got it wrong, as others have.
The other question was on the pharmacy sector. How did the Department not see the extent of the patent cliff?
Mr. John McCarthy
The Deputy is getting into firm-specific developments and the examination of specific drugs. One must appreciate that individual firms would be very reluctant to provide data as to the likely trajectory of production. In the absence of that data, it is difficult to forecast on such issues. I speak to colleagues across Europe all the time and none of them has to forecast on a firm level in the way we must, as we are so small and some of the multinationals are so large relative to GDP.
I thank Mr. McCarthy.
Mr. John McCarthy
I answered Deputy Richard Boyd Barrett's question about people participating in various schemes and so forth. It is my best understanding that if they are on a scheme and classify themselves as employed, they are in employment. I need to check and perhaps might revert to the committee.
Yes, there are the likes of the JobBridge activation schemes, etc.
Mr. John McCarthy
I think I am right, but I am not 100% sure.
My understanding is a person must be on the live register to qualify for these schemes.
Mr. John McCarthy
That is, the live register as opposed to the quarterly national household survey. Our focus is on the latter.
Yes. I thank Mr. McCarthy and his team, including Ms Dalton, Mr. Enright and Mr. Sweeney, for engaging so comprehensively and informatively with the committee. The issue of the availability of presentation material is one we must examine. I commend the team for its engagement with the committee, but it might have been of greater assistance if we had the material available. I thank the officials for their engagement and adding to our understanding of the matter.
The joint committee adjourned at 8.25 p.m. until 3 p.m. on Thursday, 7 November 2013.