8/3/2012: Economy on a flat-line: Sunday Times 4/3/2012


This is an unedited version of my article in Sunday Times March 4, 2012.

This week, the conflicting news from the
world’s largest economy – the US, have shown once again the problems inherent
in economic forecasting. Even a giant economy is capable of succumbing to
volatility while searching to establish a new or confirm an old trend. The US
economy is currently undergoing this process that, it is hoped, is pointing to
the reversal in the growth trend to the upside in the near future. The crucial
point, however, when it comes to our own economy, is that even in the US
economy the time around re-testing of the previously set trend makes short-term
data a highly imperfect indicator of the economic direction.
In contrast to the US economy, however, Irish
data currently bears little indication that we are turning the proverbial
corner on growth. It is, however, starting to show the volatility that can be
consistent with some economic soul-searching in months ahead. Majority of Irish
economic indicators have now been bouncing for 6 to 12 months along the
relatively flat or only gently declining trend. Some commentators suggest that
this is a sign of the upcoming turnaround in our economic fortunes. Others have
pointed to the uniform downward revisions of the forecasts for Irish growth for
2012 by international and domestic economists as a sign that the flattening
trend might break into a renewed slowdown. In reality, all of these conjectures
are at the very best educated guesswork, for our economy is simply too volatile
and the current times are too uncertain to provide grounds for a more ‘scientific’
approach to forecasting.
Which means that to discern the potential
direction for the economy in months ahead, we are left with nothing better than
look at the signals from the more transparent, real economy-linked activities
such as monthly changes in prices, retail sales and house price indices, and
longer-range trade flows statistics, unemployment and workforce participation
data.
This week we saw the release of two of the
above indicators: residential property price index and retail sales. The former
registered another massive decline, with residential property prices falling
17.4% year on year in January 2012, after posting a 16.7% annual decline in
December 2011 and 15.6% decline in November 2011. With Dublin once again
leading the trend compared to the rest of the country, there appears to be
absolutely no ‘soul-searching’ as house prices continue to drop. House prices,
of course, provide a clear signal as to the direction of the domestic
investment – and despite all the noises about the vast FDI inflows and foreign
buyers ‘kicking tyres’ around empty buildings and sites – this direction is
down.
More interesting are the volatile readings
from the retail sales data.
The headline indices of retail sales volumes
and values for January 2012, released this week were just short of horrific.
Year on year, retail sales declined 0.34% in value terms and 0.76% in volume
terms. Monthly declines were 3.7% across both value and volume. Relative to
peak, overall retail sales are now down 25% in value terms and 21% in volume.
January monthly declines in value and volume were the worst since January 2010.
Stripping out motor trade, on the annual basis, core retail sales fell 1.94% in
value terms and 2.74% in volume terms, although there was a month-on-month rise
of 0.3% in value index. Monthly performance in volume of sales was the worst
since February 2011.
Looking at the detailed decomposition of
sales, out of twelve core Retail Businesses categories reported by CSO, ten
have posted annual contractions in January in terms of value of sales. The two
categories that posted increases were Fuel (up 5%) and Non-Specialised Stores
(ex-Department Stores) (up 1.7%). The former posted a rise due to oil
inflation, while the latter represents a small proportion of total retail sales
– neither is likely to yield any positive impact on business environment in
Ireland. In volume terms, increases in sales were recorded also in just two
categories. Non-Specialised Stores sales rose 1.0%, while Pharmaceuticals
Medical and Cosmetic Articles rose 1.5% year on year. Overall, only one out of
12 categories of sales posted increases in both value and volume of sales. All
discretionary consumption items, including white goods and household
maintenance items posted significant, above average declines in a further sign
that households are continuing to tighten their belts, cutting out small-scale
household investment and durables. The trend direction is broadly in line with
November 2011-January 2012 3-months averages, but showing much sharper rates of
contraction in demand in January.
The above confirm the broader downward trend
in domestic demand that is relatively constant since Q1 2010 and is evident in
value and volume indices as well as in total retail sales and core sales. More
importantly, all indications are that the trend is likely to persist.
One of the core co-predictors – on average –
of the retail sector activity is consumer confidence. Despite a significant
jump in January 2012, ESRI consumer confidence indicator continues to bounce
along the flat line, with current 6 months average at 56.5 virtually identical
to the previous 6 months average and behind 2010-2011 average of 57.3. Based on
the latest reading for consumer confidence, the forecast for the next 3 months
forward for retail sales is not encouraging with volumes sales staying at the
average levels of the previous 6 months and the value of sales being supported
at the current levels solely by energy costs inflation.
Lastly, since 2010 I have been publishing an
Index of Retail Sector Activity that acts as a strong predictor of the future
(3 months ahead) retail sales and is based both on CSO data and ESRI consumer
confidence measures, adjusted for income and earnings dynamics. The Index
current reading for February-April is indicating that retail sales sector will
remain in doldrums for the foreseeable future, posting volume and value
activity at below last 6 months and 12 months trends.
Which means that the sector is likely to
contribute negatively to unemployment and further undermining already fragile
household income dynamics for some of the most at-risk families. During the
first half of the crisis, most of jobs destruction in both absolute and
relative terms took place in the construction sector, dominated by men. Thus,
for example, in 2009 number of women in employment fell 4.2%, while total
employment declined 8.1%. By 2010, numbers of women in employment were down
2.8% against 4.2% overall drop in employment. Last year, based on the latest
available data, female employment was down 2% while total employment fell 2.5%.
In other words, more and more jobs destruction is taking place amongst women,
as further confirmed by the latest Live Register statistics also released this
week, showing that in February 2012, number of female claimants rose by 3,479
year on year, while the number of male claimants dropped 8,356 over the same
period.
The misfortunes of the retail sector are
certainly at play in these. Per CSO, female employment in the Wholesale and
Retail Trade sector has fallen at more than double the rate of overall retail
sector employment declines in 2010 and 2011. Relative to the peak, total female
employment is now down 10.2%, while female employment in retail sector is down
17.9%.
Traditionally, acceleration of jobs
destruction amongst women is associated with increasing incidences of dual
unemployment households. This is further likely to be reinforced by the
increasing losses of female jobs in the retail sector, due to overlapping
demographics and relative income distributions. Such development, in turn, will
put even more pressure on both consumption and investment in the domestic
economy.

Source: CSO and author own calculations

The forthcoming Referendum on the EU Fiscal
Compact will undoubtedly open a floodgate of debates concerning the economic,
social and political implications of the vote. Yet, it is the economic merits
of the treaty that require most of the attention. A recent research paper by Alessandro
Piergallini and Giorgio Rodano
from the Centre for Economic
and International Studies, University of Rome, makes a very strong argument
that in the world of distortionary (or in other
words progressive) taxation, passive fiscal policies (policies that target
constitutionally or legislatively-mandated levels of public debt relative to
GDP) are not feasible in the presence of the active monetary polices (policies
that focus solely on inflation targeting). In other words, in the real world we
live in, the very idea of Fiscal Compact might be incompatible with the idea of
pure inflation targeting by the ECB. Which is, of course, rather
intuitive. If a country or a currency block were to pre-commit itself to a
fixed debt/GDP ratio, then inflation must be allowed to compensate for the
fiscal imbalances created in the short run, since levying higher taxation will
ultimately lead to economic distortions via household decisions on spending and
labour supply. Given that ECB abhors inflation, the Fiscal Compact must either
be associated with increasingly less distortionary (less progressive) taxation
or with the ECB becoming less of an inflation hawk.