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Ireland’s economy looks set to grow by 4% again in 2018. For the fourth year in a row Ireland will be the fastest growing economy in Europe with rapid increases in retail sales, falling unemployment and surging tax revenues. Brexit poses the biggest threat to continued growth. Ireland’s prospects largely rest on the UK agreeing to a ‘transitional’ period with the European Union (EU).
This article is from our latest edition of MarketWatch, an in-depth report focusing on the Global Economic Outlook for 2018.
Despite this stellar performance, rising house prices, European and US corporate tax reforms and Brexit have raised concerns that Ireland’s good run will come to an end. But we must remember that Ireland’s rebound mainly reflects the severity of the recession that preceded it.
Figure 1 illustrates that despite a strong recovery since 2013, Irish employment is still 5% below its level 10 years ago. In contrast, other economies have seen employment surpass pre-recession peaks recorded in the late 2000s. This suggests Ireland’s recovery has further to go to catch-up with its peers.
This may seem strange when Ireland’s unemployment rate is 6.1%, with just 138,000 unemployed. However, the unemployment rate is a bad measure for a small economy like Ireland. Net emigration of Irish nationals was 140,000 between 2010-2017. Had these emigrants remained they would have pushed up the unemployment rate.
In 2017 net inward migration was 20,000. Ireland must take action to facilitate the return of emigrants as they are more likely to have the qualifications and skills required to take-up highly paid employment. If not, the labour market will soon start to constrain Ireland’s ability to grow.
The key bottleneck facing the economy is the housing market, evident in double-digit house price and rent inflation. Supply remains at abnormally low levels - close to 10,000 versus natural demographic demand of at least 30,000. If homebuilding does not pick-up, the lack of supply will start to hinder Irish economic growth.
The government has recently unveiled a number of initiatives to stimulate housing supply. These include the Help-to-Buy scheme, a fast-track planning process, and the Local Infrastructure Housing Activation Fund (LIHAF). Further action is probably required to reduce the cost of building. For example, requirements for underground car parking spaces in new apartment blocks, even in the centre of Dublin, significantly add to costs.
Ireland’s longer-term plans are outlined in the National Planning Framework, which selects Cork, Galway, Limerick and Waterford as key development hubs alongside Dublin. However, these plans could be undermined by politics.
Ireland has been very successful at attracting foreign direct investment (FDI) - evident in the cluster of technology firms in Dublin expanding their operations. Yet US President Trump’s corporate tax reforms and European proposals for taxation of digital companies are examples of moves towards global tax reform.
Our view is that Ireland can expect to continue to attract FDI. The Organisation for Economic Co-operation and Development (OECD) initiatives to end ‘offshore’ tax shelters and schemes such as the ‘double-Irish’ have led to companies relocating assets into Ireland, pushing up their corporate tax payments. Meanwhile, Brexit means that Ireland’s main competitor for FDI, the UK, is unlikely to have continued access to the EU single market. This will only increase Ireland’s attractiveness to foreign companies.
The Department of Finance has estimated that if the UK fails to agree a deal with the EU and trade reverts to World Trade Organization (WTO) rules, Irish gross domestic product (GDP) could drop 2% within 1-2 years. Given the economy would already be growing by 2-3% per annum, these estimates suggest Irish economic growth would flat line. However, the impact could be larger than 2% of Irish GDP.
A cliff-edge Brexit would undermine the regulatory and legal basis for UK trade and likely cause severe disruption. Business and consumer confidence would suffer, so spending may be dented more than the Department of Finance estimate suggest. Also, the agricultural sector, small and medium enterprises and indigenous manufacturers would be more exposed than multinationals.
So Ireland’s prospects largely rest on the UK agreeing a transitional period with the EU. Although this may seem to be an increasingly brave assumption, our belief remains that cool heads will prevail and a worst-case scenario will be avoided.