17 Feb 2020
Economic Eye February 2020 - When growth is not enough

Economic Eye February 2020 - When growth is not enough

Authors
Graham Reid

EY Ireland Head of Tax & Law and Head of Markets

Passionate about our clients and the collective power of our Firm to solve their biggest problems. Growth driver. Relationship builder.

Eve Bannon

EY Ireland Economic Advisory Associate Director

Specialising in macroeconomic analysis, forecasting and economic impact measurement.

17 Feb 2020

Political developments have dominated the all-island economy since our last report. The Republic of Ireland (ROI) election resulted in an unprecedented outcome that, at the time of writing, has not resulted in the formation of a new government, while after three years, the Northern Ireland (NI) Executive has returned. Meanwhile, the Conservative Government in the UK are preparing their first budget since achieving a greatly-enhanced majority at the December election. If economic growth was all that mattered, the political outcomes would be very different. ROI’s growth is expected to be close to 6% in 2019 and the UK’s just 1.3%, yet the electorate endorsed the Conservatives in the UK, but did not do the same for Fine Gael. 

Little reward for prudence

The measure of success in an economy and how citizens experience economic growth is being reassessed. The quality of public services and state of the environment are fast becoming the most important issues, and the disconnect with GDP as a measure of success is greater than ever. The newly-formed NI Executive made its first order of business to call out the need for increased funding to deliver services.

The Fiscal Council in ROI has been warning against excessive spending, but the reward for the level of prudence shown by Fine Gael has not been evident at the ballot box. Only in the US does the maxim “it’s the economy stupid” still hold. The nexus of economic, social and environmental considerations is the new paradigm that is reshaping the political landscape.

Who funds public services?

Responding to citizens’ desire for enhanced public services is not easy. The need to unwind austerity, increase staff numbers and invest in facilities is expensive and comes at a time when labour supply is very limited. The rapid population growth in Ireland (276,100 over the last five years) has exerted pressure on public services and infrastructure, similar to the UK experience. The question of who pays for enhanced services and infrastructure is an issue across the island.

The UK Government is suggesting that the NI Executive will need to look at ways to raise more revenue locally, and there is growing evidence that tax increases may be palatable across the island if ring-fenced for frontline services. Government bonds have proved popular and can be issued at a low cost by the ROI and UK Governments, but the overall debt burden for both, to date, makes most political parties reluctant to do so.

Reasons for business optimism

The level of global anxiety has edged back very slightly in recent months, as trade tensions cool somewhat, and fears of an oil price hike dissipate. Looking at the macro fundamentals, there are reasons for optimism. Interest rates are historically low, inflation remains muted, more people are in work and pay growth is picking up. Growth rates in NI support low inflation, but ROI’s sustained high growth at a time of negligible inflation is unusual. With debt servicing costs low and strong levels of job security, the island’s domestic consumer market is relatively buoyant. When coupled with mildly expansionary government spending, this offers a degree of comfort for businesses.

Forecasts edge up slightly

ROI forecasts have been revised up since we published our last report and although the UK and NI are lower, they have improved on our monthly pulse forecasts released between issues. The modest improvement in global conditions and the persistent strength in the domestic sector have led to the upward revision in the ROI outlook. In NI, the planned increase in government spending and high levels of job growth have improved the employment forecast and helped to prevent the growth outlook from slipping into negative territory. Growth of 3.4% is forecast in ROI in 2020 and 0.8% in NI.

The labour market is still projected to slow in NI in 2020, though not to contract as previously forecast, and the moderation of ROI job growth (to 1.6%) largely reflects tighter labour supply. Downside risks are mostly external; a weakening local economy, a deterioration in the progress of the Brexit trade negotiations and the recent outbreak of the coronavirus. Within the Brexit trade negotiations, it is the specific terms of NI to Great Britain (GB) and EU trade that are of particular importance for the all-island economy.

Table showing the EY 2019 - 2023 growth forecasts
Economic Eye February 2020 - When growth is not enough
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1

Global outlook

Are we experiencing a synchronised global slowdown?

The period of synchronised global growth enjoyed in early 2018 has transitioned decisively into that of a synchronised slowdown

The world economy is now predicted to have grown by 2.9% in 2019, as opposed to 3.6% the previous year. 2020 forecasts have been consistently revised down since late 2018, as global economic concerns weigh on the outlook.

Table showing 2020 global forecast revisions

So, what is causing this increased concern over global growth? Initially, global geopolitical tensions and specifically, trade wars between the US and its main trading partners acted as a catalyst, but now other factors are threatening the outlook. Weaknesses in emerging markets, social frustrations within countries and consumption shifts in response to climate change are all contributing to the downward revisions to growth. Brexit has also taken its toll over the last three years as businesses and consumers alike stall spending and investment decisions.

Unfortunately, further disruption is likely to come as tense negotiations begin in March to figure out the future trading relationship between the UK and EU. The Bank of England has elected to hold interest rates steady and warns that late 2020 will be challenging, as the full extent of Brexit becomes clearer.

The ECB has also adopted an accommodative monetary policy and has kept interest rates constant, until such a time that inflation is closer to the target range of 2%.In China, slower reported growth triggered investor fears of a global slowdown given its importance to world trade. Recently, the coronavirus outbreak is further damaging the Chinese economy and its residents, as entire cities remain on lockdown, travel restrictions have been imposed on those who have visited China recently, and global chains close Chinese stores in an effort to contain the outbreak.

It is hard to predict the full fallout from the virus, and if the level of infections and deaths continue to grow rapidly and spread further across the globe, the implications for the global outlook could be serious.

In the US, trade tensions have softened slightly, although the cost since the beginning of the trade wars is reportedly 0.3 percentage points in real US GDP and almost 300,000 jobs, according to Moody’s in late 2019. Despite this, 2.1m jobs were created in the US in 2019, only marginally lower than the total amount of people employed in ROI, which highlights the scale of the US economy and why it is so influential on global politics.

Attention has turned to the rapidly growing US national debt. The national debt has risen by $3 trillion during Trump’s presidency, to over $23 trillion. In an election year, this increased spending, combined with the positive job growth story is more tangible to voters. Short-term economic gains carry more weight than securing longer-term sustainability and exhibiting fiscal restraint. The US Federal Reserve also elected to hold its interest rates steady, as it takes a 'wait and see' approach, after three cuts in the latter part of 2019

The World Economic Forum (WEF) annual meeting in Davos took place in January, with technology, the environment, geopolitics, healthy futures, future of work and equality among the themes. In its annual Global Risks report, climate issues took the top five long-term risks in terms of likelihood to occur.

The ongoing extensive bushfires in Australia have held the world’s attention, as the dramatic consequences of climate change were broadcast to the world. The tide appears to be changing on climate issues, and it is becoming more widely accepted that climate inaction is likely to create economic difficulties in the medium to long term.

Table showing global growth forecasts for 2020 and 2021
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2

Republic of Ireland

Headline growth forecasts

ROI headline growth is impressive; GDP is more than 25% larger than it was three years ago, there are 170,800 more people in work (seasonally adjusted to Q3 2019) and underlying domestic growth of 3-4% is still well above trend

It is unlikely that this growth will be maintained as the labour supply becomes increasingly constrained. The building of 21,240 homes in 2019 has been lauded as an improvement, but falls short of demand, with net migration of c.34,000 annually. The recent election reflects the increased disconnect between citizens and economic growth. It is clear that the remarkable stoicism and patience displayed by Irish people during the crash and sustained period of weak growth does not extend to periods of economic prosperity.

Table showing 2020 - 2022 ROI growth forecasts

Consumers - Up 2.5%

Domestic conditions remain robust. Strong population and job growth are supported by low inflation and healthy pay increases. The twin conditions of low inflation and fast growth are rare and mean that consumer firms should enjoy favourable trading conditions this year. Looking ahead, there is no immediate likelihood of a rates increase, a cut is more likely, even if unwarranted in ROI, and it will be 2021 before any moderation in consumer spending is projected. Changing spending patterns mean that retailing may not enjoy as strong a boost as leisure, sports, arts, culture and restaurants.

Government - Up 4.1%

The Government spoke of restraint during the recent boom, pointing to the significant €176bn of net debt, which equates to nearly €36,000 per citizen. The official data records relatively strong increases in government spending (3.9% in real terms in the year to Q3 2019). Hiring of frontline staff and new pay settlements are driving spending which is expected to grow at 4.1% in 2020, moderately below the 4.4% estimated for 2019. Despite the first year of a new government usually being the best time to enact cuts or reform, the manifestos of the prospective parties on housing and healthcare, make such an approach unlikely.

Investment - Up 5.8%

The underlying profile of investment is positive in ROI and growth has been strong as a result. It is difficult to interpret the aggregate data because of the distortionary effect of elements such as Intellectual Property. In the year to Q3 2019, capital investment in dwellings grew by 22%. The final figure for 2019 is expected to be over €4bn, three times the level of four years ago. The outlook remains robust; net migration is strong, there is a demand backlog and a policy commitment to accelerate building. Commercial building continues apace to meet employment growth. Machinery and equipment investment should pick up in 2020 after a slightly sluggish 2019, particularly as borrowing costs remain low.

Trade - Exports up 4.95 / Imports up 5.4%

Despite global trade wars, Brexit and increasingly inward-looking policies in many developed markets, Irish exports have been resilient. Exports are another component of GDP that can be subject to distortion, however the forecast is for exports to grow by just under 5% in 2020. This forecast depends on steady Brexit progress and no weakening of global trade. A deterioration in global trade terms is less likely than in 2019 due to the election year in the US and the shocks to major economies experienced in recent months. Imports are projected to grow faster than exports as strong consumer demand complements supply chain imports.

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3

UK and Northern Ireland

Headline growth forecasts

Somewhat surprisingly, recently published GDP data recorded NI as being in recession in 2018. However, this does not mirror labour market, tax receipt or spending data.

The weak NI performance is a further reminder that the region’s fortunes are more closely aligned with the UK than ROI. The outlook for the UK has improved slightly in recent months, though at 1.2% in 2020, it is still below trend and weaker than in our last Economic Eye report. The modest pick-up in growth in 2021 and 2022 is dependent on a free trade agreement being reached with the EU. NI growth is expected to lag behind the UK, though a significant cash injection to the new Assembly is projected to boost this slightly.

Table showing 2020 - 2022 UK and NI growth forecasts

Consumers - Up 1.4%

Consumer spending remains steady in the UK, as slowing migration in the wake of Brexit is partially offset by increased real wages. Consumer confidence in NI is still depressed, though volatile, but actual spending levels are remarkably stable. Retail job growth is positive, though increasingly orientated towards self-employment and retail sales have grown. With interest rates still low, and possibly even falling again in 2020 depending on global conditions, borrowing costs are favourable. Consistent house price increases further add to NI consumers’ willingness to spend.

Government - Up 2.5%

Government spending is adding to overall growth, with a 2.5% increase projected in 2020, despite a continuing message of fiscal prudence from the UK Government. In NI, the possibility of increased funding (£1bn or 0.2% of NI GDP) to the restored Executive could provide a boost to growth. This should positively impact the NI economy over the next parliamentary cycle and has resulted in an upward revision to the forecast. A swift resolution to the health workers’ pay disputes and an acceleration in recruitment plans across many departments are boosting spending levels.

Investment - Up 1.1%

Investment levels remain weak in the UK, and an improvement to 1.1% in 2020 from 0.7% in 2019 is hardly cause for celebration. Despite ongoing Brexit uncertainty, there is only so long that investment can be put off for many businesses in a global market, and there should be an element of "necessity spending" in 2020. Longer term, if Brexit uncertainty is removed, there is considerable pent up demand that could accelerate investment levels considerably. In NI, pockets of commercial development continue, and housing investment is steady. A potential increase in government capital spending should boost investment and growth, but it may be 2021 or beyond before much of the spending is realised.

Trade - Exports up 3.45% / Imports up 2.1%

Trade performance has disappointed in the UK, though not as much as was feared during the Brexit period. Total exports for the full year 2019 are up 5% in constant prices since 2017, though a forecast of 3.4% for 2020 is still below longer-term trends and global growth in trade. NI exports have been hit by significant closures and weakening trade in several high-profile manufacturers, though growth in tourism and across a range of professional services and ICT firms have offset this to a degree. The complexity of NI’s trading relationship with the EU and GB post Brexit presents a significant risk to future export performance.

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4

Labour market

Impressive job creation

The level of job creation across the island is impressive given prevailing global uncertainty

It has been particularly remarkable in NI against a backdrop of weak growth, the lack of an Executive and several high-profile industrial closures. Provisional 2019 NI estimates suggest over 3% growth in total employment, with self-employment taking up a significant share (26,000 of the 40,700 seasonally adjusted workforce jobs in the year to Q3 2019). Weak survey data and poor growth performance suggest that there is a strong possibility of the job estimates being revised downward.

2019 was the seventh year of job growth in ROI and the forecasted slowdown partly reflects the tightening of labour supply. Unemployment is now just 128,000 people, only 29,700 below the pre-recession low of Q4 2006. Job creation has been particularly strong in urban areas, with consumer and private service sectors leading the way. Recent protests by farmers reflect challenging conditions in agriculture and the fragility of prospects in rural Ireland’s most important sector.

Looking back at the last six years, the most striking feature of the labour market is its diversity. All broad job categories have enjoyed employment growth in the UK, NI and ROI. The growth in public service jobs across the island are noteworthy given that 2010-2019 was a period of restraint in public spending. Although not all health and education services are provided by the public sector, it is nonetheless surprising that net job creation was greater than in professional services in ROI. Industry has increased its employment in all three jurisdictions, again bucking the trend in service sector growth that was expected.

The diversity of the labour market is expected to continue with increased government spending supporting public sector job growth. The possibility of higher personal taxation may begin to drag on consumer sector growth, though tourism could partially offset this. ICT has moved to the top of the sectoral forecast table for NI and ROI, though the classification between ICT and professional services is often opaque. The outlook for retail employment is relatively weak as online shopping and technology continue to disrupt traditional business models. The high street is orientating towards restaurants, leisure and wellbeing activities which are not uniformly classified as retailing.

Construction should be boosted by increased capital spending in both economies and by accelerated house building in ROI.

Wage growth to remain robust

With tight labour market conditions across the island, wage inflation is likely to remain relatively robust. The forecasts reflect the total wage bill in an economy and as a result, an increase in job creation in lower paid sectors can suppress the overall rate of growth. With hotel, leisure and care industries creating jobs and the gig economy on the rise, this will have a modest effect on the forecasts.

However, significant pay rises in high-end professional services and ICT will help to maintain healthy wage growth in both NI and ROI. With inflation expected to be below 2% in both NI and ROI, this represents a considerable boost to consumer spending power. As environmental concerns impact spending patterns, this will translate into structural changes across the economy. 

Will spending orientate to locally-sourced goods with lower environmental costs, will air travel lose popularity and will car ownership be forgone for more restaurant and experiential spending? A healthy level of spending is suggested by the wage data, but this may not be in the traditional shops or on the same products.

Circles showing CPI inflation in ROI and UK
Table showing 2019 - 2023 EY job forecasts
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5

Business issues

A more balanced picture emerging?

There has been plenty of research to suggest difficult times ahead in 2020

EY’s Q4 Profit Warnings report registered the highest annual number of warnings since 2015, which amounted to 17.8% of UK quoted companies and surpassed the figure from the peak of the financial crisis. Across the island, survey data has pointed to increased levels of concern, particularly in NI. The NI Chamber of Commerce quarterly survey in January suggested that 57% of its members expected a recession in 2020, though this has fallen from 77% from its previous survey. Across the EY client base, the outlook is less gloomy, with 63% describing their clients’ mood as positive, an increase since our last survey.

Bar chart showing the results of an EY  conversations sentiment survey

Innovation and technological solutions have been at the top of the list of opportunities since the survey’s inception in late 2018, with improving efficiency and developing new products the key areas of focus. Unlocking the power of data analytics makes its way into the top five for the first time, which is closely linked to innovation. Improving staff performance through recruitment and training remains at number five.

Bar chart showing the key opportunities identified by clients in and EY conversations sentiment survey

What are the key challenges identified by clients?

Finding talent is the top challenge for the fourth consecutive quarter, rising from 61% in our last survey. The labour markets in both ROI and NI are growing tighter, with record-low unemployment in NI and a potential slowdown of immigration due to Brexit. ROI is close to full employment, and housing supply may curb future migration flows. These factors, combined with higher wage demands, will make recruiting more challenging for firms.

Retention, flexible working and hiring from new skills pools now become crucial. Dealing with Brexit remains the second biggest risk but falls in prominence from 56% to 45%. This reflects the mood among firms that Brexit is now official, which brings a degree of clarity, but no negotiations have yet taken place to work out what it will mean in practice. Increased competition makes its way into the top five, in place of cybersecurity as a key challenge.

Circles showing the key challenges identified by clients in an EY conversations sentiment survey
Three tables detailing the key challenges identified by clients in ROI, UK and NI

Summary

If economic growth was all that mattered, the political outcomes would be very different. ROI’s growth is expected to be close to 6% in 2019 and the UK’s just 1.3%, yet the electorate endorsed the Conservatives in the UK, but did not do the same for Fine Gael.

About this article

Authors
Graham Reid

EY Ireland Head of Tax & Law and Head of Markets

Passionate about our clients and the collective power of our Firm to solve their biggest problems. Growth driver. Relationship builder.

Eve Bannon

EY Ireland Economic Advisory Associate Director

Specialising in macroeconomic analysis, forecasting and economic impact measurement.