Tag Archives: Ireland

A2 Economics – Phillips Curve – an Irish Perspective

Coming from Ireland I took a keen interest in the book entitled “Understanding Ireland’s Economic Crisis” edited by Stephen Kinsella and Anthony Leddin. It is a series of papers written by Irish academics which focuses on the causes of the largest destruction of wealth of any developed economy during the 2007-2010 global financial crisis. One paper on “The Phillips Curve and the Wage-Inflation Process in Ireland” lent itself to the Unit 6 of the A2 CIE syllabus. Remember the Phillips curve:

Bill Phillips, a New Zealander who taught at the London School of Economics, discovered a stable relationship between the rate of inflation (of wages, to be precise, rather than consumer prices) and unemployment in Britain over a long period, from the 1860s to the 1950s. Higher inflation, it seemed, went with lower unemployment. To the economists and policymakers of the 1960s, keen to secure full employment, this offered a seductive trade-off: lower unemployment could be bought at the price of a bit more inflation.

The graphs below show the unemployment and inflation in Ireland between 1987 and 2012.

Notice the following:
1987: – 17% unemployment with over 3% inflation
1988-99: – unemployment falls to 5% and inflation 1.5%
1999-2000: – inflation increases from 1.5% to just over 7%. This increase was largely due to expansionary fiscal policy (demand-pull inflation) and capacity constraints that led to higher costs of production (cost-push). This led to a classic Phillips Curve situation as unemployment was at 4% and the unexpected increase in inflation had caused workers to ask for higher wages. With the low rate of unemployment their bargaining position was very strong.
2001-2004: – during this period we see the typical Phillips Curve wage-price spiral. When there is an unexpected rise in inflation this is accompanied by inflationary expectations and Ireland saw a dramatic upsurge in nominal pay awards. As demand-pull inflation fed into cost-push Irish inflation remained relatively high over the next 3 years.
2005-2008: – with unemployment still around 4% wages continued to rise significantly as inflation remained around the 5% level.
2008-2011: the global financial crisis hits the world economy and unemployment in Ireland hits 15% in the space of 2 years. Meantime the trade-off with inflation starts with the CPI reaching over -6% at the end of 2009. More recently we see inflation getting up to 3% with the rate of unemployment increasing at a diminishing rate.

Although economic indicators are improving in Ireland there is still a long way to go before they can be more confident about its outlook.

Portugese workers told to emigrate – Irish already gone

The high levels of unemployment have led one European leader to suggest leaving the country. According to the FT in London, Portugal’s prime minister, Passos Coelho, has indicated to the younger generation that if they can’t find any work they should “leave their comfort zone” by going overseas. Some from the political left have suggested that although there is a lot more freedom since the dictatorship ended in 1974, this has not translated into opportunities for employment. When Portugal joined the euro in 1999 they became a net importer of migrants but last year it is estimated that 150,000 emigrated overseas and a significant number of them being graduates. As with a lot european countries inflexible labour laws which make it costly to dismiss older workers mean that companies are less likely to employ younger workers. However changing the labour laws to make it easier to get rid of workers isn’t going to go suddenly create more jobs.

In Ireland, since the GFC in 2008, 250,000 people have left the country. What’s more worrying is that the youth unemployment (18-24 year olds) has risen to approximately 33% and that is not taking into consideration those who have emigrated. However to any government youth emigration has some benefits:

1. There is less need for social welfare support
2. It reduces the chances of social unrest which generally tends to originate from the younger members of the population.

Unemployment Figures in Portugal and Ireland

Ireland: model growing economy to model survival economy

Recently a lot has been written about how Ireland could be the model economy of how to overcome a debt crisis by using austerity measures. Interesting to note that in the 1990’s the ‘Celtic Tiger’ was heralded as a shining example of how to run a successful modern economy. Now that the economy has become one of the basket cases of Europe it is ironic that they are, according to Angela Merkel and Nicolas Sarkozy, providing the antidote.

Although the economy is performing better there is still a lot of pain being suffered especially from those who can least afford it – as within most eurzone countries it is the “working” person who suffers the most. However a year after its €67.5bn bailout economic conditions have been improving in the Emerald Isle.

– Exports are up 5.4%
– GDP is up 1.2% in Q2 2011
– Budget deficit is down from 32% of GDP in 2010 to 10% of GDP in 2011

But the bad news is still there:

– Salaries of nurses, teachers, civil servants etc have been cut 20%
– 2012 will see €3.8bn in tax increases and spending cuts
– Retail sales fell 3.8% in October from a year earlier
– Unemployment is now at 14.5%
– The above figure would be higher except for the increasing numbers leaving the country

However although Ireland is making gains in rectifying the economic problems in their economy, it could be all in vain when you consider what might happen to the eurozone.

Central Banks give cheap loans to help global markets

Central Banks worldwide have agreed to provide cheap loans in US$’s to banks in Europe and other parts of the global economy. There is obviously serious concerns about the economic climate in Europe but will it calm the markets? The truth of the matter is that more liquidity alone is not going to solve the economic problmes of the eurozone countries. The graphic below does show some positive signs with bond yields on the way down which suggests that there is less risk associated with their purchase. However there is still a long way to go for stability to return. See graphic below from the WSJ.

Central banks have offered cheaper credit before:
March 2011 – interevened to reduce the value of the Yen following the earthquake and tsunami.
October 2008 – central banks cut rates to reduce the shock on financial markets when Lehman Brothers went under.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.” combined statement form the 6 central banks. These include:
-US Federal Reserve,
-Bank of Canada, the Bank of England,
-Bank of Japan,
-European Central Bank and
-Swiss National Bank.

Does Austerity Work?

Recently The Economic Focus column in The Economist had an article that discussed how successful austerity is in generating growth in an economy. Barack Obama said “We have to cut spending we can’t afford so to put the economy on sounder footing and to give our businesses the confidence they need to grow and create jobs”. The UK and the European Central Bank (ECB) are also followers of Obama and argue that cuts to government deficits add to the GDP of an economy. The ECB argues that a fiscal contraction (reduced government spending and increased taxation) may turn out to be expansionary if expectations of lower future taxes and higher lifetime earnings become particularly strong. However, recent research states that this hardly ever happens. A study of 173 fiscal-policy changes in developed economies between 1978 and 2009 showed that cutting a budget deficit by 1% of GDP on average:

* reduces real output by about 2/3 of 1%
* increase unemployment 1/3 of 1%

There have been some cases where economies have grown with the implementation of austerity measures.

In Denmark between 1983-86 budget cuts actually led to a rise in domestic demand and consequently GDP. However its economy was already growing at 4% when austerity commenced. Furthermore, interest rates already at 23% came down as the fiscal environment improved. House prices rose by 60% increasing wealth and confidence.

Between 1987-89 improved budgetary conditions led to greater growth in the Irish economy. Again, like Denmark, Ireland had high rates of interest (13%) and with a more prudent approach rates dropped as did the Irish currency (the Punt) at the time. This led to an increase in exports by 10% from 1987-90 accounting for most of the growth of the Irish Tiger.

From 1991 – 1998 budget surpluses were used to pay off debt. But it was Italy’s exit from the Exchange Rate Mechanism (ERM) – see previous post on ERM – that led to a 40% decrease in value of the Lira against the D-mark. Again a weaker exchange rate led to more competitive exports and the Italian current-account went into a surplus and GDP increased.

The success of austerity programmes are characterised by initially high interest rates and weaker currencies which have led to export growth. However, America will struggle to replicate these as:

1 Their interest rates are near 0% already
2 Export volumes will be hampered by weak demand because of debt reduction in other developed nations.
3 Exports only account for a small proportion of their GDP
4 With China holding so much debt in US$ they will not want to see a dollar depreciation.

Higher natural rate of unemployment will mean structural reforms

The recent special report in The Economist looked at the altering structure of the labour market worldwide. Obviously globalisation and technology have brought big changes in the nature of work, and levels of unemployment will remain high in the developed world as developing countries see their numbers employed being boosted.

Edmund Phelps, Nobel Economist, thinks that the US natural rate of unemployment in the medium term is realistically around 7.5% which is significantly higher than a few years ago. Remember the natural rate occurs when inflation is correctly anticipated – this level of unemployment results when the economy is at full employment.

Michael Spence, another Nobel prize-winning economist, agrees that technology is hitting jobs in America and other rich countries, but argues that globalisation is the more potent factor. Some 98% of the 27m net new jobs created in America between 1990 and 2008 were in the non-tradable sector of the economy, which remains relatively untouched by globalisation, and especially in government and health care. Lowering this natural rate will require the following:

1. changing education to ensure that people enter work equipped with the sort of skills required so that there is no mismatch
2. adjusting the tax system – incentivise work
3. modernising the welfare safety net – encourage those to find work
4. encourage entrepreneurship and innovation.

This is easier said than done.

Long-Term Unemployment
This has increased dramatically in many countries – 58% in Ireland, 40% in both Spain and Japan, and 30% in the US, see graph below.

The concern with these figures is that the longer poeple are out of work the less likely there are able to find future employment. There are two reasons for this:

1. Their skills get out-dated very quickly and this is especially prevalent in the current labour market as technology is starting to takeover many procedural white-collar jobs.
2. Motivationally they find it hard to engage in the process of lookign for work and this is esepecially prevalent once a person is on a generous welfare benefit.

According to The Economist:
Long-term unemployment often turns into permanent unemployment, so governments should aim to keep people in work, even if that sometimes means continuing to pay them benefits as they work.

Ireland’s win – Positive Externalities and loads of Consumer Surplus

The game between Australia and Ireland on Saturday night at Eden Park was the biggest upset so far in this RWC. The RWC in New Zealand generally brings pleasure to a significant part of the population. Some will pay to go to games; others will pay to watch it on SKY TV; some will watch it on free to air on TVONE and Maori TV; others will listen to it on the radio; another group will enjoy reading about it in the newspapers. Irish supporters, including myself, will take great pleasure in talking about such a result – lets face it we don’t have much to cheer about at the moment with the state of the economy. What all this alludes to is the fact that as part of this entertainment comes without the public paying for it, the public benefits from an externality.

Those who have flown over for the RWC to support Ireland and went to the game will have no doubt spent a significant amount especially when you consider the state of the euro. Nevertheless the satisfaction (utility) derived in NZ$ from the game would have been much greater than the price they paid for the ticket. This suggest that there is a lot of consumer surplus present – the difference between the price that a consumer WOULD BE WILLING TO PAY, and the price that he or she actually HAS TO PAY. The RWC has been a great success so far and there have been more positive than negative externalities (transport system). Also it looks as if it will be a Northern Hemisphere v Southern Hemisphere final – a positive externality for the IRB? Go Ireland!!!!!

Iceland starts to thaw

The recent OECD* survey on the Icelandic economy paints a rosey picture when you consider what has happened to its economy over the last 3 years. Iceland’s approach has been different to that of the US and Euro Zone counterparts. Instead of introducing policies of quantitative easing and bailouts of banking institutions the Icelandic authorities allowed its banks to fail. Foreign debt, which totaled US$62 billion, left the country with no real choice but to default on the banks’ creditors. This policy has been called “Bankrupting your way to recovery”. In a recent radio interview on the BBC Iceland’s president Olafur Ragnar Grimsson said that Iceland’s approach is about much more than getting the banking sector operational but affirming the will of the people over the financial institutions. Iceland’s GDP for the last quarter is 2% and unemployment is at 5.8% – the latter being high by Icelandic standards.

Compared with the likes of Greece and Ireland who have gone through similar debt problems the one key option with is not open to its eurozone counterparts is that Iceland had its own currency the Krona. As the economy and banking system collapsed so did its currency which has its advantages and disadvanatges.

* The price of visiting Iceland has effectivley halved – Reykjavik was seen as one of the most expensive places to visit as a tourist
* As most of Iceland’s consumer goods are imported this has meant higher prices of cars, food, electronics etc.

Should Greece and Ireland learn from this? According to Stephanie Flanders – BBC Economics Correspondent – Greece already had huge amounts of debt before the crisis unfolded and it doesn’t hold much relevance as Iceland had no public debt at this time. However Ireland, like Iceland, had handled its public finances well but its financial framework poorly.

*Organisation for Economic Cooperation and Development – The OECD provides a forum in which governments can work together to share experiences and seek solutions to common problems.

Germany racing ahead in the euro zone

Since the introduction of the Euro in 1999 the German economy has left its euro zone colleagues behind when it comes to competitiveness and trade revenue. The New York Times produced a worthwhile article showing that Germany’s balance of payments has gone from a small deficit to a strong surplus, but in the euro zone as a whole the balance of payments position has deteriorated slightly. German competitiveness against the rest of the world was probably helped by the fact that the relatively poor performance of other members of the euro zone held down the appreciation of the euro against other currencies – a weaker euro makes German exports cheaper. The graphs below show the German economy against the major euro economies and the troubled euro economies which were forced to seek assistance. However, since the financial crisis, Ireland has improved its position more than any other country in the euro zone, but both Greece and Portugal have continued to lose ground to Germany.