Savings, savings, everywhere...

Collectively, we find ourselves in the historically unusual position of having a surplus of income over expenditure.  And what is even more unusual is that this is true for both the household and government sectors at the same time.

Historically, the country has had only three periods of significant surpluses on the current account of the balance of payments.    

The first was during World War II when rationing and trade restrictions curtailed spending. The current account returned to deficit when the war ended.  The second period of surpluses was during the early part of the 1990s when the start of the Celtic Tiger resulted in strong income growth. These surpluses were much smaller than the previous episode and disappeared when spending growth caught up and exceeded income growth by the early 2000s.  

The third example of sustained current account surpluses is now, driven by a combination of strong income growth, including corporation tax revenues, and also, for a time, restrictions on spending.  Latest estimates put the 2023 surplus at around 3 per cent of national income in 2023, close to where it was pre-COVID.  

To get some insight into the source of these surpluses we can look at the outturns from the CSO for Savings minus Investment, [S - I], of the household and government sectors.  [S – I] from the national accounts is equivalent to the balance on the current account of the balance of payments in the international accounts.  Here they are in nominal annual terms (four-quarter sums) for the household and government sectors since 2000.

As can be seen above for the last two years or so this has been positive for both sectors.  In the 12 months to the end of June, the government sector had an [S – I] of €10.8 billion while it was €6.8 billion for the household sector.

The trough of late 2007/early 2008 when the household sector was spending far more than its income (mainly due to buying new houses) can be compared to the current level. Both are around €16 billion – though in opposite directions.

When household stopped borrowing to buy all those houses, government borrowing increased significant in 2008 and 2009 as tax revenues, which were been spent as soon as they came in, were reliant on property-based taxes.  The deficit on the public finances was closed over the following decade with the green bars above ticking modestly into positive territory by the end of 2018.

Of course, there has been a lot of growth and a significant bout of inflation since 2008/09 so a nominal comparison isn’t very informative.  We can put the above nominal figures as a share of GNI* (with a linear interpolation used to get the four-quarter sums and Budget-day forecasts used for 2024).

This shows what we would expect. The hole that was opened up prior to 2008 was much deeper than the heights of recent years. But the current position is still significant: in combined terms the household and government sectors have an excess of income over expenditure (both current and capital) that is equivalent to around five per cent of national income. 

This is roughly where it was pre-COVID (2019) but the composition has somewhat changed.  Back then, the excess was driven almost entirely by the household sector whereas now there is a contribution from the government sector (with the government’s position benefitting from soaring Corporation Tax revenues).

Compared to the first half of 2019, nominal aggregate disposable income of the household sector was about 43 per cent higher in 2024.  Nominal consumption expenditure was around 41 per cent higher.  This gives a slightly higher savings rate in 2024 compared to 2019, 17 per cent versus 15 per cent.

The change since 2019 is that more of that saving is going to capital formation rather than going on the financial balance sheet.  In nominal terms, household investment is running at around €16 billion a year, compared to €6 billion in 2019.

A good share of this increase is just price effects.  The volume of new housing purchased by the household sector is up about 10 per cent on what it was in 2019 but prices of new housing units are up around 20 per cent.  The value of purchases of new housing by the household sector rose from €3.3 billion in 2019 to €4.4 billion in 2023.  That makes only a minor contribution to the increase shown above.

A much larger share of the increase in household investment is likely due to renovations and improvements of existing dwellings.  We can see this from the breakdown of investment provided in the quarterly national accounts – though in this instance we are looking at an economy-wide measure than one specific to the household sector.  The government and corporate sectors will undertake some improvements but the household sector will be the main driver of changes.

In nominal terms spending on renovations and improvements rose from under €3 billion in 2019 to close to €8 billion now.  Again, there will be a price effect but the QNAs also show a steep volume increase, with volume close to doubling since 2019 and at there highest ever levels.  The key activities here are renovations, extensions and retro-fitting.  This seems to be the one spot on which there is additional spending.  If more new housing was available spending there would likely increase as well.

To conclude, we’ll look at the finer detail of the household sector from the Institutional Sector Accounts. First, the current account:

The bottom line is that slightly higher savings rate compared to what it was in the equivalent period of 2019 (the first six months of the year).  The data are nominal and we note that the CPI during the first half of 2024 was three per cent higher than a year previously and up almost 20 per cent compared to what it was in 2019.

The largest relative changes are for interest flows with both incoming and outgoing interest up just over 100 per cent.  The fastest increase in wages received was from the government sector, plus nine per cent, compared to around seven per cent for other sectors.

We can see how the saving is used from the capital account.

All told, the household sector was a net lender of €7.8 billion in the first half of 2024.  The largest destination of these funds are household deposit accounts. 

Latest figures from the Central Bank show that household deposits with entities regulated by it are growing by around €700 million a month, and at almost €160 billion are up €50 billion on where they were at the end of 2019.

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Corporation Tax motors along

Corporation Tax receipts continue to pour in for the Exchequer. 2023 seems set to extend the decade long run of each year exceeding the previous year – though the gap to last year has narrowed.

In July, CT receipts for 2023 were running about €1.5 billion ahead of those for 2022.  August and September weren’t as strong as last year reducing the gap to €600 million. 

August seems to have been affected by some firm-specific idiosyncrasies that will wash out, while there is little to be taken from the September figure.  September is month T+9 for firms with a December year-end and is when they file their tax return and make their final tax payment for the previous year.

On a 12-month basis, CT receipts seem to have plateaued around €24 billion which is an extraordinary amount.

Which means that the growth of the 12-month sum has also eased considerably.

Optimism for the remainder of 2023 is mainly due to the strength seen in June. Companies with December year ends pay the bulk of the CT in June and November (corresponding to month 6 and month 11 of their financial year).

The €4.2 billion collected in June of this year points to November receipts of around €6 billion, which would be €1 billion more than the same month last year.

And with the rate for large companies set to rise to 15 per cent and the exhaustion of capital allowances for onshored intangible assets the risks to forecasts would seem to be on the upside.

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What to do with €30 billion of savings?

To paraphrase a former Taoiseach, as a community we are living away within our means. This can be represented using the recently published Q4 2022 update of the Institutional Sector Accounts.  Here we show gross savings minus gross capital formation [S-I] for the government and household sectors – this is equivalent to a sector’s contribution to the current account of the balance of payments. Here they are on a four-quarter sum basis:

There was an expectation that household savings would decline as the pandemic eased but savings remain significantly above pre-pandemic levels.  For the government sector there has been an improvement due to the reduction of Covid-related income and business supports and the government’s position has been further boosted by soaring Corporation Tax receipts.

Although, the quarterly figures are only preliminary, summing over the four quarters of 2022 shows the household sector to have had a surplus of savings over investment of €20.5 billion with the government showing a surplus of €9.5 billion on the same measure.  Combined they sum to €30 billion.

The evolution of the line in the above chart, as well as the composition between household and government sectors is as good a starting point as any to discuss the performance of the economy since the year 2000.  But reaching an unprecedented position of +€30 billion is as worthy of examination as the developments that led to the deterioration to –€20 billion during the credit bubble.

Ireland’s Savings in Comparative Terms

But where do we stand relative to other countries? Here is a set of EU countries selected as those which have the necessary data available from Eurostat. The data are scaled by Net National Income which mitigates, but doesn’t completely eliminate, the need to adjust the figures for Ireland. Apart from the calculations done to get the [S-I] figures, no adjustment is made to the Eurostat data.

We see that Ireland is also high in comparative terms with other countries, though for the household sector there is a relatively small difference to Germany, Czechia, Sweden, The Netherlands and France.  With most EU countries running government deficits it is Ireland’s government surplus that leads to most of the gap. Still, for the household sector one can query whether we are at a sufficiently mature stage to be savings on a par with households in Sweden, The Netherlands and Germany.

The post is titled “what to do with €30 billion of savings” but we do know what has been done with it.  Households have put most of their surplus on deposit and the government has started contributing to a National Surplus Reserve Fund. 

The increase in household sector deposits has been noted for sometime.  Irish households have been deleveraging for around 15 years now. Post-2008 this was mainly via a reduction in debts. This has now switched to being an increase in deposits.

In the financial accounts of the Central Bank of Ireland, the household sector had just over €150 billion of currency and deposit assets at the end of 2019.  By the end of 2021 this had increased to €185 billion with a further rise to €195 billion by the third quarter of 2022.

This increase in household sector deposits in Ireland has been one of the fastest in the EU14.

However, the level does not stand out, whether using a ratio of deposits to income or using a balance sheet measures such as a ratio of deposits to loans.

While there certainly is some interest in what households do with the near €200 billion of currency and deposits assets they now have (and knowing more about the distribution of those would be a useful step in that regard), a more pertinent issue is probably what happens to savings behaviour going forward. Will household saving continue at an elevated level? Should the government be running a budget surplus?

Macroeconomic Constraints: Real and Financial

The economy faces constraints but these are more real (resources) than financial (income).  The unemployment rate is below five percent while pressures in housing are well documented. But the domestic economy is running a very large balance of payments surplus – perhaps only second to Norway in European terms. Norway is benefitting from higher energy prices; Ireland from booming Corporation Tax revenues.

But in Ireland, it seems it is the household sector that is saving the largesse not the government sector.  Norway (population 5 million) added €100 billion to its sovereign wealth fund last year.

In response to the surge in inflation, the government introduced a large set of compensatory measures.  Some of these were targeted where they were needed but many were universal and seem only to have added to the burgeoning deposits of certain households.

If these measures are not repeated in 2023 then we may see some reduction in household savings. If not offset by spending elsewhere, this would see the government surplus rise (also aided by first quarter Corporation Tax receipts which have been particularly strong).

But what level of budget surplus is politically sustainable?  Should the government be increasing taxes aimed at households with elevated savings rates to recapture the benefits of the soaring Corporation Tax receipts or to ensure that those savings aren’t released into an economy already operating at close to capacity?  The need for increased housing supply is undeniable but should activity in other sectors be squeezed to try and create room for more construction activity? No solutions are offered here as we are merely pointing to the trade-offs faced.

The unusual position of the economy can be illustrated with a chart of the unemployment rate (representing an internal resource imbalance) and the current account of the balance of payments (representing an external income imbalance).  The two macroeconomic loops the Irish economy has experienced in the last 50 years are also highlighted (1975 to 1998 and 2003 to 2019).

The imbalances experienced by the Irish economy have typically been in the top left quadrant: high unemployment and a large balance of payments deficit.  The economy is now in the opposite position: low unemployment and a large balance of payments surplus. 

The economy certainly has the income capacity to increases spending but it does not seem as if there is the resource capacity to do so.  Higher spending may push up domestic inflationary pressures which heretofore has largely been driven by external factors. 

There is also the sustainability of the income.  In the textbook descriptions, taxation is viewed as a withdrawal from the circular flow of income that would not be considered, at least directly, to lead to an increase in national income. 

Ireland’s Corporation Tax revenues do not fit with the textbook analysis.  Four-fifths is paid by foreign-owned companies and the bulk of that arises from (U.S.) companies that have a presence in Ireland to service international markets.  Corporation Tax is an injection to national income and that injection is reaching ever higher levels.  In the 12 months to the end of March, Corporation Tax receipts reached €24 billion.

Conclusion

Ireland is in a position of wanting to do things (such as build houses) and having the income to finance this activity but not the resource capacity to undertake it. With the unemployment rate close to four percent an increase in spending would likely lead to a rise in inflation.

We could view building houses as something we want to do all the time – which we should – and not just when Corporation Tax receipts are booming. To that end we could increase taxes to provide a sustainable revenue source to fund public capital spending on housing.  This could also create the resource space in the economy to accommodate that activity.

However, that is an economic argument not a political one.  Tax increases while the government is running surpluses are unlikely to get much traction.  But political myopia to the trade-offs we face does not mean that they do not exist. We should have something to show for the ongoing boost to national income: but that something should not be a surge in domestic inflation.

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What did we do with €166 billion of Gross National Savings?

The last post used the sector accounts to give the steps that led to there being €166 billion of gross national savings in 2021. Here we will look at bit closer at what this €166 billion was used for.

A large chunk of it was already accounted for by one item included in the previous post – €105 billion of gross capital formation.  This left an excess of just over €60 billion of gross savings over investment. 

Accounting for net capital transfers and the proceeds from acquisitions less disposals of non-produced assets meant that the total amount available for net lending was €64.4 billion.  The sectoral split shows that almost all sectors were net lenders in 2021 with the only significant net borrowing being the €7 billion deficit recorded for the government sector.

So, that leads us to ask what did we do with that €64 billion? The answer is in the financial transactions account, though the numbers here are pretty big.  Unfortunately we are not provided with the same sector split in this account (foreign-owned etc.) that is available elsewhere.  Still the main sectors do provide some insight.

Across all sectors, total transactions in financial assets led to an increase in these assets of €644 billion while there were transactions giving a €583 billion increase in financial liabilities.  The gap between them is net financial transactions and this was €60.9 billion in 2021. 

This is not exactly equal to the €64.4 billion of net lending that was available in the capital account but given the scale of the figures it is not a surprise that they do not fully match.  What may be a surprise in 2021 is that the largest contributor to the statistical discrepancy between the two is the household sector.

That aside, the figures for the household sector are the most straightforward.  Households added almost €14 billion to their deposits in 2021.  They also put nearly €4 billion in insurance and pension schemes. 

The figures indicate the household bought nearly €6 billion of equities in 2021. Digging a little deeper into that item shows that around two-thirds of that was made up of purchases of unlisted shares.  Transactions in unlisted shares was something that piqued our interest a few years ago but the scale here is significantly smaller.

The government column shows that there were excess liabilities taken on relative to the deficit that needed to be financed.  With €20 billion borrowed versus a deficit of €7 billion this meant that €13 billion was added to the government’s financial assets, mainly deposits, which are held with the Central Bank.

The Central Bank itself is included as part of the financial corporate sector.  The numbers here are enormous (in large part due to IFSC activities) but the net figures are pretty small.  The figures for the non-financial corporate sector are also large and again it is hard to identify discernible patterns in the components but financial transactions did result in an improvement of around €44 billion in the financial position of the sector.

So what did we do with €166 billion of gross national savings?  Spending on capital formation by all sectors added around €105 billion to the capital stock and left just over €60 billion for net lending. The household sector added €22 billion to its financial position, the corporate sectors sectors €46 billion, the while the government sector had to borrow €7 billion.  The next step will be look at the impact these had on the national balance sheet.

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Underestimating housing consumption in the national accounts

It's not just household-level data such as the SILC where our approaches to the provision of social housing present measurement issues. In the national accounts, payments such as to HAP landlords are currently counted as a benefit-in-kind for households.  This is in contrast to the benefit-in-cash approach now applied in the SILC.

And, up to 2020, there was a further difference between the micro-data and macro-data approaches to measuring social housing.  In the national accounts an imputed social-transfer-in-kind was previously included for the 130,000 or so households who are local authorities tenants.  This has now been removed.

In the government accounts, on the revenue side, local authorities were treated as generating market output for sale.  For social housing this would be the rent contributions received from tenants plus an imputed amount to bring the value of the output in line with market values, which were based on rents in the private rental sector, using both unregulated and regulated rents.

On the expenditure side, this imputed output was used as a social-transfer-in-kind to households. There would also be expenditure incurred as compensation of employees, intermediate consumption and depreciation or fixed capital formation for the provision of local authority housing. 

This meant that the imputed value was on both sides of the accounts and netted out for the balance.  The  impact of local authority housing on the general government balance was the different between the rent contributions received from tenants and the other expenditure items incurred.

It also meant that the consumption of housing services by local authority tenants was based on the market value of the housing services they used as it is for private tenants (through actual rents paid) and for owner-occupiers(through imputed rents). 

The change introduced this year means that the consumption of housing services of local authority tenants is now treated as non-market output and the value of the consumption of that in the national accounts is based on the costs of providing it (mainly compensation of employees, intermediate consumption and depreciation) rather than an imputed market value. 

It should be recognised that most government-provided services (health, education, policing etc.) are included in national accounts on a cost rather than value basis.  The change to also do so with local authority housing had no net impact on the government’s accounts.  The imputed rents of local authority tenants were removed from both the revenue and expenditure  sides, as imputed market output for revenue and the social-transfer-in-kind for expenditure. 

Indicators like government spending to national income would have been reduced.  And so indeed would national income when the market output based on market value was replaced by non-market output based on costs. 

This change was introduced between the April 2021 Government Finance Statistics and the July 2021 Government Income and Expenditure Accounts.  The July publication included the following note:

Reclassification of local authority housing rent as non-market output

To date the provision of local authority housing was treated as a market output. This meant that the difference between the differential rent paid by the tenant and a market rent was calculated and included as P.11 (market output), with a corresponding imputed expenditure D.632 (social benefit in kind). However, Approved Housing Bodies (AHB) reclassified into the local government sector are considered as non-market producers, with no imputed rent calculation made.

On review, this approach was deemed not appropriate and thus a decision has been made to treat the local authority housing output as non-market. This ensures consistency with AHBs. This determination means that there is no longer an imputed D.632 expenditure related to local authority rent. Local authority rent payments are now recorded as P.131 (incidental sales and fees of non-market establishments). This methodology has been applied from 1995.

There can be lots of reasons for revisions between releases so attributing them solely to a methodological change may not always be correct.  Here are the figures for market and non-market output in the April and July releases.

For the three years shown (2018 to 2020), the market output of the general government sector was revised down by an average of €1.6 billion – and now takes a value of zero.  For the same years, non-market output was revised up by an average of €1.25 billion.  This suggests that around €350 million of housing consumption may have been “lost” as a result of the change in methodology.

In the greater scheme of things €350 million of consumption may not be that significant, though as a similar treatment is applied for housing by AHBs the underestimate may be slightly larger.  The underestimate is limited to the extent to which the costs of providing LA or AHB  housing is less than the market value of that housing.

In pre-COVID 2019, actual individual consumption was €133 billion, of which the consumption of housing services was €28.5 billion.  The consumption of housing services was made up of:

• Household Consumption Expenditure
  • Actual rentals for housing €5,393m
  • Imputed rentals for housing €16,459m
  • Maintenance and repair of the dwelling €289m
  • Water supply and miscellaneous services relating to the dwelling €357m
  • Electricity, gas and other fuels €3,091m
• Government Consumption Expenditure
  • Social transfers-in-kind via market producers €824m
  • Social transfers-in-kind via non-market production by Government €2,087m

A few hundred million extra in there isn’t going to make a huge difference but again maybe points to difficulties in measuring outcomes in relation to housing in Ireland.

There is no doubt that local authorities are not market establishments so deeming the goods and services they provide to be from non-market production has logic to it and imputing values is not an exact process.  However, for housing, a relatively close market comparator can be found, i.e. the private rental sector.  This can be used to give a market value for the output produced.  And up to this year that is what was done for local authority housing in Ireland.

For most EU countries, this isn’t an issue.  Almost all of the consumption of housing is the result of household expenditure.  Government spending does not go to provide housing, at least not directly.  The general government sectors don’t make payments to landlords or provide housing directly.

As the list above shows, in Ireland government consumption expenditure is responsible for around 10 per cent of total consumption of housing.  This figure is by far the largest in the EU.

For 21 of the EU27, the share of housing consumption due to government expenditure is less than one per cent (and is essentially zero for around half of those).  The closest country to Ireland is France and even then that is at a level that is less than half the outturn for Ireland. 

That is not to say there isn’t public or social housing in most of these countries. There is.  But it is happens in such a way that it is provided by entities that are outside the general government sector.  And they generate their revenues from rents paid by tenants rather than payments by government.  That’s not to say that either approach is right or wrong just that they are different.

The value of housing consumption may be underestimated in other countries to the extent that regulated or controlled rents are used in determining imputed rents for owner occupiers.  In Ireland, for around five per cent of households, the value of their housing consumption is based on the cost of providing those housing services rather than what the tenants might have to pay as private tenants. Again, neither is right or wrong. Just different.

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The government sector in the institutional sector accounts

The CSO will publish the 2020 Government Finance Statistics (GFS) in the next few weeks but we can get a preliminary look at what they will say from the Institutional Sector Accounts (ISAs) that were published last week.

Here’s the government sector current account for the five years to 2020.

For 2020, the most significant changes were subsidies paid (+€4 billion), social benefits paid (+€6 billion) and consumption expenditure on goods and services (+€5 billion).  All told, these contributed to a €16 billion deterioration in the current account position of the government sector.

One of the remarkable things is that all of these changes were on the expenditure side with revenue holding up.  There was a decline in taxes on products and production.  Taxes on products (such as VAT and Excise Duty) were down €2.5 billion with taxes on productions (such as commercial rates) down just under €1 billion.  Some of this fall was just to reduced activity while some was due to forbearance and payment breaks.

Taxes on income and wealth rose in 2020. This was entirely due to increased Corporation Tax from non-financial corporates which rose another €1 billion but taxes on income from the household sector (Income Tax and USC) were essentially unchanged in 2020.  Social contributions received (mainly PRSI) were also largely unchanged in 2020.

On the spending side some of the other changes were the eight per cent rise in compensation of employees paid by the government sector with this almost reach €25 billion in 2020.  It might be surprising the the GDP of the government sector rose seven per cent in 2020 (schools closed etc.) but in the absence of prices the value added of the government sector is mainly measured by the wages paid.  Finally from the current account, we can also see that the interest bill continued to fall and the interest amount in the sector accounts falling by a further €1 billion in 2020.

There were also limited changes in the capital account.

The most significant change here was the further €1.5 billion rise in government gross capital formation in 2020 to reach €9.7 billion.

There was little change in most other items in the current account meaning that the overall change in the government’s non-financial position was a deterioration of €18 billion.  The government sector went from a modest net lending position of €1.5 billion in 2019 to a net borrowing position of €16.5 billion in 2020.

To the extent the the increased spending highlighted in the current account is temporary this deficit will fall as the need for emergency measures falls.  But if some of those represent permanent spending increases, as is likely, some of the deficit will be persistent.  It is that permanent increase in spending rather than any necessity to “pay the COVID bill” that will impact subsequent budgetary plans.

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The Level of Government Spending in 2018

Government spending, excluding spending on old-age social protection, in the countries that made up the EU28 in 2018 was equivalent to around 35.8 per cent of the Gross National Income of the region (GNI* is used for Ireland).  Spending on old-age social protection was equivalent to a a further 10.1 per cent of GNI. 

As shown in the following table, the figures for Ireland were 36.4 per cent and 5.2 per cent. [Click to expand.]

The figures for the “peer” group are the regional aggregates for the nine countries other than Ireland listed in the table. The “nordic” group are the aggregates for Denmark, Finland and Sweden. In the table, the ten countries are ranked by their total expenditure excluding old-age social protection a a share of national income.  Ireland place sixth. 

The bottom panel compares government spending in Ireland (as a share of GNI*) to the equivalent figures for each region (as a share of GNI).  In aggregate terms, government spending in Ireland excluding old-age social protection is pretty much in line with the outcome for the EU-Peer group (Ireland was lower by 0.2% of national income).

Relative to the EU-Peer group Ireland recorded a higher level of spending for housing, health, education and social protection excluding old age.  Ireland was lower for general public services, defence, economic affairs, environmental protection and recreation and culture.

If we limit the comparison to Denmark, Finland and Sweden, EI-Nordic, then we see that government spending in Ireland in 2018 was around 3.3 per cent of national income lower than the aggregate level for this group.  Ireland was higher than these countries for public order, environmental protection, housing and health while it was lower for general public services, defence, culture, education and social protection excluding old age.

The most significant difference between Ireland and all the groupings of countries shown is for spending on old-age social protection.  To match these groups Ireland would have to spend around five per cent more on this category, which is a doubling of the current level.  For 2018, this would have been equal to additional spending of around €10 billion.

This doesn’t necessarily mean those aged 65 and over in Ireland have a lower income compared to the same groups in other countries.  Ireland has a lower share of this group than other countries and have incomes which are supported by private pensions.  The elderly in Ireland also typically have lower housing costs than their equivalents in our peer countries. 

In overall terms, Ireland does have a lower level of government spending than in our EU-Peer countries.  The single most important reason for this is spending on old-age social protection.  Those countries raise more in social insurance contributions and pay out more in pensions – with higher benefits going to those who made higher contributions, i.e. had higher incomes.

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Where stands the crisis of 2020? Some insights from a century of leading and lagging indicators

The Irish economy is no stranger to crisis.  Since the 1950s, the most severe of these have occurred in roughly 25-year intervals.  The current crisis has brought about the sharpest downturn, at least in employment terms, that the economy has ever experienced.  As the duration remains uncertain it is cannot be definitively classed as severe so it may be that comparisons to previous crises aren’t wholly appropriate but it may be instructive to look at what preceded and coincided with previous episodes.

Regardless of whether  COVID19 has ended the sequence of 25-year intervals between severe economic crises hopefully we have not returned to the rhythm of the early years of the State when no decade passed without a severe crisis, or more, of some form or another.

The chart below shows a time series for the real growth of the Irish economy since just after Independence. The series is smoothed by taking a three-year, centred average.

The shaded periods are when this three-year average growth rate was negative, and this will also be used in the charts that follow.  Five such negative growth episodes can be identified:

• 1930s: Great Depression and Economic War
• 1940s: The Emergency (WWII)
• 1950s: Balance of Payments Crises
• 1980s: Procyclical Fiscal Policy
• 2000s: Bursting of the Credit Bubble

The Gerlach and Stuart (2015) estimates are based on GDP and provide the most plausible annual estimates up to the late 1940s.  A series based on GNI* from Fitzgerald and Kenny (2017) is shown from then but it differs little from the Gerlach and Stuart series right through to the end of the 20th century. 

The Fitzgerald and Kenny series is chosen because it better fits with the constant price GNI* for 2013 on as published by the CSO.  A chart showing unsmoothed versions of both historical series, and illustrating the strong overlap between the two, is here.

The negative growth episodes of the nineteen thirties, forties, fifties, eighties and a decade ago could be joined by a similar outturn for the start of the twenty twenties.  Given that we have gone through periodic economic crises it may be instructive to look for some “then and now” comparisons for some key indicators.

The most severe of Ireland’s economic crises have typically being preceded by a deterioration in the current account of the balance of payments.  From Fitzgerald and Kenny (2017) we have annual estimates of the current account balance as a share of gross national income beginning in 1938 which here is combined with the modified current account of a share of GNI* from 1995 on.

As stated, a deterioration in the current account has been a leading indicator for major negative growth episodes, with the deteriorations in the late-1970s and mid-2000s in particular due to economic mismanagement and pro-cyclical fiscal policy.  The presence of a large balance of payments deficit before these crises hit severely restricted the policy options available to respond to the downturn with “restoring order” taking precedence of over supporting incomes and economic activity. 

But in a case of “this time it’s different” we can see that in the past few years there has been a balance of payments surplus that is unmatched since the years of The Emergency (World War II to the rest of the world).  Indeed the 6.3 per cent of GNI* figure for the 2019 current account surplus taken from the Stability Programme Update may be an underestimate.  This strongly suggests we do not have structural imbalances that need to be corrected first before responding to the crisis.

When the slowdown took hold in 2008 one of the first fiscal responses was to announce a package of spending cuts in July 2008.  This time around one of the response was to announce a multi-billion package of increased spending.  A year ago, we said that the economy had savings that could have been spent but suggested it maybe should be a sector other than the government sector that did so. 

We can look at how the sectoral balances contribute to that six per cent of national income surplus we have been running on the current account (with all adjustments to make the sectoral balances consistent with the modified current account applied to the non-financial corporate sector which is where the MNC distortions occur).

A chart showing the domestic sectors for recent years stripping out the impact of foreign-owned companies is here.  Previously, we thought it might be the household sector that could cut loose a bit, but needs must, and it is the government sector that is doing the spending.  Indeed, it could be that the household sector, which has been deleveraging for a decade actually increases its savings during the crisis which is something we will come back to. These savings can be used to fund the government’s spending.

Of course, flows are only part of the story. Stocks matter too.  From Fitzgerald and Kenny (2017) we also have a long-run series of government debt as a share of national income.  The path of the ratio of public debt to national income before each crisis has not been the same.

The debt ratio was already rising in advance of the crises of the 1950s and the 1980s.  The ratio was declining in advance of the 2008 crash but that still saw the largest run-up of public debt of any crisis (to date).  In recent years the debt ratio was on a declining path, however the level is still elevated and at around 100 per cent of national income is the highest it has been as the country potentially enters a severe crisis.

For private debt we can get a measure of personal, i.e. household, debt from Stuart (2017) and this shows that increasing household debt was really only a factor in advance of the crash of 2008.

And in the decade since, the Irish household sector has undertaken a remarkable level of deleveraging – reducing debt was what a large share of the household sector surplus shown with the breakdown of the current account was used for.  Household loan liabilities have fallen from €205 billion at their peak to around €130 billion now.  As the chart shows, the household debt to income ratio peaked at around 215 per cent in 2009; at the end of 2019 it was 115 per cent and is approaching ‘normal’ levels faster than anyone could have imagined.

As stated earlier, it could be that the household sector actually increases its savings in response to the crisis – this may show through an increase in deposits.  This would not be unusual.  The household savings rate is something that tends to react to a crisis rather than something that foretells it. 

Using Stuart (2017) we have estimates going back to 1945 and it can be seen that the savings ratio does increase at the start of each negative growth event meaning the reduction in household consumption is greater than the reduction in household income.  Remarkably, the Stability Programme Update estimates that the household savings rate will jump from 10 per cent in 2019 to close to 20 per cent this year, which would be the highest for the series by some distance.  In nominal terms this would be an increase of around €10 billion.

The savings rate only reflects the difference between income and consumption; one would need to add the impact of investment spending to get the final non-financial position of the household sector. Such a sectoral breakdown of investment is only available back to 1995 and is what is shown in the chart of sectoral composition of the current account.  The large borrowing position of the households sector in the decade before 2008 is clearly evident, as is the net lending the sector has done in the decade since.

Another response variable or lagging indicator can be the real growth in household disposable income.  Using Stuart (2015) we can see that this followed the same pattern as each of the last three major negative growth crises took hold: it too turned negative.

We do not yet know what will happen to aggregate household income in this crisis.  Yes, earnings will fall very significantly for a period but there will be an offsetting effect from government transfers.  As already pointed to, additional social welfare spending of almost €7 billion has been allowed for (thus far).  This is countercyclical policy and is maybe another reason why comparisons to previous crises are not be appropriate.  We still don’t have enough information but if there is a shaded area for the early-2020s added to future versions of these charts it could be the first time the real growth of household disposable income does not also turn negative (on a three-year average basis).

Fiscal policy was a contributory factor to the reduction in household income seen in the 1950s, 1980s and a decade ago.  Some automatic stabilisers would have played a role in mitigating income losses but steps taken to address imbalances, perceived or otherwise, which included tax increases and real expenditures cuts, meant that the impact of the downturns on incomes was exacerbated by fiscal contractions.  Fiscal policy was procyclical.

From Fitzgerald and Kenny we have a long-run series of the balance of the government sector right back to the earliest years of the State.  It can be seen that there was a wide range of levels and trends in the government balance prior to the previous three negative growth events.  There was a deficit that was reducing in the mid-1950s; the late-1970s saw a large government deficit that was increasing and during the mid-2000s budget surpluses were recorded. 

But what is as significant is what happened to the government balance not long after economic growth turned negative in the 1980s and 2000s: it improved.  And this was a forced improvement brought about through tax increases and real expenditure cuts which started almost as soon as those crises hit which is the opposite of what is required to support incomes and economic activity in a downturn.

The past few years have seen the headline government balance improve and move to a (small) surplus.  If the government had stuck to its own spending plans maybe the surplus would have been a bit bigger and fiscal policy was probably acyclical, at best.  But there is capacity now for policy to be countercyclical and in large part it is down to what is shown below.

At the end of 2019, government debt was equivalent to almost 100 per cent of national income.  In the 96 years since 1924, according to the estimates from Fitzgerald and Kenny there have been only been 13 years when the debt ratio was higher.  But if we look at the interest chart we see that the interest to national income ratio does not reflect this.  In fact, since 1924 there have only only be 35 years when the interest ratio was lower than the 2.2 per cent recorded in 2019. 

As some of this interest is paid to the central bank it is recycled back to the government.  And as long as the ECB keeps the taps opened the massive additional borrowing that will happen will not significantly increase the interest ratio – in the short term at least.

And to conclude, here another lagging indicator that illustrates why this crises will be different to previous ones: the escape valve of emigration is unlikely to be available to alleviate unemployment.

This is yet another series where the response to the 25-year crises is clearly evident.  In fact, it has been pointed out that the crisis of 2020 may be the first since that linked to The Great Depression in the early 1930s when net outward migration does not increase.  Emigration did increase in the mid-1930s but by then the international economy was pulling out of The Great Depression. 

Taking the unemployment series from Gerlach, Lydon and Stuart (2016) it is probably safe to predict that the record unemployment from 1935 of 18 per cent will be exceeded in 2020 (at least for part of it).

So where stands the crisis of 2020? The short-term shock is likely to be the most severe the economy has ever experienced.  But relative to what has gone before we have identified a number of key differences. 

The most significant of these is probably the large balance of payments surplus.  The government might not have a rainy-day fund but the household sector has been saving for a decade.  And as the government cuts back on its emergency measures there will be capacity, and hopefully the confidence necessary, for households to increase their spending. 

A second difference arises from the fact that this is a global crisis. If a country using a common currency experiences an asymmetric shock there is a risk of interest rates exacerbating the problem.  Ireland has a high level of government debt but the medium-term risk of adverse interest rate moves is low so we can expect the interest burden of public debt will remain low.

We enter the crisis from a position of structural strength.  And the response so far, at a macro level at least, can be considered to have been appropriate.  Duration remains the key unknown.  But if the phased re-opening of the economy is successful, and microeconomic policy can keep viable businesses alive, it may that this shock, sharp and all as it will be, does not break the 25-year cycle between severe, multi-year negative growth events of the Irish economy.  Here’s hoping.

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What do we do with €112 billion of annual savings?

Last week the CSO published the Q4 update of the (non-financial) Institutional Sector Accounts.  These are a great source of information on what is happening in the economy but are terribly difficult to navigate.

Here is a summary of the aggregated current account (Q1 to Q4 2018) by sector. Click to enlarge.

The starting point is the first estimate of nominal GDP for 2018 which is €318.5 billion.  Looking across by sector we can see where this is generated and the clear domination of the non-financial corporate sector in Ireland’s GDP figure (which in turn is dominated by foreign-owned MNCs). The final column gives the flows with the rest of the world. Figures in parenthesis are amounts paid by the relevant sector.

Deducting wages paid and adjusting for taxes paid and subsidies received on products and production gets us to Gross Operating Surplus/Mixed Income.  For the household sector, mixed income is a combination of the earnings of independent traders (the self-employed) and the rent that owner-occupied are imputed to pay themselves (this income is deducted as consumption later down the table so the bottom line is unchanged).  As with GDP, the main generator of GOS in the economy is the NFC sector.

Adding wages received, adjusting for taxes received and subsidies paid on products and production, and accounting for property income paid and received (mainly interest and dividends among others) gets is to Gross National Income.

The move from Gross National Income to Gross Disposable Income is done by adjusting for taxes and transfers.  Most of this are inter-sector flows with payments by one sector being receipts of another.  For example, income taxes paid by households and companies go to the government sector (some minor cross-border flows notwithstanding). 

GDI is a couple of billion lower than GNI because of some cross-border transfer flows.  The rest of the world received about €5 billion more under "Other Current Transfers" from Ireland than Ireland receives from abroad under this heading - €9.5 billion out versus €4.5 billion in. 

Some of this has to do with Ireland’s foreign-aid budget and other transfers.  A large part of it is made up of Ireland’s contribution to the EU budget but it should be noted that earlier in the table the €1.6 billion of "Subsides Paid" from the rest of the word mainly come from the EU and these make up the bulk of the €1.5 billion of "Subsidies Received" by the household sector (agriculture).

Anyway, by this point we have a total economy Gross Disposable Income of €248 billion, of which we use “only" €136 billion on consumption.  That leaves us with Gross Savings of €112 billion and the breakdown by sector can be seen in the bottom row. 

To see what we did with this we turn to the capital account.  Again click to enlarge.

The first panel of the table gives the change in net worth by taking into account capital taxes and transfers and consumption of fixed capital (depreciation on existing assets).

The second panel shows what happened to gross savings and it can be seen that we did €82.8 billion of gross capital formation on produced capital assets and had net purchases of €22.5 billion of non-produced assets (such as marketing assets and customer lists).  That left the economy in a net lending position of €6.6 billion for 2018 (with this €6.6 billion being borrowed by the rest of the world).

The continued deleveraging of the household sector is evident in its net lending position of €5.5 billion.  This will have been, in part, used to repay debt and the household sector has significantly reduced its outstanding debt over the past decade.  The government sector had close to a balanced position in 2018 so, unlike the household sector, did not have a surplus to reduce its debt.

The big figures are again in the NFC sector with €83 billion of Gross Savings fully offset by €62 billion of investment in produced capital assets (gross capital formation) and €22 billion of net acquisitions of non-produced assets giving a net borrowing position of €1 billion.

This relatively modest outcome at an aggregate level probably belies significant changes within the sector.  It is highly unlikely that the companies with the €83 billion of Gross Savings were the companies that invested €84 billion in assets.  The companies with the savings would have used that to reduce their debts (built up when acquiring assets, including intangible assets, in earlier years) while those acquiring assets in 2018 would have funded that by new borrowing of their own.  So while the accounts might show €112 billion of Gross Savings most of it is the result of MNC activities and is not ours to spend.

It is probably a little more than a coincidence that the numbers in the NFC sector were so close in 2018 giving a net outcome of "just" minus €1 billion.  And, it should be noted, that these are just the first estimates.  Things could be very different when the National Income and Expenditure results are published during the summer.  We saw this for the 2015 results though such changes are largely limited to the NFC sector.

The previous compositional issue is also true for the household sector, though on a smaller scale.  While the household sector had net lending of €5.5 billion, repayments against existing debt would have been much larger than this, possibly twice as large.  Those in the household sector who undertook investment (which is mainly on houses) could have funded this with new borrowing.  The balance of repayments on existing debt and new borrowing for investment gives the overall net lending position of €5.5 billion.

This is a Gross Saving that is ours to spend.  Eventually the deleveraging will stop.  Whether that leads to an increase in consumption or investment is hard to tell.  The vulnerable position of the government sector probably means that some caution in the household sector is warranted but whether this caution will persist remains to be seen.

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Corporation Tax and the Balance of Payments

A previous post looked at how the current account of the balance of payments can be an early-warning indicator of an economy “living beyond its means”.  This is particularly so if the unsustainable income arises via credit expansion.  The post concluded, though, by saying that a red flag might not always go up for the balance of payments if the unsustainable income flows through it.

Getting a handle on Ireland’s underlying balance of payments position isn’t straightforward.  The CSO have published a modified current account that attempts to strip out many of the distortions, mainly from MNCs, that pollute the headline position. 

For our purposes here we are interested in the end result rather than the modifications made.  The most recent version of the modified current account is available for the period 2007 to 2017 and here it is as a proportion of GNI*.

As we now now know there was a significant deterioration in the current account up to 2008.  Since then, like many economic indicators for Ireland, there has been a significant turnaround.

In the early years of the crisis one factor that contributed to the improvement in the current account was the reduction in imports.  We were spending a large amount of the unsustainable, credit-fueled income on imported goods.  There was a reason champagne was removed from the Consumer Price Index in 2011 (see Table 1.1).

In recent years, food exports have boosted the underlying position, most notably dairy products for the past two years or so.  On the income side, the amount of outbound interest on the government’s debt has been declining.

There is some level of uncertainty about all of these but concerns over volatility do not necessarily translate into concerns of sustainability.  One item affecting the current account that generate such concerns are Ireland’s surging Corporation Tax revenues.

And this is what we see if we put Ireland’s revenues in the context of the EU15.

It wouldn’t be usual to link tax revenues to the current account.  In general, tax revenues are raised from activities and entities in the domestic economy while the current account reflects the cross-border flow of trade, income and transfers.  But Ireland is unusual for the amount of Corporation Tax that comes from foreign-owned companies and unique for the amount that comes from foreign companies which are US-owned companies.

The following table gives the domestic company/foreign company split for the gross operating surplus generated in the business economies of the EU15.  Gross operating surplus (GOS) is a relatively useful proxy of the corporate income tax base but some caution is warranted because it is before the deduction of depreciation.  For this, and a few other reasons, we will use data from 2014 rather than a more recent year.

The foreign share in GOS is highest in Ireland (69.4 per cent).  Luxembourg is the only other country to have more than half of GOS generated by foreign-controlled companies.  The median for the EU15 is 24 per cent.

And it is for US companies that Ireland really stands out.  After Ireland’s highest share at 56.8 per cent, next is again Luxembourg but this time the gap is all the way to 14.7 per cent.  The median for the share of GOS generated by US-owned companies in the EU15 is 3.6 per cent.  It was only in the sentence before last but Ireland is 56.8 per cent (or at least was in 2014; it is likely higher now).

The issue is that the surge in Corporation Tax is coming through the current account. The current account looks fine.  The deficits built up in the previous boom have been eliminated and there have been underlying surpluses for the past few years.  This suggests we could increase our consumption and investment spending from within our existing resources.

However, we need to be mindful of the impact Corporation Tax from US MNCs has on how we measure those existing resources using the current account.  These receipts are somewhat of a transfer to Ireland that are boosting the current account – could we compare them to the EU receipts of the late 1980s and early 1990s?

Of course, we don’t know what will happen Corporation Tax revenues over the coming years and it is much better to be receiving €10 billion of Corporation Tax than not receiving it. Our point here is that looking for the current account to provide a red flag for “living beyond our means” - as the previous post did – may not be wholly appropriate.  The current account will only reflect any unsustainability in these Corporation Tax receipts when it is too late, i.e. when they are gone.  

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Ireland is not really “low-tax” or “low-spend” but is “young” and “low public pension”

Government revenue as a proportion of GDP is lower in Ireland than in most other EU countries.  The most complete figures are for 2012 and these show a level equivalent to 34.2 per cent of GDP (using ESA2010).  For 2013 the level was 34.8 per cent of GDP but a detailed breakdown of this is not yet available for all EU countries.

Here is the breakdown of general government revenue in all 28 EU countries. For the most part we will stick to comparisons in terms of GDP but will explore some implications of the GDP/GNP gap towards the end.  Click to enlarge.

In the total column Ireland is third from the bottom with only Romania and Latvia recording lower levels.  Ireland is around ten percentage points of GDP below the weighted average of the EU28 and 8 percentage points below the simple arithmetic mean of the 28 member states.

Ireland is at the EU average for receipts from taxes on income and wealth.  The lower overall revenue is largely driven by lower than average receipts in two categories:

• Taxes on production and imports: 3 pp below EU28
• Social contributions: 8 pp below EU28

Unsurprisingly, Ireland is also below the EU averages when it comes to general government expenditure.  Again click to enlarge.

For expenditure Ireland rises to eighth from the bottom (though the 42.2 per cent of GDP figure for 2012 had fallen to 40.5 per cent of GDP in 2013).

The sources of the lower-than-average expenditure in Ireland are broader than the reasons for the below-average revenue.  The eight percentage point of GDP gap to the EU weighted-average (it is a four point difference to the un-weighted arithmetic mean) can be explained by:

• Intermediate consumption: 1.5pp below EU average
• Social benefits: 2pp below EU average
• Social transfers-in-kind: 2pp below EU average
• Other current transfers: 1pp below EU average
• Gross capital formation: 1pp below EU average

Current transfers of one form or another account for 5 percentage points of GDP of the gap to the EU average.  Ireland is lowest in the EU when it comes to public gross capital formation as a proportion of GDP (though capital expenditure by the ESB, Bord Gais as it was and other semi-states is not included).

If we examine public expenditure by function the following picture emerges. Note the figures in the following table were compiled using ESA95 meaning there are some methodological differences to those in the previous table.  Click to enlarge.

Unsurprisingly, the bulk of the gap to the EU average is explained by social protection expenditure.

• Social protection: 4pp below EU28 level
• Defence: 1pp below EU28 level
• General public services: 1pp below EU28 level

Our final step is to look at social protection expenditure and see it is exactly we are spending less on (and paying less for through lower social contributions).  Unfortunately the detailed breakdown by function is not available for four countries (Belgium, Spain, Romania and Slovakia) but the details for the other 24 countries are presented below.  This is the first table where most of the green cells are in the top half of the rankings.  Click to enlarge.

Ireland’s public expenditure on social protection is in top 12 for six of the eight sub-categories (and 13th in another).  Ireland is in the top four for ‘family and children’, ‘unemployment’ and ‘housing’.

The only category where there is a gap of note to the un-weighted arithmetic mean (of the 24 countries for which data is available) is ‘old-age’.  Ireland is almost five percentage points of GDP below the mean level of public social protection expenditure on ‘old age’.  This is mainly expenditure on social welfare pensions

The finals columns of the above table show that excluding the ‘old age’ sub-category, in 2012, Ireland had the third-highest level of social protection expenditure among the 24 countries for which the measure can be constructed.  This ranking is likely to be unchanged even if the data were available for the other four countries.

If Ireland collected and spent the equivalent of an additional five per cent of GDP on public pensions to mimic the “average” EU system then government revenue and expenditure figures would be closer to the EU average:

• 40% of GDP versus EU average of 45% for revenue, and
• 47% of GDP versus EU average of 50% for expenditure

It is social welfare pensions more than anything that account for the “low-tax” “low-spend” monikers that are sometimes applied to Ireland.

Of course there are factors that explain the relatively low level of public social protection expenditure on old age (if not the level of revenue).  A big factor is the proportion of the population aged over 65.  In 2012, Ireland had the lowest ‘over 65’ dependency ratio in the EU. 

The proportion of the population aged over 65 was 12 per cent in Ireland compared to an EU level of 18 per cent.  Obviously though this can only explain around half of the gap between Ireland’s public social protection expenditure on ‘old age’ and the EU mean.

Across the EU every one per cent of the over 65 dependency ratio adds the equivalent of around 0.52 percentage points of GDP to social protection expenditure on ‘old age’. This is shown in the final column of the above table which is social protection expenditure on ‘old age’ as a proportion of GDP divided by the dependency ratio.

In Ireland every one percentage point of the dependency ratio equates to 0.39 percentage points of GDP on ‘old age’ social protection expenditure.  This explains the other half of the gap between Ireland’s expenditure in this category and the EU mean.  Only Croatia (0.20) and Lithuania (0.33) spend less under this measure (noting it can’t be calculated for Belgium, Spain, Romania and Slovakia using present data).

We have fewer pensioners and have a system of social welfare pensions that involves less revenue and expenditure than in other EU countries. As a proportion we spend about one-third less than the EU mean on public social protection pensions. This is likely because we have social welfare pension benefits that are not pay related rather than having a flat rate payment that is too low. 

What changes, if any, should be introduced to our public pension system are not at issue here.  All that is being highlighted is the impact expenditure on ‘old age’ has on our government finance aggregates.

If we make the heroic assumption that social protection pensions are provided on a cost-neutral basis (i.e. contributions received match benefits distributed) and strip these figures out of government revenue and expenditure we get the following picture.  Again click to enlarge.

After doing this we can see that revenue remains below the EU mean (by about 4 percentage points of GDP) and expenditure is pretty much the same as the EU mean.

The panel on the right tries to take account of the GDP/GNP gap that exists in Ireland using a rough hybrid measure.  Thus the two adjustments made to the panel on the right are:

• removal of ‘old age’ social protection expenditure and implied revenues, and
• adjustment of national income figure for Ireland

After this it can be seen that government revenue in Ireland is close to the arithmetic mean (again noting that four countries are excluded because of data availability).  For expenditure as a proportion of adjusted national income Ireland is above the EU mean and ranks sixth highest of the 24.

Outside of ‘old age’ social protection Ireland does not spend a relatively low amount on public services and supports.  If there are problems with the public sector it does not appear to be because we don’t spend enough money.

Of course the interesting thing will be where these measures move to.  The year 2012 cannot be take as a steady-state position given the size of the deficit that existed.  We already know that, as a proportion of national income, revenue grew slightly in 2013 with a larger fall in expenditure. 

The simple conclusion is that given demographics (fewer people aged over 65) and public pension system (flat rate payments) it is not surprising that Ireland is below EU averages for government expenditure.

Expenditure will rise as demographics dictate – the key is having the resources to meet it.  We are not lacking spending to pay for the services we want now - though obviously the composition of that expenditure can be changed.  We could raise additional revenue to spend now but perhaps it would also be advised to begin raising it to cover the inevitable pensions expenditure that we will need in the future.

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