State suddenly finds itself in a good position to fund more investment

The people of Ukraine are suffering the harsh effects of the protracted war precipitated by Russia’s invasion – many homes and cities destroyed, lives put at risk through attacks on civilian areas, and now the destruction of energy infrastructure. While nothing on the scale of the hardships being experienced by Ukrainians, other European countries have taken an economic hit from the gas price shock occasioned by the war, leaving us all poorer.

Inflation has risen sharply, driven by higher energy prices and second-round effects on other costs, leading the European Central Bank to raise interest rates. Across Europe governments have also mobilised resources to support Ukraine, accommodating willingly millions of refugees and sending aid to Ukraine itself.

The economic fall-out from the war has brought a premature halt to the buoyant economic recovery from the pandemic that had been under way. For most EU economies the result is likely to be a recession, a fall in real household incomes, and rising public debt as governments strive to protect worst-off households from the energy price surge.

For the Republic the story is a little different, with unemployment at a record low, the economy expected to inch forward, and government finances returning to surplus, but there remain concerns that some nasty surprise is awaiting us in the new year.

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It’s well recognised that GDP is a poor measure of real economic activity in the State given the role of the multinational sector. As a result the Central Statistics Office has developed alternative measures of our underlying economic performance, like GNI*, to give a clearer picture of economic realities, but there has until now remained a suspicion that the picture they paint may still be too rosy.

Earlier this week the Department of Finance published an interesting technical paper examining whether Ireland’s growth, as shown by GNI* data for 2021, was “fast or spurious”. The conclusion was that the 2021 data are internally consistent and likely to be reliable. The picture that the figures paint of a strong and resilient economy seems to be correct.

Underpinning this strength in the face of adverse headwinds is the boom in corporation tax. This, on its own, has added at least 2.5 per cent to real national income this year. It is a windfall rather like what Norway experienced 30 years ago when it discovered oil. However, unlike an oil find our corporation tax can help fund climate investment rather than add to emissions. As it probably will not last indefinitely we should treat it as a bonus that should be wisely invested. Nonetheless it will help sustain our standard of living next year.

The Department of Finance paper emphasised that one of the other key features of the Irish economy, which makes it different from our EU neighbours, is the very high rate of saving by both households and government. The pandemic doubled the household savings rate as people could not spend their money. But even though the lockdown is over to the end of September household savings were still exceptionally strong.

Although a small fraction of the €50 billion in excess savings is currently being invested in building new homes, most of the savings still remain on deposit in banks. While we may see a further drawdown to pay for higher fuel bills this winter, next year Irish households are still likely to have much more savings than our EU partners.

In addition to household savings, there has also been a huge turnaround in government saving, partly driven by the corporation tax bonanza. This has allowed the Government to support households suffering from high energy prices and to increase its investment spending while still running a surplus. Government saving in Ireland this year is also likely to be much higher than in our neighbours. A result of this heavy public and private saving is a very large surplus on the current account of the balance of payments.

This means that the State is in a good position to fund more investment in coming years – in houses, infrastructure and tackling climate change. Reform of the planning system has also been announced, aimed at tackling a major obstacle to speedy delivery. The big constraint will be producing the promised investment when the economy is close to full employment. If the supply of labour is limited we need to reallocate workers from less urgent areas of the economy to construction, reskilling as required. Paschal Donohoe’s new ministerial title includes delivering the National Development Plan, underlining the importance of turning plans into reality.