The past month has seen a shift in economic expectations on the prospects for the coming year, most notably in the financial markets, and to a lesser extent on the part of business and consumers. Few expect a bumper year, but the pessimism prevalent in the month following the September 11th attacks on the US has given way to cautious optimism. In the US, surveys of consumer and business sentiment show an upturn, albeit from low levels, and the markets are now pricing in higher interest rates as early as the spring, on the basis that the economy will then be growing again. Equity markets too have rallied strongly, with investors looking for a rebound in company earnings in 2002; the Nasdaq, for example, is up some 40 per cent from its mid-September low.
From an Irish perspective it is also interesting to see most commentators revising up their growth estimates for 2001, which is gratifying for those of us who have argued that the downturn was not as dramatic as popularly portrayed and certainly did not warrant terms such as "slump" or "recession".
Even the Central Bank joined in the revisionism, recently raising its GDP estimate for 2001 to 7.25 per cent, which is still probably too low, but is a welcome recognition that the year was not quite the dismal experience some thought.
Similarly in the housing market: the building industry has repeatedly claimed that 2001 would see a marked fall in house completions relative to 2000, which was a record in terms of housing supply. Yet we now know that completions rose strongly in the first nine months of the year, and that barring a major collapse in the final quarter, completions could well exceed the previous years total of over 49,000.
The record level of house-building also explains why house prices have softened, although here again the deceleration in house price inflation is far from the sharp falls in property values predicted by some with monotonous regularity for the past five years.
In fact for most people 2001 was an extraordinarily good year economically: employment rose by over 40,000, pay per head increased by over 10 per cent, inflation declined, tax rates fell as did interest rates, thereby reducing the cost of a mortgage to well under 5 per cent. Job losses did increase, so it wasn't all positive , but here again the headlines tell only half the story, with job gains more than offsetting the losses in the aggregate, if not in the multinational sector. The media concentration on IDA-sponsored companies, which experienced a net job loss of under 4,000, is also misleading as total employment in these companies accounts for less than 140,000 out of a total employed workforce of around 1.8 million.
So Irish retailers did not experience a poor 2001, as consumers had the resources to keep spending, although many chose to save more than in the past which limited the pace of real spending growth to 5 to 6 per cent , from 9 per cent in 2000. For corporate Ireland, though, the year was certainly a more painful experience.
The global slowdown hit profit margins, prompting a sharp fall in discretionary business spending, hurting anyone dependent on this spending. Business travel was a casualty, which explains why mainstream airlines like Aer Lingus and British Airways hit turbulence while the low-cost carriers were less severely affected. Advertising has also been affected, which may explain why newspapers took a jaundiced view of economic trends through the year.
For the broad tourist sector there were two additional negatives, one stemming from the restrictions imposed to combat foot-and-mouth disease, and the second in the wake of the terrorist attack on the US which hit international travel.
Here again though, many Irish residents took advantage of the subsequent fall in travel and accommodation costs, providing some support for the tourist trade. Incidentally, this highlights the need for industry to respond through the market when faced with falling demand, rather than call for Government aid, the ritual response of too many sectors in Irish society.
Looking forward, most Irish commentators are looking at 3 to 4 per cent GDP growth in 2002, but again this may be too low.
The US economy is showing signs of life and it would be singular if consumer and business spending did not respond to the scale of the monetary easing witnessed over the past year. Interest rates are at levels last seen when John F. Kennedy was president, having fallen from 6.5 to 1.75 per cent in only 11 months.
The omens are also good based on past experience. The US economy is in its second consecutive quarter of negative growth, and there has never been more than three consecutive declines since the second World War.
Using a broader definition of economic cycles, the US entered recession in March according to the official arbiters, and recessions on this criteria last 11 months on average, which points to a recovery in the first quarter of 2002.
There are other straws in the wind pointing to recovery: the price of computer chips has risen sharply in the past month, some key IT companies have begun to upgrade their forecasts and commodity prices have stopped falling.
The labour market in the US is also beginning to bottom out, judging by the trend in weekly jobless claims, which should in turn boost US consumer confidence, already supported by lower taxes, lower interest rates, lower inflation, higher stock prices and the success of the US military campaign in Afghanistan.
Uncertainties remain but the outlook for the US and therefore the global economy looks brighter than it did a few months ago. That's good news for Ireland and in truth it is hard to arrive at some of the low growth estimates currently produced. Consumer spending accounts for around half of GDP and as long as employment holds up in the aggregate, which it will, spending by Irish consumers will remain firm, thus underpinning growth again in 2002. Pay per head may well rise at a slower pace than in 2001, reflecting lower turnover in the jobs market, but a figure of 8 per cent is likely, with the private sector seeing the deceleration and not the public sector.
The tax cuts announced in the budget will also kick in from the spring and inflation will probably average 4 per cent, down from this year's 5 per cent reading. The news on interest rates may well be mixed, though, with an early 2002 cut by the European Central Bank to give way to rising rates in the latter part of the year, but this will only materialise if the global economy has recovered.
Unemployment will tick higher in the first part of the year, before stabilising, because the pace of job creation will slow to below the natural growth in the labour force, which will remain high for some years even without the added impetus of net immigration. The Government is also spending freely, which will add to GDP in 2002, and as this year has demonstrated, Irish exports are far more resilient than imports, so adding a further positive impetus from the external side.
The key negative, as in 2001, is investment spending by corporate Ireland, which turned down in the second quarter of 2001 and could well continue to decline into 2002, as firms trim capacity and postpone expansion plans until the global outlook becomes less cloudy. Nevertheless, the economy in aggregate should pick up noticeably from the second quarter, and finish the year on a strong note.
After all, we are simply witnessing a cyclical downturn which has actually been very mild, and we will shortly experience a cyclical recovery. Not the end of the world then, which is reassuring, if not for those who would prefer to see the downturn in more apocalyptic terms.
Dan McLoughlin is an economist with Bank of Ireland Group Treasury
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