Q2 GDP - The Irish Depression

Michael Burke: The Q2 GDP data published today do little to alleviate the gloom surrounding economic prospects. Both measure of output contracted in the quarter, GDP by 1.2% and GNP by 0.3%, in real seasonally adjusted terms. GDP has now contracted in 11 of the last 14 quarters, while GNP has contracted for 9 consecutive quarters, that is, the domestic economy has begun its third straight year of contraction. This compares to an Euro Area average contraction of 'only' 4 quarters, which ended a year ago.

The scale of the decline is also well above that in the Euro Area, where the economy contracted by 4.4%. From its peak in 2007, this GDP has contracted by 13.4% in real terms while GNP has fallen by a staggering 17.3%. Worse, in nominal terms GDP has declined by 19.5% and GNP by 24.1%. This measure, GNP at current prices, is decisive with regards to taxation revenues, whose slump is the overwhelming source of the widening public sector deficit. Taxes are paid in cash terms, unreflective of real terms changes in the price level.

As has been pointed out previously, this deflationary economic trend, which seems to be welcomed by many commentators, is actually disastrous for government finances because it erodes the current level of taxation while the debt stock is unchanged. The debt burden, and the activity required to service interest on it, is rising in real terms. Depending on which measure of output is used, the price level has fallen by between 5% and 9% since 2008. Since virtually all taxes derive from the domestic sector, the decisive measure of deflation for these purposes relates to GNP, where prices have fallen 9.2% since the end of 2008. In the US, many commentators fret that that a hollowed banking system and low growth could lead it into a Japan-style lost generation of deflation and rising real debt levels. For this economy that threat is a current one.

In terms of the components of growth, personal consumption fell again in Q2, down 1.6% from the same period a year ago. This repeats a pattern seen in 2009, as the government's attack on welfare and public sector pay feeds directly into lower consumer demand. Government spending on its own account also continues to detract from growth, a real decline of €2.5bn since austerity policies were introduced. Net exports subtracted from growth in the quarter, hence the greater decline in GDP than in GNP, as import demand rose.

It is possible that this rise in imports is partly associated with the modest rebound in investment (gross fixed capital formation) in the quarter, at an annualised rise €2.4bn, which was the one bright spot in the report. However, the rise in imports was than double the rise in investment and, since all other components fell, personal and government consumption as well as inventories, it is more likely that the rise in imports was due to an autonomous rise in the activities of multi-national corporations and their accounting practises.

These universal falls in demand, and modest export growth in the quarter, suggest that the investment uptick has little to sustain it. Even now, investment remains 52% below its peak level. The decline in investment has driven the recession, beginning 3 quarters earlier which is now €27.4bn below its peak, compared to declines of €27.6bn and €22.8bn for GNP and GDP respectively. This remains an investment recession.

Until policymakers recognise that fact, and that government investment must rise to off-set that decline, the effects of this Irish Depression will persist.