We all know that the world economy, and Ireland in particular, has undergone the most severe economic downturn since the Great Depression over the last 3 years. It’s got all sorts of people who had never even heard of a recession interested and opinionated in the field. So with that in mind, the purpose of this column is to explain economic events and policy decisions in terms that anyone can understand, and in particular, how they affect students. So what better way to start off the year than to give an overview of Ireland’s finances?
GDP & GNP
Gross domestic product (GDP) is the standard measure of a country’s economic activity – defined as the market value of all final goods and services produced within a country in a given period. Gross National Product, meanwhile, measures the market value of the all final goods and services produced by a country’s citizens in a given period – so in the case of Ireland, it excludes the economic activity of foreign companies working in Ireland, and includes Irish citizens abroad, resulting in a lower figure than GDP.
From 1995 through to the peak of 2008, Irish GDP grew from €51.9 billion to €189.9 billion in today’s prices, averaging an astonishing 7% growth per year. More importantly, GDP per capita rose from €14,400 to €43,500 in the same time period. To put that into perspective, the UK’s GDP per capita rose from €15,200 to €33,700. So in the space of a decade and half, Ireland grew to become the EU’s third richest country, behind only Luxembourg and Denmark.
However, while the boom of the nineties was fuelled by exports, in particular relating to information technology, the growth of the naughties was driven by an unsustainable property bubble. In 2008 it all came crashing down, with GDP falling from €190 billion in 2007 to €156 billion in 2010, contracting by 3% in 2008, 7% in 2009, and 0.4% in 2010. GNP has been hit even worse, falling from €163 billion in 2007 to €128 billion in 2010 – contracting by 2.8% in 2008 and 9.8% in 2009 – suggesting that Irish indigenous firms have been affected more severely than multi-nationals. The Central Bank’s latest forecasts predict modest GDP growth of 0.8% this year, and a slight contraction of 0.3% in GNP.
So what does GDP actually compose of? There are a few different ways of breaking down GDP, the most standard of which divides it into: personal consumption, investment, government expenditure, and imports and exports. Consumer spending – which makes up just over half of GDP – has fallen consistently since 2008, as people’s wages have been cut and unemployment has risen. Moreover, it is forecasted to continue to contract for the next 2 years. Investment has fallen far more dramatically, tumbling from a peak of €48 billion in 2007 (25% of GDP) to €18 billion in 2010 (12% of GDP). This can be mainly attributed to the complete collapse of the property sector.
Government Revenue and Spending
The main element of economic activity that we are interested in is government expenditure. It’s the component which makes the most headlines, owing to the obvious fact that it is directly linked to our politicians’ decisions. Firstly, in the run up to the crash, the government ran what may have appeared to be rational fiscal policy at the time, but in hindsight undoubtedly made the looming crash much worse. Prudent fiscal policy is counter-cyclical, i.e. putting the breaks on an expanding economy through higher taxes or spending cuts, and vice versa. It involves running surpluses during expansions and running deficits during contractions, in order to stabilise the fluctuations of a market economy.
However, in the run up the crisis, the government’s “if I have it, I spend it” fiscal policy was a dual approach of tax cuts and increasing spending. While government expenditure had been significantly reduced during the nineties, from a high of 47.1% of GNP in 1993 to 34.6% in 2000, by 2007 it had crept back up to 38.6%. The problem with this approach was that it added further fuel to the unsustainable property boom of the naughties, leading to an inevitably harder fall.
To be able to spend money, governments obviously have to collect tax revenue. Revenue has fallen from a peak of €47.9 billion in 2007 to €34.4 in 2010, despite measures to increase taxation. Meanwhile, despite cuts in expenditure, government spending has increased from €40.9 billion in 2007 to €47 billion in 2010 (depending on what you include). The result has been deficits of 7.3% of GDP in 2008, 14.4% of GDP in 2009, and 31.9% of GDP in 2010. Of course, a significant amount of this money has gone towards recapitalising the banks, the merits and flaws of which are not for this article. Even without the bank recapitalisation though, 2010’s deficit would have still been 11.6%, with the government spending 36% more than it received in revenue, so spending cuts have clearly been warranted and highly necessary. Again, the nature and extent of these cuts won’t be discussed here for now.
More important than deficits though, is the government’s overall debt to GDP level – i.e. the total amount of debt that the government has accumulated through deficits over the years. The only way to reduce this ratio is by running fiscal surpluses or through economic growth. Thanks to extraordinary growth and some modest surpluses, government debt was reduced from 93.5% in 1993 to a very respectable 23.1% in 2007. However, within the space of 4 years has risen to 94.9% at the end of 2010, and is expected to hit at least 110% by the end of this year. These levels are highly unsustainable, hence Ireland’s inability to borrow from the markets and the need to reduce the deficit rapidly.
Imports and Exports
So hopefully this has given a decent overview of the state of Ireland’s economy, and can put every policy decision – be it spending cuts, tax hikes, public sector pay, or student fees – in context. Throughout the year I’ll be looking at particular policy areas with an emphasis on how they effect students, but to be able to have a debate about specific policy issues, we have to first grasp the overall picture.
Sources: Central Statistics Office, Central Bank Quarterly Bulletins, Department of Finance Monthly Economic Bulletins & Budgetary and Economic Statistics, ESRI Quarterly Economic Commentary, Eurostat.
