Analysis: 10 years after the financial crash caused a worldwide recession, what are the threats to the Irish economy today?
Ten years ago, the collapse of Lehman Brothers’ bank triggered as series of events that lead to the collapse of the Irish economy. From its peak in the final quarter of 2007, the economy contracted by 15 percent, unemployment rose to 16 percent and property prices fell by 60 percent.
While the Lehman's collapse was a catalyst not the cause of the recession, the development of an unbalanced, overheated economy was entirely homegrown. Property prices had lost touch with reality, driven by a flood of liquidity. The construction industry had been allowed to dominate the economy, contributing a fifth of activity. Banks were dangerously exposed to the property sector and reliant on funding from international financial markets, providing a quick route for contagion from the property market to the rest of the economy.
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From RTÉ Radio One's Drivetime, former Vice President at Lehman's Larry McDonald and Professor of Finance at Trinity College Brian Lucey look back at the collapse of the bank
10 years on, we once again have rocketing property prices, low unemployment and the fastest growing economy in the European Union. With this, concerns are growing it might be about to end in the same way as before. Fortunately, though superficially similar, there are important differences. The economy is significantly less reliant on the construction sector. Employment in the sector is 40 percent lower than the boom, stamp duty is no longer a significant component of government revenue and the sector’s overall contribution to the economy is less than half the 2007 level. Property prices, though high, are 20 percent below the peak. The combination of a 10 percent increase in population and limited construction over the last decade has generated a demand that will limit price reversals.
Banks are in better position to withstand a decline in property prices, being better capitalised and no longer reliant on funding from international financial markets. Bank of Ireland’s loan book is fully funded by customer deposits, compared to a shortfall of €50 billion in 2008. It has a capital cushion equivalent to 12 percent of its loan book, over twice the level of 2008. The sale of non-performing loans may be politically unpopular, but potential losses from the weakest loans are moved off banks’ balance sheets and often out of the state.
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From RTÉ Radio One's Today With Sean O'Rourke Show, economist and columnist with Independent Newspapers Dan O'Brien talks about the collapse of Lehman Brothers a decade on
If we are not in immediate risk of another recession, is the early 2000s a better parallel, with trends in place that will unbalance the economy? Again, the answer is no. There is little evidence of an economy overheating. Unemployment, although low, is still above the rate seen in the years before 2007 and wage growth remains muted. Outside the property market, prices are stable with low inflation. Regulators are better prepared; the 20 percent mortgage deposit requirement provides banks with a significant cushion in the event of widespread mortgage defaults.
More significantly, unlike the years before the property crash, we are not waiting for the government to slow the economy as we can rely on help from our neighbours. Just six months away from Brexit, the details are unclear, but we know it will have a negative impact. The worst-case scenario, a hard Brexit, is expected to bring the unemployment rate back towards eight percent, which is unpleasant but not comparable with 2008. The high growth rate will allow the economy to absorb a significant shock before contracting.
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Latest episode of the Brexit Republic podcast with RTÉ's Europe Editor Tony Connelly and Deputy Foreign Editor Colm Ó Mongáin
Despite delusions of grandeur in some quarters, Britain is no longer a significant world economy and Brexit is a local event without global impact. Against a background of global growth, exports to the rest of the world should remain strong. Improving government finances allow room to reverse some austerity measures to support the economy. A realignment of property prices would be welcomed by many. On its own, any Brexit recession should be shallow and short.
So it’s different this time? Unfortunately, not. Politicians, like generals, like to fight the last war. The combination of a collapsing property market and insolvent banks will not be the cause of the next major recession. However, there is one striking set of similarities between now and 2007 with the potential to end the same way. The economy is again significantly exposed to one sector. Rather than attempting to mitigate this, successive governments have built our economic model around it.
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From RTÉ Radio One's The Business, a discussion on how Ireland's low tax rates act as a draw for foreign direct investment
This time the danger is our reliance on attracting far more than our share of global foreign direct investment (FDI), in particular, the European headquarters of US multinationals. Just like the construction industry, we have become disproportionately reliant on a single sector for both employment (over 200,000 are directly employed in the sector) and tax revenue.
Initially, Ireland attracted these companies based on a low cost, well-educated, English speaking workforce with access to the European Union. As with the property boom, a long run of success made us complacent. Ireland is no longer a cheap place to do business. Eastern European countries are cheaper and have the same access to EU and global markets.
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From RTÉ Radio One's News At One, business reporter Adam Maguire on EU predictions about Ireland's economic growth
As our universities drop in global rankings, we can no longer claim to be better educated than our competitions, while English is spoken across Europe. We ignore the erosion of our advantages, again assuming there is something special about Ireland. The reality is that multinationals locate here because of the low corporate tax rate. When companies come here for low tax, we cannot be surprised when they move on as lower rates becomes available elsewhere. There is already evidence of tax cuts in the US beginning to attract companies home.
Costs and complexities of reorganisation and relocation should lead to a gradual reversal of FDI flows and a manageable rebalancing of the economy. Recent changes in geo-politics have increased the probability of an abrupt reversal. The US is more aggressively encouraging corporations to return home. There is growing protectionism and increasing probability of a global trade war. These conditions could combine to trigger a collapse of the FDI bubble and a recession similar to 2008. Back then, we were able to reset and start again. But once we lose these companies, there is no obvious route to attract significantly more than our fair share in the future.
The views expressed here are those of the author and do not represent or reflect the views of RTÉ
