The economy could overcome the Covid by the end of 2022
Economic crises can have lasting effects because they hamper investment in physical and human capital (through education and training). Therefore, future economic activity could be affected many years after the economy has recovered from a recession. If it was the consequence of the financial crisis of the period 2008-2012, it is probably different with the depression linked to the pandemic, from which we are emerging today.
While the Omicron variant casts a gloomy veil as Christmas approaches, what remains surprising is how limited the effects of the pandemic have been on much of the economy. Certain sectors of the economy, such as the arts, entertainment and tourism, have of course been very badly affected.
As always with the Irish economy, the Central Statistics Office runes are hard to interpret, but you don’t need to consult the Oracle of Delphi to know that many sectors of the economy have experienced a strong recovery this fall. The Institute for Economic and Social Research on Thursday produced a fairly optimistic forecast for the new year, with a return to full employment expected by the end of 2022, and very rapid growth in domestic demand.
By the end of next year, at Omicron, and possible future variants, the economy should be pretty close to what it would have been without Covid. However, the makeup of this output may be different, reflecting the changes the pandemic has brought about in our patterns of behavior.
IT and pharmaceutical
An important reason why the Irish economy has outperformed other EU economies is that we have specialized in the production of goods and services where demand increases rapidly with increasing income. Thus, the demand for IT services continued to grow, and the pandemic also gave new impetus to the production of pharmaceuticals. These factors have supported well-paid employment and related income from corporate and income taxes.
Perhaps the biggest economic surprise is the soundness of public finances in the face of the huge drop in output in 2020 and early 2021. Part of the reason is that booming high-tech sectors are paying a lot of money. corporate and income taxes. However, the recovery in VAT receipts reflects the fact that the very high savings rate due to lockdowns is now starting to return to more normal levels, and with this readjustment consumption has jumped since the summer.
As a result, it now seems likely that government borrowing for the year will be less than 3% of national income, while in the October budget the finance ministry forecast a deficit almost twice as large.
On its own, this year’s hike in corporate taxes paid by foreign companies will add about 1 percent to domestic production. In the period since 2013, it has added about 0.4% each year to the growth in real national income. While corporate tax revenues are not immediately threatened, much of it is vulnerable to forces beyond our control. Thus, the revenue from this tax should be viewed in the same way that Norway viewed its oil windfall – as a potentially exhaustible resource. What Norway has done is save a lot of that “temporary” income, and Ireland should do the same with some of the unexpected corporate tax dividends.
The vagaries of the virus
With the economy returning to full employment by the end of next year, production will also be close to capacity. In turn, the government’s budget should be close to balance. If this favorable outcome is not disturbed by the vagaries of the Covid virus, it will pose very different challenges to the Government for 2023 and the following years.
As in the early 2000s, once the economy reaches capacity, the government’s job will be to keep demand under cover. Failure to do so could see exceptional domestic inflationary pressures, especially in areas such as construction where imported goods cannot replace domestic production. The way the government should do this is to generate a growing budget surplus as rapid growth continues.
At the same time, the government will face significant demands for increased spending to tackle services related to aging, the housing crisis and climate change, and improve health and social protection services. In an economy of full employment, the financing of this expenditure must be done through an increase in taxation to redirect the scarce national production needed to where it is most needed. This reflects the fact that most of these new demands cannot be met by imports – goods and services must be produced locally. Under these circumstances, borrowing would only add to inflationary pressures, not to our well-being.