The Northern Ireland economy

As far as I know, there has not been a single blog relating to Northern Ireland since The Irish Economy blog began earlier this year. Northern Ireland is having a relatively good recession for various reasons on which I do not wish to dwell. However, it has serious long-term problems which have been addressed in a report commissioned by the devolved economy Minister. The report is available here. What will interest readers of this Blog was that 4 out of the 5 report authors are economists, of which I am one.

In essence, the Northern Ireland economy has operated under wartime conditions for nearly four decades. Public sector output amounts to around 60% of gross value added (the regional equivalent of GDP). More specifically, industrial policy has consisted of providing large scale grants to both inward investors and indigenous firms. This has been partly successful: employment growth has been high in the last decade and at the peak of the recent boom, the unemployment rate was hovering just above 4% as in the Republic of Ireland case. What was different was that productivity growth was low to non-existent. Consequently living standards have not converged on the UK and have diverged markedly from the Republic of Ireland and other successful countries.

Managing Housing Bubbles in Regional Economies under EMU: Ireland and Spain

 

Today Thomas Conefrey and myself publish a working paper entitled “Managing Housing Bubbles in Regional Economies under EMU: Ireland and Spain”. It is available here .

With the advent of EMU, monetary policy can no longer be used to prevent housing market bubbles in regional economies such as Ireland or Spain. However, fiscal policy can and should be used to achieve the same effect. This paper shows that the advent of EMU relaxed existing financial constraints in Ireland and Spain, allowing a more rapid expansion of the housing stock in those countries to meet their specific demographic circumstances. However, the failure to prevent these booms turning into bubbles did lasting damage to the two economies, damage that could have been avoided by more appropriate fiscal policy action.

The failure to tighten fiscal policy in Spain and Ireland in the early years of this decade laid the ground for the housing market bubbles in the two economies. The Stability and Growth Pact proved a distraction: government budgetary balance was not an appropriate fiscal target for those two economies. By contrast, Finland, having learned from its mistakes twenty years ago, ran substantial government surpluses to prevent domestic overheating. Specifically in relation to overheating in the housing market, we consider that a temporary tax on mortgage interest payments (first suggested in 2001) should have been used to target overinvestment in housing, investment which seriously crowded out the traded sector of both economies. This tax would have mimicked an increase in interest rates. Obviously it will be a very long time before such a tax might be needed in either Spain or Ireland to limit overinvestment in housing.

The paper shows that demographic circumstances in both Spain and Ireland meant that it was appropriate that investment in housing in those two economies should have been somewhat higher than in their neighbours. Even after the housing bubbles have burst, the relatively low endowment of housing infrastructure in the two economies (relative to adult population) means that there will be a need for additional investment in the next decade, when the current excess supply has been worked off.

In the paper we also include a graph taken from our paper “Recovery Scenarios for Ireland” published in May  which, inter alia, considered likely housing demand over the coming decade. Our model included estimated 2009 population numbers which were quite close to the latest estimates published by the CSO. We assume that between 2009 and 2015 there will be cumulative net emigration of up to 120,000. Our analysis would suggest that the underlying population increase would lead to somewhat higher demand for housing than Brendan Walsh has estimated in a recent post for the period to 2015. In addition to the pure “demographic” effect we also factor in some increase in headship on the basis of the recent rise in the number of households, which possibly reflects falling rents.


 

Bank Asset Price Bounce: Irish versus US Banks

Perhaps the most contentious issue in NAMA planning is the distinction made between the long-term economic value and the current-market prices of bank assets, particularly developer loans collateralized by Irish property portfolios. 

Optimists see a strong case for a liquidity-related price bounce in these bank assets, that is, low current-market prices recovering to higher “true economic value” prices over coming years, as financial market distress dissipates.  This optimistic view, forecasting a bank asset price bounce, provides a strong justification for setting up NAMA, and also justifies paying the banks more than current-market prices for their bad loan portfolios (but still much less than accounting book value).

Pessimists forecast either flat or declining market prices for these bank assets over coming years.  This pessimistic view implies that NAMA (if it comes into existence) should pay current-market prices or less for bank assets. 

 I think that the optimists might be over-extrapolating from the current US environment.  There are important differences for the case of Irish bank assets.  In my opinion, the market prices of US bank assets will bounce up strongly sometime during the next few years, whereas the prices of Irish bank assets will recover more modestly or not at all.

Tilting at windmills

In considering how to value land under current economic circumstances answers may turn up in unexpected places. One of the most important state regulatory authorities, the Commission for Energy (CER), has taken the plunge and revised down their assumed value of land. In this case it is the site procurement cost for windmills. My colleague Laura Malaguzzi Valeri pointed me to page 41 of their document on Fixed Cost of a Best New Entrant Peaking Plant & Capacity Requirement for the Calendar Year 2010 where they say:

 “Due to the significant movements in the economy over the last year, the value of land has reduced. An independent assessment was carried out on current land values, and the RAs are satisfied that the estimate for 2010 is an reasonable reflection of the current costs.”

As a result, they have revised downward the value which they assume by 63%.

Because wind producers are price takers on the competitive wholesale market this will not affect current electricity prices. Nonetheless, the fall in land prices should reduce the long-term cost of producing wind energy, with beneficial effects for consumers.

If NAMA want to read up on the details of this valuation it can be found at:

http://www.allislandproject.org/en/capacity-payments-consultation.aspx?article=f6ff1ea8-5f01-416d-a863-cb945a3d71d9

Dept Fin Capacity review

(from LorcanRK) The Department of Finance published their review today:

http://www.finance.gov.ie/documents/publications/reports/2009/Dfincapacityreview09.pdf

Well worth reading for any that want to get an insight to the way the place works (or is supposed to work)