Findings reveal substantial improvements in economic sustainability since the crisis even after adjusting for well-known globalisation related effects
The Department of Finance has today (Thursday) published a new economic paper entitled The Balance of Payments in Ireland – Two Decades in EMU. The paper examines the evolution of the current account of the balance of payments in Ireland over the last two decades and its importance as a macroeconomic indicator.
One of the key lessons to be learned from the crisis, from a macroeconomic point of view, is that the balance of payments (BOP) matters greatly and that its signalling power in identifying macroeconomic imbalances should be heeded. Prior to the euro area crisis, it was commonly thought that external imbalances within a monetary union were not a major cause of concern. In hindsight, the BOP, and in particular the current account, proved to be a very good indicator of the build-up of imbalances in competitiveness and sustainability in certain Member States, including Ireland. The European Commission has recognised this and now monitors the current account as part of the Macroeconomic Imbalance Procedure (MIP).
Commenting on the publication, Minister for Finance and Public Expenditure and Reform, Paschal Donohoe T.D., said:
‘The current account of the balance of payments is a key indicator of the sustainability of an economy. This paper, covering two decades and adjusting for some of the multinational related distortions in Ireland’s economic statistics, highlights the key economic insights and lessons that can be drawn from the current account of the balance of payments’.
“The current account is an indicator of external economic imbalances, in particular sustainability and competitiveness. For example, large current account deficits in Ireland in the years leading up to the financial crisis were a reflection of the economy’s loss of competitiveness, but were scarcely heeded. Although the balance of payments receives far less attention than other macroeconomic indicators such as the unemployment rate or the public debt ratio, it is nonetheless vital to monitor.
“By outlining the evolution of Ireland’s macroeconomy through the lens of the balance of payments, this paper traces the macroeconomic story of the excesses that built up in the Irish economy, the economic pain endured by Irish residents during the crisis, and the subsequent hard-won gains in the recovery period.
“My Department has made a concerted effort to make the workings of the Irish economy and the formulation of economic policy more accessible to the general public. This paper is a continuation of that effort, explaining how we can use the information in the balance of payments to identify the development of economic imbalances.”
The paper’s key findings include:
- The boom-bust-recovery cycle in Ireland over the past two decades can be seen clearly through the lens of the current account of the BOP. A large deterioration in the current account preceded the crisis, as domestic savings were insufficient to finance unsustainable levels of housing investment. There was then a significant improvement following the bursting of the property bubble. This was facilitated by enhanced competitiveness and the improvement in external demand.
- This swing saw the headline current account improve from a deficit of almost 7 per cent of GDP in early-2008 to a surplus of 10½ per cent of GDP last year.
- The current account in Ireland, however, has been distorted and artificially inflated by globalisation factors in recent years, as is the case with a number of Irish macroeconomic indicators, including GDP.
- To address this, the paper focuses on the modified current account (CA*) as produced by the CSO, which strips out these impacts to better reflect the economy’s underlying external balance. The CA* has also improved significantly in recent years, from a deficit of 7½ per cent in 2008 to a surplus of 6½ per cent last year.
- In recent years, when the current account balance is adjusted for the economic cycle, it has been broadly in line with that expected based on economic fundamentals.
- While the current account is generally thought of in terms of net trade and income (i.e. profit) flows, the current account is also the difference between savings and investment by domestic residents (households, Government and firms).
- Prior to the crisis, the household sector was investing more (mainly in property) than it saved and this investment was financed with borrowing from abroad, leading to a large current account deficit. When the crisis hit, households were forced to increase their savings and reduce investment to begin a deleveraging process. Meanwhile, government savings fell sharply during the crisis years when a large fiscal deficit emerged, requiring a substantial level of government net borrowing. The household, Government and corporate sectors are all now net lenders, i.e. they are saving more than they are investing, with a large current account surplus recorded as a result.
- Ireland is a net external debtor country with very large international liabilities (in net terms), i.e. the foreign liabilities of Irish residents exceed their foreign assets. However estimates of net international liabilities are distorted by both financial services firms operating in the IFSC with little interactions with the domestic banking system, and the cross-border intra-group liabilities of multinational enterprises in Ireland, whose activities are, in general, financed from abroad. Estimates of an underlying international investment position are substantially lower than the headline.
Notes to Editors
- The balance of payments is a record of all economic and financial transactions between the residents (households, corporations and Government) of a country and the rest of the world (non-residents). It consists of three separate but inter-related accounts: the current account, financial account and capital account.
- The current account measures transactions of domestic residents with the rest of the world that encompass both trade (in both goods and services) and income (e.g. profit) flows.
- The financial account records cross-border transactions in financial assets and liabilities, such as the acquisition and disposal (across borders) of debt and equity instruments.
- Finally, the capital account records capital transfers, as well as the acquisition and disposal non-financial assets, which are not regarded as capital stock investments from a national accounts perspective.
- The modified current account, as produced by the CSO, removes many of the globalisation-related factors that contaminate the headline figure. These include trade of intellectual property assets and portfolios of aircraft owned by the leasing sector as well as depreciation of these assets, imports of R&D services and related depreciation, and foreign profits of firms that have ‘redomiciled’ their headquarters to Ireland.
- In the years 2016-2018, Ireland recorded current account balances of -4.2, 0.5 and 10.6 per cent of GDP respectively, with the balances in 2016 and 2017 significantly affected by the importation of intellectual property assets (which reduce the balance). Correcting for this, and other globalisation related distortions, gives a modified current account balance of 3.4, 3.7 and 6.5 per cent of GNI*.
- The European Commission’s macroeconomic imbalance scoreboard sets a threshold of a deficit of 4 per cent of GDP or a surplus of 6 per cent of GDP, expressed as a three year average, as an imbalance in this area. Ireland’s headline current account averaged just over 2 per cent over the last three years, with the modified current account as a share of GNI* about 2 percentage points higher, both comfortably within the 6 per cent threshold.
Deborah Sweeney, Press Adviser to Minister Donohoe - 086 858 6878
Aidan Murphy, Press Officer, Department of Finance - 085 886 6667