Notes On The Front

Recession Hangs Over Budget 2023

There were two major projections from the government on budget day that have not yet entered the public debate. 

First, the economy is projected to flat-line next year.  The government projects 0.4 percent growth in real GNI*.  This is the preferred measurement for assessing economic activity in the state.  0.4 percent is barely any growth at all and is only just above the recession zone.  The Finance Minister omitted this in his speech, instead focusing on the lesser known ‘modified domestic demand’:

‘ . . . my department has revised down its forecast for Modified Domestic Demand – the most appropriate measure of our domestic economy – to 1¼ per cent for next year.’

This is incorrect.  The most appropriate measure is GNI*. Referencing this, though, might have raised awkward questions.

We can get a sense of the deterioration in government projections by reviewing the Department of Finances’ revisions of the components of economic growth – from April (Stability Programme Update) to September (the budget).

The revisions downwards are quite significant, especially given that they occurred within five months.

• Consumer spending projection has been cut in half
• Modified investment (which factors out multinational distortions) has been revised downwards by nearly 2/3.
• GNI* has been slashed to nearly zero.

While employment growth is expected to moderate at 1.2 percent (down from a projected 2.1 percent in back in April), unemployment has not been revised upwards.

The government projects all this to be temporary.  GNI* and consumer spending is expected to bounce back in 2024, though investment will remain relatively muted.   Hopefully, this is the case.  But with such uncertainty in international markets it is difficult to project beyond a year. 

The second piece of bad news which hasn’t received enough attention is the inflation projection for next year.

In 2022 the government is projecting an inflation rate of 8.5 percent.  Next year it will remain high at 7.1 percent.  This is well above other estimates from the Central Bank, ESRI and NERI who projected inflation for next year at between 4 and 4.5 percent.  And it is well above what the government was projecting six months ago. 

This means that over this year and next inflation will run at 16.2 percent.  Incomes will have to rise by this amount over 2022 and 2023 just to stand still.  This wasn’t expected.

Continued high inflation will depress consumer spending which, in turn will impact on investment (businesses are reluctant to invest if consumer spending isn’t sufficient to produce a return on their investment).  The Government is projecting that inflation increases will moderate by 2024, rising by only 2.4 percent with energy prices rising be even less. But this should be treated with caution as no one knows how this current crisis will impact on the medium term.

So we have an economy flirting with recession within a high inflation environment.  The government is banking on the assumption that social transfers, especially the once-off component, will serve not only to protect living standards but also bolster consumer spending.  It is further hoping that their subsidies to the business sector will deter further price rises and maintain employment.

Let’s hope it comes right.  For if the Irish economy falls into a slump with high inflation rates (what is popularly known as stagflation) it will become extremely difficult to dig ourselves out.

A first step is to start highlighting all this in the public debate.  It would be bad enough to fall into recession.  But to pretend that the prospect doesn’t exist would be just as bad.

 

 

How Much Would Price Controls Cost

[The following post is a big number heavy – and others may have better estimates)

John Fitzgerald is pessimistic:

‘ . . these [energy’ price increases will probably drive the Irish economy, as well as the EU’s, into recession . . . We are looking at a possible 5 per cent loss of income and output, which could be enough to cause the rapidly growing Irish economy to reverse engines, with a serious negative impact on employment.’

I hope he’s wrong.  I fear he may not be.

The EU Commission recent proposals come up short of controlling energy prices.  At best, they recognise the profiteering occurring in some sectors of the energy market.  The thrust of their proposals is to levy windfall profit taxes in order to boost social transfers. 

The issue of energy price controls has gained some momentum since I first raised this last year.  Such price controls should be seen, for the time being, as temporary, tactical and forensic.  But even then, it will come at a price.  With the help of Eurostat and the CSO let’s do some relatively crude back-of-the-envelope estimates.

• In 2021, households spent €3.1 billion on electricity, gas and other domestic fuels (home heating oil, solid fuels, etc.). If we assume energy inflation running at 48.6 percent in the last year (to August), households will be spending on €4.6 billion this year. 

• In 2019, the business sector spent €4.7 billion. However, that includes €1.1 billion consumed by the power generation sector.  So that leaves €3.6 billion spent on energy inputs by non-utility businesses.  With energy inflation running at 62.5 percent over the three years we could expect business spend to rise by €2.2 billion.  This would mean the business sector could spend €5.8 billion on energy this year.

So in 2022 we could expect a total economic spend of €10.4 billion on energy.  However, the risk is to the upside with cost variations depending on the particular energy fuel being used.

Temporary and Tactical

A temporary, tactical approach would see price controls operating over the winter months.  That is the immediate challenge to ensure that people can stay warm at affordable rates, and businesses continue to operate.  The CSO shows that 69 percent of residential gas consumption occurred between October to March in 2021 – essentially quarter four and quarter one. Business consumption was 51 percent during this period.  I can’t find seasonal consumption patterns for electricity but we’ll assume it mirrors gas.

Therefore, spending over the six autumn / winter months is estimated to be €6.1 billion:  €3.2 billion for households and €2.9 billion for businesses.

Let’s look at the reduction in prices if we rolled back prices to August 2021.

Rolling back prices to August 2021 would result in a 33 percent reduction in prices, varying between 28 percent (electricity) and 42 percent (home heating oil).  It should be noted that rolling back prices to August 2021 brings us close to pre-pandemic levels. 

In terms of cost over the winter months (adding an additional 10 percent to help reduce upside risks) we could see the state spending

• For households: €1.2 billion
• For businesses: €1.1 billion
• Total cost: €2.3 billion

€2.3 billion to roll back prices to August 2021 levels for six months:  this is a significant cost. 

Forensic

Fortunately, this cost can be reduced through a number of targeting mechanisms. High-income, high-consumers don’t need the cut and are probably in a better position to reduce consumption.  A subsidised cut could be delivered through a tiered-tariff imposed by the Regulator over the six months:

• Standing Charge: the most regressive component of an inevitably regressive cost.  This could be eliminated during the target period.

• Tiered Tariff: just as with tax rates, energy charges could be reduced for the first 2,000 kWh (average household consumption is 4,400 kWh), with graduated bands above that. 

In this way, price controls could be directed toward low-average income households.

For businesses, a similar targeting could occur for energy-intensive firms.  For instance, the manufacturing sector makes up 33 percent of all business spend.  Further, we could also exclude data centres from subsidised price cuts.

Targeting the subsidised price cuts could reduce the total cost.  And it should be noted that the state would also save money – 15 percent of business spend comes from the public administration, health and education sectors.  This would save money for the Exchequer. 

Recouping the Cost

• A windfall profits tax should be levied. The Finance Minister recently told Ged Nash, TD, that raising the corporate tax rate on energy companies from 12.5 percent to 50 percent would yield €271 million.

• The price cap could be introduced on a cost-plus basis, acknowledging that most of the costs originate from outside the state (importing fossil-fuels). This would temporarily squeeze profit margins for companies. 

• Some of the cost could be returned to the state. For instance, a portion of the subsidised cost to business could be repaid over a ten-year period, linked to profitability.  A bank levy-type charge on energy companies could be introduced but one would have to look out for companies passing this on to the consumer.

• Costs could be further reduced through temporarily reduced network charges, putting the cost on public utilities.

All of the above would lead to tariffs being set by the Regulator.  For this emergency period, there would be limited competition between energy retail firm with profit levels frozen or rolled back to pre-covid levels on a cost-plus basis. 

This would require a sophisticated price control regime.  However, the benefits would be considerable. 

• For households, costs would be reduced before the Government’s energy-subsidy transfers. This could reduce the costs of transfers.  Further, it would mean relief for hard-to-target households who are just above social protection thresholds but wouldn’t benefit from tax cuts.

• For businesses, costs would be reduced in two ways: the direct cost of purchasing energy, and the reduced input costs where energy plays a significant role.  This is about reducing energy costs throughout the supply chains. 

The reduction in business costs could allow for higher wages – especially for low-average income groups (those with a high propensity to spend).  This would drive consumer spending and increase net business revenue.  The alternative would see the business sector facing rising costs and falling demand due to wage restraints. This would be a recipe for John Fitzgerald’s recession.

Temporary, tactical and forensic price controls can help us get through a potentially grim winter.  The issue of unwinding price controls following this period will be challenging.  However, we may find that having established a price control infrastructure (and improving it as it goes along), we may keep it.  Not only because it may be necessary.

But because we need to start treating energy a public good.