Cliff Taylor: Traditional economic certainties are breaking down

In this strange period of crisis-era economics, it is a real challenge to work out exactly what is happening – and why. Forecasters are finding it difficult, to say the least. The scale of the economic rebound from Covid-19 lockdowns took everyone by surprise, as did the labour shortages which hit not only here but in many other countries too. This was followed by a surge in inflation unprecedented in recent years.

We are still trying to work out the impact of what economist Adam Tooze has christened a “polycrisis”, where a range of factors acting together have particularly complex and unpredictable consequences. There are new economic dynamics. And on top of this is layered a whole new political backdrop which is now central to economic decision-making. This upends much of the old economic certainties within which Ireland found a way to thrive.

The questions are fundamental. When Nobel laureate Paul Krugman tweets – as he did earlier this month – that economists may have been working with the wrong model to try to understand inflation in the light of the momentous upheavals, you can see that the experts are as confused as the rest of us.

And this is important, because economic policy needs to be based on evidence and on a reasonable expectation that the action taken will lead to a particular set of results. In normal times, the surge in inflation would indicate that economies had overheated and the case for rapid increases in interest rates would be a slam dunk. Now, as Krugman argues, a much more complex set of factors seem to be at play – including a change in consumer demand post-Covid, a massive reorganisation of the workforce and interruptions to supply, notably of energy but more widely via upheavals to supply chains.

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Political forces

If much of inflation is, indeed, due to a messy economic readjustment, then a lot of it may be temporary. For this reason, some forecasters expect inflation to fall sharply next year. And so the case for central banks keeping on increasing interest rates weakens, particularly as this hurts economies which are already slowing. But central banks are still basing their actions on old-world theories, worried that inflation is getting embedded as the expectations of consumers and businesses change. This sets the stage for rising tensions between the European Central Bank and European Union governments in 2023.

As if the economics of this weren’t complicated enough, we have a whole new set of political forces influencing economic decisions. Politics has always been important, of course, setting the rules of trade, for example, and providing a backdrop against which businesses operate. But, since the 1980s, a big drive towards globalisation seemed to increasingly ignore political factors. Businesses operated across the world, manufacturing where it was cheapest – often China or southeast Asia – and setting up complex supply chains to supply goods and services to international markets.

Two things have changed this. First, the pandemic upended supply chains, particularly those involving China where Covid shutdowns led to massive upheaval. Then the war in Ukraine increased tensions and increased the threat of the world dividing into competing political blocs. A whole new layer of complexity has been added to business and economic decisions.

Supply chains previously constructed purely on cost grounds will now be based much more on security of supply and avoiding having one point of failure while acutely conscious of political risk. Companies are shortening supply chains, moving them closer to home and restructuring how they move funds. For a small country like Ireland which has thrived from globalisation – particularly of big US businesses – this is important, even if its implications are still not clear.

Industrial reset

And industrial policy is now being reset to the new politics. The EU, for example, is undertaking a major drive to attract chip manufacturers – to be formalised via a proposed new Chips Act. This is designed to safeguard supply for Europe – we have seen shortages of chips through Covid, and Taiwan, the subject of increasing tensions with China, is currently a major producer . The EU wants to step in as a much bigger player.

This was the context for Intel’s decision earlier this year to invest an initial €33 billion in Europe. While Ireland got a slice of this, the landmark commitment was a €17 billion investment in Magdeburg, west of Berlin, where it will manufacture two new processors, near the EU’s major markets.. The German government will provide €6 billion of this, plus other infrastructure investments.

Small countries – like Ireland – will worry that this new policy will inevitably favour the bigger countries with deeper pockets and big domestic markets. The big Intel investment in Magdeburg in a warning signal. And there is a wider context here too as Brussels proposes an increased use of subsidies for green investment in response to those being introduced in the US. This would again favour big EU countries with deeper pockets – and threatens transatlantic tensions, which would not be good for Ireland, as the European home of many big US companies.

This mix of economic uncertainty and the new global politics influencing economic decisions makes the future even more difficult than usual to predict. For Ireland, 50 years of EU membership has been the foundation stone of progress and now many of the big issues are effectively decided at EU level – our corporate tax rate, our interest rates, the key backdrops for industrial policy and more. There are big political challenges looming here as the sands shift. And economic ones too, where Ireland is under pressure to up its game.

Read about the Magdeburg investment and you see evidence of clean energy on tap, abundant water, a huge land bank to build on and an education system restructuring itself to provide skilled workers. Ireland has had a remarkable record in attracting foreign direct investment but if this is to continue we need, to use that old football phrase, to watch our house.