We combine these four supply-side channels to estimate the aggregate supply-side or permanent effect of the NDP, CSF and EU. As discussed above, not all expenditure under the NDP is treated as having long-term growth consequences; in particular income support is treated as having very marginal supply-side effects. In total, just under half of total NDP expenditure is identified as having substantial long-run supply-side effects.
A further channel, which arises in both the demand side and supply-side simulations, is the improvement in the balance of payments and government borrowing requirement, which arises as a by-product of the EU funding. We treat the EU structural funds as a direct inflow through the current account of the balance of payments. This represents a simplification in the case of capital transfers. However as argued in Honohan (1997, p. 38), since these flows do not have to be repaid and are resources available for domestic investment – which is indeed their intended purpose – they represent a net gain to the external position of the Irish economy.
In the results shown below for the effects of the CSF, the balance of payments shows a sustained improvement, as does the position of the public finances. The debt/GNP ratio is allowed to continue to improve throughout the period as debt is repaid. This represents a further gain to the economy as the improvement in the
MACRO-ECONOMIC BACKGROUND 65
26 All of the estimates reported here are quite insensitive to variations in the
benchmark macro-scenario (the “with NDP” scenario), here based on the MTR 2003-2010, as experience has shown that the HERMES model is almost linear in this regard. No reasonable variation in the benchmark would alter any of the numbers reported by more than 0.1 per cent.
public finances could allow a sustainable further domestic fiscal stimulus (through raising expenditure or cutting taxes).
The increase in employment and output from the NDP will have additional effects, through the multiplier process, on all sectors of the economy. These multiplier effects are embedded in the
HERMES model. The increase in growth and employment financed by the NDP will reduce certain aspects of government spending and increase tax revenue through buoyancy effects. The results of these indirect changes are likely, in time, to more than offset the cost to the government of financing the NDP. As with the CSF, depending on how these benefits are used, they may add to the growth rate in the medium term. For example, if these indirect benefits are used to repay foreign debt then future debt interest payments will be reduced. In this section we have assumed that the additional revenue buoyancy is used to repay debt.
RESULTS
In this section we present our estimates of the impact of the NDP, CSF and EU investments. We begin by presenting the direct demand side effects of the NDP over the period 2000-2003. We then discuss the aggregate long-run effects of the total NDP, structural fund expenditure including co-financing (CSF) and EU structural expenditure alone (EU). Finally we present our estimates of the impact of the infrastructural and human capital supply-side effects separately.
The results are shown as the difference between the “with” and “without” scenarios in each case. When we talk of, for example, a change in GNP or consumer prices as a result of the NDP we are talking of the difference between the level of GNP and consumer prices in the “with NDP” scenario and the levels in the “without NDP” scenario. Thus when we talk of the NDP raising GNP in 2002 by over 7 per cent this does not mean that the growth rate will be over 7 per cent up, but that the level of GNP in 2002 will be 7 per cent above the level it would otherwise have been without the NDP. As discussed above, the “without NDP” scenario is not meant to be realistic but rather it is used as a tool to help quantify the overall impact of the NDP investments.26
Figure 3.6 summarises the aggregate demand and supply-side impacts of the NDP and CSF respectively on GNP. As can be seen from the graph, the initial impact of these investments is much greater than the more permanent effects shown for the period after 2002. This is because the demand side impact is purely transitory, while the supply side impact takes some years to build up. The long-
run effects of the NDP on GNP are substantial. By 2015 the cumulative effect is to raise GNP by almost 3 per cent.
Figure 3.6: Total Effects of NDP and CSF on GNP
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 1 2 3 4 5 6 7 8 % 2000-2002 NDP 2000-2002 CSF
Long-run Effects NDP Long-run Effects CSF
Given a cumulative investment of 19.8bn euro, over 20 per cent of GNP, this suggests a long-run return on investment of around 14 per cent, which is high but not implausible. Bradley, Morgenroth and Untiedt (2003)in a macro-regional evaluation of the structural funds, estimated a cumulative Structural Funds multiplier defined as the cumulative percentage increase in GDP divided by the cumulative Structural Funds share in GDP.27 This multiplier helps
to standardise Measures of the impact of Structural Funds interventions by controlling for the scale of expenditure. Their estimates are based on the 1994-1999 Structural Funds expenditure and suggest a high multiplier for Ireland (2.8) over the period 1994- 2010 relative to the other Objective 1 countries; Portugal (2.5), Greece (1.1) and Spain (1.8). We have calculated this multiplier for the NDP 2000-2002 expenditures over the period 2000-2015 based on the results shown in Figure 3.6. These indicate that our results are of a similar order of magnitude for the NDP multiplier at around 2.4.28
Demand Side Effects
The cumulative demand-side impact of the NDP on GNP in 2002 is 5.4 per cent. This is lower that the actual size of the NDP due to leakage through imports of capital goods and material inputs. The balance of payments surplus and the exchequer surplus both fall by
27 Bradley, J., E. Morgenroth and G. Untiedt (2003). “Macro-regional Evaluation
of the Structural Funds using the HERMIN Modelling Framework”, ESRI, Working Paper 152.
28 Our results are biased downwards since the demand side effects are only in place
MACRO-ECONOMIC BACKGROUND 67
3.8 and 4.3 percentage points respectively, reflecting the ratcheting up of imports and the exchequer costs of funding the large investment programme.29 The increase in activity in the building and
construction sector leads to a significant increase in building sector output prices and in particular in house prices.
Table 3.12: Short-Run Effect of NDP on Key Macro-economic Variables 2000 2001 2002 GDP (%) 2.9 4.3 4.7 GNP (%) 3.4 4.9 5.4 Balance of Payments as % of GNP -2.8 -3.8 -3.8 Exchequer Surplus as % of GNP -4.3 -4.4 -4.3
Debt/GNP Ratio (as % of GNP) 2.7 4.8 8.5
Consumer Prices (%) 0.0 1.1 1.5
Average Wage Rates -0.4 1.6 2.3
Unemployment Rate (as % of Labour Force) -3.2 -3.8 -3.8
Total Employment (thousands) 60.3 84.7 97.6
Labour Force (thousands) 7.5 19.9 32.5
Net Immigration (thousands) 0.0 16.2 21.1
New House Prices 2.7 13.3 14.2
Building and construction deflator 3.5 4.7 4.7
The sizeable growth in output is reflected in strong growth in employment. The NDP demand-side effects are concentrated in labour-intensive sectors such as building, health and education. The simulation suggests that the NDP injected almost 100,000 jobs by 2002 inducing net immigration of 21,000. Together with a rise in participation rates, this led to an increase in the labour force of over 32,000 by 2002. These numbers suggest that the unemployment rate would have been almost 4 percentage points higher by 2002 without the NDP. This “no-NDP” is clearly an unrealistic alternative but this does serve to illustrate the magnitude of the demand-side boost to the economy provided through the NDP.
Inevitably such a large injection of funds will lead to an increase in prices in the short run. Average wage rates are estimated to be 2.3 per cent higher, with consumer prices up 1.5 per cent. However the sectors where the NDP had a large inflationary impact are the housing and other building and construction sectors. We estimate that the NDP housing investment programme, together with the rise in general income levels, gave rise to new house prices being over 14 per cent higher by 2002. The inflationary effect in other building and construction sectors is, albeit more modest, at 4.7 per
29 As discussed later, this is a net deterioration since the inflow of EU funds
cent, double the increase in average wages. The latter effect may well underestimate the inflationary consequences of the NDP.
Supply Side – Aggregate Effects of NDP
At the heart of any extensive investment programme is an objective to boost the economy’s long-run growth potential. The best performance indicator of this target is the impact on GNP and GDP. In Figure 3.7 we show the impact of the NDP on the level of GNP and GDP. Details of the impact on other major aggregates are shown in Appendix 4. This indicates that the supply-side effects take some time to fully work through the economy. It is only from
Figure 3.7: Impact of NDP on GNP and GDP
2000 2002 2004 2006 2008 2010 2012 2014 1 2 3 4 5 6 7 8 % GDP GNP
Figure 3.8: Impact of NDP on Balance of Payments and Government Surplus 2000 2002 2004 2006 2008 2010 2012 2014 -6 -5 -4 -3 -2 -1 0 1 2 3 % of GNP
MACRO-ECONOMIC BACKGROUND 69 Figure 3.9: Impact of NDP on Unemployment Rate
2000 2002 2004 2006 2008 2010 2012 2014 -5 -4 -3 -2 -1 0 1 2 % of Labour Force
2010 onwards that the full long-run impact of the NDP can be seen. Initially the impact on GNP is lower than on GDP due to the cost to the exchequer of foreign borrowing to fund the NDP, and due to the increases in profit repatriations in manufacturing driving a wedge between GNP and GDP. However, by the end of the period their paths converge as the public finances move into surplus due to the strong performance of the economy (Figure 3.8).
The strong supply-side impact of the NDP on the economy drives strong growth in employment, which induces higher rates of net immigration. This means that the impact on GNP per head is more muted at 2.3 per cent by 2015, with the remainder of the long- run increase in GNP absorbed by an increase in the population.
While the demand-side effects of the NDP are strongly inflationary, over the long term the inflationary effects disappear, with prices and wages roughly unchanged by 2015. Increases in labour supply in the long-run serve to modify wage demands, while improvements in productivity keep consumer prices unchanged. The strong employment effects of the NDP fall off beyond 2002. However, increases in human capital, together with strong output growth, ensure a long-run positive effect, with total employment 50,000 higher than without the NDP. There is no lasting long-run effect of this higher employment on the unemployment rate. In 2000 the unemployment rate, at just over 4 per cent of the labour force, was close to a full employment rate, so that any further increases in employment will, over the long run, induce increases in participation, immigration or higher wages.
It is interesting to note the time-path of these effects. Once the initial demand-side stimulus ends after 2002, there is an increase in the unemployment rate peaking at 1.6 (Figure 3.9) in 2006. This is mainly due to the strong increase in the labour force, peaking in 2005, driven both by increased migration and labour force participation, attracted by the improved labour market
circumstances in the years 2000-2002. (Of course this rise assumes a complete ending of the NDP in 2003.) In addition, improvements in human capital also increase the supply of skilled labour (Section 3.3). The unemployment rate gradually moves back to equilibrium as the labour supply effect is attenuated by renewed migration and as the supply-side productivity effects begin to kick in increasing employment. The assumption here that the NDP ended in 2002 is purely used for illustrative purposes. In reality, as discussed later in this report, the NDP will continue at a rather similar level of activity for the foreseeable future.
In the long run the improvement in competitiveness, arising from the NDP, results in a permanent increase in value added in industry of almost 4 per cent by 2015. Output in the market services sector is also over 3 per cent above the “no NDP” levels. This is due to some direct supply-side effects from the NDP, but also through the indirect multiplier effects of the demand stimulus to the economy.
Despite an initial deterioration in the public finances due to funding the NDP, the long-run consequences for the public finances are positive due to the high rate of return on these investments. By 2015, despite funding an investment campaign which cost the domestic exchequer cumulatively almost 19 per cent of GNP between 2000 and 2002, the exchequer surplus as a percentage of GNP is one percentage point higher and the debt/GNP ratio falls by almost three percentage points. This reflects the revenue buoyancy consequent on the long-run stimulus to the economy through positive supply-side effects, together with some reduction in government expenditure on transfers and debt interest.