Abstractions of reality





We are becoming used to claims that the UK might have to pay a very hefty bill in order to leave the EU.

In contrast, one and a half years ago a consultancy report (K Hubner and KLC Consulting August 2015, “Modelling Irish Unification”) claimed that Irish unity could be something of a money-making exercise – one consequence of unity would be that incomes would rise in both Irish economies in the 5-10 years after unification.

Hubner’s were conditional forecasts – KLC made certain assumptions and then forecast how the economy might respond. As the report itself concedes, “The models are abstractions of reality, embodying many assumptions”.

The sensible thing to do, therefore, is review KLC’s assumptions. Four in particular are problematic:

1. The exchange rate

KLC assumes a short to medium term boost to economic activity in Northern Ireland as unification replaced a high sterling exchange rate with a weaker Euro one. Given the devaluation of the pound, which occurred in the summer of 2016, this assumption now looks inappropriate.

2. A big boost to trade

KLC assumes borders are bad for trade.

It looks at how trade between Northern Ireland and the Republic of Ireland would grow if the Irish border disappeared. What this fails to allow for is the fact that Northern Ireland’s “export” trade with Great Britain is about four times greater than that with the Republic of Ireland.

If there was a border between Northern Ireland and Great Britain then surely, using KLC’s logic, that trade would be reduced? Indeed, it is very likely the loss in terms of less trade with Great Britain would exceed the gain in terms of greater trade with the Republic of Ireland.

In 2015 total sales from the Northern Ireland economy were £66.7bn, of which £43.7bn were to Northern Ireland itself, £13.8bn to Great Britain, £3.4bn to the Republic of Ireland, £1.9bn to the rest of the EU and £3.8bn to the rest of the world (NISRA website 2017, Broad Economy Sales and Exports Statistics).

3. An economic miracle in terms of productivity growth in Northern Ireland

KLC assumes that one response to unity would be that the Northern Ireland economy would suddenly start to look like the Republic’s in terms of the rate of Corporation Tax, the structure of industry and, very importantly, the level of productivity.

For Northern Ireland to close its productivity gap with the Republic of Ireland over 15 years, as this report assumes, would require the sort of very rapid economic growth, perhaps of the order of 6% annually, which the local economy has never sustained over any period since the Second World War.

Northern Ireland could, of course, adopt policies to improve its productivity whilst remaining within the UK and now has the legislative ability to adopt a rate of Corporation Tax which differs from the UK average.

4. It will cost the Republic of Ireland nothing to replace the fiscal transfer which the UK currently provides to Northern Ireland within the Sterling monetary framework.

KLC’s description of how the fiscal transfer would be handled is unclear.

The figures quoted in their text are lower than the official estimate where this annual fiscal transfer to Northern Ireland is over £9bn (Department of Finance October 2015, Net Fiscal Balance Report 2012-13 and 2013-14. https://www-finance-ni.gov.uk/publications/northern-ireland-net-fiscal-balance-report).

Possible scenarios are where the Republic of Ireland’s taxpayers and citizens either pay more taxes or enjoy less public services so as to provide the resources to fund the fiscal transfer to Northern Ireland.

It looks as though KLC is in fact assuming that the Republic of Ireland would simply borrow to make good this funding gap.

Even, putting to one side the question of whether the EU would set aside its stated fiscal rules to let the Republic engage in this fiscal extravagance, this may not be a costless option. If the Republic was borrowing the equivalent of £9bn every year for the next 15 years there is the danger than this would lead to public debt/GDP ratios rising remorselessly.

The danger of a debt spiral increases if one of the terms of unification was that the Republic would assume “Northern Ireland’s share” of the UK national debt. If that share was 3% – in line with the relative population – then €60bn would be added on top of the existing Irish government debt of €200bn; a 30% increase and Irish taxpayers would be obliged to pay at least €2bn every year in extra interest charges.

The Hubner/KLC Report has been referenced by Kevin Meagher, in his recent book on Irish unification (K. Meagher 28 December 2016, “Why reunified Ireland offers best outcome for the North’s future”, irishtimes.com), as well as other pro-unity commentators.

The recent track record of economic forecasts of large scale political-structural changes in the economy, notably the forecasts of the economic impact of Brexit, has been a very chequered one.

This implies that in terms of the KLC report, we should be more than cautious.

Questionable assumptions will produce questionable results.

Esmond Birnie: Economist