Construction boom could overheat economy, says ESRI

The renewed boom in construction will drive the Irish economy to full employment next year, two years earlier than expected, the Economic and Social Research Institute (ESRI) has predicted. However, it warned that the disproportionate role being played by the construction sector had the potential to overheat the economy similar to what happened during the boom.

Previously, the ESRI had forecast it would take until at least 2020 for the economy to return to full employment, given the severity of the financial crash. However, in its latest quarterly outlook, the think tank said the current upsurge in housebuilding would see this achieved earlier than expected.

It predicted that unemployment would fall to a post-crash low of 5.6 per cent by the end of next year, a level of joblessness which the ESRI equates with full employment. If unemployment were to fall below this level, that would almost certainly confirm that the domestic economy was overheating, the institute said.

“We’re treading a fine line between driving the economy to produce more houses and pushing it into overheating territory,” the ESRI’s Kieran McQuinn said.

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Apart from damaging competitiveness, this could also force the Government into a more contractionary fiscal stance, limiting the scope for future tax cuts, he said.

Driver of growth

In its report, the ESRI said the housing market was now the main driver of growth in the domestic economy, with increased activity in construction affecting aggregate consumption and investment.

It said rising rents were fuelling increased levels of personal consumption, while higher rates of commercial and residential construction were underpinning investment.

The ESRI said the construction sector would assume a growing importance in the domestic economy over the medium term, reflecting the level of disinvestment that has occurred since 2007 and the fact that demand continues to outstrip supply.

It said it expected housing completions to rise to 18,500 this year, still below the 30,000 needed to meet demand.

The institute warned that the same housing imbalances were at play in the lead-up to the crash.

“Not alone did the housing bubble have severe consequences for the banking sector, but overall economic activity was distorted in a number of ways by the disproportionate significance of the construction sector,” it said.

Growth outlook positive

Despite the warnings, the ESRI said the growth outlook for the Irish economy remained positive on the back of strong domestic demand and continued export growth.

As a result, it upgraded its growth forecasts, with gross domestic product (GDP) expected to expand by 3.8 per cent this year and by 3.6 per cent in 2018.

It said the external environment, however, remained highly uncertain, with Britain heading towards a hard Brexit and the new US administration assuming more protectionist trade policies.

Dr McQuinn said a hard Border with the North was becoming increasingly likely given the British government’s desire to exit the EU customs union and make its own trade deals with other countries.

“In light of the external risks, the Irish economy must seek to minimise the impacts of trade-related adverse shocks,” he said. “This entails maintaining competitiveness in labour markets and strengthening productivity in general. A small open economy particularly reliant on international trade is highly vulnerable to significant changes in international trading conditions.”

In its report, the ESRI also warned that Ireland’s inflated level of GDP flattered the State’s headline debt-to-GDP ratio, which fell to 76 per cent last year, noting that the absolute level of debt still left the economy vulnerable to outside shocks.