The ESRI's view

Commet: As job losses again capture the economic headlines, there is a danger that today's woes will come to be seen as the normal state of the Irish economy. While there was a need for a downward adjustment in expectations, such an adjustment could go too far.

The ESRI believes that, after this period of underperformance, there should be a corresponding period of catch-up, through quite rapid growth, to return the economy to full employment by the end of the decade.

The purpose in undertaking forecasts for a period of five or more years is to look beyond current difficulties and provide a basis for strategic policy making.

In the ESRI Medium-Term Review, published today, we take as given the latest forecast by our colleagues for 2003 and 2004, and consider how the economy is likely to perform over the rest of the decade once a recovery becomes established among our major trading partners. Because of the uncertainty of forecasting, we focus on average growth rates for the 2005-2010 period.

Experience suggests a higher degree of accuracy in such forecast averages than in predictions for individual years. We can also examine a series of "what ifs" to see what might go wrong or right, and to assess how domestic policy can best influence outcomes.

Our best estimate is that, once the economy recovers from its difficulties, it has the potential to grow more than 5 per cent a year for a further period to the end of the decade. Whether this potential will be realised will depend on a recovery in the world economy and on our policy choices.

If domestic policy is to promote growth, it should also be robust in the face of a range of economic outcomes.

The biggest obstacle to realising Ireland's potential growth is the loss of competitiveness over the past four years. This has been greatly aggravated by the strengthening of the euro. It has also been aggravated by unwise fiscal policy from 2000 to 2002, which stimulated inflation, especially in wage rates.

To claw back the loss of competitiveness will take at least two years. But if the economy proves as flexible as it has in the recent past, the second half of the decade should see the economy recover lost ground.

If we rapidly regain competitiveness and expand our infrastructure, there is the possibility that this review could prove pessimistic.

Under these circumstances, the economy could grow at closer to 6 per cent a year for a limited period, fuelled by higher skilled immigration. However, our analysis suggests that there is scope for a bigger margin of error on the downside.

A failure to rapidly adjust our competitiveness to the changed external environment and to implement the necessary infrastructural investment could see the economy choked, reducing medium-term growth to closer to 3.5 per cent a year.

We also considered what might happen if the euro continued to strengthen, which could greatly aggravate competitiveness problems.

The pattern of growth over the coming decade will be rather different from that of the late 1990s. While high-tech manufacturing will continue to have a significant role, increasingly the "baton" of growth will be taken over by the market services sector. As jobs become higher paid, requiring higher skills, they tend to move off the production floor into offices and laboratories.

This change in the structure of the economy has important implications for development policies over the coming decade. Some of the factories disappearing today will be replaced in the future by expansion of a wide range of business services, from finance and software development to legal services and communications.

A "no regrets" approach to fiscal policy should maintain tight control over the public finances until the economic recovery becomes well established. If recovery were delayed, such caution would avoid the need for later drastic action. On the other hand, if the recovery occurred earlier or was stronger than expected, it would then allow a more ambitious programme of improvement in public services or investment.

In the case of public investment, a prudent policy would involve continuing substantial investment in infrastructure. Even with a disappointing growth performance, such investment will be necessary and, if growth proves stronger than expected, inadequate infrastructure could prove a major barrier to further success.

The continuing commitment to such infrastructural investment represents a major reduction in resources available for current consumption. As a result, while Ireland is technically becoming one of the richest countries in the world, it does not feel that way. Countries such as France and Belgium, where they undertook major infrastructural investment in the past, are now free to spend their income on consumer goods and services, while in Ireland we have to devote a significant part of our income to investing in housing for our children, and to putting in place a level of public infrastructure to support a high standard of living.

The ESRI suggests that it is realistic for Ireland to aspire to a substantial improvement in living standards in the next decade.

John FitzGerald is an economist with the ESRI and one of the authors of the report