The economy may bounce back in 2010 - but it is not immediately obvious how this can be achieved

FOR YEARS it appeared as if the Irish economy could do no wrong and indeed those who raised even the mildest queries about its fundamentals were dismissed as cranks. Then we went through a period, from about 2004 to 2006, when there were murmurings about overheating in the property market. Some commentators began to admit the remote possibility of a soft landing, so soft that it might not even be felt.

Now with Davy's - a firm of stockbrokers - predicting a fall in house prices of over 18 per cent in the next 18 months, GNP growth of 1 per cent this year and less than 2 per cent next year, unemployment reaching 7 per cent and housing completions falling to 25,000 a year, it is hard to maintain the fiction of a soft landing anymore. So, how hard is it going to be?

We are fortunate that the ESRI has given us a most useful framework for analysing this question over the medium-term.

This is the only think-tank that tries to forecast five or more years ahead and it has a good track record. It is a brave exercise, facilitated by a macro-economic model of the economy but also guided by the judgement of experienced economists.

The central scenario indicates that the economy may bounce back in 2010, achieving a growth rate of about 5 per cent, and that between the years 2008 and 2015 growth might average 3.75 per cent per year.

The rate of unemployment could reach 7 per cent in 2011 but is likely to improve slightly from that point on. This seems to be related to the assumption that immigration will slow down to less than 11,000 per year.

Taking an even longer perspective, the ESRI suggests that Ireland will outperform the EU up to the year 2025, at which point our living standards will be 20 per cent above the European average.

Some commentators have suggested that these forecasts may be too optimistic because they are based on optimistic assumptions. The ESRI does, however, look at a less favourable scenario - one in which competitiveness is further eroded. And here the news is not so good. The 3.75 per cent average growth rate could relatively easily be reduced to around 3 per cent or possibly less.

This is the kind of pedestrian performance we racked up in the 1970s. The danger is that a succession of modest growth rates could undermine the confidence that was built up in the 1990s.

It is clearly important from a policy point of view that competitiveness is not further undermined. But it is not immediately obvious how this can be achieved.

There seems to be an assumption that the labour market is very flexible and that workers will accept whatever wages the market will bear. When the tide was rising, the labour market worked reasonably well but will it continue to do so when the tide is ebbing?

In principle, the outlook for Ireland should be fine if the inflow of foreign direct investment from the US continues unabated. Of course this is a tautology. It is an extraordinary fact that over 60 per cent of our GNP already comes from foreign multinationals and 90 per cent of our merchandise and service exports.

So, by definition, we have little to worry about if US multinationals continue to find us as attractive a location (relative to others) as they did during the Celtic Tiger period. The answer to this question is vitally important. Much depends on competition from other countries in terms of tax regimes, availability of skilled workers, intellectual and physical infrastructure, etc.

We simply cannot be complacent on this matter. The number of competitor countries hoping to attract footloose foreign multinationals has grown enormously.

The ESRI points out that we are beginning to specialise in business and financial services and that this sector will account for an amazing 60 per cent of GNP in 2025 and 70 per cent of total exports.

The economy as a whole is unlikely to see anything like the Celtic Tiger rates of growth again.

In fact, the forecasts of the ESRI suggest quite a modest performance over the medium to long run, at least by reference to the 1990s. Nevertheless, there should be ample opportunities in the business and financial services sector. In a sense, the economy is going to depend increasingly on IFSC-style activities and become quite like Luxembourg.

It is unlikely that the Government sector will become any more efficient and there is likely to be a continuing shortage of revenue. Fiscal policy will be very constrained.

Because of EMU membership the Government has no control over interest rates or the exchange rate.

Consequently there will be very little the Government can do to influence the economy one way or another. There will probably be more outsourcing to the private sector and more Public Private Partnerships. In these circumstances entrepreneurship will be at a premium.

Private sector entrepreneurs will drive the economy. If foreign companies do not locate here on a significant scale, the question is whether domestic companies will be able to generate the relatively modest rates of economic growth predicted by the ESRI. This is the challenge that faces us over the coming years.