ECONOMICS:The upturn has been stronger than expected, resulting in a recent spate of upward revisions to growth forecasts, writes PAT McARDLE

OUR MAJOR trading partners, the US, the UK and the euro zone, all emerged from recession in the second half of last year (see chart). However, we are still debating where we stand and what the future might hold in terms of economic growth. Severe – and in all probability permanent – damage has been done and potential or trend growth rates will be lower in the future.

Ireland’s recession was deeper and longer than elsewhere. GNP contracted by 0.5 per cent in the first quarter of 2010, thereby prolonging our recession into its eighth successive quarter.

The odds are that Q2 will see a roughly break-even situation and it is hoped that decent positive growth will be recorded in the second half of the year, finally bringing the recession to an end, a year after the rest.

Had we used GDP instead of GNP, Ireland would have shown growth of 2.7 per cent in Q1, dwarfing the rest, but this was boosted by multinational profits and does not reflect the reality on the ground. Neither does it capture the impact of the ever-increasing cost of servicing debt held by non-residents and the falling profits earned by Irish companies abroad.

Our peak-to-trough fall in GNP was 16.5 per cent, vastly greater than the others (euro zone minus 5.3 per cent, UK minus 6.4 per cent, US minus 3.8 per cent). Iceland had a worse banking crisis but a lesser peak to trough fall in income of 12.9 per cent.

So much for the past. The upturn has been stronger than expected, resulting in a recent spate of upward revisions to growth forecasts.

The monthly consensus forecasts for Irish 2010 GDP from Reuters are now unambiguously positive, but GNP remains in negative territory in terms of the average for the whole year. Interestingly, the consensus for 2011 growth, at about 2.75 per cent, has been reduced rather than increased since the beginning of this year.

In keeping with this, the Department of Finance recently upgraded its 2010 figures, but left the longer-term forecasts first produced in last December’s budget unchanged.

The ESRI also revised up its short-term forecasts but, here, too, the changes to its longer-term projections went in the other direction. While a strong recovery is universally forecast, views regarding future growth potential differ widely and have become more conservative. This has significant implications.

Back in 2005, the ESRI produced high and low growth scenarios for the period to 2020.

That was long before the downturn and when the US was still booming. The favourable scenario assumed that the US would sail on, taking us with it. The low growth scenario (see table) was based on a severe adjustment in the US feeding into a sharp housing correction here. This was meant to be a shock but it still envisaged rates of expansion and levels of house completions that we would envy today.

Three years later, the downturn was well under way and the ESRI reflected this in its benchmark forecasts, which are also summarised in the table. They were broadly similar to those in the earlier negative scenario.

By 2009, the situation had turned out to be much worse than anyone expected. By now, it was clear that the annual average growth rate in 2005-2010 would be negative, but the ESRI surprised many of us by assuming that much of the lost ground would be recovered as the economy bounced back with an above-average, 5.4 per cent, annual growth between 2011-15.

However, the Department of Finance did not agree and the 2010 budget was based on a more conservative, 3.7 per cent, growth rate over the next five years. This made a big difference as the ESRI projections had implied that only half of the €7.5 billion budget cuts planned over the next four years would be required.

Then, last week, the ESRI came back into the picture, with updated high and low projections, but did not express a preference between them. Despite the better-than- expected global picture, these forecasts no longer envisage a major rebound because the 2009 paper “did not take account of likely further fiscal adjustment in 2011 and subsequent years”.

Each scenario assumes that the €7.5 billion fiscal consolidation package announced last December will be implemented in full, but the ESRI cautions that additional fiscal action would be required if the more pessimistic scenario were to materialise. The high growth scenario assumes that the economy in general and the labour market in particular will respond as flexibly as it has done in the past.

The low growth one is based on a lower responsiveness to global developments but could be produced by a range of other factors, such as a higher long-term cost of borrowing, a poorly functioning financial system or problems in the labour market resulting in structural long-term unemployment.

Finally, lest we become complacent, the IMF has produced a significantly more downbeat prognosis which sees the economy only gradually returning to its reduced potential of 2.5 per cent by 2015. Basically, the IMF expects that most of the factors cited in the ESRI low growth scenario will materialise and that additional fiscal correction of €3 billion, over and above the €7.5 billion already planned by the Government, will be required. Obviously, this would further retard growth.

At this stage, the best we can hope for is that growth will be close to the budget projections but there is a significant chance that it will be somewhat lower and that more, not less, fiscal correction will be required.

While recorded growth in the next five years may exceed 3 per cent, beyond that there is a growing consensus that the capacity of the economy to expand is about 2.5 per cent.