ECONOMICS:International experience tells us that swings in housing markets are typically associated with swings in economic performance. Economic growth is usually robust during housing booms and weak during housing busts. In fact, a downturn in new homebuilding is often a warning sign of an oncoming recession writes,  Alan Ahearne

With house prices declining in the Republic, the close association between housing markets and real gross domestic product (GDP) suggests that economic activity will soften here in 2008. What is less clear is the likely extent of the slowdown. Are we facing a soft landing or a recession?

At the recent Fianna Fáil parliamentary party meeting, Taoiseach Bertie Ahern suggested that the economy might expand by 4 per cent next year. The consensus forecast for 2008 among economists polled recently by Reuters is only a bit lower, at 3.7 per cent. Some economists are more bullish, with Bank of Ireland's Dan McLaughlin pencilling in GDP growth of 4.5 per cent for 2008.

Growth of 4 per cent next year would be respectable. In its Quarterly Economic Commentary released today, the Economic and Social Research Institute expects real GDP to expand 4.7 per cent this year, so a softening to 4 per cent in 2008 would be barely noticeable.

But some simple arithmetic underscores just how difficult it will be for our economy to meet that expectation. In fact, the risks of a recession are probably greater than many people think.

The economy's performance next year will be shaped to an important extent by the intensity of the slowdown in new homebuilding. Analysts generally agree that 75,000 new dwellings will be built this year. Most also agree that the medium-term sustainable level of homebuilding is about 55,000.

Homebuilding typically drops below its medium-term path in the years immediately after the end of a housing boom.

The reason for this is that, in the later stages of booms, developers tend to overbuild, and the resulting housing glut needs to be run off before building activity can return to normal. This suggests that we should expect a slowing in the pace of new homebuilding to well below 55,000 units next year. The Construction Industry Federation projects 45,000 units.

Forward-looking measures of building activity are consistent with an adjustment of this scale. Davy's Rossa White estimates that housing starts - a leading indicator of completions - have declined steadily to fewer than 38,000 in August at a seasonally-adjusted annual rate.

All told, 50,000 house completions in 2008 seems like a reasonable assumption, down from 75,000 this year. Since new homebuilding accounts for about 10 per cent of real GDP, this drop of one-third in completions will subtract roughly 3½ percentage points from growth next year.

For real GDP to rise 4 per cent next year, the remaining 90 per cent of the economy would have to expand at a whopping 8.5 per cent rate. To put that figure in perspective, over the period 2004-2006, real GDP (excluding new homebuilding) rose about 4.5 per cent per year on average. In 2007, the corresponding figure is expected to step up to nearly 6 per cent. The crucial point is that a soft landing requires a dramatic acceleration in the non-homebuilding components of GDP from an already strong performance. It's difficult to see how that can be achieved. If anything, growth in GDP (excluding homebuilding) may ease in 2008.

Personal consumption surged 7.5 per cent this year, the largest rise since the late 1990s. But with employment growth expected to slow next year, a repeat of this is unlikely. The spur to spending this year from Special Saving Incentive Accounts (SSIAs) and income tax cuts will probably be missing in 2008. Higher oil prices also threaten to restrain consumption and consumer confidence has already tanked.

Some economists hope that an acceleration in home improvements will fill some of the gap. But such spending is only about one-third as large as new homebuilding. Also, 2007 looks like being a bumper year for this category of spending, boosted by SSIAs. If anything, we may see some payback in 2008.

Non-residential investment is expected to jump more than 10 per cent this year. Few analysts see scope for faster growth in 2008, nor is public investment set to accelerate. The National Development Plan will add about three-quarters of a percentage point to real GDP growth in 2008, about the same as this year.

That leaves us only with exports. Recent weeks have seen the euro rise against the sterling and dollar. The turmoil from the US subprime debacle and credit crunch has increased downside risks to global growth. These are hardly ingredients for a marked improvement in the 5.5 per cent rise in exports expected this year.

There are good reasons to expect that real GDP growth (excluding new homebuilding) will ease back to its 2004-2006 average of 4.5 per cent next year. In that case, the economy will post an overall growth rate close to zero. The landing may not be as soft as the consensus view.

Alan Ahearne is a former senior economist at the Federal Reserve board in Washington DC. He lectures at the JE Cairnes Graduate School of Business and Public Policy at NUI Galway