Tax cuts in the Budget should aim to increase the supply of labour rather than net real wages, according to the Organisation for Economic Co-operation and Development (OECD). In its latest Economic Outlook, the organisation says Budget cuts in indirect taxes to reduce headline inflation should be avoided. And it suggests "it would be helpful" to spread public investment over time both to raise efficiency and to reduce demand pressures. Irish economic growth should start to slow down steadily next year with gross domestic product growth of 7.9 per cent, followed by 7 per cent in 2002, from a projected 11 per cent this year, the Paris-based think tank forecasts. As labour shortages become more pronounced, Irish economic growth will slow down, it expects.
Strong broad-based economic expansion is forecast for the current year. While the OECD expects Irish wages to increase rapidly, it forecasts that inflation will peak this year and then decline slowly to below 4 per cent by 2002.
Tight labour market conditions will mean high wage increases which, in turn, will stimulate demand for imports. The OECD expects imports to rise and exports to slow, gradually moving the current account into deficit next year.
The key policy issue for the Government will be to ensure that price and wage increases do not get out of control, it warns. Price and wage increases have, in part, been stimulated by the weak exchange rate and oil price rises, it allows.
On inflation, as measured by the harmonised consumer price index, the OECD says increases in indirect taxes accounted for three-quarters of a percentage point of the increase from 2 per cent in the middle of 1999 to 5.75 per cent in the third quarter of this year. Another factor was the rapid rises in the cost of goods and energy because of the weakness in the nominal exchange rate and oil price rises. These causes may be temporary, but there has been a rapid rise in service prices in response to strong demand and the need to pay wages similar to those in the high-productivity exporting sectors, the OECD stresses. It warns that "possible second round effects from compensatory wage increases have become an issue as pressures mount to change the terms of the national wage agreement".
The OECD says that the main risk to its latest forecasts is that the current surge in inflation could become entrenched in expectations leading to both wages and inflation overshooting and resulting in a greater slowdown in activity than forecast.
On the global economy, the OECD says growth appears to have peaked, with growth in most OECD countries expected to slow. The United States has become the Republic`s largest export market, passing out Britain for the first time since records were collected.
Sales of Irish-produced goods to the US have risen in the eight months from January to August by 55 per cent to just over £8 billion, while trade with Britain has grown by 22 per cent to top £7.9 billion. Total exports for the period were £41.2 billion, a rise of 25 per cent. Imports totalled £27.6 billion, giving a surplus of £13.6 billion. One of the biggest components of the increase in exports to the US has been organic chemicals which rose 55 per cent to £8.75 billion. Organic chemicals include the active component of Viagra, the impotency drug, which is manufactured in Cork and exported to the US.
