Analysis: Earlier inflation bequeaths high prices in Ireland today, writes Cliff Taylor, Economics Editor
There is one key to understanding the report from the National Competitiveness Council (NCC) on prices. It is that while the rate of inflation has now fallen back to EU norms, the actual level of prices here is now way above the average. The key issue is not that prices are now rising way too fast, it is that the legacy of previous inflation has left us with a problem.
The report outlines this clearly. In the four years to May, prices increased by 22 per cent more than among our European trading partners. Most of this happened between 2000 and 2003, as inflation is now close to the average. Between 2001 and 2002, Ireland overtook the UK and Sweden to become the third most expensive country in the EU for consumer goods and services, behind only Denmark and Finland. Looking at the so-called euro zone, the 12 states that adopted the single currency, we are now virtually on a par with Finland as the most expensive.
There is an argument that higher inflation and rising prices here were a function of the extraordinary growth recorded by the economy during the boom period. And certainly this was a factor. Ireland went through a period of "catch-up" when living standards here moved from well below the EU average to at or slightly above it, depending on what measure you use. This increased wealth was most clearly and controversially reflected in the upward march of house prices.
Some analysts now feel that house prices here have "overshot." In other words, they are higher than justified by the state of the economy and when compared with what prevails elsewhere. Hence the warnings from some quarters of a house price decline.
The NCC makes precisely the same point about consumer prices. Its analysis indicates that the overall consumer price level here has risen by more than is justified by our economic performance. They calculate - and it should only be taken as a rough estimate - that consumer prices here are now 8 per cent above their sustainable level . This is the level which keeps the economy competitive enough to maintain full employment.
This estimate does not seem unreasonable. Looking at the overall price level in the different euro zone countries, the NCC report shows that prices in the Netherlands and Germany, the next most expensive after Finland and Ireland, are 15 per cent below the level here.
So are we being ripped off? There is always a chicken and egg situation to analysing price rises, particularly when looking at the link between increasing incomes on one side and rising prices in the shops and bars on the other. However, whatever allowance is made for currency and other outside factors and the relatively small size of the Irish market, there are some things which are hard to explain. Why have prices in restaurants and cafes increased so rapidly, accounting for close to a fifth of total inflation over the past year? Why are energy costs here now at, or near, the top of the league, particularly for industrial users? And why is Ireland the most expensive country in the euro zone for basic food items, such as dairy products, soft drinks and fruit and vegetables?
Competition is clearly part of the reason. Prices have increased much faster in non-traded service areas of the economy - such as restaurants and pubs - which have accounted for more than two-thirds of inflation in recent years. Lack of competition in areas such as the law has knocked on to high costs in areas such as insurance. In contrast, strong growth in the retail sector means the price of clothing and footwear here is now at the lowest level in the euro zone.
And does it matter, now that the economy is back on a growth path again. The danger with a price level above what it should be is that it leads to a gradual loss of competitiveness and jobs. The NCC points to a 10 per cent fall in manufacturing industry employment over the past three years as evidence of this. Yesterday's announcement by Fruit of the Loom that it was pulling out of Ireland shows that we can no longer compete in some sectors. Fortunately, rising services employment has more than compensated so far. However the danger is that a continued loss of competitiveness will increase the job losses and limit the gains in the long term.