Many of the pledges in FF's election manifesto may have to be deferred, writes Paul Tansey, Economics Editor
The prolonged boom in the Irish economy is drawing to a close. While economic growth will continue for the foreseeable future, it will be at a much slower pace than has been experienced over the past decade.
In the 10 years ending 2006, the Irish economy doubled in size and increased the numbers at work by 53 per cent. Those days of wine and roses are now over.
For the three years through 2010, the pace of real economic expansion is expected to decelerate to 3.5 per cent annually, the Minister for Finance, Brian Cowen, announced yesterday. This compares with a real growth rate in Gross National Product of 6.5 per cent during 2006.
The economy has turned. To hammer home the point, the Department of Finance yesterday knocked more than a full percentage point off its growth forecast for 2007. At the time of the last Budget, the department was forecasting a real growth rate in Gross National Product this year of 5.3 per cent; now that projection has been cut to 4.25 per cent.
The department has also reduced its forecast for real economic growth in 2008 from 4.6 per cent at the time of the last Budget to 3 per cent yesterday. This measures the extent of the decline in the economy's fortunes since last December. The department's growth projection for 2008 is in line with other independent forecasts, national and international, for Irish economic performance next year.
The downward revisions of the country's growth prospects make a tough Budget inevitable in December. Introducing the Pre-Budget Outlook yesterday, Cowen said that maintaining the existing level of public services during 2008 would cost almost €51 billion, a €2.3 billion or 4.8 per cent increase on this year's bill. Thus, the Government is having to spend hard in order to stand still in terms of public service provision.
But the Minister is also committed to reducing the rate of current public spending growth from its present annual rate of 13 per cent to something approaching half that level. This would imply a current public growth rate of 7 per cent to 8 per cent in 2008 compared with 2007. However, 4.8 percentage points of this target increase is already spoken for, leaving relatively little room for the announcement of real improvements in the range and quality of public services on Budget Day.
Furthermore, there is no pot of gold on the horizon next year in terms of tax buoyancy. Given the projected deceleration in the rate of economic growth to 3 per cent next year, there will be relatively little extra cash rolling into the Exchequer during 2008. As a rule of thumb, tax revenues at existing tax rates can be expected to climb slightly faster than the rate of growth in money national income. With the economy set to expand by 3 per cent next year and allowing an overall national inflation rate of 3 per cent, the Minister cannot expect overall tax revenues to grow by much above 6.5 per cent in 2008 - unless he increases tax rates on Budget Day.
It is not only the 2008 budget that will be tight. Many of the commitments in the Fianna Fáil election manifesto and the subsequent Programme for Government may now have to be deferred until after 2010.
During the course of the election campaign, Fianna Fáil - to its credit - made it plain that the full implementation of its manifesto promises was grounded on the economy achieving an annual average growth rate of 4.5 per cent over a five-year term. This was a reasonably credible growth forecast at the time. But times have changed, and for the worse.
With the projected rate of economic growth now cut back to an annual average of 3.5 per cent over the three years 2008 through 2010, there will simply be insufficient growth in the economy to permit the introduction of many election commitments within the foreseeable future.
The deterioration in the economic outlook stems from an anticipated weakening of domestic demand in the years immediately ahead. Reduced housebuilding activity is the proximate - but not the only - cause of the deceleration in economic growth. Housing completions are expected to decline from 88,000 in 2006 to between 70,000 and 75,000 this year. Moreover, the downward drift in housing construction is expected to continue, with the Department of Finance forecasting average housing completions of about 60,000 annually in the years to 2010. Even a turbo-charging of government capital spending under the National Development Plan cannot compensate for such a precipitous fall in housing construction. As a result, total investment spending in the economy is expected to stall altogether next year and to recover only slowly thereafter.
While overall investment spending is forecast to be stopped in its tracks next year, the consumer spending spree is also forecast to run out of steam from 2008 onwards. The volume of consumer purchases of goods and services has been rising at an annual rate of 6 per cent this year and last. For the three years from 2008, total real consumer spending is forecast to increase at a much slower average rate of 3.5 per cent annually.
Three principal factors underpin the expected slowdown in consumer spending from 2008 onwards. First, employment growth is set to weaken. The numbers at work are forecast to rise by just 26,000 in 2008, compared with an increase of 86,000 in 2006. Moreover, additions to the numbers at work are projected to remain subdued again in 2009 and 2010. Slower growth in employment means lower growth in personal incomes and hence weaker levels of consumer spending growth.
Second, interest and mortgage rates have risen appreciably over the past year, confiscating discretionary personal income in the process. As a result of higher interest bills, households have relatively less to spend in the shops and on services.
Third, consumers are becoming more cautious, and cautious consumers spend less and save more. Weaker consumer sentiment, combined with the absence of any further SSIA releases to spur consumer spending, will play a part in leading household spending to lower growth paths from 2008 onwards.
While the curtain may be falling on Ireland's boom, it is important to realise that the economy is not heading for the abyss. Real economic growth will continue into the future at reasonable, though not remarkable, rates. Moreover, Ireland will continue to out-perform its neighbours in the growth stakes.