The growth of our economy last year was seriously underestimated. The 1997 Budget was based on a forecast 5.5 per cent GNP rise, and up to the middle of the year the Central Bank and the Economic and Social Research Institute were sticking to this figure.
Then they revised it up to 6.75 per cent. Not until December did they recognise that this was far lower than the rate at which our economy was growing, and the Central Bank refused to contemplate a growth rate higher than 7.5 per cent for the year just ending. The ESRI, more realistically if belatedly, revised its estimate of 1997 GNP growth to 9 per cent.
This reflects a recent consistent tendency to underestimate our growth rate. Over the three preceding years, 1994 to 1996, the ESRI's mid-year estimates proved to be more than two percentage points too low on average, while the Central Bank erred on the low side by over 2 1/2 percentage points each year.
These consistent errors were of about the same magnitude as the actual average growth rate of the rest of the European Union in these years.
Not surprisingly, I am inclined to be sceptical about their growth forecasts for the current year. The Central Bank projects a growth rate of 6.75 per cent for 1998, and the ESRI has forecast that this year's growth will fall by a third, to 6 per cent.
The ESRI has offered three reasons for this forecast of a sharp reduction in our economic growth rate this year: the Asian economic crisis; a belief that "some slowing down of growth would be normal at this phase of the economic cycle", and that this will not be fully offset by the expansionary Budget; and the expected fall in interest rates and supply constraints.
On the first point, in its analysis of the international economy the ESRI points out that the impact of the Asian crisis is likely to be smaller in Europe than in the US, and could be largely offset by lower interest rates.
Indeed, its own forecast for the European economy suggests that the Asia factor will be more than offset by lower interest rates. It projects an increase of almost a quarter in the EU growth rate this year, and 70 per cent of our exports are shipped to European countries.
The second reason the authors of the Institute's Quarterly Commentary give for their forecast seems equally unconvincing. For we do not seem to be at a point in a growth cycle when a downturn could reduce this calendar year's growth rate by a third compared to last year.
Export data, industrial output figures and retail sales in 1997 all point to a sharp acceleration in growth in the second half, and for a 9 per cent growth rate in the calendar year, it must have been running at an annualised rate of 10-11 per cent between last June and December.
Even if, since Christmas, there has been some slowing down, the annualised growth rate of the early months of this year can scarcely have fallen back to below 8 per cent. This seemed to be confirmed by Exchequer receipts at almost 10 per cent above last year's level. The consumer price rise in January of 1.8 per cent suggests a growth rate of around 8 per cent.
Now, if economic growth is running at around 8 per cent, an average growth rate of 6 per cent for the calendar year implies a deceleration of growth to 4 per cent by the end of the year, and that seems improbable.
Indeed, with further large employment increases due, as foreign-owned high-tech firms expand capacity and establish new plants, with income boosted by tax cuts in April, and with short-term interest rates likely to fall by 2 per cent by the end of the year, it seems more likely that domestic demand will accelerate again in the second half than that the rate of growth will halve between now and then.
It is true that sooner or later we will face serious supply constraints. Already a domestic shortage of workers with the kind of education and skills required by modern high-tech industries is emerging. And the recent substantial inflow of returning emigrants with such skills may soon diminish in the face of the sharp rise in housing costs here, especially in and near Dublin, Galway and Cork, where most of the new skilled jobs are being created by foreign-owned, high-tech industries.
But this labour supply problem will not halt growth overnight: rather will it develop gradually over several years, exerting an intensifying inflationary impact on pay rates, which could gradually spread outwards from key areas, such as the software sector, to other parts of the economy.
Once again, all this does not point to a sudden halving of our growth rate within 12 months.
To sum up, while our quite extraordinary growth rate of the last few years may well taper off in the next year or two, it is most unlikely that our 1998 growth rate will fall as low as the ESRI's 6 per cent forecast. Even the Central Bank's forecast of 6.75 per cent growth in the calendar year 1998 seems on the low side.
Now there is a danger that these forecasts of a big drop in our growth rate this year may encourage a belief that we are well on the way to a "soft landing" after extraordinarily rapid economic growth.
On the contrary, against this background of a probable slower easing of the growth rate than forecast, and given the impending inflationary pressures, both domestic (because of a growing shortage of suitable labour) and external (because of the recent sharp drop in the exchange rate of the pound) our economy is now at risk of over-heating.
All this makes a "soft landing" far from certain. Instead, a need for intervention by the public authorities to head off inflationary pressures may emerge before long. And, as yet, there is no indication of any serious preparation for such a situation.
As recently pointed out in The Irish Times and elsewhere, with our impending participation in the single currency, two of the traditional weapons employed by governments to deal with such a problem, increases in interest rates and in the exchange rate, will disappear; indeed, they have already effectively disappeared.
What are we left with?
I have already pointed out in this column that a number of alternative fiscal measures are ruled out. Our EU membership and the operation of the single market preclude increases in VAT rates. Our public authorities are committed to reducing rapidly the rate of corporation tax on services, to bring it down to 12.5 per cent and thus maintain a low tax rate on industrial profits after our exemption from the EU requirement of non-discriminatory tax rates ends.
Next, because of the failure of the recent Budget to increase personal allowances significantly, or to raise the lower tax band level more than minimally, the Government must now commit £350 million to such changes in the next Budget.
And although excise duties on drink and tobacco could be increased, there is a limit to the possibilities of this approach if we are to avoid creating a major diversion of trade to Northern Ireland.
Thus the Government has few weapons left to slow economic growth, should this be necessary to reduce inflationary pressures. And those that remain could be politically very unpalatable, e.g. a temporary reversal of the recent cuts in tax rates; a big increase in hydrocarbon duties, petrol tax; or extending VAT to food. What I have found worrying has been the reluctance of economists to address this aspect of our adherence to the single currency. Terry Baker, in his article on this page last Wednesday, was right to point out that the economic advantages to Ireland of participation in the single currency are now even greater and more clear-cut than when the ESRI came down in favour of it a year ago.
And, as he also pointed out, the likelihood of our facing unsustainable competition from Britain through a devaluation of sterling to a level well below the Irish pound, which from where sterling is now would mean a devaluation over one-third, is now small.
It seems to me that many economists have been too preoccupied with that somewhat improbable eventuality, at the expense of addressing the more likely problem of how in practice we might best tackle overheating and inflation should they threaten to get out of control.
The inappropriately expansionist character of the recent Budget clearly suggests that at Government level the need to be prepared for such a danger is not understood and is not being seriously prepared for.
Paradoxically, the Government seems to have been preparing to deal with the downside of such deflationary action, by building up reserves, many of them hidden, with which to promote a recovery of economic growth after such an episode. But no similar preparations seem to have been made for the deflationary measures, the impact of which would in time require such remedial action.
It is this apparent policy lacuna that makes it important that the issue of how to deal with possible overheating and inflation should be publicly debated now.