The economy is heading into its most difficult period in many years and the international outlook is poor, writes Cliff Taylor, Economics Editor
The economy stopped in its tracks in the first quarter of this year. Or so the latest data from the Central Statistics Office would suggest. They show no change in Gross National Product (GNP) in the first three months of the year and estimate an average annual growth rate in the first six months of 2 per cent.
Looking out over the next few months, it is difficult to see any significant upturn. On the contrary, the economy looks to be heading for a rocky period as the hangover from the boom years and a poor international outlook combine to dim our prospects.
It would be a mistake, of course, to place too much emphasis on quarterly figures, which are inevitably affected by timing and statistical factors. However two things are clear from the latest figures. The first is that the shuddering slowdown in the economy which started late last year has continued, with growth slowing from 4.6 per cent on average last year to 2 per cent in the first six months of 2002. There is no arguing with Charlie McCreevy's analysis that "the boom is over".
The second is that the Republic is still a "dual economy" in many respects, with a small number of major multinational companies still growing rapidly, while much of the rest of the economy languishes. Gross Domestic Product (GDP) is the figure which measures economic growth before the deduction of multinational profit repatriations. It rose by 5.5 per cent on an annual basis in the first six months, nearly three times the increase in GNP, (arguably the best growth measure because it adjusts for the repatriation outflows).
An analysis of the latest figures from Irish Intercontinental Bank points to extraordinary growth in the pharmaceutical sector early this year as evidence of how the GDP figures can be boosted by the activity of a few large firms. Irish-style growth levels are, of course, quite respectable by the standards of a lacklustre international economy. Make no mistake, the US Federal Reserve Board - its Central Bank - was driven by serious concern about US growth prospects when it decided to cut interest rates this week by half a percentage point. And only a stubborn and unjustified anti-inflation paranoia stopped the European Central Bank from following suit yesterday.
However growth of around 2-3 per cent is bound to feel pretty tardy when compared with the 8 to 11 per cent annual rates recorded between 1998 and 2000. Consumer spending is slowing rapidly, rising by 2.3 per cent in the first half and there was a worrying 1.1 per cent drop in the overall level of investment.
What do the latest figures indicate for the economy next year? They suggest that the short-term outlook is quite poor. The fastest growing area of the economy in the first half of the year was the public service and Government spending, which was running some 9 per cent ahead of 2001. With the Minister for Finance, Mr McCreevy, having no alternative but to apply the brakes to Government spending this year, the contribution of this area to growth is set to slow. Also, international economic conditions - particularly in continental Europe - look fairly depressed in the short-term, which will slow export growth.
The Economic and Social Research Institute, in its quarterly commentary published yesterday, predicts GNP growth of 3.3 per cent next year, with GDP forecast to rise by 4.2 per cent. Overall, they predict a "soft landing" is in prospect. But as the report's authors themselves concede, there remain "substantial risks" to this outlook, arising from uncertainty over the international outlook and the danger that a rising euro and/or high inflation could damage competitiveness.
Forecasting the precise level of economic growth is always difficult, as technical factors can play a significant part. However there is now a likelihood that the economy is heading for what will feel much more like a hard landing than a soft one. The prospects for the next six months or so look fairly grim, with a tough Budget, falling consumer confidence and rising unemployment as businesses come under pressure to cut costs.
The hope is that an international recovery will start to lift growth here towards the end of next year, but at this stage the outlook for the world economy remains uncertain. And unfortunately some of the "excesses" of the boom years will take time to work themselves out of our economy.
Many consumers have borrowed heavily for mortgage or other purposes and will now be cutting back - either because they have to due to falling income, or they choose to because of nervousness about the future. A lot of businesses are also being forced to readjust for more difficult times. And the Government, the economy's biggest spender, is also being forced to trim its sails.
What is the proper policy response to this outlook? The ESRI's advice of a "neutral Budget" - one which neither adds nor subtracts money from the economy - looks sensible. The Government faces a huge challenge in slowing the 20 per cent annual rate of current spending growth this year to the required single figures next year.
Here, its defining action will be how it deals with the public pay benchmarking report - if this becomes merely, as Joe O'Toole once put it, an "ATM machine" giving out money to public servants not linked in any way to increased productivity and a breaking of the old system of pay relativities, then there is simply no prospect of controlling spending next year.
The overriding goal of policy must be to try to ride out the difficult months that lie ahead, while positioning the economy to benefit from an international upturn. With many of our expectations still harking back to the boom years, this will be no easy task.