Mismanagement will worsen coming crisis

Yesterday's Irish Times supplement on the economy sounded a fairly optimistic note about the year ahead

Yesterday's Irish Times supplement on the economy sounded a fairly optimistic note about the year ahead. This seemed, however, to reflect the views of business economists rather than the more detached opinion of economists outside the business sector.

The end of the US boom had always been bound to create problems for a small European economy as dependent as Ireland is on investment by US firms, and lately on exports to that country.

(In one of her articles yesterday Jane Suiter said most products manufactured by US firms here are re-exported to the EU: while this is true of computers and related equipment, the opposite is the case with chemicals and pharmaceuticals, which have contributed two-fifths of our total export increase this year, all of this due to exports to the US.)

Because of the inevitable dollar/euro adjustment at the end of the US boom, indigenous Irish firms - many recently having it easy in export markets because of the euro's under-valuation - are likely to lose markets abroad as well as at home.

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While most of the commentators in yesterday's supplement seemed to base their optimism about 2001 on the likelihood of a soft landing in the US, Elaine Lafferty reported that most economists thought a US recession was a real possibility next year, with the American economy landing much harder than anticipated. And our economy could scarcely have been managed worse in the run-up to this potential crisis.

Even had we not been at hazard from possible events in the US, it would have taken considerable economic skill to wind our own boom down gently as we approached the buffers of full employment. For the whole thrust of the management of our economy for decades has been the maximisation of economic growth, with a view to ending emigration and unemployment, so it was never going to be easy to secure the overnight, profound policy shift needed to deal with full employment.

One could have forgiven a government which, in these difficult circumstances, misjudged the fine-tuning required to bring us safely through a situation which has few parallels anywhere else. But it is going to be difficult to forgive the Government's refusal to even recognise that we were facing a potential crisis.

Instead, our Government has done everything in its power to accelerate economic growth further, just when we needed to control our domestic boom.

Let's go back a couple of years to look at recent budgetary policy.

In 1998 our economy grew by almost 8 per cent, and unemployment fell from 8.7 to 6.4 per cent, clearly heading for full employment within two years. The Minister for Finance, Charlie McCreevy, had not yet entirely lost the run of himself, for in his budget speech he referred to four pressures "that we have to watch closely and make sure they are tackled".

He went on to specify these as an acceleration in pay increases, which "concerned" him; a scale of domestic price increases that made him "unhappy"; labour shortages in certain sectors; and a continued very rapid rise in house prices which was "a cause for concern".

During 1999 the economy again grew by almost 8 per cent, and unemployment fell from 6.4 per cent to 4.7 per cent, getting very close to full employment. What did the Minister then do, faced with the imminent prospect of full employment and with a 3.5 per cent, accelerating, increase in consumer prices?

First of all, far from sounding an even stronger note of caution, he chose to mute the warnings of a year earlier. And then he proceeded, by offering huge tax cuts, to accelerate economic growth.

And he did this so clumsily that these massive tax cuts had to be followed by further tax concessions to calm his own backbenchers' anger.

A year ago his Department's budget forecast stated that even before these additional post-budget tax cuts, his budget had added 2 per cent to growth in 2000. This raised GNP growth in 2000 to well over 8 per cent instead of allowing it to fall back to 6.3 per cent, as his Department said would have happened if he had introduced a neutral budget.

And so we roared through 2000 with the second-highest rate of economic growth ever recorded in Ireland - straight into the buffers.

Finally, just four weeks ago, with unemployment now down to almost 3.5 per cent, and inflation at 7 per cent (in part because inflationary pressures aggravated by past budgets had pushed service prices up by that amount), Charlie McCreevy introduced a Budget that boosted disposable income by an additional 3 per cent. According to his Department's estimates, this is likely to boost the rate of private consumption growth to 8.5 per cent next year.

What a way to face into the kind of crisis that could result from a possible hard landing in the United States.

The dangers of this situation are recognised in the Department of Finance, although not apparently by the Minister, who is clearly gambling on something turning up. For, in its report on the economy prepared last month, the Department took care to mention some of the risks it saw facing us, while still expressing some optimism about the year ahead.

Thus: "Prevailing tightness in the labour market creates a risk that the economy could overshoot . . . The ensuing loss of competitiveness would damage economic and employment growth, push up unemployment and undermine capacity for further social progress . . . Therefore, while the benign scenario of gradually moderating growth is seen as the most likely path for the economy, there is a range of factors that could upset these economic and budgetary projections."

One cannot help wondering whether in the light of developments in the US since that was written, the Department would today maintain the optimism that on balance it expressed last November.

All this has potential political implications. There is now every reason to believe that the economic situation may worsen at some point during the year ahead . An election postponed until mid-2002 might take place in very unfavourable circumstances.

So, even if the PDs are not provoked by some tribunal event into leaving the Government and precipitating a premature election, it cannot be excluded that the Taoiseach might himself decide to make a run for it before the kind of events the Department of Finance envisaged last month as a downside risk actually come to pass. That might offer the best prospect of Fianna Fail returning to power.

And, if returned to office, Bertie Ahern might then decide to appoint someone other than Charlie McCreevy to the Finance portfolio, to handle the consequences of the mishandling of the economic situation in the past two years.