High mobility of capital and technology means prospects of economy are unclear

Opinion: In the short term there is a prospect of a spurt of growth but attention needs to be paid to sowing the seeds of long-term prosperity

Fri, Jan 10, 2014, 00:01

A conference being held today in Dublin, “Future Directions for the Irish Economy” (organised by the European Commission and Trinity College Dublin), provides a timely opportunity to debate the policy choices facing the political system in shaping Ireland’s economic future.

In particular, there is considerable uncertainty about the future prospects for the Irish economy. In part, this reflects a broader debate concerning the growth potential of advanced economies (for developing countries, “catch up” dynamics can drive growth for some time to come).

However, special features of the Irish economy mean that its future path is especially unclear. At a structural level, the very high international mobility of workers, capital and technology is a defining characteristic that means the range of possible growth outcomes is much wider than for most other advanced economies. At the same time, high openness means that policy choices are especially important, since there is a large payoff to successful policies that encourage inflows of workers, capital and technology and a severe penalty for poor policy choices that result in corresponding outflows. Of course, high openness also means that Ireland is especially exposed to the spillover impact of foreign policy choices (for instance, changes in the US corporation tax regime pose an obvious risk).

The legacy of the crisis is another source of uncertainty. There are few relevant precedents to inform estimates of the long-term impact of Ireland’s high levels of sovereign debt, private-sector debt and net external liabilities. This adds a layer of complexity in evaluating policy initiatives, since the “balance sheet” effects of reforms must be assessed in addition to their potential impact on future economic performance. It also leaves Ireland vulnerable to upward movements in global interest rates, which are increasingly likely as the world’s major central banks move to normalise monetary conditions in the next few years.

In the short term, there should be considerable scope for a growth spurt, building on the encouraging signs of elevated activity levels during the second half of 2013 and facilitated by the recovery in the US and UK economies. However, while very welcome, this phase of recovery from a severe economic slump does not in itself lay the foundations for robust long-term growth.

After five tough years of crisis management, it is appropriate that the economic policy debate pivots towards longer-term issues. While the government’s Medium-Term Strategy 2014-2020 (published in December 2013) lists many of the ingredients of a pro-growth regime, the political system must grapple with fundamental choices in setting priorities and combining the individual components into a unified growth strategy. Growth policies typically play out over a 15-30 year horizon, such that 2014-2020 is not a sufficiently long horizon in evaluating the net benefits to various economic policy reforms. For instance, reforms to the education system might have a substantial long-term impact, even if there is little direct impact on economic performance over the next 5-10 years.

Given the constrained fiscal situation, the government cannot realistically pursue every possible growth-enhancing policy initiative, so that priorities must be established. In particular, there are multiple possible trajectories for the Irish economy, with different sustainable combinations across the various sectors (multinational sector, indigenous export sector, domestic sector and public sector). Making a choice among these alternative pathways is an important challenge for the political system; in turn, this choice should determine the underlying long-term strategy that guides decisions about each individual policy proposal.

In related fashion, the political system must also find the balance between economic growth and other policy objectives such as social cohesion and environmental sustainability. While faster economic growth can make major contributions to other policy goals (reducing long-term unemployment is an important element in improving social inclusion; the extra tax revenues generated by a larger economy can finance more spending on environmental projects), some genuine trade-offs remain. In common with many other countries, a fundamental challenge facing Ireland is to find the balance between maximizing growth and attaining a socially-sustainable income distribution, in view of the global trends (new technologies, globalisation) that are fostering greater inequality in market-driven earnings.

A further challenge for the political system is to maintain the fiscal discipline that is necessary for financial stability, especially given the temptation to pay a post-crisis “success dividend” in the form of tax cuts or spending increases. While activity levels might be temporarily boosted by a relaxation of fiscal targets, it is still necessary to lower the debt-GDP ratio to a “safe” level over the medium-term, since Ireland remains vulnerable to a return to crisis conditions so long as sovereign debt hovers at such a high level. Moreover, the incomplete and gradualist approach to banking union that has been adopted at the European level means that the sovereign-bank “doom loop” remains an important source of contagion, with sovereign risk also endangering the stability of the domestic banking system. In this regard, the willingness of the political system to take guidance about the prudent level of the fiscal balance from the Irish Fiscal Advisory Council will be an important theme in the coming years.

Finally, it is desirable that the political system has access to high-quality economic analysis and robust empirical evidence in formulating its strategic policy choices. In principle, the Irish Government Economic and Evaluation Service (IGEES) that was established by this government in 2012 can fulfill this important advisory role by undertaking and publishing the specialist studies that are required to underpin critical economic policy decisions.

Philip R. Lane is Whately Professor of Political Economy at Trinity College Dublin

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