From turmoil on Wall Street to war in Iraq?

From 'cock of the walk' to 'perp walk', how the mighty have fallen, writesCliff Taylor, Economics Editor.

One key uncertainty hangs over the short-term economic outlook heading into the New Year. What will happen in Iraq?

The prospect of war has already affected oil prices. And the uncertainties of the international political situation have eaten away at business confidence. Together with the fall-out from the financial market crises, the rumblings about war in Iraq have hindered any recovery in international investment. There will be no sustained international upturn until the war is over - or cancelled.

Confidence is fragile for other reasons too. It was damaged in 2002, most notably by a string of corporate scandals in the US, which shook financial markets to the core. It has been a long way from the "cock of the walk" behaviour of the tech sector at the height of the bubble in 1999 to the "perp walk" of 2002, as leading figures in Enron and other formerly high-flying firms were arrested for alleged crimes. The resulting blow to investor sentiment contributed to a significant fall in major stockmarket indices for the third year running.

Nor were European markets helped by an extraordinary downturn in Europe's biggest economy, Germany, which does not appear to have grown at all this year and has little prospect of growing next year.

The Irish economy - one of the most open in the world - has not escaped the international malaise.Growth has slowed markedly and the record 10.7 per cent GNP growth in 2000 now seems but a distant memory. If the economy here is to resume on a steadier growth path, then an international recovery is needed - and so far the timing of that remains most uncertain.

The more fundamental question now is whether the Irish economy is merely readjusting to a still-healthy but sustainable rate of growth, or whether next year may see something of a post-boom hangover set in. Many of the economy's "vital statistics" remain, on the face of it, sound. Unemployment, though rising, remains low, our national indebtedness is relatively low and the overall level of national wealth has risen substantially.

But there are worrying signs as well. The rate of inflation is uncomfortably high, pushed up by the indirect taxes imposed by the Minister for Finance on Budget day. This is threatening competitiveness - and this problem could be exacerbated by a rising euro. Our ability to pay for and manage the necessary improvements in our economic and social infrastructure is in question - and in turn this is feeding into wider economic and social problems.

It is a tough and difficult environment for Irish business. There appear to be few signs of relief in early 2003. Most forecasters believe the economy will be sluggish early next year and that an improvement in international conditions will improve the outlook in later months. However, any delay in the international recovery could throw this relatively benign scenario off course.

A key concern for business is that Ireland is now an increasingly expensive place in which to operate. The costs of employment here have moved well up the international league table but other costs are rising too. Insurance costs for many firms are quickly becoming prohibitive, for example. And the poor state of road infrastructure and the resulting congestion also imposes a heavy cost on industry. Costs in other areas have also crept up. A recent report from the National Competitiveness Council estimates that Ireland ranks fourth highest of 16 countries surveyed for office occupation costs, second highest of 10 for house price inflation, second highest of eight major economies for industrial electricity prices and seventh most costly from 16 for telecoms costs.

Competitiveness is key for a small open economy like Ireland, where national wealth and development are driven by the export sector. And there is no doubt that many of the competitive advantages that drove investment and job creation here during the "Tiger" years are either less significant now or have disappeared altogether.

Many of our major multinationals are retrenching after a couple of difficult years and the pipeline for new investment projects is weak, with the possible exception of some significant pharmaceutical plants.

Over the next few years, a key question is whether Ireland can retain a significant share of the mobile foreign investment that is heading towards Europe. We still have some key advantages such as possessing a well-educated and English-speaking workforce. However, the cost of investing here must now look relatively high when compared with other lower-cost locations in Central and Eastern Europe. Now that many of these are heading for EU membership, it is clear that Ireland faces a whole new range of competitors for mobile investment.

This puts more of an onus for growth on the indigenous sector. Here, there has been a new dynamism during the boom years; now the question is how this can survive in more difficult times. Again, the competitiveness of our economy is a significant issue for these firms.

So the economy reaches an important turning-point, with the boom over and nobody quite sure what to expect now. Forecasters believe the economy has a long-term sustainable growth rate of 4-5 per cent. But policy choices will affect whether this potential can be achieved over the next few years. And so will our old friend "events".

In the short term, the first few months of the year will tell a lot. For as long as the prospect of war remains, then the markets and investors will remain nervous about its possible consequences. Unless Iraq can satisfy the arms inspectors - and the US - expect much analysis of the economic fall-out from various types of conflict in the weeks ahead. Naturally, a prolonged conflict would pose the biggest threat to the growth outlook, threatening a lengthy spike in oil prices and seriously affecting US confidence. In turn, the "Iraq factor" will be a key influence on the financial markets, where some stability - after three successive years of red ink - would do much to boost confidence and investment.

So a nervous and uncertain start to the New Year. Internationally, political factors will dominate the economic agenda. At home, meanwhile, the economy and money remains top of the agenda as the Government, business and consumers finally get used to the idea that the boom really is over. The question is: What comes next?