Gloomy ESRI outlook on investment performance

The ESRI has taken a more pessimistic view, writes Paul Tansey, Economics Editor

As autumn has turned to winter, the Economic and Social Research Institute (ESRI) has cut its 2008 forecast for growth in real Gross National Product (GNP) from 2.9 per cent to 2.3 per cent. A steeper forecast decline in house building activity next year is the principal reason for the ESRI's more pessimistic assessment of the economy's growth prospects.

In its autumn commentary, the ESRI had projected housing completions at 65,000 in 2008. Now, in its winter commentary, it has reduced its forecast for housing completions next year by 10,000 to 55,000.

The importance of house-building to the national economy has been magnified by the housing boom. By 2006, when housing completions reached an unmatched 88,000, housing accounted for half of all gross fixed investment spending in the economy and for more than 15 per cent of Gross National Product.

Since housing looms so large in total fixed investment, the steep declines in housing output forecast for 2008 are dragging overall fixed investment into negative territory.

As can be seen from the table below, the ESRI is now projecting that overall gross fixed investment next year will decline by 3.7 per cent. Thus, the contraction in house building is now subtracting substantially from national economic growth.

The ESRI has also reiterated its earlier forecast that house prices in December 2007 will be 15 per cent lower than in December 2006. Given the magnitude of this projected fall in prices, the ESRI says that it expects house prices to stabilise during 2008.

In its latest forecast, the ESRI has also adjusted downwards its forecast for the growth in consumer spending volumes in 2008 from 4.0 per cent to 3.8 per cent due to a weakening in consumer confidence evident in recent surveys.

These two factors - reduced housing completions and a weaker tone in real consumer spending - underpin the downward revision from 2.9 per cent to 2.3 per cent in the ESRI's forecast for real GNP growth in 2008.

The ESRI's latest GNP growth forecast for 2008 is half a percentage point lower than the 2.8 per cent GNP growth forecast contained in Budget 2008, published just a fortnight ago.

The table below compares the components of both forecasts.

As can be seen, there is a great deal of common ground between the two sets of forecasts. Both anticipate real consumer spending growth of 3.8 per cent next year.

Projections for the growth in real Government day-to-day spending are similar.

The substantive point of difference between the two forecasts lies in expectations about investment performance next year. The ESRI is forecasting a 3.7 per cent decline in the volume of gross fixed investment in 2008, whereas the Department of Finance is anticipating a fall of just 1.6 per cent.

This divergence is difficult to explain for two reasons. First, both forecasts agree that housing completions - the largest component of fixed investment - will reach only 55,000 next year.

Second, the ESRI is more optimistic about capital spending on machinery and equipment - which accounts for almost one-quarter of all fixed investment - than the Department of Finance.

Where the ESRI anticipates an 8 per cent volume increase in capital spending on machinery and equipment, the Department expects only "a small positive growth rate" in this component of investment.

The only feasible explanation in the circumstances is that the Department knows something about public capital spending or tax-based investment incentives that has yet to be revealed to the rest of us.