Icarus economy unlikely to crash down to earth

The extraordinary economic boom of recent years has led to many a forecast that a "bust" lies ahead. Parallels are drawn with Britain in the late 1980s, or the collapse around the same time in the high-tech driven New England economy. It is only a matter of time, the doomsters argue, before the "Icarus economy" crashes down to earth.

There is no doubt that there are risks in the economic outlook. But, as a member of the single currency zone, a much greater risk than a sudden collapse is a slow and grinding downturn, because of the economy losing its competitive edge.

As the Economic and Social Research Institute said in its latest commentary this week, "the adjustment to an undue relative inflation of costs is likely to prove a long and difficult process".

Let's look at the crash theory first, which by the way is commonly held in big investment houses in London. If the economy is going to head into a downward spiral, then a catalyst is needed. The most obvious one would be higher interest rates. A sharp rise in borrowing costs would compel many homeowners to pull back their spending, as happened in Britain in 1988-90. Euro interest rates are likely to start to edge up next year, but overall borrowing costs here should not rise by more than one percentage point from current levels. Indeed, given the new competition in the market from the Bank of Scotland, mortgage costs may not stand much higher in a year's time for the average borrower than they do now.

Who knows what lies ahead for euro interest rates over the next five years or so. But there is no reason to suggest that they will rise sharply enough to have a significant impact on borrowers here. What else could cause a "crash?" Perhaps a serious loss of employment in a major sector of the economy? The most obvious risk lies in the high-tech sector, where 15,500 people are employed directly in the top seven US firms here - which together have plans to raise this to more than 20,000 in the next couple of years.

These firms account for nearly £2 billion (€2.54 billion) in spending in the economy each year - according to Forfas figures - one-eighth of wages in the multinational sector and one-third of all Irish raw materials purchased by the multinational sector. Together they also indirectly support thousands of other jobs. The catalyst for the downturn in New England was a collapse in the mini-computer industry (who remembers them?) and in government defence spending, the two bedrocks of the boom there. The fast-moving nature of the high-tech industry means that one or two of the big firms here could - probably will, given the pace of change in the sector - face rocky patches in the years ahead. But a massive shakeout in the high-tech sector is not on the horizon. Fortunately, most of the big operations here are diversified and are moving into higher value-added manufacturing and research activities.

More vulnerable in the years ahead will be the lower-tech manufacturing plants in consumer electronics and - possibly - some call centres which could easily be switched to lower cost locations in the years ahead. So, like all other developed economies, we face challenges in the years ahead from lower-cost locations for many jobs, but there is no reason at the moment to predict a serious downturn in the employment graph.

So if a "future shock" to our economy is not in prospect from either higher interest rates or a collapse in the jobs market a sudden bursting of the economic bubble looks most unlikely. Instead, we will either head for a "soft landing", with economic growth easing back to a more sustainable level of, say 4 to 5 per cent a year, or growth will ratchet down to an even lower level.

Over the next couple of years, the main threat to growth would be if the economy loses its competitiveness - most likely through a sustained increase in the cost of wages or other costs to business. For this reason, as the ESRI highlights, it is important that the next national agreement, if there is one, maintains a reasonably moderate basic pay increase level. Employees could then be further rewarded through tax reductions and, crucially, through the much-wider application of profit and other gain-sharing mechanisms. Whether such a deal can be negotiated at all remains to be seen.

The difficulty of losing competitiveness within the single currency zone is that there is no possibility of devaluing the pound to help compensate.

In the absence of this currency buffer, higher costs - unless they are offset by rising productivity - will reflect in lower employment, falling profits and lower economic growth. And the price of a sustained loss of competitiveness would be a sustained underperformance in terms of economic growth - not a dramatic collapse but more a gradual and potentially unpleasant slowdown.

At the moment, it looks more likely that the economy can continue to perform reasonably strongly in the years ahead. The challenge facing economic policymakers is to leave us in a position where we can continue to outperform the average. The key decisions will be how to attack specific problems in the economy such as the housing crisis and labour shortages and how to invest most efficiently to build the economy's productive performance.