Slow motion

ECONOMICS:The Irish economy is set for a prolonged period of slower growth. In its pre-Budget outlook published last week, the Department of Finance forecast that, for 2008 through 2010, "overall growth will on average be of the order of 3.5 per cent per annum".

In the intervening days, there have been few dissenters among economists from this medium-term assessment.

Two factors support the department's forecast that the economy is moving to a lower growth path in the years ahead.

First, its assessment of the short-run outlook is closely in step with other leading independent forecasters. Its view of next year closely mirrors the 2008 projections presented recently both by the Central Bank and the Economic & Social Research Institute (ESRI).

As shown in the table, all are now anticipating a real growth rate in gross national product in the range 2.9 per cent to 3.25 per cent next year; all foresee a stalling investment performance, induced by a decline in house-building activity in 2008; all expect a marked deceleration in the pace of employment growth next year.

Adding an international voice to the chorus, the International Monetary Fund (IMF) also recently forecast real growth in Irish gross domestic product (GDP) of 3 per cent next year.

Thus, there is a strong consensus among the principal independent forecasters that the economy is set for a fairly steep slowdown in 2008.

However, in extending the forecasting horizon to 2010, the department was venturing into uncharted economic territory. There are no other recent assessments of the economy's medium-term outlook. The ESRI is not due to publish its comprehensive medium-term review until next spring.

Hence, the department's projections of a long goodbye to the boom provoked shock, if not awe, among many.

The second reason the department is on the right track lies in the nature of the slowdown itself. This is not simply a cyclical slowdown prompted by a downturn in residential construction. The underlying trend growth rate for the Irish economy is also faltering.

If the forecast slowdown was purely cyclical in nature, a faster rebound might be anticipated.

After a period of overheating, it might be surmised that the economy would undergo an enforced cooling-off period.

In the course of this adjustment phase, resources would be reallocated from a weakening domestic sector to a still-buoyant international market and the economy would kick on again.

However, this seamless transition is now a receding possibility. Rapid reallocation of resources from the domestic sector is effectively blocked by the erosion of Irish cost and price competitiveness and by decelerating productivity growth.

These latter two factors are now pressing downwards on the economy's underlying or trend growth rate.

As a result, the economy is facing a future where a cyclical downturn is superimposed on a declining trend growth rate.

Prof Philip Lane of Trinity College outlined clearly the likely evolution of the economy's fortunes at the ESRI Budget Perspectives 2008 conference in Dublin this week.

"Taken together," he said, "the deterioration in external competitiveness and the shift in composition of domestic economic activity suggest that Ireland faces a period of slower economic growth over the medium term."

The budgetary implications of a medium-term slowdown in Ireland's growth rate are clear and they transcend the 2008 financial exercise. First, the rate of growth in tax revenues will decelerate, since they are closely linked to the pace of economic expansion. At unchanged tax rates, this means lower income growth for Government.

Second, the very rapid increases in current public spending seen in recent years are at an end.

The pace of future increases in current public spending will need to reflect the lower underlying trend growth in the economy. Where society decides that it wants more public spending than is justified by underlying growth, it will have to pay for it through extra taxation.

Third, since the regaining of competitiveness and the enhancement of productivity growth are the only escape routes for the economy, public investment that can be clearly shown to promote these outcomes is justified, even where it requires recourse to borrowing.