Chris Johns: Ireland faces bigger threats than overheating

The OECD has joined the chorus warning of the potential of an overheating Irish economy. Overheating is one of those things that is often mentioned, but there is no commonly accepted definition of the term. Different people use it in a variety of ways. It’s talked about with dubious confidence: we know it when we see it but that certainty often arises from a glance in the rear-view mirror.

Fretting about overheating is almost as common as calls for “structural reform”. OECD reports on Ireland for decades have asked for structural policy changes. It sounds good, is often based on real concerns, but can sometimes not be terribly helpful – or politically practical.

For instance, EU policymakers are currently advising Italy that what is needed is structural change rather than political turmoil. It might be true, but it is as unhelpful as it is tone deaf. Some politicians need to take a refresher course in emotional intelligence.

Alan Greenspan, the famous one-time US Federal Reserve chairman, once said that bubbles are near impossible to see in real time, and are best dealt with once they have burst. His point was that we can get it wrong – jump at shadows – and do as much harm as good.

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He has been pilloried for this perspective (and much else besides) but his point is a good one. We need to be careful. It is important to dig deeply into what overheating actually means, describe what is causing it, what the scale of any likely problem will be, and which policy levers are best suited – if any – to do something about it.

Obvious candidate

To be fair to the OECD, they do some of this. But what is overheating? Inflation is always an obvious candidate, either of the headline variety and/or via wage pressures.

Wage growth is picking up in Ireland, and the OECD is forecasting a rise in inflation to just over 2 per cent next year. But that’s a forecast, with all of the usual caveats. And I wonder whether inflation at that level qualifies as overheating.

The balance of payments is another suspect, but there is nothing in the data that suggests any concerns. And for as long as the Central Bank keeps its regulatory grip on the banks, credit growth should not cause a problem.

Policy should be about acknowledging all risks and problems, particularly the ones that are real

Most commentators rightly say that inequality is one of the main scourges of the modern age. Inevitably the focus is on the US, which does have a problem, as do others. But thanks to the redistributive nature of Ireland’s tax and welfare system, domestic inequality looks good in an international context. There is inequality in the data for pre-redistribution wages. So a bit of pay growth may not be a bad thing, particularly if it occurs at the lower end of the scale.

Ultimately, however, wages depend on productivity, and Ireland has an issue here. Low productivity in many firms is on the OECD’s list of concerns, and should be at least as big a focus for policy as overheating. Productivity is a real problem, whereas overheating is only a maybe.

Most central banks target 2 per cent inflation. So the OECD’s forecast doesn’t look to be a big deal. Ireland’s much vaunted labour market flexibility could help: if wages do eventually damage competitiveness the harm may not be too great before the problem starts to self-correct.

Nearest lamppost

I wonder whether worry about overheating is the economic equivalent of the drunk who looks for his dropped keys only under the light of the nearest lamppost? Is overheating the biggest threat that Ireland faces? Surely lack of affordable housing is a bigger issue?

My own view is that overheating pales into insignificance behind Brexit and the crisis that will be unleashed should Italy leave either the euro and/or the EU. Trump’s trade war is a big worry.

Our policymakers are doing a great job with limited means when it comes to Brexit, but the question remains: are we doing enough to prepare for a hard UK exit? Italy, I suspect, is understandably filed in the “too difficult” box.

Policy should be about acknowledging all risks and problems, particularly the ones that are real, rather than threatened. Dealing with the problems of today and building resilience to a wide variety of potential shocks, most of which we cannot foresee, is at the heart of good policymaking. I suspect the overheating warnings are partly a device for pressuring the Government for tighter fiscal policy.

There are good reasons for budgetary caution – don’t spend corporate tax revenues as if they are permanent, for instance – but overheating is not high on that list. Coded warnings risk being unhelpful, and lack both transparency and the context of an overall analysis of what is really needed.