Uncertainty is the theme for the economic outlook heading into 2003. A tentative recovery evident in the world economy in the early months of this year has fizzled out. Confidence was affected by the fall-out from a series of financial scandals in the United States.
This contributed to a period of weakness on financial markets and affected confidence and investment. More recently, another factor has emerged - the threat of war in Iraq. In turn, the impact of these factors internationally has taken its toll on the Irish economy, which has shown signs of weakness in recent months.
Developments in the Middle East will be the dominant theme not only in the political field in the early months of next year, but also economically. A rise in oil prices in recent weeks has been the most obvious symptom of this. However the threat of conflict has also dampened business confidence and stalled the hoped-for rise in investment necessary to kick-start recovery.
Economic strategists have been calculating the potential impact of a range of possible "war scenarios." A quick victory by US-led troops could lead to a temporary and limited rise in oil prices, they calculate, while a prolonged conflict could send prices higher for a prolonged period, dipping the world economy into recession.
At this stage, given the political uncertainty, there is little point debating these theories in great detail. However it is clear that the prospect of war will provide a significant deterrent to investment at the start of next year and that, if there is a war, its course will have a major impact on economic prospects.
For international economic policymakers, this creates a difficult backdrop. Already, they face significant problems. The US economy has worked through much of the excesses of debt which contributed to weakness early this year. However a large current account balance of payments deficit remains and the US government has pushed its finances into the red trying to stimulate the economy. Nonetheless, there is reasonable hope of some pick-up in the US later next year.
The outlook in the big euro-zone economies is less bright. Germany, in particular, is mired in recession and both business and consumers appear to face something of a crisis of confidence. The Schröder government is struggling to chart a way forward.A further reduction in euro zone interest rates is thus a possibility, even though this would not suit Ireland, where inflation remains a problem. The Japanese economy, meanwhile, shows no sign of emerging from its lengthy recession.
Little wonder, then, that the main forecasting agencies have downgraded their forecasts for international growth next year. Most expect the main world economies to grow by 2-2.5 per cent next year, with the euro zone likely to grow by less than 2 per cent. All emphasise that the risk is, if anything, that growth could be even lower than this, if the expected recovery in the second half of the year does not kick in.
What then for our economy? The outlook is for a difficult start to 2003, with the persistently high rate of inflation being the major concern. If this leads to a sustained spiral of wages and prices, then the consequences in terms of competitiveness and employment could be serious.
The coalition partners in Government need to quickly get a grip on the situation, starting with the public finances.
Exchequer returns for this year, due to be published early in January, are likely to show that spending growth was held to around the 14.5 per cent target for 2002. This is some progress from the position at end-September. However it is still the case that the 14.5 per cent target was too high in the first place, particularly following on from even faster spending growth the previous year.
Spending targets for next year must be strictly adhered to. Crucially, the Minister for Finance, Mr McCreevy, must follow through on commitments to secure better value for money, both in day-to-day and capital spending. His colleagues in the Cabinet must share the responsibility of achieving this. Wasteful spending is not a problem which can be tackled overnight, but tackled it must be if we are to have any prospect of having the kind of public services and infrastructure which are required.
The Government must also develop a clear strategy for dealing with inflation. It was a mistake to increase excise duties and VAT to such an extent on Budget day that the inflation rate could touch 6 per cent next month. This high inflation rate, combined with the tight exchequer finances and the cost of public pay benchmarking, have made talks on a new national partnership agreement very difficult. Achieving a deal would add a welcome stability to the economic outlook, but only if it is on the right terms.
Measures to promote competition in protected sectors of the economy must also be pursued vigorously, as a further means of holding down the rate of inflation.
Heading into a difficult economic period, we need a Government that can focus on the key issues of competitiveness, inflation and efficiency in public spending.
There is nothing that our policymakers can do about the international picture, which will determine the short-term outlook. Rather, their job is to do all in their power to ensure that when the international upturn comes, the Republic will be in a position to take full advantage.