In the room with "Recession" written on the door lives an elephant named public sector pay and pensions, writes Danny McCoy.
THE CASCADE of bad economic news over the last 12 months has finally pushed the Irish economy into recession, according to the latest quarterly forecast from the ESRI. The institute's prognosis, while grim, is certainly not fatal if correct responsive actions are taken. It must be borne in mind that the aim of any forecast is not to precisely predict the future but to advise on how to take meaningful action in the present. Here the ESRI has some significant advice for those who want to face up to reality. Failure to do so would undermine Ireland's future economic prosperity. A necessary measure identified by the institute is the containment of public sector pay.
The rise in unemployment is already prompting a greater degree of wage restraint in the private sector through market forces. This pay restraint must also be reflected in the job-secure public sector. The private sector will not be prepared to pay for higher public sector pay growth through the loss of their jobs or businesses. The rapid deterioration in the public finances has to be addressed. The only way of doing this, while sustaining Ireland's long-term prosperity, is by reining in current expenditure while preserving much of the capital expenditure committed under the National Development Plan. Given the scale of the public sector wage and pensions bill, a pay pause in the public sector needs to be given serious consideration by the Government in the national interest.
In the absence of control over monetary policy, fiscal and incomes policies are among the only tools left for Irish policymakers to address economic downturns. The emerging pressure on our public finance must be used to gain control over current spending, which has been growing at excessive rates in recent times of buoyant revenue growth. Public sector pay and pensions is the elephant in the room that must now be tackled. It is necessary, though by itself not sufficient to restore the public finances to a sustainable path.
Public finances are under pressure from both sides of the balance sheet. Tax revenue will fall below 2007 levels this year and next. Housing-related activity, which has driven strong revenue growth, will no longer boost the Government coffers. Increasing unemployment and the return of emigration will depress revenues from income taxes. On the expenditure side, the deteriorating labour market will drive up the number of people on unemployment benefit and social security.
In the absence of budgetary intervention, the ESRI projects a general Government deficit of 3.9 per cent in 2009. This would be the first time Ireland has breached its obligations under the EU's Stability and Growth Pact (SGP). We would by no means be the first member state to do so and the pact does allow for excessive deficits considered "temporary and exceptional".
Going from GDP growth of 5.3 per cent one year to a fall of 0.4 per cent the next can certainly be classed as exceptional. While Ireland may not face sanctions under the excessive deficit procedure, the importance of the SGP rules must not be underestimated. Adherence to the rules sends an important signal to international markets about Ireland's economic management. At a time when we again look to the external sector as a source of growth, we must improve our standing as an internationally attractive location.
Rising unemployment poses a problem wider than just its fiscal implications. Many of those affected were employed in the construction sector. Activity will recover over the medium term, with demand estimated at just below 50,000 units per annum. A return to the frenzy of 2006 with nearly 90,000 completions, however, is neither desirable nor likely. It follows then that many construction workers must find employment in a different sector of the economy. The transition can be difficult, as Ireland is increasingly becoming a knowledge-driven economy. Great responsibility is placed on State agencies involved in training and education to ensure that the skills gap is bridged.
The ESRI points out that the collapse in domestic demand, in both personal consumption and corporate investment, particularly in construction, will be the main drag on economic growth this year and next. More positively, net exports have returned to be a positive driver of economic activity. This renaissance is primarily a result of the strength of services exports. While this is a welcome indication of a brighter future once the international fog of uncertainty abates, it is not inevitable that Ireland will retain its current market share of the expanding global economy. Irish competitiveness remains seriously challenged by a high domestic cost base and less than stellar growth in productivity.
The desire to have a sustainable society, founded on a competitive, environmentally sound economy, will be seriously challenged during this current slowdown. Important as it is to look beyond the current situation to build for the future, the bedrock of sustainability is a competitive economy. It was ever so for a small trading nation, despite the denial of the primacy of competitiveness in some quarters in recent years.
As a small, regional economy, Ireland is vulnerable to falling out of fashion with international investors. Evidence can be found in the fact that the Irish Stock Exchange index has lost nearly half its value since its peak a little over a year ago. Ireland must recreate its attractiveness for foreign investment. As a tiny trading nation, this is the only way to survive.
Many commentators this week have invoked the spectre of Ireland of the 1980s. We are a long way from there yet but in the words of Mark Twain: "History doesn't repeat itself, but it does rhyme." The task for Government, for employers, for unions - all stakeholders in Irish society - is to ensure that this does not happen. The ESRI in its Medium Term Review 2008-2015has mapped out a path for the Irish economy. Return to growth is not something that will automatically happen. However, it is something we actively choose by making the right choices. We must continue to invest in the productive capacity of the economy. While this has been a residential construction-led slowdown, at a time of a weakened global economy, there are many strengths to Ireland's economy. Irish businesses have repeatedly shown themselves to be resilient in the face of stiffer international competition by moving to higher valued-added activities.
The opportunities for Ireland are immense and the ESRI's projected medium-term potential growth for the economy is likely to be in the order of 3.5 per cent. This year we will underachieve that potential, with rising unemployment the major consequence. However, with the right competitiveness combination of productivity enhancement and cost containment, Ireland can re-emerge stronger in tandem with the inevitable resurgence of the global economy.
What we need today is realism that the Irish economy is in significantly choppy waters, but if we all stay on board together and row in the same direction to restore competitiveness, our economic fortunes can be rekindled.
Danny McCoy is director of policy at the Irish Business Employers Confederation (Ibec)