Economics: Perhaps more than is commonly acknowledged, the year 2000 marked a watershed for Ireland., writes Jim O'Leary

In that year, the economy's traditional locomotive ran out of steam, and its growth dynamic changed in a fundamental way. The Celtic Tiger expired and a constitutionally much weaker animal took its place. I have written about the phenomenon before, but I'm drawn to it again because the more time passes, the more significant the watershed appears, and the more ominous the portents for the future.

First, let's consider the locomotive. In the economy, the role of locomotive has traditionally been played by exports. During the halcyon years of 1993 to 2000, export volumes increased by 17 per cent per annum, driven by huge inflows of foreign direct investment. Since 2000, merchandise exports have virtually stagnated. In the first seven months of this year, merchandise export volumes rose by a paltry 2 per cent, broadly in line with the average of the previous four years.

Over the same period, there has been a steep deceleration in the rate of growth of industrial output. In the January-August period of this year, industrial production was down on the same period of 2004. Not surprisingly, industrial employment has fallen. Here, different statistics paint different pictures. The least dramatic is the Quarterly National Household Survey, which suggests a fall of 26,000 (8 per cent) over the past four years, the first sustained decline in industrial employment since the recession of the mid-1980s.

Concern at the decline of manufacturing would be misplaced if other internationally traded sectors of the economy were growing strongly. It doesn't matter whether Ireland's exports are dominated by medicines and machines or by software writing and financial services and, despite the recent contraction of industrial employment, we have some way to go before industry's share of the total falls to UK or US levels. But the stagnation of manufactured exports has been accompanied by a pronounced slowdown in the growth of services exports too. Indeed, in the first half of 2005, services exports in value terms were barely higher than a year earlier.

Why has the locomotive lost so much steam? Labour cost competitiveness provides an obvious explanation. Since 2000, average compensation per employee here has risen by a cumulative 30 per cent; amongst our main trading partners, the average increase has been about 17 per cent. In addition, currency movements (in particular, the euro's appreciation against the dollar and sterling) have resulted in Ireland's effective exchange rate appreciating by about 13 per cent. Overall, Irish producers have lost competitiveness in labour cost terms by about 25 per cent in the past five years.

Despite the travails of the internationally exposed sectors, aggregate economic activity has been growing strongly, with GDP likely to rise by 4-5 per cent this year after similar growth in 2004. How come? Well, the answer in a word is: construction. We have embarked on an orgy of building. We are erecting anything in prodigious quantities: houses, apartments, shopping malls, leisure centres, roads and motorways, office parks and holiday cottages. Is that an eclipse? No, it's just that the sky is thick with cranes.

A few numbers to illustrate what's been happening. Since 2000, total employment in the economy has risen by about 260,000 (16 per cent). Of this, almost 100,000 is due to the public sector. On the other hand, there are 17,000 fewer engaged in agriculture. Private sector non-agricultural employment, therefore, has risen by about 180,000. Of this, the construction sector has contributed 76,000. Thus, more than 42 per cent of the private non-farm employment increase of the past five years is accounted for directly by construction. This is before including rising employment in construction-related activities such as building suppliers, materials manufacturers, estate agents, mortgage brokers, etc. If we allowed for these, we would comfortably account for more than half of the private sector employment gains since 2000, and that's before speaking about multiplier effects. Ireland has become a giant building site, the economy now more Celtic Beaver than Celtic Tiger.

Almost 13 per cent of total employment (more than 17 per cent of the private non-farm workforce) is engaged in construction. The corresponding proportions for the UK and US are 7 per cent and 5.4 per cent respectively. Is this situation sustainable? Of course not. Our need for new infrastructure, though large, is finite. Our need for hotels, shopping malls and leisure centres, likewise, is a good deal closer to being realised.

Our need for house building, which probably accounts for 60-70 per cent of the overall workforce in construction is already being more than fulfilled. Last year and, it seems, this year as well, almost 80,000 housing units were built in this country. How many do we need? Until recently, analysts thought that we needed no more than 40000-45,000 per annum to provide for new household formation and obsolescence. In the light of the latest population estimates, these figures have been revised significantly upwards. Now, it is suggested, we may not be building too many houses, since we need to provide houses annually for tens of thousands of immigrants, a large proportion of whom work in construction.

I get worried when confronted with circular causation. I am especially worried about the circular causation implicit in this proposition. What it amounts to is as follows: the pace of construction activity is so hot that we need immigrant construction workers in increasing numbers. Our need for increasing numbers of construction workers means that we need even more houses than we would otherwise. This means the pace of construction activity must accelerate further, which means in turn we need even greater numbers of immigrant construction workers, and so on.

This has at least some of the hallmarks of a pyramid scheme, a pyramid scheme on a truly enormous scale, and that is not a comforting thought.

Jim O'Leary lectures in economics at NUI Maynooth. He can be contacted at jim.oleary@nuim.ie