ESRI warns Government on basing spending plans on GDP numbers

The Economic and Social Research Institute (ESRI) has cautioned the Government against making economic plans based on the State’s headline growth numbers as they are exaggerating the true level of economic activity.

As measured by gross domestic product (GDP), Ireland’s economy grew by 7.8 per cent last year, more than three times that recorded in either the US or the UK and nearly five times the euro area average.

In its latest economic commentary, the ESRI said a surge in multinational profits, most of which are repatriated offshore, had inflated Ireland’s GDP growth by approximately 2 per cent last year.

The institute said gross national product (GNP), which rose by 5.7 per cent, was a more accurate measure of activity because it stripped out multinational profit flows.

Despite the caveat, the ESRI remained upbeat about Ireland’s economic outlook, predicting GDP would rise by 4.8 per cent this year and 4.1 per cent in 2017, underpinned by a strong rebound domestic demand. GNP, meanwhile, was expected to expand by 5 per cent in 2016 and 4.3 per cent next year.

“Given the expected increases in personal consumption and investment in 2016, we expect the Irish economy to be quite near to its potential level by the end of 2016,” the ESRI’s Kieran McQuinn said.

Significant downside risks

The forecasts were subject to significant downside risks from a slowdown in China and a potential Brexit scenario, however.

There was now “growing ambiguity” about the outcome of the UK vote, which had the potential to damage Ireland’s lucrative export trade, the think tank said.

Amid the uncertain global climate, the ESRI again warned the Government against eroding the State’s tax base to fund income tax cuts.

The outgoing Coalition promised voters to abolish the Universal Social Charge by 2020 if re-elected.

“In the short to medium term, any buoyancy in taxation revenues currently being experienced would be more prudently employed through a combination of investment in public infrastructure and/or reductions in the national debt, rather than through significant cuts in personal taxation rates,” the ESRI said in its report. It also warned that any shock to bond yields could “very quickly” increase the cost of servicing the State’s national debt.

While noting that GDP typically lags employment growth, the ESRI said it expected last year’s 7.8 per cent GDP growth to feed into continuing employment growth in the coming year.

It predicted the State’s headline rate of unemployment to drop to 8.7 per cent this year and to 7.5 per cent by the end of 2017.

The institute said it did not expect housing completions to increase to 25,000, the level needed to meet demand, until after 2018. However, if this was achieved “sooner rather than later”, it would have a positive affect on employment and growth.

Conversely, it warned of the potential to overshoot the required level of house supply because of the level of pent-up demand.

To this end, the ESRI called for a more rules-based approach to the Central Bank’s macroprudential rules, which restrict mortgage lending.

The institute wants the limits to be set according to an agreed set of metrics rather than arbitrarily adjusted by the Central Bank.

While the inconclusive election result poses some uncertainty domestically, the likely effects on headline financial and economic indicators are likely to be minimal at least in the short term.