Growing economy still faces downside risks

Forecast: There are considerable downside risks to economic growth next year, according to the Economic and Social Research Institute (ESRI).

In its Winter Economic Commentary published this morning the institute identifies the risk as structural problems in the US economy and an over- dependence on housebuilding in the domestic economy as the main threats.

Notwithstanding these caveats the economic think tank is predicting the economy will grow by 5 per cent this year in gross national product terms and 4.6 per cent next year. "The strength of the domestic economy is most apparent in the robust performance of the Irish labour market, which is expected to record employment growth of 2.6 per cent in 2004, with the rate of unemployment expected to average 4.4 per cent," it said yesterday.

Strong levels of growth in the US will underpin the Irish economy next year, according to the ESRI but the current account and budgetary deficits being run by the US administration are unsustainable and will require some form of macro-economic adjustment in the coming years, it argues. The US balance of payments deficit is now 5.5 per cent of gross domestic product and the budget deficit is 4.2 per cent of GDP.

"US households have to get their budgets in order and that means spending less," according to Mr Danny McCoy, one of the authors of the commentary.

He added that any fall in US private expenditure would weaken the international economy and in particular the economies where growth is currently export-led. These include the euro area countries and Japan, he said. Pending an adjustment, the deficits will continue to weigh on the dollar.

Housebuilding contributed 1 percentage point to the 5 per cent increase in economic output that the ESRI expects the economy to deliver this year.

This level of output, roughly 80,000 new houses a year is 50,000 ahead of underlying demand and is unsustainable, according to the ESRI. An economic shock leading to a rapid fall off in housebuilding would have a significant negative impact, it warns.

In its bulletin the ESRI examines what might be the consequences of a 50 per cent fall in house-building activity over a three-year period. They conclude that it could reduce GNP by around 3 per cent a year in each year of the shock and have a similar impact on employment.

The institute is not predicting a reverse of this magnitude, but warns that the housing market is volatile.

As with the US deficits, the best interests of the Irish economy would be served by a gradual unwinding of these positions, it argues.