In between the best and the worst of times

Economics/Robbie Kelleher: Economic issues seem to get a more than disproportionate share of news coverage during the summer. Last year, the main focus was, not surprisingly, on the Government's apparent post-election U-turn on economic prospects and the implications for spending plans by the larger and more sensitive Departments.

This year, the prognostications of economic forecasters and the regular release of economic data by the Central Statistics Office have attracted substantial coverage, not just in the financial pages but also in general news stories. Most coverage has focused on the demise of the Celtic Tiger and the fact that we appear to be heading into a much tougher economic environment than that with which we had become accustomed to over the past decade.

Some coverage, I believe, has been overly negative. That may sound odd coming from somebody who has held a more cautious view than most on prospects for the economy. Take the recent coverage of the Quarterly Economic Report of the Economic and Social Research Institute (not the five-year review published yesterday: see page 3) for example. It was greeted with "doom and gloom" and "It's all over" type headlines.

I was on holidays when the report was released and was, therefore, surprised when I returned to my office last Monday and opened it to discover the institute was forecasting growth in real GNP this year of 2.4 per cent and 2.9 per cent for 2004.

I find it odd in several ways to describe such a scenario as "gloomy". The first is that it leaves the ESRI at the more optimistic end of the range of economic forecasts available for the current year. The Central Bank had already reduced its forecast growth rate for the current year to just 1.25 per cent and other forecasters, including ourselves, have been even more cautious.

But it is odd in two other ways. First, if achieved, it will represent a significant re-acceleration in the pace of economic growth after a year of near stagnation in 2002. Second, it will mean the economy has indeed managed an exceptionally soft landing. Back in 1993, if I had predicted that the level of real GNP would almost double in the following eight years and that, in the subsequent three years, not alone would the economy manage to hold those gains, but would continue to grow at a rate of almost 2 per cent per annum, I would have been considered outrageously optimistic.

But that now is the scenario routinely described as being particularly gloomy. Even the most pessimistic of forecasters are not suggesting any of the gains of the Celtic Tiger years are likely to be reversed; they are merely predicting the pace at which they will be added to in the coming years will slow appreciably. It is important to distinguish between levels and rates of growth.

What has happened is that definitions of normality became hugely distorted during the years of exceptional growth in the 1990s. In the US a recession has a technical definition of two consecutive quarters where GDP declines in value. In Ireland, in recent years, we came close to defining a recession as a year in which the growth rate was anything less than 5 per cent.

That is not to say that a significant slowing in the rate of economic growth does not require some serious adjustments. The most obvious consequence is in the labour market. In a young population with a growing workforce there will not be sufficient net job creation to prevent unemployment rising. In the current cycle, the jobless rate bottomed at 3.7 per cent and has risen a full percentage point since. We expect it to rise further to about 5.5 per cent at the end of the current year and around 7 per cent at the end of 2004. But, again, this needs to be put in perspective. Back in 1993 when the unemployment rate exceeded 16 per cent it had been deemed unlikely that the economy would ever experience an unemployment rate as low as 7 per cent. The other sector that needs to adjust to the new reality is the Government sector. When the rate of growth in real economy slows, so too does the tax base. In 2001 Government tax revenue rose by just over 3 per cent, in 2002 it grew by less than 5 per cent. This year the growth in tax revenues will be similar and overall current revenue is likely to be broadly similar to last year. Moreover, this sluggish growth in tax revenue occurred despite some significant hikes in tax rates, particularly indirect tax rates.

This is not going to change in the near future. Over the next few years the rate of growth in the real economy will be 1-2 per cent and the inflation rate will not be materially different. That means the nominal tax base will grow at no more than 3-4 per cent. We are in a world of low numbers - low growth, low inflation, low interest rates. That also applies to the Government.

Spending plans will have to be prepared, therefore, against this background. We cannot continue to survive in a world where increases of 8 per cent or more in an expenditure head are associated with a regime of serious "cutbacks".

Unfortunately we committed ourselves to the last national partnership deal and the benchmarking proposals before the reality and constraints of a world of low numbers had been fully appreciated. A world of low numbers does not mean we have to hand back any of the gains of the last decade. But it will cause significant tensions if a particular segment of the economy plans its business on the basis of a world that has long since past.

Robbie Kelleher is head of research at Davy Stockbrokers