Merchants of doom should not be dismissed

A new school of economic thought has emerged. The "it'll all end in tears" brigade is now out in force, issuing warnings that the years of plenty are fast coming to an end and some kind of an economic crash is inevitable. After all, look what happened to those Asian tigers?

Economists, of course, are gloomy by nature. It's not called the dismal science for nothing. Many of those who cut their teeth in the days when the debt burden used to double every few years have found it hard to adjust to our economic success. It's just no fun when you can't lecture the government every day on how to extricate itself from some economic mess.

It is not hard to point at the vulnerable areas of the economy and to construct a case that the overheating in areas such as the housing market and parts of the jobs market are bound to come back to haunt us. But what is really difficult is identifying the likely trigger for an economic downturn. Because as we enter monetary union, all the old theories no longer apply.

In the old days, things were a lot easier. The overheating in the housing market would already have prompted the Central Bank to push up interest rates goodness knows how many times. This would have hit borrowers, quite possibly have left the banks with some bad debts and knocked economic confidence in general. And so we would be into a cycle where the economy would have slowed and inflationary pressures abated, before the bank started to lower interest rates again.

True, it rarely worked quite so simply in Ireland, as the small and open nature of the economy leaves us exposed to international influences and limits the ability of policy-makers to control what happens. But before we started heading for EMU, the monetary brake of higher interest rates was the one which was certain to be pressed whenever inflation started to speed up. With this now off the agenda, the likely catalyst for an economic downturn is far from clear.

There are, of course, no shortage of candidates. The Asian crisis could lead to some kind of global slowdown. Britain, our biggest trading partner, is flirting with recession, which could hit Irish growth prospects. The high-tech sector, on which so many jobs are reliant, remains most unpredictable and Ireland would be exposed in the event of a general downturn.

But which of these is likely to affect us, how soon and how severely is impossible to predict. Internationally, for example, the extent to which the Asian crisis will affect the West is a matter of considerable uncertainty. The economy here could trundle on quite happily for some time and most forecasters have already pencilled in rapid growth next year, albeit at a lower rate than this year's expected rise of 10 per cent or so in Gross National Product.

There is, of course, another kind of downturn which could affect the economy. It is the kind which would be caused if we start to lose our competitive position due, for example, to a sustained rise in the rate of inflation. The danger of an inflationary psychology setting in are becoming clearer by the day.

Economic theorists point to the importance of the pound's exchange rate in determining the rate of inflation. So the weakness of the pound against sterling towards the end of last year is now feeding through to the shops. These pressures may abate. But the danger is that they start to feed through to wages and salaries and thus become permanent additions to the cost base of exporting businesses. If the Government starts to concede the many pay demands in the public sector, for example, it will inevitably lead to pressure for increases in private business, while at the same time compromising the long-term outlook for the Exchequer finances.

Higher wages and salaries are to an extent part of the normal ebb and flow of supply and demand in the jobs market. However, as we head into monetary union and fix our exchange rate irrevocably, the focus will be relentless on the need to remain competitive and build the economy's productive capacity. If inflation and wage rises move above our competitors, we may not feel the impact immediately, but we will pay over the long term in fewer jobs and lower earnings.

This, of course, is dismal scientist territory. We have to be aware that nobody predicted the extent of the economic boom and that the factors underlying it are still a matter of debate. Such is the momentum of our economic growth that, while some slowdown is inevitable, we could still continue to outperform our EU partners significantly for some years, helped by the kind of demographic and educational factors identified by the ESRI.

But don't dismiss the warnings. The worrying thing about the economy is that it is building up a few areas of real vulnerability. Many borrowers have taken on large loans to buy houses or for other purposes. As a paper from Central Bank economist Geoff Kenny pointed out, many financial institutions may also be lending too freely, leaving themselves vulnerable to bad debts in a downturn.

Meanwhile, many businesses have also borrowed highly for expansion, while those in the high-tech sector are having to pay fortunes to hold on to skilled staff. Also, the Irish stockmarket, like many of its international counterparts, looks decidedly frothy.

The danger of all this it that it leaves the economy vulnerable in a downturn. In particular, the high level of personal borrowing is based on a future of rising employment and low interest rates which is by no means guaranteed. So the bubble is there. But no-one is sure about what might burst it, or whether we might yet get away with a less painful deceleration from our record growth rates.