Public sector dragging inflation upwards

Comment: Oil and interest rates are having short-term negative effects, but Government's impact endures

It is a silent and deadly killer. Sometimes it moves quickly, as in the 1970s. Sometimes it moves slowly, as in recent times. Inflation has always been an enemy of the people, eroding the value of earnings and savings as well as the competitiveness of exporters. Last week's inflation statistics showed the consumer price index, the standard domestic measure of inflation, running at only 2.5 per cent. The latest harmonised index of consumer prices - a measure adjusted to allow comparison with our EU partners - shows our inflation rate running at 2.3 per cent (it excludes mortgage repayment costs and some other things, hence the difference). This is slightly below the EU average of 2.4 per cent and only modestly higher than the 1.9 per cent of our euro-zone partners.

The rates at which prices are increasing and the levels at which they are positioned are not necessarily the same. Imagine Ireland's inflation and EU inflation as two runners in adjacent lanes on a race track. Both are going at the same speed, but one runner is considerably ahead of the other.

We were reminded of this during the week by a survey by market research company AC Nielsen. It showed that grocery prices in Ireland are 15 per cent higher than in the EU as a whole. The finding tallies with a raft of evidence that Ireland is first or second in the league of most expensive countries in Europe, if not the world. In the four years between 2000 and 2003, inclusive, Ireland's annual inflation rate averaged around 4.7 per cent, considerably higher than the EU average.

This is not where we want to be. Ireland's position as a high-cost economy is reflected in our worsening position across a range of competitiveness and productivity indicators. According to a recent survey by The Conference Board, an international business organization, our labour productivity still ranks fourth in the world (this is flattered by the presence of multinational companies). But labour productivity growth here is much slower than in newer EU member states. Here the runner analogy works as follows. In productivity terms we are still ahead of most of the pack, but losing ground and liable to be overtaken.

We want to lose the inflation race and win the productivity race. The two objectives are broadly synonymous. As the partnership talks commence, the links between competitiveness, wage demands and inflation move into focus. Inflation, in fact, is a key benchmark that trade unions use to preserve the purchasing power of their members' wages.

A recent forecast by Pat McArdle of Ulster Bank suggests that our inflation - as measured by the CPI - will gather pace this year. Last December's ECB rate hike still has to be passed on and this will impact on January's inflation rate. Further rate hikes, expected in March and June of this year won't help in the short term. And although those rate hikes should work against inflation in the medium and longer-term (ie from the end of this year) they will be hard put to slow the impact of accelerating economic growth, double-digit growth in government spending, SSIAs and a continuing expansion in private sector credit.

The government forecasts inflation to average 2.4 per cent in the coming year. Pat McArdle expects inflation to rise to 2.9 per cent in January. His last two inflation forecasts have been spot on.

Given the inflationary momentum of the other developments I just mentioned, the risks to the inflation outlook this year must be on the upside. Inflation of three per cent next year is possible. Whatever its actual outturn, inflationary pressure in Ireland is higher than in most of our EU partners.

Which brings us back to our performance relative to the EU. If we want to improve Ireland's cost competitiveness, we need prices to grow more slowly than they are doing in our EU partner economies.

This is possible. The abolition of the Groceries Order, an increasingly aware consumer and structural change in the retail market are just some of the pressures working to reduce prices. The Central Statistics Office's (CSO) latest inflation release shows that inflation in the food and non-alcoholic beverage sector was actually negative, at -1 per cent.

Globalisation is also helping. clothing and footwear goods prices fell by 2 per cent last year while prices of furnishings, household equipment and routine household maintenance goods fell by 1.2 per cent. Inflation was also modest for alcoholic beverages and tobacco where, in the absence of any budgetary increases in taxation, prices rose by just 0.6 per cent. And although we have among the highest fixed and mobile call charges in Europe, increased competition is at least easing the pressure here. Communications costs fell by 0.5 per cent last year.

If this inflation performance was replicated across the entire basket of consumer goods, our higher relative price position vis-a-vis Europe could be eroded over a number of years. A fall in general prices is not necessary, just a slower rate of price increase. But inflation in Ireland remains at a positive, albeit modest, pace. Why is this?

The answer is oil, interest rates and government. Oil prices have had a temporary impact on inflation which is now beginning to subside. Interest rates hurt our inflation in the short term, pushing up mortgage repayment costs, but help it in medium to long term by dampening demand.

But government is an enduring source of inflationary pressure. Indirect tax increases in 2000 and 2001 - the period in which our inflation raced ahead of Europe - added at least two percentage points to inflation. And the latest CSO statistics show that government is dragging up our inflation rate. Education costs rose by 4.9 per cent last year. Health costs rose 5.8 per cent. Transport costs rose 3.1 per cent, although some of the blame here lies with higher oil prices. And utilities and local charges - provided by semi-states and local authorities - rose by a massive 9 per cent.

The conclusion is clear. The private sector is fighting to improve Ireland's cost competitiveness. The public sector is most definitely not.