A bumpy ride perhaps, but not the road to disaster

Among the most valuable and powerful insights into the behaviour of the Irish economy are those that come from thinking of it as small and open. Its small size makes it a price-taker on international markets. Its openness means that economic activity is dominated by those sectors that are involved in international trade.

The small, open economy behaves in a different way from its larger, less open counterparts. When small size and heavy reliance on international trade are combined with an elastic labour supply, that difference can be very marked. In these circumstances, the small, open economy can grow much faster and for much longer than larger economies with relatively fixed endowments of labour.

Ireland's experience of the past six years exemplifies this. The cumulative growth of almost 60 per cent in GNP since 1993 is without contemporary parallel among the big economies of the West and has very few historical precedents, except among economies with similar characteristics.

However, the small, open economy model can be taken too far. Certainly, the more extreme versions of the theory are based on gross simplifications. These may be useful for pedagogic purposes or for generating interesting academic papers, but are less than useful, indeed can be positively dangerous, when applied to policy issues.

For example, Ireland is not so open that people spend all their money on imports. A substantial proportion of consumer spending goes on goods and services that are produced at home: childcare, meals out, entertainment, hair-dressing etc.

Moreover, a non-trivial fraction of the retail price of pretty well all imported goods reflects domestic storage, distribution and sales costs. It follows that the inflation rate in Ireland is not simply a function of price movements in the rest of the world and exchange-rate changes, but also reflects domestic influences.

Our inflation rate, therefore, is not something that is entirely outside our control. If the economy is operating at full throttle there is every chance that, because of the pressure on domestic productive resources, inflation will move higher than it would otherwise be.

This raises another important point. Yes, the paradigm appropriate to analysing an economy like Ireland is different from the one that is appropriate to economies such as the US, Germany or even Britain. And yes, that paradigm indicates that it is likely to take the Irish economy a good deal longer to reach the point of overheating than it typically takes the US, Germany or Britain.

But, once that point is reached, the consequences are broadly the same across all economies: an acceleration of inflation in one form or another.

ALL the signs are that that point has been reached. There is unmistakable and extensive evidence of overheating in the Irish economy at this stage. In the first instance, that evidence is present in various price measures.

Average earnings growth in areas such as manufacturing and banking, which was running at less than 3 per cent as recently as 1997, had accelerated to the 5.5 to 6 per cent range by the middle of this year.

The rate of price increase for the services element of the consumer price index (CPI) is now running at just under 6 per cent, compared with less than 4 per cent this time last year.

The overall rate of CPI inflation (excluding the effect of falling mortgage interest rates) is currently 3.5 per cent, up from 1.5 per cent less than two years ago, and is set to accelerate further, to at least 4 per cent, in the coming months.

House-price inflation, although it has decelerated considerably over the past 12 months, is still running at a hefty two-digit pace.

Whether any of this matters a great deal to the long-term health of the Irish economy is a moot point. To some extent, current rates of wage and consumer price inflation are simply the inevitable consequence of the extraordinary growth of output and employment that has been achieved in recent years.

However, accelerating inflation will erode competitiveness, and to that extent such policy instruments as are available should not be used in a way that would exacerbate upward pressure on prices. In other words, there is no case for being indifferent to an unnecessary acceleration of inflation.

In any event, it would betray an extremely myopic perspective to seek evidence of overheating only among indices of price movements. There is a growing body of evidence from other sources. The most frequently cited is the infrastructural deficit. This is at its most obvious in terms of the traffic congestion now present in the Greater Dublin area and elsewhere at virtually all hours of the working day.

More recently, it has begun to manifest itself in congestion of the telephone network. Prospectively, if appropriate action is not taken, it may manifest itself in breakdowns in the electricity supply network.

There are many other, more workaday, manifestations of overheating. Have you recently tried to find a plumber or an electrician to fix a leaking pipe or wire up extra sockets? Or, tried to engage a builder to build an extension?

Indeed, how long did it take you to get planning permission for the extension in the first place? How long, after placing the order, were you waiting for delivery of that new car? What's the waiting-list like at your local creche, or the one five miles away?

The answers to these and similar questions tell us as much about overheating as the CPI does. They also tell us that overheating is as much to do with the erosion of the quality of our lives as it is about declines in the purchasing power of our incomes.

None of this means, contrary to what the prophets of doom would have us believe, that the Irish economy is about to go bust or explode. On the contrary, the outlook for 2000 is bright, at least as far as conventional measures of economic activity are concerned.

GNP should expand by about 7 per cent. Consumer spending should grow by as much as 8 per cent. Employment will increase by a further 60,000. The unemployment rate will fall to below 5 per cent. New car registrations will probably top 200,000. Upwards of 50,000 new homes will be built.

The bad news is that the ambient temperature of the economy will rise by several degrees. Congestion will be greater, queues and waiting-lists longer, traffic jams worse, pubs and restaurants more crowded, tradesmen more elusive, houses more expensive, prices generally significantly higher.

Perhaps the net result will be that we will move closer to the realisation that economic growth is not everything. There's more to life than GNP.

Jim O'Leary is chief economist with Davy Stockbrokers