The sharp downturn in the property market has brought the over-reliance on the housing and construction sector as the key driver of growth in the Irish economy into renewed focus. Last week the Economic and Social Research Institute (ESRI), in its latest quarterly commentary, reduced its economic growth forecast for next year.
It did so in response to the slowdown in the housing sector, and to the decline in construction activity. In 2006, the economy grew by 6 per cent in GNP terms, buoyed up by rising house prices in a booming property market, when a record number of nearly 100,000 homes were built. A year later, however, the economic outlook has altered significantly.
The economy, as the ESRI points out, is delicately poised between slowdown and recession. For now, the odds favour a benign, rather than a malign, scenario unfolding. Much, however, may yet depend on external economic factors, including how the credit crunch, which has paralysed global financial markets for months, is settled, and how quickly.
The ESRI forecast is for far fewer houses to be built in 2007. House prices are expected to decline further by year-end. A possible ECB decision in the months ahead to raise interest rates would mean higher mortgage repayments for borrowers. For next year, the ESRI predicts the rate of growth will be just half that of 2006, a deceleration largely explained by the weak performance of the housing sector. In 2008, the ESRI forecast is for the construction of 65,000 homes, a reduction of almost one third on the record 2006 figure.
The authors of the economic commentary place Ireland's record rate of house building in an international perspective. Last year the number of houses built in Ireland was half the number built in the UK, which has a population some 15 times higher. Such a rapid rate of expansion by one sector in the economy was clearly unsustainable.
An over-reliance on construction as the primary engine of growth produces an unbalanced economy, one that sooner or later has to be rectified. As the ESRI points out, the major adjustment in the housing market that is now under way will produce short-term difficulties for the construction sector in the form of job losses and higher unemployment. There is, however, no other way if the economy is to return to the path of sustainable growth in the years ahead.
The adjustment process will result in a reduced future role for the construction sector in the economy. It will also mean, as we have already seen, a sharp reduction in tax revenue. As fewer houses are sold and as house prices drop, the tax receipts from property will decline.
The public finances, however, are in a remarkably healthy state to handle that adjustment. The ESRI, in forecasting a balanced budget next year, has suggested the Minister of Finance even has some scope to introduce a mildly stimulatory Budget in December.