Economy is sound despite problems it faces

The policies the Minister adopts should reflect a realistic evaluation of the economy at present and realistic expectations for…

The policies the Minister adopts should reflect a realistic evaluation of the economy at present and realistic expectations for the future, writes Austin Hughes

For the past while, it has not been hard to understand why economics is known as "the dismal science". Gloomy news has been everywhere. Collapsing stock markets, job layoffs, faltering growth rates and runaway public spending dominate the headlines.

Without doubt, the Irish economy, like economies around the world, is going through a difficult period at present. Unfortunately, things may not get noticeably better soon. We cannot hope to insulate ourselves from weak global conditions. But, we can make sure we don't make mistakes that could turn the current downturn into a crisis.

On most measures, the Irish economy is weathering the world slowdown better than most others.Although unemployment has edged higher for more than a year, the increase from a 3.6 per cent lowpoint to 4.4 per cent at present is relatively modest. By reference to Ireland's economic past - or most countries' economic present - this economy is still working reasonably well.

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Much the same story comes from other economic indicators. Drawing on other data published last week, I reckon GNP growth will be around 3 per cent this year, a far faster pace of increase than in most other countries. Unfortunately, if it is far faster than elsewhere, it is also far slower than the frenetic pace we had become used to during the boom years.

In my view, the real problem the Irish economy faces at present is that we must adjust simultaneously on two fronts - to weak economic conditions and to the reality that the boom is over, never to return. The current exceptional weakness in traditional engines on global economic activity such as the US and Germany should end. At home, the extraordinary era of tumbling interest rates and tax rates, of changing population structures and dramatic increases in investment is gone for good.

What this means is that Irish economic growth may not rebound dramatically in 2003. Instead, we may be looking at a prolonged period of fairly modest growth.

In these circumstances, the emphasis must be on consolidating the gains of recent years rather than foolishly trying to bring back the boom. To adjust successfully we must make decisions based on a long- term view rather than short-term considerations.

Let me give one example of what this adjustment might mean in practice. Responsible management of the public finances is central to Ireland's economic prospects. This is not only because public spending and tax decisions play a key role in the life of the economy but also because the thrust of budget policy has a powerful "demonstration" effect on the actions of businesses and households.

The end of July Exchequer figures published last week underline the dilemma facing the Minister for Finance and the Irish economy as a whole. Public spending is running at a pace that could only be afforded at the peak of the boom while tax revenues reflect the current sluggishness of the economy. For businesses, the corresponding imbalance would be between rising costs on one side and faltering demand on the other. For households, a spiralling cost of living and the weight of expectations in terms of spending are at odds with weaker income growth.

That the Government has undertaken a review of public spending is scarcely surprising, but it seems to me that the central focus on meeting the Minister's commitment to deliver a budget surplus this year is not the right approach in the current circumstances. The evidence of budget figures for the first seven months is that a substantial budget deficit is in prospect. It is most unlikely that a dramatic economic upswing will alter this prospect.

Of course, Mr McCreevy could ensure a surplus occurs in a couple of ways. As holder of the public purse strings, the Minister could delay various items of spending from December until January. There might be any number of cosmetic measures through which Mr McCreevy could ensure the end-year accounts show an Exchequer surplus.

Of course, this approach would merely transfer problems into next year. Indeed, efforts to disguise underlying difficulties would probably add to a deterioration next year.

At the other extreme, Mr McCreevy could implement substantial, if painful, cutbacks in spending and further increases in public services charges that might also deliver a surplus. In a fragile economy, this approach could easily backfire.

In the first seven months of the year, the Government has been injecting large increases in public spending into the economy and getting virtually no increase in tax revenues. To reverse this abruptly and pull large amounts of money out in the next few months could lead to a further weakening in economic activity.

The approach Mr McCreevy takes should reflect the fact that the Irish economy is facing difficulties but is still sound. Budget adjustments should be neither cosmetic nor of crisis proportions. A budget deficit this year would be no great evil. A failure to ensure that over the next year or so public spending adjusts to a pace that can be sustained for the next five years might be. Much the same sort of adjustment faces Irish businesses and households. Incomes and employment can continue to grow in this economy for the forseeable future if we are realistic in our expectations.

Austin Hughes is chief economist, IIB Bank