Key Year For The Economy

One question will dominate discussion on the economy over the coming months - Is the boom coming to an end? Economists, a group…

One question will dominate discussion on the economy over the coming months - Is the boom coming to an end? Economists, a group never noted for speaking with one voice, are divided on the subject, although most are reasonably optimistic about next year. Signs of a sharp slowdown in the US are, however, causing some concern. What does seem clear, is that the period of exceptionally strong growth in the Irish economy cannot continue for much longer; what is more difficult to predict is the timing and extent of the slowdown.

Since the mid-1990s, the economy has grown at an extraordinary rate, turning the Republic from a laggard in wealth terms to one of the more prosperous EU economies. The most extraordinary turnaround has been in the jobs market, which has moved from high unemployment to labour shortage.

Now, however, the economy is running at full capacity. FAS, the employment agency, is actively working overseas to find people willing to come here to work. Traffic is almost permanently congested. And increased prosperity has driven house prices out of the reach of many first-time buyers and forced others to borrow heavily.

Inflation has picked up sharply, another sign that demand in many areas of the economy exceeds supply. The fall in the value of the euro and rising oil prices contributed significantly. But inflationary pressures are also being generated domestically, by higher prices for services, upward pressure on wages and rising house prices.

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As ever, an assessment of the international influences on our prospects requires us to look both to the US and to Europe. The US is emerging as our largest single trading partner and is the source of most inward investment. Meanwhile, we are tied to the euro zone in a monetary union and have close trading and general economic ties with our EU partners. There is concern about the outlook for the US as signs have emerged of a faster-than-expected slowdown. As reported in the Business This Year supplement with today's Irish Times, confidence among the public has been hit by the fall in the US stockmarket and its impact on wealth.

It is too early to conclude that the US economy is heading for a "hard landing" - but it is a real possibility. One point of vulnerability for the US is its large current account deficit, which has been financed to date by a large inflow of foreign capital. But if there is a sharp US slowdown, it would affect many Irish exporters. More serious would be the potential impact on major US employers in Ireland, particularly if the gloom now affecting the technology sector was to spread. Fortunately, a large number of US companies now have deep roots in the economy here and it is unlikely that the entire sector will suffer a major shakeout. However the overall contribution of this sector will slacken.

One side-effect of the US slowdown - and renewed doubts about the outlook for Japan - is a recovery in value of the euro. For the first time in a decade, forecasts are that the EU economy will grow more quickly than the US next year. The outlook for the big euro zone economies - Germany and France - is quite good, although concerns about structural rigidities in both could yet come back to haunt the euro.

The Irish economy will be heavily influenced by these diverse international factors. It is possible that trends will move in our favour. A gradual recovery in the value of the euro - which has gained strongly in recent trading sessions - would help to bring down the inflation rate, as would continued stability in the oil market. The revised terms of the Programme for Prosperity and Fairness may yet promote renewed industrial peace. If the US economy was also to avoid a "hard landing", then growth here might gradually decelerate to a more sustainable rate.

However, there are risks. A combination of a sharp US slowdown and a rapid recovery by the euro could hit industry hard. A renewed rise in inflation could put further pressure on wages and threaten to undermine competitiveness. And if we are to tackle the labour shortage by bringing in thousands of overseas workers, the subsequent pressure on housing will give a further push to house prices.

There is nothing the Government can do about the international outlook and control of interest rates - the traditional weapon to slow an overheating economy - has now passed to the European Central Bank. However some policy priorities are evident.

The IDA Ireland drive to attract industry to the less-developed regions of the Border, Midlands and West is a key element in a policy of encouraging growth and prosperity to spread outside Dublin. A number of recent announcements suggests that this drive is starting to bear fruit, but the difficulty of attracting projects to areas with less-developed infrastructure should not be underestimated.

For this - and many other - reasons, the delivery of the investment programme under the National Development Plan is a priority. Our infrastructure is now inhibiting growth. Congested roads, inadequate public transport and a shortage of housing are also seriously affecting people's quality of life. These issues will take time to address. But to do so will require a planned and co-ordinated focus which has been lacking to date.

So will the improvement of public services in general and particularly the health service. Most people who need it can now get a job. But the division of the health service between those who can afford private insurance and those who cannot is one of the serious causes of inequality in society. There are signs of a debate now starting on the best way forward and it is clear that new approaches are urgently needed. These are the issues now concerning people, but the Government is struggling to come to terms with this agenda. Its approach to using its resources to tackle inequality appears piecemeal, it faces an enormous challenge in delivering the National Development Plan and its latest Budget risks adding to the house price spiral.

Yet the issue which will worry our policy makers most in the short term, is what will happen to the international economy. We are vulnerable to a sharp downturn in the US - or to some other unexpected shock - and can only hope that our luck holds and that the economy can shift relatively painlessly to a more sustainable level of growth.