Well over two years have passed since overheating of our economy first emerged as a potential threat, against which I warned in this column in December 1997 and March 1998. Nevertheless, despite the emergence of this disturbing factor, budgetary policy in the intervening period remained unapologetically expansionary, with a resultant unnecessary inflationary impact upon house prices.
The uncontrolled buoyancy of our economy is evident from the fact that in both 1998 and 1999 GNP rose by between one and two percentage points more than the Central Bank had projected at the start of those years; in each case to around 8 per cent, or well over three times the growth rate of the rest of the European Union during those years.
Moreover, following last December's Budget, the Central Bank raised its inflation figure for this year from 4 per cent to 5 per cent, and its GNP growth estimate from 6.5 per cent to 8.25 per cent. The OECD has now forecast that this growth will turn out even higher, at around 8.7 per cent.
This budgetary boost to our economic growth reflects the impact of the 2 per cent increase in disposable income which the Central Bank has estimated to be the consequence of last December's Budget and of the subsequent additional reliefs the Government felt obliged to offer in order to compensate taxpayers aggrieved by inequitable features of the Minister's initial proposals. If from 1997 onwards the Government had adopted a more cautious budgetary stance, we would not now be faced with serious inflationary pressures.
I am aware of the view that in an economy as open as ours budgetary policy has a limited capacity to influence the rate of economic growth. But this is clearly belied by the Central Bank's estimate of the impact of last December's expansionist Budget. And now that we are participants in EMU, budgetary policy is the only counter-inflationary weapon at our disposal.
The excuse given for that Budget's unduly generous character was a need to meet the Government's obligations under the national pay agreement. The terms of the last and current agreements have required significant cuts in personal taxation for PAYE workers.
But recent budgets have gone well beyond what these agreements required, and some budgetary measures have been widely judged to run counter to the progressive thrust of those agreements, e.g. the cuts in the top rate of tax in 1998 and again this year.
The time has now come for the Government to review radically its budgetary policy. The section of last Tuesday's OECD report dealing with Ireland assumes the Government "will implement only some of the basic elements of its tax cut plans in 2001 and that public investment scheduled for 2000 will only be partially realised".
The latter is likely in any event because of lags in launching projects. And there is probably also some room for holding back on the Government's tax-cutting plans for next year without prejudice to its three-year commitments under the new agreement. But given the Government's persistence since 1997 in introducing over-expansionary budgets, there will be scepticism about its willingness to pursue such a rational course in next December's Budget.
If, however, this kind of action were to be taken, the OECD believes that, in conjunction with inflationary pressures, our GNP growth rate could be slowed to 7 per cent next year. Although that would still be twice the likely EU growth rate, it would be lower than we have seen here since 1994, and could place us on a path to a sustainable growth rate of, perhaps, 5 to 6 per cent in 2002.
As the OECD has pointed out, it is unsatisfactory that we should now depend upon inflationary pressures to reduce a dangerously high growth rate, when this result could have been achieved by more responsible budgetary policies in recent years. This has been a very dangerous way to run the economy, for it has created the risk that, in the OECD's words, "inflation could pick up and competitiveness erode more than foreseen".
The OECD adds that this could become a cause for serious concern "if accompanied by a sharp strengthening of the nominal effective exchange rate, which would require a rapid adjustment of wage growth". And it concludes: "There is some risk as well that a sharp downward adjustment of house prices could destabilise the economy" although, "with tight bank supervision, such a risk remains manageable".
There are some signs of an easing of the housing market, with many properties being withdrawn because of resistance by buyers to excessive reserve prices set by over-optimistic sellers. Moreover, it would appear from the commercial property pages of our newspapers that development land is being traded freely rather than being held back by developers, as has been suggested.
So while measures to enable local authorities to buy agricultural land compulsorily at non-exploitative prices would be welcome, attempts to use tax measures to solve what now seems to be a non-problem of land-hoarding appear unnecessary, and could end up having perverse effects.
The action needed from the public authorities is to remove the bottlenecks they have allowed to develop in the planning process and in servicing building land.
When at some point housing demand comes into line with supply, house prices will stabilise, or might even start to fall. While lower prices might be welcome, a collapse in prices could be very damaging to our economy and to the viability of households which had entered into heavy mortgage commitments, especially if such a collapse were to coincide with a severe downturn in the US economy. At that point we might need some stabilising factor to ensure that activity in the house-building sector would be maintained and that any fall in house prices would be gradual and would not create negative equity for recent house-buyers.
Happily, in our economy there exists just such a potential stabilising factor, in the form of the co-existence of a huge and ever-growing suppressed demand for social housing and a budgetary surplus more than adequate to enable a Government to accelerate rapidly its under-endowed social housing programme. This combination offers an unusual opportunity for extensive and effective counter-cyclical action if the Government has its plans ready for such a contingency.
Such plans would need to have two aspects. First, an adequate stock of serviced land in public ownership together with local authority housing plans ready to be put speedily into effect, preferably through private contractors rather than by the slower and more laborious direct labour route. In this way, construction employment could be maintained.
At the same time local authorities, aided by greatly boosted Government funding, should move to purchase private dwellings to house people on the waiting lists, thereby preventing any sudden collapse of house prices.
The Ministers for the Environment and Finance will presumably have prepared themselves for moves of this kind, so as to tackle rapidly and effectively a sudden shift in the housing market, thus safeguarding against a totally unnecessary construction industry and housing price slump.
We have a long way to go before we can be sure of emerging from our combination of unsustainable growth and inflationary pressures. But the odds remain in favour of such a positive outcome.
gfitzgerald@irish-times.ie