ANALYSIS:The ESRI sees unemployment rising to 9.4 per cent and net emigration of 50,000, writes Jim O'Leary

IN THE space of just two months, the ESRI has moved from being one of the most sanguine forecasters of Irish economic activity to one of the most bearish. The institute's October Quarterly Commentary forecast a decline of 0.7 per cent in gross domestic product (GDP) next year; its latest report has cut that dramatically to minus 3.9 per cent.

This implies the expectation of a cumulative fall of more than 6 per cent for 2008 and 2009, and indicates a slump of unprecedented severity by Irish standards.

Even in the 1980s, the worst two-year performance, in 1982-1983, saw output fall by just over 3 per cent. In international terms too, there are few enough precedents for a recession of this depth. The only one from the modern era that comes readily to mind is Finland in the early 1990s. GDP there declined by 13 per cent between mid-1990 and mid-1993 and unemployment rose from 3 per cent to 18 per cent. The collapse in house building is expected to continue with completions dropping by more than 50 per cent to just 22,500 - one-quarter of what was achieved in 2006.

Other areas of construction will also decline: a special article published with the commentary and written by John McCartney, formerly of Lisneys, predicts a fall of 50 per cent in office building activity in Dublin.

The volume of consumer spending is forecast to shrink by 3.6 per cent as households attempt to rebuild battered balance sheets. Exports, under pressure from weaker conditions in overseas markets and the much depleted competitiveness of Irish producers, are expected to decline, albeit by a comparatively modest 0.4 per cent.

The implications of this assessment are grim.

Employment is seen falling by 5.5 per cent next year, or by 120,000 in absolute terms. Again, this is uncharted territory. Bleak as labour market conditions were in the 1980s, a collapse of this magnitude was unheard of back then: the steepest one-year loss was 24,000 in 1985. Apportioning next year's huge projected employment loss between changes in unemployment, migration and labour force participation is hard to do with any confidence.

However, a sharp rise in unemployment and an abrupt reversal of migration flows seem inevitable. The ESRI sees the unemployment rate rising to an average of 9.4 per cent in 2009 and net emigration of 50,000. The latter would exceed any natural increase and produce a fall in the population for the first time since 1990, thereby introducing another negative element into the deflationary dynamic now afflicting the economy.

The implications for public finances are very troubling. Next year's budget deficit is forecast to exceed 10 per cent of GDP or €18 billion in absolute terms, and the debt/GDP ratio is projected to rise to 47.5 per cent, almost twice the corresponding ratio at the end of 2007. These numbers make the targets set out in the October budget - a deficit of 6.5 per cent of GDP (€12.2 billion) and a debt ratio rising to 43 per cent - look positively cheerful, and decidedly anachronistic. Dim and all as the ESRI's assessment of prospects is, the truly scary thing is that it is not hard to see how matters could be even worse. A clear example of this is exports. Here the forecast of a marginal fall in volumes in 2009 is predicated on the hope that activity in our main trading partners will start to recover around mid-year, and seems to have been put together when exchange rates from an Irish point of view were nowhere near as adverse as they have become in recent days.

Granted, the dollar and, more particularly sterling, may rebound strongly from current levels and international economies may do likewise in 2009 - but if neither of these conditions is fulfilled, Irish exporters will be doing well to prevent a substantial decline in exports next year.

The one welcome implication of all the above is that inflation will decelerate sharply. The ESRI's view is the average consumer price index inflation rate in 2009 will be negative to the tune of 2 per cent, principally because of falling mortgage rates and energy prices.

My own view is next year's inflation rate will fall more deeply into negative territory than this. For one thing, there is a good chance the ECB will cut interest rates below the 2 per cent level assumed by the ESRI. For another, it is highly probable the sterling/euro exchange rate will remain higher for longer and exert more downward pressure on import prices than the ESRI has allowed for.

An interesting feature of the latest commentary is the inclusion of recent research results on public-private pay differentials. The analysis shows that, controlling for the influence of factors such as education, experience and gender, the public sector pay premium (ie the margin by which average pay in the public sector exceeded the private sector average on a like-for-like basis) increased from 10 per cent in 2003 to 20 per cent by 2006, thanks to benchmarking. The authors go on to note: "This differential would be difficult to justify in normal economic circumstances. The current context of economic recession, with falling employment, growing unemployment and a crisis in the public finances, suggests that the public sector pay premium should come on the agenda for discussion with the Social Partners as a matter of urgency."

Even as Ministers tiptoe gingerly around whether to reopen negotiations on the 3.5 per cent pay rise planned for next September, the case for a substantial cut in public sector pay rates is fast becoming unanswerable.