ECONOMICSSome media outlets have been in a frenzy over the absence of an urgent policy response to the downturn from the Government, writes Jim O'Leary

THE SENSE of crisis has deepened in recent weeks as the pace of economic activity has continued to slow and the prospect of protracted recession has entered the frame.

Publication of last week's Quarterly Commentary from the ESRI was a crystallising moment in this regard. Some sections of the media have whipped themselves into a frenzy of outrage over the absence of an urgent policy response to the downturn from Government. The Government itself has been less than assured in its demeanour, and its statements convey the impression of people whose heads are spinning in the face of unfolding events. What follows is an attempt to help stop the head-spinning.

The point of departure here is to recognise that the Government's power to influence events for the better is small. This is for a number of reasons. First, some of the key factors shaping the downturn - the turmoil in the financial markets, the weakening of demand in Ireland's main trading partners, the sharp rise in the value of the euro against sterling and the dollar, the stratospheric levels to which oil and commodity prices generally have risen - are beyond the Government's control.

Second, the Government has few policy instruments at its disposal, all the fewer since joining the euro zone and giving up the option to vary the exchange rate and domestic interest rates.

Third, the main instrument that it retains control over, fiscal policy, an instrument of questionable potency in a small open economy at the best of times, is especially unreliable at a time of greatly heightened uncertainty for households and firms, such as the present.

A realisation that there is little the Government can do to alter the course of the economy in the short run brings me to the first high-level principle that should govern policy-making at this time, namely that the focus should remain firmly fixed on long-term objectives and not be deflected by breaking news, however gloomy.

The likelihood of serious policy errors increases in proportion to the degree of panic and susceptibility to the pressure to be "doing something".

A second and related guiding principle relates to competitiveness, specifically the competitiveness of the internationally trading sectors of the economy. We need to rediscover a core truth about the Irish economy after years of being seduced by the lure of property and construction, and it is this: the only route to sustained growth in employment and living standards is the exporting of goods and services, not consumer spending, and not building houses.

Exports are the locomotive of growth; consumer spending and house-building are in the nature of carriages.

Reasserting the supremacy of competitiveness as a guiding principle provides a good means of proofing policy proposals at a time like this, and thereby discriminating between the meritorious and the meretricious. Accordingly, the Government should be slow to entertain proposals (such as cutting VAT or excise duties) that are designed to boost consumer spending, principally on the grounds that this means putting the cart before the horse (or carriages before locomotives), but also because it is doubtful that they'd work at the moment.

Likewise, and for similar reasons, proposals whose purported effect is to boost the demand for housing (such as increasing mortgage interest relief or cutting stamp duties) should be resisted.

Part of the reason why such measures are unlikely to have much effect at present is that credit availability is now more of a constraining factor than affordability in the housing market.

Focusing on competitiveness also has implications for the expenditure side of the budget. In the first instance it means that investment projects that have passed a rigorous appraisal process and whose purpose is to enhance the productive capacity of the economy should proceed at an undiminished pace. (This does not necessarily mean that all capital spending in the National Development Plan should be spared from review and deferral, because there may well be elements in it that don't pass this test.)

Second, it means that there should be no rowing back on commitments in relation to education, a key purpose of which is to impart the knowledge and skills that will underpin future economic growth.

Finally, the focus on competitiveness has implications for pay. Here I think the private sector can look after itself in the sense that market forces will guide pay settlements towards the levels that can be borne by individual firms. In practice, given the kind of trading conditions currently facing many firms, this will probably mean a pay freeze for a significant proportion of private sector workers.

On grounds of solidarity, but also in order to maximise the possibility of preserving existing levels of service without having to resort to raising taxes, there is a strong case for a pay freeze in the public sector. Indeed, it might be useful for Government to offer a guarantee of no reductions in service levels as a quid pro quo for the public sector unions agreeing to such a freeze.

Jim O'Leary is a senior fellow at the department of economics, finance and accounting at NUI-Maynooth. He can be contacted at jim.oleary@nuim.ie