ANALYSIS:The scale of difficulties and the challenges facing us is clear in these latest predictions, writes DAN O'BRIEN

ECONOMIC FORECASTING is an art whose practitioners have not had a good recession. No organisation which produces forecasts anywhere predicted the kind of shock to the system that has taken place globally over the past two years. But the profession’s failings do not mean that economists should give up trying to predict the future.

In every aspect of life, we must all make some assumptions about the future. Even if these turn out to be wrong, the thought processes involved in arriving at them are almost always useful.

Economics is no different.

Today, the Economic and Social Research Institute (ESRI) rolls out its latest forecasts for the economy. There are many issues covered which gave food for thought. Four jump out.

First, the think tank points out that if the 100,000 people who have left the labour market had remained in it, the rate of joblessness would now stand at 17 per cent, instead of the current 13 per cent.

This serves not only to emphasis the magnitude of the jobs crisis – if that were necessary – but also how urgent the need for a more proportionate policy response is. The ESRI advocates the sort of “active labour market” measures that are in place in many countries with proactive, policy-informed political classes.

Such policies involve helping the newly jobless to reskill quickly and rapidly move up the job-search learning curve. They include both carrot and stick to ensure incentives to work are strong and disincentives are removed quickly.

But there are real doubts as to whether the institutional capacity exists to design and implement such polities. The Department of Social Protection has been slow to reform the current framework, and the fragmentation and dysfunctionality of the State’s training agencies give reason to believe that their capacity to implement such policies successfully, even if they were put in place, is lacking.

Second, the institute’s decision to revise radically its budget deficit forecast for 2010 was a tough call. To forecast an imbalance as horrifyingly large as one-fifth of gross domestic product (GDP) – representing a near doubling on its April estimate – is not a decision to be taken lightly. At a time of such fragility, a forecast by such an authoritative source could in itself spook the markets.

Hopefully, the forecast will not do this but will rather facilitate a process of gradually allowing bond traders to come to terms with a headline deficit figure in 2010 that will almost certainly be far above Greece and other Mediterranean euro area economies.

Third, and related, the institute believes public debt levels will rise to 94 per cent of GDP by the end of 2011. As it happens, this is above the 90 per cent threshold which appears to damage economic growth according to a recent and influential study of centuries of public debt dynamics by two US economists, Carmen Rheinhart and Ken Rogoff. This is merely one more concern about the medium-term growth outlook.

Fourth, the institute’s economic growth forecasts, when broken down into their constituent parts look plausible, with one exception – spending on investment. Arithmetically, the ESRI’s forecast for 2010 could only be reached if there is growth in investment spending in the April-December period.

There are a number of reasons why this is unlikely. Most generally, investment spending in the construction sector overshot wildly during the boom years. The institute believes it will undershoot on the downswing, flooring at 14 per cent of GDP.

As investment normally accounts for about 20 per cent of GDP in western European economies, the institute’s figure would represent a shallow bottom.

Given all that it says about the direction of the construction sector and the financing constraints all types on businesses are facing owing to a broken banking system, the contraction in investment spending is very likely to be bigger than the institute suggests.