Government predictions on GDP may look silly if current trends persist, writes Marc Coleman.
As far as the Government's view of our economy is concerned, it's a case of "steady as she goes". That, at least, is the message contained in the so-called Economic Review and Outlook published yesterday, which contains the Government's latest economic forecasts. In its last budget time forecast, the Government predicted that gross domestic product (GDP) - the measure of goods and services produced in our economy each year - would grow by 5 per cent. That number remained unchanged yesterday.
But there is a problem. The Central Statistics Office (CSO) has also been busy producing data on the state of our economy. But the CSO reports on what is and what has been. In economics, the past is a not a perfect predictor of the future. But it is usually wise to ensure that forecasts for the immediate future - ie to the end of the present year - are not too different from what we know about the very recent past - ie since the start of the year.
The CSO's picture of the recent past and the Government's picture of the immediate future are beginning to look different.
What do we know about the economy's recent past? Firstly, we know that over the course of 2004, annual GDP growth fell from a roaring 6.8 per cent in the first quarter to just 2.3 per cent year-on-year in the last quarter.
We also know that GDP grew by less than 2.5 per cent in the first quarter of this year. And we know why this is. According to CSO data, exports declined in that quarter while imports grew strongly. The so-called external side of our economy is doing less well than before and dragging down our GDP growth rate as a result.
How did the economy grow in the second quarter of this year? The CSO has not yet produced data on economic growth for that period, so we don't know for sure. But data on the external side of the economy - exports and imports - is available and the signs are not good.
Exports fell annually by about 5 per cent in June, while imports continue to surge, reflecting strong car purchases up to the middle of the year.
On the bright side, gross national product (GNP) is growing at a higher, more steady, rate of about 4 per cent. This measure reflects the value of goods and services produced by Irish residents. The distinction between it and GDP is that it excludes the produce of multinational companies operating here on the grounds that, although produced here, it doesn't belong to us. By the same token GNP includes the goods and services produced by Irish-owned companies operating abroad, which GDP excludes. The multinational sector performed poorly at the turn of the year, helping to explain why GDP growth was lower at the start of the year than its GNP counterpart.
But it is the quality, rather than the overall level of that growth, that matters now. What growth there is comes increasingly from domestic demand, driven in turn by consumption and construction. This is, in turn, related to strong borrowing growth. The construction sector, for example, accounts for a hugely disproportionate share of overall employment growth. This sector has peaked or is peaking and when it slows down it will take growth rates down with it.
The Government is not predicting this to happen during 2005. In fact the Government has justified its "no change" approach to its forecast by actually increasing its expectations for domestic growth this year. Is that really wise? We are facing rising oil costs, declining competitiveness and a slower pace of expansion in the world economy compared with last year. And as far as the domestic economy goes, we have no data on how the vital housing sector is doing this year, statistics on this having failed to materialise as usual, for some reason.
In October the CSO will produce a more complete view of the economy's actual performance in the second quarter. If GDP growth rates continue at recent rates, the Government's forecasts will start to look silly. This will produce consequences besides some embarrassed clearing of throats in Government buildings.
For a start, the latest forecasts underpin the Government's prediction of a budget deficit of at most 1 per cent of GDP, as well as its economic and budgetary forecasts for future years. If today's forecasts are over-optimistic then employment and tax revenue growth will be lower than expected and spending requirements will on balance be higher. The budgetary outlook will have to be corrected. In such a scenario either backbench TDs will be disappointed, or the taxpayer will suffer increased taxation to fund the spending increases, or borrowing will increase.
More worryingly, these forecasts set the stage for wage negotiations that begin this autumn. Siptu economist John McCartney has pounced on the latest forecasts. They are, he says, evidence that the Government now has the scope for significant pay increases and tax cuts.
Steady on there. Remember those strong car sales that caused strong import growth? Well they also contributed strongly to recent tax revenue growth. But as most car sales occur in the first half of the year, there is little more money to come from this source and revenue buoyancy will have to rely on a smaller number of sources to end-year. And those other revenue sources are affected by borrowing-related consumption, which could start cooling off.
The latest picture of the economy is not bad as such, but presents no grounds for exuberance or extravagance.
In spite of Davy stockbrokers downwardly revising their economic forecasts for 2005, the Department has stuck to its budgetary forecast. It has done so in the face of negative evidence on the actual state of our economy.
Its prediction for GDP growth of 5 per cent in 2005 requires growth to jump from 2.5 per cent in the first quarter to a sustained rate of 6 per cent for the remainder of the year. Could that really happen? Watch this space.
