The slowdown has permitted an overheating economy to cool without forfeiting the gains of the previous decade, writes Jim O'Leary

On the face of it Ireland has weathered the global economic slowdown remarkably well. During 2001-03 GNP may have grown at a more sluggish rate (less than 2 per cent per annum) than in any three-year period since the mid-1980s, but most other macro indicators point to a solid performance.

GDP, for example, grew at an average annual rate of more than 5 per cent. More meaningfully, total employment expanded by more than 2 per cent per annum (a rate well exceeding what most other economies are capable of in good times), while the unemployment rate increased by not much more than one percentage point and remains close to its historical lows.

Increasingly, therefore, Ireland's economic slowdown seems more a blessing rather than a curse. It has been pronounced enough to permit an overheating economy to cool down - witness the considerable declines in most measures of inflation over the past year or so - without being so sharp as to unravel any of the output and employment gains of the previous decade.

Most observers are agreed that an international economic recovery is now well established, and forecasts for next year reflect the expectation that it will gather momentum. The latest OECD Economic Outlook forecasts GDP growth of 3 per cent in 2004 for the OECD area as a whole, about twice the average rate of the 2000-03 period. Within the OECD, the US is expected to lead the pack, and by a considerable margin. The US economy is expected to grow by more than 4 per cent next year, compared with rates of less than 2 per cent in the euro zone and Japan. A growth rate close to 3 per cent is forecast for the UK.

These forecasts imply that Ireland's principal trading partners will expand in 2004 at an average rate not much slower than what was achieved in the late 1990s. Weighting the US, the UK, the euro zone and Japan by their respective shares in Irish trade, yields an average growth rate of about 2.7 per cent for 2004, compared with an average annual rate of 3.2 per cent for the years 1998 through 2000.

Yet by the standards of the late 1990s, when double-digit annual GDP growth was achieved, the Irish economy is expected to grow modestly next year: by about 3.5 per cent according to the OECD, the Department of Finance and the Central Bank.

Why, in the face of a robust global upswing, is the pick-up at home expected to be so muted? Well, there are several reasons.

The first has to do with time lags. In economic recovery, the US is the leader and Ireland is a follower (as is Europe generally). Reflecting this, the forecasts for 2005 have Irish GDP growth accelerating to the 4.5-5 per cent range. But even this growth rate would be pallid compared with the late 1990s, an observation that helps identify another explanation, which is that the Irish economy is no longer capable of registering double-digit growth. Why? Because it no longer has the resources, especially the resources of people, required to do so. The labour force is growing at an annual rate of less than 2 per cent, not enough to fuel the employment growth - almost 6 per cent per annum - that took place between 1998 and 2000.

But there is a third reason for the comparatively lack-lustre performance that most analysts see in prospect for the Irish economy. Bear in mind that unemployment is not expected to fall back but to rise further, albeit modestly. This implies that the economy is not expected to achieve its potential, and when such expectation coexists with forecasts of a sustained upswing in the global economy, it can imply a problem with competitiveness.

Such a problem is obvious, has been eloquently attested to in several recent reports, and manifests itself in numerous ways. The most important manifestations relate to labour costs and infrastructure. As far as the former are concerned, Irish producers have probably lost competitiveness to the tune of 15-20 per cent over the last two years.

As for the latter, it is sufficient for present purposes to point out that a recent World Economic Forum ranked Ireland second last amongst 16 industrialised countries in terms of overall infrastructure quality.

One risk facing the economy as we enter 2004 is that the competitiveness problem could get worse before it gets better due, for example, to a further sharp rise in the euro against the dollar and sterling.

On the other hand, there is scope for pleasant surprises. Every year springs its ration of surprises. What might 2004 have in store?

I think one surprise may come in the form of a lower-than-expected inflation rate. I say this for a number of reasons.

One is that there is virtually no upward momentum in prices at present. It is not widely appreciated, but in the seven months to November the CPI declined by 0.1 per cent (in other words, inflation is currently negative).

A second reason is that the disinflationary effects of the euro's appreciation of the past 12-18 months have yet to be felt fully.

A third reason is that the direct impact of this year's budget on the CPI will be a good deal less than the impact of last year's.

All told, I can see the annual inflation rate falling by another 1 percentage point over the coming three to six months. That would take the headline rate down to about 1 per cent by late spring. A case of the inflation rate decelerating towards present rate, as it were.

One benign consequence of this should be seen in wages. Negotiations on a successor agreement to Sustaining Progress are scheduled to start in the spring. If they take place against the background of an inflation rate as low as I expect, there is a good chance that a wage norm in the range of 2-3 per cent will emerge. In this connection it is worth noting that the wage increase negotiated under Sustaining Progress was a cumulative 7.2 per cent for the 18-month period to mid-2004.

It now looks as if the cumulative increase in consumer prices over the same period will be around 3 per cent , implying a real wage increase of 4 per cent or more. This is well ahead of what was anticipated at the time the deal was struck, and indicates that the trade unions drove a much harder bargain than the employers again.

Jim O'Leary lectures in economics at NUI-Maynooth. He can be contacted at jim.oleary@may.ie