The Government needs to impose wage restraint and adjust the “unusually favourable” property tax system to maintain growth, according to a survey of the the Irish economy by the OECD.
According to OECD's Economic survey of Ireland 2008, Irish economic growth has "faltered" in recent years due to the strength of the "low productivity construction sector" and said improvements in productivity hinge on increased competition in "sheltered sectors" of the economy.
It expects the Irish economy to expand by 2.9 per cent this year, down from an average of 5 per cent since 2001. However, it is more optimistic about 2009 when it expects economic growth to rebound to 4.2 per cent. It expects an unemployment rate of 5.5 per cent.
Despite the weakening housing market, the OECD expects the Irish growth rate "could remain above the euro area average" although it notes number of short-term risks, and in particular public spending.
According to the OECD it is “crucial to avoid expensive commitments” and said restraint would be necessary in the upcoming pay negotiations.
Overall the economic fundamentals of the Irish economy, with its skilled workforce, a flexible labour market and moderate taxation remain strong, according to the OECD.
Economic growth over the last five years has allowed the Government to increase public spending at a faster rate than any other OECD country except Korea.
However, the sharp deterioration of tax revenues, particularly those that are property related, has seen the Government surplus shrink sharply.
The survey notes that the value of housing investment in Ireland has reached almost 16 per cent of gross national income - the highest in the OECD - but the market has turned since 2006.
It said house prices appear to have "overshot their long-run equilibrium level" said a further easing in house prices was possible, adding that there was a risk prices could fall below their long-run level before recovering.
The "generosity" of Irish property taxes - one of the most favourable rates among those countries surveyed – has "generally contributed to the volatility of the housing markets", although it notes that the recent reform of stamp duty were "well timed to support the housing market during the current slowdown", the survey found.
It notes that such instability is "particularly costly" in an Irish context because Ireland can no longer use monetary policy to slow house price growth or cushion the effects of a slowdown.
Tánaiste and Minister for Finance Brian Cowen said the OECD's assessment of the economy was positive overall but that he accepted the recommendation to slow public spending and moderate wage growth.
"The OECD, while recognising the challenges facing Ireland in the period ahead, acknowledges the remarkable performance of the Irish economy over the past decade. It states that the fundamentals including - a skilled workforce, a flexible labour market, moderate taxation, a business-friendly regulatory environment and a sound fiscal position - all remain strong. Of particular note is the OECD's assessment that Irish fiscal plans remain prudent overall," he said.
Mr Cowen said he agreed with the OECD's recommendation to raise productivity growth and to ensure wage moderation.
Mr Cowen said was important not to lock-in expensive spending commitments and said that although the "correction to the very strong Irish housing market was necessary, the downswing is anticipated to be short-lived."
When examining productivity concerns, the OECD survey said manufacturing productivity was high by international standards but noted that the performance of the services sector was less impressive.
"Performance is less impressive in the services sector. The buoyancy in construction and in lower-productivity services sectors has weighed on overall productivity growth in recent years," report observed.
The report found that Ireland remains an attractive destination for foreign direct investment, the OECD noted that Ireland's competitiveness "has been eroded" and said there has been some loss of export market share, despite a strong performance by the financial and business sectors.
To improve competition the OECD suggests that the Government examine "network industries" and "sheltered professions" to raise productivity and reduce costs.
It adds that spending on research and development in Ireland is relatively weak and that public resources in the area need to be allocated more effectively.
The increase of women in the workforce has boosted the growth of the economy and the OECD expects this to rise still further as extra childcare places become available under the National Childcare Strategy
However, the report notes that the current design of child benefits "does little to encourage women to join the workforce" and it says the level of out-of-school hours care needs to be addressed.
