The ESRI has revised sharply downwards its economic growth forecast in its latest report. Authors Alan Barrett, Ide Kearneyand Martin O'Brienexplain why.
One of the most noteworthy elements of the autumn issue of the Economic and Social Research Institute's (ESRI) Quarterly Economic Commentary is the extent to which we have revised downwards our growth forecast for 2008, relative to the commentary we published in June.
In that previous commentary, we forecast gross national product (GNP) growth in 2008 of 3.7 per cent. We are now forecasting GNP growth of 2.9 per cent. We have also revised down our growth forecast for 2007, although to a more modest degree. We are now expecting growth in 2007 of 4.4 per cent, down from the 4.8 per cent forecast of three months ago.
The dominant factor in these downward revisions is house-building. We now expect house completions to be 78,000 in 2007 and 65,000 in 2008, compared with our June forecasts of 82,000 and 76,000 respectively. While a fall in the rate of investment growth is central to our overall domestic growth forecast, we also see consumption growing at a slower pace in 2007 and 2008 relative to our earlier forecasts.
Consumption is now expected to grow by 7.5 per cent in 2007 and by 4 per cent in 2008. This downward revision is based partly on a fall in consumer sentiment, as measured by the ESRI/IIB index.
As a result of the general slowing in the economy, employment growth will slow in 2007 and 2008 relative to 2006, with rates of 2.5 per cent in 2007 and 0.6 per cent in 2008. For 2008, we expect the unemployment rate to average 5.6 per cent. The public finances will also be affected by the slowdown, with the General Government Surplus forecast to fall from a surplus of 2.9 per cent of GDP in 2006 to zero in 2008. A slowing of the economy in 2008 has also been forecast by the International Monetary Fund (IMF).
Earlier this week, they predicted that the economy would grow by 3.2 per cent in 2008. While they are slightly more optimistic than us, both the ESRI and the IMF are predicting a different economic picture for Ireland in 2008, relative to the recent past.
Given these predictions, the question arises of whether Ireland is facing into a period of recession. We would argue that this is not the case and that a broader view needs to be taken of the slowdown in 2008.
The first point to be made is that the fall in housing output can be viewed as a return to more normal rates of house-building as opposed to a crash.
In 2006, the number of dwellings built in Ireland was about 50 per cent of the number built in the UK. As they have a population about 15 times higher than ours, this gives some sense of how big house-building had become in Ireland.
Once the rate of house-building returns to a more normal and sustainable level (in the range of 50,000-60,000 completions per annum in our view), it will not place a drag on growth as is currently happening.
The other important point to be kept in mind is that construction, although an important part of the economy, is only one part. If we look at sectors in terms of their gross domestic product (GDP), we see that construction accounts for about a tenth of total GDP. Services now account for two-thirds of total GDP. In 2006, services grew by 6.8 per cent in volume terms and by 9.6 per cent in value terms.
For 2007 and 2008, we expect to see continued growth in marketed services, with the volume of output expected to grow at a healthy pace in 2007 and 2008. Industry, which produces about a quarter of GDP, also performed well in 2006 when its volume of output grew by 4.3 per cent. We expect volume growth rates for industry of 4.5 per cent this year and 3 per cent in 2008.
The fall-off in construction will lead to job losses and this in turn should lead to lower wage growth in 2008. It may appear unsympathetic to see a positive side-effect of unemployment but, in cold economic terms, Ireland has seen rapid wage increases in recent years and falls in competitiveness.
What is happening in construction is part of a rebalancing in the economy that will lead to more sustainable growth in the future. This is what we envisage for the immediate future and not recession.
Dr Alan Barrett, Dr Ide Kearney and Martin O'Brien are authors of the ESRI's Quarterly Economic Commentary