As growth slows, the way to stimulate the economy is to speed up public spending on infrastructure, argues estate agent economist John McCartney
The enduring success of the Rolling Stones illustrates the importance of adaptability. By perpetually reinventing itself, the band has retained its relevance through a remarkable 45 years, 55 albums and 37 top-10 singles.
Not unlike the Rolling Stones, Ireland's economy has also proved to be an adaptable performer. Throughout the 1990s exports were a key driver of growth. But when global demand collapsed following the 2001 terrorist attacks, our economy quietly reinvented itself.
Since then, the emphasis has shifted from external to domestic sources of growth. The investment component of GDP has grown by 6.1 per cent per year between 2002-2006. This largely reflects our house-building boom, but Government policy has also played its part as the last National Development Plan (NDP) injected €57 billion into the economy.
Increased consumption has also helped to fill the gap created by sluggish exports, and this component of GDP is now growing at 5.4 per cent per year.
By adapting in this way, the Irish economy has prospered where others have faltered. While Eurozone GDP growth averaged just 1.6 per cent per year between 2002-2006, Ireland's economy expanded by an annualised 5.3 per cent. Having pulled off this feat, however, we are once again facing serious challenges ahead.
To begin with, the house-building boom which rescued us after September 11th is rapidly running out of steam. New CSO figures indicate that housing construction has been slowing since 2005, and did not peak in 2006 as originally thought. Furthermore, advance indicators suggest that this slowdown will persist through to 2008 and beyond.
Compounding this, personal consumption is unlikely to keep growing at its present rate. The SSIA effect will begin to evaporate. More moderate house price growth means consumers might not have the confidence or the equity-release possibilities to sustain their current wave of spending.
We should not misrepresent this as a crisis - with Ireland's economy still growing at more than twice the euro zone average we can afford some slippage in house building and consumption. Nonetheless, it is worrying that we now find ourselves without an obvious growth driver for the economy.
Mercifully, the solution to this problem may be staring us in the face. There is now a compelling case for front-loading public capital expenditure under the new National Development Plan.
Potentially, this approach would have two benefits. Firstly, it would directly stimulate economic activity during a difficult period ahead. Secondly, it would increase Ireland's long-term growth capacity by expediting the delivery of much-needed productive infrastructure.
This proposal will probably revive warnings that investing too quickly in infrastructure would lead to construction inflation. However, things have changed dramatically since the Economic and Social Research Institute originally issued this caution last October.
At that time the building sector was stretched to capacity. As a result, input costs were growing by over 10 per cent per year and two-fifths of new construction jobs were being filled with imported labour.
Today, things are very different. In just 10 months, construction materials inflation has halved as building activity has begun to slow. Real wages in the sector are falling and, with the construction industry expected to shed up to 35,000 workers by 2008, inflationary pressures should continue to recede.
All of this means that it should be possible to accelerate infrastructure spending without compromising value for money. Of course, this is not to ignore the need for rigorous evaluation, and provision for this should be built into any revised investment timetable.
Another possible argument against front-loading the NDP is that it could push our general government deficit beyond the 3 per cent of GDP permitted in any given year under the European Union Stability and Growth Pact.
However, latest Department of Finance estimates forecast a general government surplus of €2,077 million in 2007. If, as expected, we are on schedule to meet this target, it means that we could double capital spending this year without running foul of the EU.
Given current economic conditions, there is now a strong case for front-loading public capital expenditure. Whether the Department of Finance takes this on board remains to be seen. However, initial indications are positive.
Already, and even in a more inflationary period, the Government has shown its willingness to resource infrastructure development. For example, last January it allocated €79.5 billion for capital investment in the new NDP. This is 22 per cent more than the €65.2 billion limit recommended by its consultants, the ESRI. Furthermore, exchequer returns for July show that capital spending for this year is currently 13.1 per cent ahead of schedule.
Each autumn, the estimates process provides an opportunity for the Government to reprofile capital spending within the multi-year funding envelopes it has set out for each department. If there is going to be any front-loading of infrastructure spending, therefore, we can expect negotiations to begin sooner rather than later.
• Dr John McCartneyis an economist and head of research at Lisney