In this column on October 16th last I raised concerns about two sectors of our economy - manufacturing, for some time in decline, and house-building, potentially vulnerable to a setback that could have a significant impact upon our economy. Both issues have been addressed in the most recent ESRI Quarterly Economic Commentary, writes Garret FitzGerald.
In relation to housing, the institute has revised its Autumn 2004 estimate of a small further rise in completions in 2005, and is now projecting a drop of 5,000 in dwelling completions, from an estimated 2004 out-turn of 79,000. This reflects its view that "current levels of housing completions are substantially above the levels required to meet the long-term housing needs. The underlying demographic demand for housing is estimated at around 30,000 units per annum".
Thus we are currently building 2½ times as many dwellings as are required to meet "the underlying demographic demand for housing" - proportionately seven times as many as in Britain. Economic growth has become extraordinarily dependent on an abnormal level of house-building.
While the ESRI believes that a drop of as much as 50 per cent in house-building is unlikely, it has felt it worthwhile to calculate the impact of such a reduction on our economy if it were not accompanied by an appropriate response. It suggests national output growth would fall by three percentage points (e.g. from 5 to 2 per cent per annum), with a slightly bigger effect on living standards - and unemployment would rise by as much as half, back to a level not seen since 1998. Such repercussions would not merely halt but might reverse, at least briefly, the rise in Irish living standards which was such a striking feature of the 1990s and has since continued on a more modest scale.
The institute does not suggest what an "appropriate response" might be, but it would presumably have to involve a sharp increase in public investment, possibly even on a scale that could raise borrowing beyond that permitted by the EU Stability Pact.
While a drop of as much as 50 per cent in housing output may be unlikely, a significant reduction is clearly inevitable at some point within the next couple of years. For, with only 30 per cent of all dwellings now over 45 years old, there must be a limit to the volume of further replacement housing still needed, and demand for second homes is unlikely to be sustained indefinitely at its present remarkable level of over 15,000 a year.
Part of the housing boom reflects the abnormally low level of European interest rates and this could be sustained for much of the present year, but probably not much longer than that - so it is clearly unwise to assume that our economy will be free of any housing shock in 2006 or 2007.
The ESRI has also revisited the issue of industrial output, and in its current Commentary has taken some account of a matter to which I have several times drawn attention, viz. the over-weighting in our industrial production index of certain modern industries such as basic chemicals, which includes the production of high-value Viagra. Because some of these over-weighted industries continued to grow during the recent recession official industrial output figures significantly exaggerate current manufacturing output.
The "improvement in the industrial sector" which the ESRI has observed in its recent Quarterly National Accounts reflects, of course, the continued growth of construction also rather than of manufacturing, and while the ESRI also noted a rise in manufacturing output in September last, there was no further improvement in such output in October and November, when it remained below the level of the same months of 2003. A sustained recovery in manufacturing from the four-year-old decline has yet to happen.
A third point made in my October article, still unaddressed by other economic commentators, is the significance for our national productivity growth, and consequently for future living standard improvements, of the switch in emphasis that has been taking place from manufacturing to services as the principal source of future employment and output growth.
During the Celtic Tiger period labour productivity at the national level - output per worker - rose rapidly, primarily because of the impact, direct and indirect, of high-tech investment by US multinationals. Between 1993 and 2000 the average increase in labour productivity was a quite remarkable annual 4.3 per cent - over twice that of the EU.
Moreover, because during those seven years the resultant 525,000 increase in employment was accompanied by a 300,000 drop in the number of dependants, the ratio of dependants to workers dropped by over two-fifths. The consequent dramatic fall in our dependency ratio - a drop from 2.1 to 1.2 in the number of dependants per worker - boosted the average annual improvement in per capita consumption, or material living standards, to over 6 per cent a year, something for which there does not seem to have been any historic precedent in Europe outside periods of post-war recovery.
This bonanza ended abruptly when recession struck in early 2001. For three years thereafter labour productivity and living standards both crawled upwards at a rate of less than 1 per cent a year, and, judging by the scale of the inflow of immigrant workers required last year to secure the estimated 4.5 to 5 per cent increase in GNP, there may also have been very little improvement in labour productivity in 2004.
Our 2004 experience suggests that if economic growth is to be driven primarily by the services sector then, even allowing for statistical under-estimation of growth in the output of services, we may in future face much lower increases in labour productivity, and thus ultimately also in living standards. This would inevitably mean that future economic growth may require a bigger flow of immigrant labour than hitherto suggested.
So, as the emphasis switches away from manufacturing growth towards the market services sector, where higher output requires substantial employment increases because labour productivity in services rises only slowly, we are unlikely to see living standards rising by much more than 2 per cent a year, a fraction of what we became accustomed to during the Celtic Tiger years.
I am puzzled by the silence of economic commentators on this development, which appears to me to mark a very significant change in our economic circumstances.