The Economic and Social Research Institute (ESRI) in its Quarterly Economic Commentary (QEC) published today says that it expects real Irish GNP (Gross National Product) to grow by 2.3 per cent in 2008, the slowest pace of real GNP growth since 1992. Investment is forecast to contract by almost 4 per cent in 2008 and so will partly cancel out growth in the other components of demand. The slow pace of economic growth will be reflected in the labour market where employment is expected to grow by less than 0.5 per cent. Unemployment is forecast to rise to 5.8 per cent.
The ESRI says that the last time a rate of growth below 3 per cent was experienced was in 2002, when GNP grew by 2.9 per cent (although in the same year, GDP growth was 6.4 per cent). Looking at other measures of growth, GNP adjusted for the terms of trade is expected to grow by 1.7 per cent in 2008. This lower figure relative to GNP growth reflects the expectation of a deterioration in the terms of trade in 2008. The Institute says this is part of a longer-run trend. Growth in GNP per capita is expected to be just under 1 per cent in 2008 and arises from the expectation that the population will grow by about 1.5 per cent in 2008.
The ESRI says that real growth in GNP is estimated to be 4.4 per cent in 2007. This means that 2007 has been another year of strong economic growth in Ireland. However, the growth will have been fuelled by a number of unsustainable components, including the effects of SSIAs and a highly stimulatory fiscal stance. Employment will register an impressive rate of growth in 2007, at almost 3 per cent.
In a special article (see below), it is claimed that Ireland's estimated economic growth will be reduced by up to 20 per cent a year as a result of the Government's planned reductions in carbon emissions.
The Government's climate change policy, which requires CO2 emission reductions of 3 per cent a year to 2012, would require "draconian measures" across all sectors of the economy, and should be abandoned, says ESRI senior researcher Richard Tol.
He says that carbon taxes be introduced, but only on emissions from sectors not already covered by the EU's Emissions Trading Scheme - the power generation, iron and steel, glass and cement industries.
Reducing greenhouse gas emissions by 3% per year between now and 2012 is almost impossible, because energy supply and transport infrastructure are largely fixed. Meeting this target would require truly draconian measures, such as a ban on commuting by car; a ban on dairy cows and cattle; or mass emigration, Tol says.
The QEC says that while the full-year figures for 2007 are strong, it appears that a deceleration in the rate of growth began to take hold in the second part of the year. This is largely related to a contraction in house building. Given the weight of house building in total economic activity in Ireland, the contraction is placing a drag on growth and this will be prominent in the economic story for 2008.
The Institute says that the forecasts for both 2007 and 2008 have been prepared against a background of continued uncertainty in international financial markets. The international context also includes anticipated slowdowns in the UK, the US and the Euro Area, which are in turn partly related to the global credit crunch. The rate of growth in Irish exports is expected to moderate in 2008 relative to 2007 (5 per cent versus 5.7 per cent) in response to these slowdowns.
The ESRI says that it has adopted a technical assumption that the ECB will not change interest rates in 2008. Although inflationary pressures are present in the Euro Area, growth appears to be weakening and so it is unclear in which direction the ECB will take interest rates. Based on this assumption, CPI inflation is forecast to be 3.3 per cent in 2008, while the forecast for HICP (EU Harmonized Index of Consumer Prices standard) is 2.8 per cent. This represents a significant reduction in the difference between the two measures of inflation.
In the General Assessment of the QEC, the authors looked at three issues. First, what they see as being unsustainable elements in Ireland’s recent growth performance. With these elements now receding, there is a heightened need for competitiveness to be restored so that other sectors can grow. Second, they look behind the employment forecast for 2008 of a net increase of 8,000 jobs. This increase is made up of an increase of over 28,000 jobs in services and a fall of approximately 20,000 jobs in industry (including construction). Hence, the figure of 8,000 understates the full extent of employment dynamics. Finally, they reflect on the recent Budget. While broadly welcoming the measures included and the overall fiscal stance for 2008, we note again the highly stimulatory nature of fiscal policy in 2007 and its effects on the economy.
With the ending of the housing boom, SSIA-led consumption growth and the large fiscal stimulus of 2007, the Institute says that it is clear that other sectors will now have to perform well if the growth rate is to recover in 2009. The addition of almost 30,000 jobs in "financial and other business services" in the year ended 2007 Q3 shows that there is growth potential elsewhere in the economy, even if some concerns now exist for the global employment prospects of the financial sector in the short term, given the turmoil in financial markets.
The ESRI says that the key to an improved performance is, as always, competitiveness. In this context, moderation in wage growth in 2008 would be particularly welcome. High rates of wage inflation in recent years have led to Ireland’s share of world export markets falling. A reversal of this trend is imperative in the context that we have just set out.
The employment forecasts are based on a somewhat optimistic view of the potential for labour to flow across sectors. Without detailed knowledge of the skills of those losing jobs in one sector and the skills needed in expanding sectors, the Institute says that it is difficult to model the labour re-allocation process. However, it is worth pointing out that if labour cannot readily flow between sectors, the forecast for unemployment next year might be overly optimistic. To use a slightly old-fashioned term, "structural unemployment" might emerge, whereby the number of vacancies matches the number of unemployed workers but where skill mismatches prevent job matches. In this context, the importance of training policies comes to the fore because there is a need to supplement the skills of those becoming unemployed so that they can move to other sectors.
Some of the main findings of the QEC analysis by authors - Dr. Alan Barrett, Dr. Ide Kearney and Martin O'Brien analysis include:
There are four Special Articles in the Quarterly Economic Commentary, as follows:
"Building for the Future? Interpreting an "Irish" Current Account Deficit"
The unique development of the Irish economy in recent years compared to our Euro Area partners suggests less favourable conditions ahead.
Martin O'Brien (ESRI)
In recent years the current account deficit on the balance of payments has widened sharply, approaching -5 per cent of GNP. Membership of the Euro Area implies that this development and its implications can be interpreted from both a benign and a worrying point of view:
Benign - this could be part of a desirable transition process driven by Ireland’s relatively high rate of economic growth and increased integration as a result of monetary union. In this scenario running a current account deficit is linked with high rates of investment funded by foreign capital to underpin stable economic growth in the future.
Worrying - it could indicate more unwelcome and persistent trends in terms of competitiveness problems. This interpretation implies Ireland may face a difficult period of adjustment, with significantly lower growth and higher unemployment.
The main findings are:
While competitiveness pressures are very significant, the higher pace of economic growth is slightly more important in explaining the size of the deficit. This suggests it is part of the necessary and appropriate adjustment to being part of the Euro.
However economic growth has recently been concentrated in housing investment, more so than other Euro Area countries with current account deficits and at the expense of investing in potentially more productive assets e.g. machinery.
The unique scale of activity in the construction sector, which is characterised by low productivity growth, has in itself contributed to a fall in Ireland’s competitiveness, probably beyond what was required in adjusting to Euro Area membership.
While the size of the current account deficit is appropriate given the recent pace of economic growth, by taking a closer look at the nature of that growth it is shown not to have been the most advantageous for promoting stable, trade-driven economic growth in the future, implying some form of adjustment may be necessary.
The policy implications from these findings include:
Promoting wage restraint in the public sector, which in turn would reduce the costs faced by exporters and their employees, can alleviate rising unemployment as a result of falling competitiveness.
Government could increase spending on traded goods relative to non-traded, in effect curtailing current expenditure, to try and curb demand in non-traded goods, which indirectly impacts on the competitiveness of the traded sector.
Promote more flexible wage and price setting behaviour in the non-traded sectors by enhancing competition and regulation policy in utilities, public transport and the professions. This, alongside provision of economically viable and necessary infrastructure can improve productivity in these sectors.
Government should avoid over-stimulating the house-building sector and allow the correction in the housing market to continue, freeing up resources to be used in the traded sector.
"Hub Airport Slots, Market Exit and Irish Regional Economic Development"
Sean D. Barrett (Dept. Economics, TCD)
Airline Deregulation good for Ireland and the Atlantic Region
In this paper, Dr. Sean Barrett of Trinity College Dublin finds that airline deregulation has served the Irish Atlantic region very well. He rejects the argument that the Irish government should have forced Aer Lingus to retain the Shannon-Heathrow service against its commercial judgement. He also argues that a deregulated market will serve the region better than government intervention in airline route choices.
By way of illustrating the benefits of deregulation, Dr. Barrett highlights the following points:
Between 1990 and 2006, airline travel between the Atlantic region and London increased from 995,000 to 2.682 million passengers. 94% of the increase involved new airlines and new airports.
The Shannon-Heathrow services added only 12,000 passengers or 0.7 percent of the total increase in the Atlantic region traffic to London.
The Open Skies market between the EU and the USA offers new direct route opportunities from Ireland from March 2008 to all the major markets served by Heathrow now.
The market has already generated alternatives to the Shannon- Heathrow route.
Deregulation has been highly successful in Irish aviation with passenger numbers on Irish airlines rising from 2.3 million passengers in 1985/1986, the last year before deregulation, to over 60 million passengers in 2007 with large fare reductions and new routes.
Government intervention to force Aer Lingus to serve the Shannon-Heathrow route would have damaged both Aer Lingus and the other airlines serving Ireland. The government was correct to reject the pro-intervention arguments. Barrett rejects arguments that low-cost airlines are bad for the business passenger, for tourism or for regional development in Ireland and opposes a return to the national airline model.
"Irish Climate Policy for 2012: An Assessment"
Richard S.J.Tol (ESRI)
Between 1990 and 2005, Ireland sharply reduced the amount of carbon dioxide emitted per Euro value added. On this measure, Ireland has outperformed most OECD countries. Ireland’s rate of decarbonisation was 43% in 15 years, compared to the OECD average of 22%. Germany and the UK, the self-proclaimed champions of climate policy, decarbonised by 30% and 33%, respectively. Lacklustre economic growth and a stagnant population, rather than climate policy, explain why Germany is likely to meet its emissions targets under the Kyoto Protocol. Rapid economic and population growth explain why Ireland is likely to miss its Kyoto target.
According to the Agreement for Government, Ireland will reduce its greenhouse gas emissions by three percent per year.
Achieving this rate of emission reduction in 2020 would reduce annual economic growth by 0.35% (a slowdown of more than one in ten) if emission reduction is achieved by a carbon tax. The carbon tax would be around €400/tCO2. This would raise the price of electricity from 14 c/KWh to 39 c/KWh, and the price of petrol from 1.18 €/l to 2.08 €/l. The tax would be €897 per dairy cow per year, and €49 per sheep per year.
If emission reduction is achieved by other means than a carbon tax, the costs to the economy will be substantially higher.
Reducing greenhouse gas emissions by 3% per year between now and 2012 is almost impossible, because energy supply and transport infrastructure are largely fixed. Meeting this target would require truly draconian measures, such as a ban on commuting by car; a ban on dairy cows and cattle; or mass emigration.
Instead, the government should impose a carbon tax on all emissions that are not covered by the EU Emissions Trading System. The carbon tax should equal the futures price of emission permits in early December of the previous year. The 2009 carbon tax would then be €23/tCO2.
Emissions that are already regulated by the EU Emissions Trading System should be exempted from the carbon tax. If not, every tonne of carbon dioxide reduced in Ireland would be emitted elsewhere in Europe, but there would be a real cost to the Irish economy. A tax on top of permit trade is just an elaborate way to burn money.
"The Earnings of Immigrants in Ireland: Results from the 2005 EU Survey of Income and Living Conditions"
Alan Barrett (ESRI) and Yvonne McCarthy (Central Bank and Financial Services Authority of Ireland)
This paper has three objectives:
First, a review of the developing body of work on the economics of immigration in Ireland is provided
Second, an earlier analysis undertaken by Barrett and McCarthy of the earnings of immigrants in Ireland, based on data from 2004, is updated.
Third, the earnings of immigrant women are assessed to see if they experience a "double disadvantage".
The following points, among others, emerge:
The review of the literature on the economics of immigration in Ireland points to immigrants faring less well in the Irish labour market relative to native employees.
As regards the analysis conducted in this paper, we find that immigrants were earning 15 percent less than Irish employees in 2005, taking account of different levels of age, education and workplace experience. For immigrants from non-English speaking countries, the wage disadvantage was 20 percent. The corresponding figure for immigrants from the EU’s New Member States was 32 percent.
A double disadvantage is found for immigrant women. By this we mean that the analysis shows (a) women (immigrants plus natives) earn 12 percent less than comparable men (again, immigrants plus natives) and (b) female immigrants earn 14 percent less than comparable native female employees. This double disadvantage is concentrated among female immigrants with third level degrees.
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