The ESRI - Economic and Social Research Institute - forecasts in its Medium-Term Review 2008-2015, published today that the Irish economy is heading towards a real economic growth rate averaging 3.75 per cent annually over the next decade. The Institute says business services exports will account for 70 per cent of all Irish exports but are very sensitive to Ireland’s competitiveness.

After below-trend growth in 2008 and 2009, the ESRI says economic growth will rebound in 2010 when it will exceed 5 per cent.

The ESRI says that Ireland will continue to outperform its European neighbours in the years to 2025 and that as a result, income per head of population in Ireland is projected to come close to 120 per cent of the EU15 average in the years 2020- 2025.

However, a “wasted opportunity” scenario considers the possibility that a serious loss of competitiveness could see the economy under-perform by an average of 0.7 per cent a year. The results suggest that there are significant downside risks over the medium term if policy does not promote competitiveness, broadly defined. The Institute says that on past experience the medium-term forecasts come with a margin of error on the average growth rate over the forecast time horizon. This margin is between three-quarters and one percentage point of GNP. Also the last ten Reviews have tended towards the pessimistic side in terms of their forecasts, with underestimation of future growth being more frequent than overestimation.

The total stock of permanent houses at the time of the 2006 Census was 1.77 million. Of these approximately 175,000 units were vacant houses, a further 41,600 were vacant flats and 49,800 were holiday homes. Based on these estimates the vacancy rate stands at around 15 per cent of the housing stock, a very high figure. Because of their location away from the major centres of employment growth, many of these vacant dwellings may not be useful in meeting future housing needs. Like many asset markets the housing market can experience peaks and troughs. A major policy challenge is how to deal with such volatility. Intervention is complicated by the fact that policies need to take account of both the owner-occupant and rental sectors of the market. The ESRI says that with housing demand and prices currently falling, there is little that policy can do to manage this process. However, over the coming decade when the housing market recovers the need to prevent a future bubble could require a more active fiscal policy stance.

Executive Summary

Some of the main findings of this Medium-Term Review include:

• The economy has the potential to grow at around 3.75% a year over the coming decade, despite significant short-term problems. When the current global economic slowdown ends, with appropriate policies the economy should recover quite rapidly. Even if current difficulties prove more severe than anticipated, the economy is resilient and a global recovery would still see it rebound. The prospect of continuing medium-term growth above the EU average is underpinned by favourable trends in labour supply and in productivity. While unemployment is currently rising, with a flexible labour market there should be a return to full employment. Despite current difficulties in building and construction, the economy needs continuing substantial investment in housing and infrastructure over the coming decade.
• The drivers of Irish economic growth are changing. Exports of business and financial services are a vital contributor to growth. Domestic factors, including fiscal policy and the labour market, now have an increased influence on competitiveness.
• Progress on environmental protection is likely in a number of areas such as acid rain and hazardous waste. The renewable target in electricity generation is likely to be met. With a plausible carbon tax - the cheapest means of reducing greenhouse gas emissions - Ireland will reduce emissions but still miss its target by a considerable margin. The EU targets for reducing landfill waste are also likely to be missed.
• Policy Implications. Structural policies, such as investment under the NDP (National Development Plan), will play a key role in delivering on the favourable growth scenario in this Review. Developing good health care, excellent education, and a clean environment will be increasingly important in making Ireland an attractive location to live and work. In the future fiscal policy will need to be used to manage economic cycles more actively.

The ESRI says that Ireland’s recent performance shows that its comparative advantage on world markets is shifting towards the production and export of business and financial services. Major employment growth in the future is expected to occur in this sector, which is among the most human capital intensive in the economy.

A substantial share of the profits earned in the Irish economy, especially in manufacturing and business and financial services, are the property of owners who are resident outside Ireland, in particular, foreign multinational firms. However, this also applies to many of the largest firms, such as banks, the majority of whose shareholders are resident outside Ireland. The profits, whether paid as dividends or retained in the firms are considered the income of these foreign residents and deducted from GDP to arrive at GNP. The diversification geographically in financial portfolios also means that there is a substantial, though smaller inflow of profits into Ireland to those residents who own assets abroad.

Services exports currently account for 43 per cent of total exports and by 2025. The ESRI projects that market services will account for 60 per cent of net output or value added in the Irish economy and in excess of 70 per cent of all Irish exports.

Business and financial services are projected to employ more than 750,000 people, or some 30 per cent of the workforce, by 2025 while net immigration will fall from  70,000 in each of the past two years to 20,000 this year and will average just 11,000 annually between 2010 and 2015.

Housing completions are forecast to average 48,000 annually between 2010 and 2020.

Over the period 2008 to 2015, additions to employment are projected at 169,000, an average increase of 24,000 or 1.2 per cent annually. As a result of slower jobs growth in the years immediately ahead, the unemployment rate is projected to rise, reaching a peak in 2011.

The unemployment rate, is forecast by the ESRI to increase from 4.5 per cent in 2007 to 6.9 per cent in 2011 before declining gradually to 5.3 per cent by 2015.

For forty years between 1926 and 1966 Irish wage rates ranged around 50 and 60 per cent of those in the UK. This was in spite of very substantial movement of labour from Ireland to the UK. However, from the mid-1960s onwards the wage rate in Ireland converged rapidly on that in the UK stabilising at just under 90 per cent of the UK rate between 1970 and 2005. However, recent evidence confirms that the supply of labour is no longer infinitely elastic. Instead the labour supply curve slopes upwards with significant implications for labour market behaviour.

The Institute says that while Ireland clearly has enjoyed a competitive advantage in the business and financial services sector in world markets over the last decade, this advantage is in no way guaranteed. Business services exports and output are very sensitive to Ireland’s competitiveness. This is illustrated in Table 2.4, which shows the impact of a one percentage point improvement in Ireland’s competitiveness relative to the rest of the world, assumed to begin in 2006, and sustained for twenty years. Wages in Ireland are held constant (as are import prices).

To capture the full long-run effects of competitiveness changes, the effects on the key variables are shown for 2025. The results indicate that the supply response for both tourism and business services exports is similar lying in the range 1.29 to 1.35.

Assumptions on energy prices are derived from the International Energy Agency’s (IEA) forecasts. However, it raises a key issue on the reliability of the outlook as the IEA forecasts are not recent ones.

While Ireland is specialising into certain sectors where it has special advantages, there are other developed countries with similar advantages. As a result, the ESRI modelling suggest that competitiveness relative to our neighbours is very important, not just for manufacturing, but also for business services.

In 2006, 90.2% of Irish exports - merchandise and services - were made by foreign owned firms and the reliance on continued overseas investment, indicates the importance of competitiveness.

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