Drive to increase housing supply may overheat the economy, warns ESRI
The push to boost the number of houses being built could ultimately lead to the economy overheating, the Economic and Social Research Institute (ESRI) has warned.
The think tank also said if unemployment goes below 5.5pc the Government will also have to take steps to cool the growing economy.
In its latest quarterly commentary, the first of 2017, the ESRI said it was revising up its growth forecast slightly for this year and next on the back of stronger than expected growth projections for both the US and UK, and that unemployment was falling faster than expected.
It is predicting that GDP will rise by 3.8pc this year, compared with a previous forecast of 3.5pc, and 3.6pc next year.
"That's because of the slightly improved forecast for the US and UK, but also because at the tail end of last year and the start of this year, it was evident that the labour market has performed better than expected," said research professor and author of the commentary, Dr Kieran McQuinn. "The unemployment rate has come down a little bit quicker than we expected. The overall tax take, the various different taxes, they actually shored up quite well towards the end of the year."
The ESRI said domestic sources continue to be the driving forces behind the growth in the economy, with both investment and consumption set to make strong positive contributions to GDP over the coming years. But property-related factors are dominating both areas.
Higher levels of residential and commercial supply are increasing investment, while higher rents are contributing significantly to consumption.
And with demand likely to outstrip supply for the foreseeable future, higher rents are likely to dominate spending in the short-term, the think tank said. The ESRI said that housing supply is now responding to increased demand. It said the total number of houses built last year was just under 15,000. It expects that to rise to 18,500 this year and to 25,000 in 2018.
But if it continues beyond that, to above 30,000, there is a risk that that could cause the economy to overheat, Mr McQuinn said.
"We're treading a very fine line between, on the one hand we need more housing, that's clear and evident, and our latest estimate would suggest we need even more houses that we thought we did, but the issue is that driving the economy toward producing that, there is the possibility that we could veer into overheating territory. It's a very difficult line to tread."
"If we start to build 35,000 to 40,000, or 45000 to 50,000 houses, then we're clearly into an overheating situation."
Mr McQuinn said that even if 25,000 houses are being built a year, and the unemployment rate dips below 5.5pc, there is a risk of overheating and the Government will have to make the political decision to step in and take money out of the economy. The ESRI is forecasting unemployment to fall to 5.6pc next year.
It said the expected increase in construction activity will contribute to a consistent fall in unemployment over the next two years.
The ESRI said the growing relevance of the construction sector may give rise to productivity-related issues.
"It will be recalled that one of the main reasons for the substantial deterioration in the competitiveness performance of the Irish economy in the 2000s was the disproportionate role played by the construction sector," the commentary noted.
"The increased level of construction activity could also cause the unemployment rate to reduce faster than envisaged. If unemployment were to fall below 5.5pc, this would almost certainly confirm that the domestic economy is overheating."
Meanwhile, the Nevin Economic Research Institute said Government plans to deal with the housing shortage are insufficient and that the "lack of access to affordable quality homes constitutes a significant crisis" for the State.
In its latest economic commentary, the left-leaning think tank said the housing supply shortage is associated with a range of problems - fiscal, financial and market related.
It said the Government should adopt a radically-different approach to housing, based on what it calls the European Cost Rental Model.
This would involve the establishment of a single, unitary mixed-income rental model operated by a publicly-owned company on a cost-recovery basis. This would be known as the Housing Company of Ireland, and Nevin said it would be more ESB than Irish Water.
The funding for the company would come from a number of sources, including the exchequer, the Ireland Strategic Investment Fund, including the proceeds from the sale of part of the stake in AIB, the European Investment Bank, Nama surplus funds, a new Irish Housing Solitary Bond and other sources.
The aim would be to have 70,000 new homes over a five-year period, including 20,000 vacant but habitable houses currently in place, with a total capital investment of €12bn, which would, ideally, be treated as being "off the books" by Europe.
Rents would be charged at full economic cost, but low-income households would be subsidised. Similar schemes are already in operation in Austria and the Netherlands, Nevin said.