Monday 19 November 2018

Comment: Our blistering economy does not need Budget fuel

 

Finance Minister Paschal Donohoe’s Budget is tomorrow. Photo: Gareth Chaney/Collins
Finance Minister Paschal Donohoe’s Budget is tomorrow. Photo: Gareth Chaney/Collins

Loretta O'Sullivan

'Are we there yet?' This is a question that usually emanates from children trapped in the back seat of a moving car. In recent months, though, there has been a growing chorus of grown-ups asking much the same thing - albeit the subtext differs.

For the children, it is about reaching their granny's and granddad's house or the playground and having fun.

Whereas for the adults, it is about the economy reaching capacity and a gnawing feeling that the situation might get out of hand.

In both cases, the distance left to go depends on the current location and the final destination. In a car, it's easy enough to put A and B into Google Maps and get an answer. For the economy, figuring out C is a bit trickier.

One way of going about it is to look at what the economy is actually producing and what it could potentially produce if it was getting the most out of all of its resources.

Bodies such as the European Commission, the OECD and the IMF make regular stabs at this. Their latest calculations suggest that Ireland is operating a little above its potential.

Or, to put another way, we are demanding more goods and services than the economy can sustainably supply. Generally speaking, when things get to this point, price pressures start to build.

Another means of getting at C is to draw on measures of capacity utilisation from business surveys.

This information hasn't been available for a number of years but is being collected again as part of Bank of Ireland's Economic Pulse research.

The findings indicate that firms in industry are currently using 76pc of the resources available to them. This is pretty much in line with the historical average; so on this basis, capacity pressures look to be in and around the norm.

Comparing today's unemployment rate with its long-run equilibrium is also helpful when trying to get a handle on how much further there is to go. Recent CSO estimates put the former at 5.4pc.

If we use the rough rule of thumb of 5pc or a bit below for the latter, 'full employment' would seem to be in sight.

Typically, when the labour market gets to this stage, wage pressures start to build.

It is fair to say that none of these approaches are perfect. They suffer from varying degrees of shortcomings.

Irish GDP is subject to distorting globalisation effects, for example, and has a tendency to be revised. Potential growth isn't observable, so has to be estimated.

Industry is just one sector. Under-employed and discouraged workers aren't captured by the standard unemployment metric. And so on.

Also, we haven't seen much upward price and wage pressures to date - at least at the aggregate level.

Annual consumer price inflation is running at around 0.75pc, with wage growth around the 3pc mark. The weak pound has being keeping a lid on import prices, while scarring effects from the crisis and changes in the composition of the workforce - fewer construction jobs and more services ones - are some of the reasons put forward for the still relatively subdued pay landscape. Economists are forecasting an uptick in inflation and earnings over the coming year, though.

There are, of course, parts of the economy that are clearly already under strain. The housing market is chief among these, but other infrastructure areas, such as transport, are at a tipping point too.

Taking everything in the round, the answer to the question about the economy reaching capacity is that we appear to be 'thereabouts'. This means that there is no need to add further fuel to the tank.

This requires a prudent approach to the public finances. This is the task that Finance Minister Paschal Donohoe and the Government face with tomorrow's Budget.

While it is not an easy one - politicians have to get re-elected, whereas economists don't - the lessons of the not-too-distant past are relevant for us all as the country moves forward.

Dr Loretta O'Sullivan is the group chief economist at Bank of Ireland

Irish Independent

Business Newsletter

Read the leading stories from the world of Business.

Also in Business