Wednesday 19 June 2019

Loretta O'Sullivan: 'Expanding without overheating is the challenge facing the nation'

The ongoing uncertainty of Brexit is a major issue for Leo Varadkar’s Government and the
Irish business community
The ongoing uncertainty of Brexit is a major issue for Leo Varadkar’s Government and the Irish business community

Loretta O'Sullivan

Those of a certain vintage will recall a nursery rhyme that opens with the line 'Mary, Mary, quite contrary, how does your garden grow?'. These days there is a sing-along version doing the rounds which replaces the silver bells, cockle shells and pretty maids of old with a profusion of colourful flowers. All are still in a perfect row but now ingredients like seeds, water and space get a mention.

How is this relevant? Well, if we substitute the garden with the economy and re-label the inputs labour, capital and productivity, we have the essence of how countries grow.

Growth in Ireland has been strong for some time and a range of metrics like the low unemployment rate suggest that the economy is rapidly using up its available resources.

Typically it is at this point that price and wage pressures start to build and overheating risks emerge.

As talk of the economy reaching full capacity has increased, so too have the danger warnings, with the Central Bank and the Fiscal Advisory Council among the commentators stressing the importance of prudent economic and budgetary management. The idea behind this is to stop things getting out of hand by keeping a lid on demand. Roses get pruned for much the same reason.

Of course, pruning also encourages fresh growth and, indeed, bolstering the economy's ability to produce more goods and services is something that we need to start giving more thought to. This will involve measures to boost the labour force and the capital stock.

In the case of the former, population increases including inward migration will have a role to play but there is also scope to raise the participation rate among some groups.

In the case of the latter, upping business investment will be key. Recent Bank of Ireland Economic Pulse research looked at firms' plans for replacing plant and equipment, purchasing new premises and investment in ICT among other things and sheds light on the factors influencing investment decisions. Demand from customers, at home where businesses are serving the domestic market and overseas where they are exporting, is generally seen as supportive. The same goes for financial conditions and technical factors get a broadly positive response as well.

Uncertainty is a drag, however. Unsurprisingly, the weed with the strongest chokehold in this respect is Brexit. This is reflected in the fact that half of Irish businesses impacted by the UK's decision to leave the EU indicated that they had put their investment plans for next year on hold.

The situation remains fluid, with a draft deal on the table and Prime Minister May surviving last week's leadership vote, but getting the agreement of the UK parliament will be difficult if not nigh on impossible. This means that some firms are going to be living with Brexit uncertainty for another while yet.

In sustainably growing the economy, there is one further consideration - the somewhat nebulous concept of productivity. The thinking here is that while it is all well and good to have more workers and more capital, improving the overall efficiency with which these resources are used will also be important.

Public investment can contribute to this by enhancing the productivity of labour and capital.

Investment in infrastructure, for example, creates an enabling environment, lowering firms' costs and increasing competitiveness. But with firms in many part of the country scoring the existing transport and telecommunications network poorly according to Pulse research, there is clearly a way to go on this front.

While the new National Development Plan sets out various initiatives to address these gaps and is a start, it is likely to face some challenges in doing so, not least a shortage of construction workers.

Let me close by referring again to the opening analogy. Mary undoubtedly put a lot of hard work and loving care into tending to her garden. In relation to the economy, we basically need to do the same, boosting its productive capacity while also keeping overheating risks at bay.

This may prove to be a difficult balancing act but the prize of sustainable growth is surely worth it.

  • Dr Loretta O'Sullivan is group chief economist with Bank of Ireland Group

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