The growing threat of inflation could yet scupper economic recovery,writes John McManus
Inflation now represents the single biggest threat to the Republic's economic prospects. Various other caveats that the Economic & Social Research Institute attaches to its generally upbeat prognosis pale when compared to the resilience of inflation.
The economy is on a trajectory that should see it grow by 3.1 per cent in Gross National Product terms this year. GNP is the value of the goods and services produced by the economy less profits repatriated by multinationals and other outflows.
The outlook could be even better than the figures suggest, according to the ESRI. "These rates, however, mask the very significant upswing in growth throughout the year to rates above trend growth of 5 per cent by year end," said the ESRI in its Quarterly Economic Commentary published yesterday. Growth in 2003 will be 4.4 per cent, which is the level at which most economists concur the economy is capable of sustaining in the long term.
Unfortunately it may have come just a little too soon, according to Mr Danny McCoy of the ESRI. The sudden deceleration in the second half of last year was not really sufficient to cool inflationary pressures, he believes. "The short, shallow downturn meant it did not deliver a reality check." Mr McCoy said yesterday. As a result, pressure on wages is likely to be sustained and there is now a real risk of a wage-price spiral which will undermine the economy.
Unemployment, which averaged 4.9 per cent in 2001 is expected to fall to 4.4 per cent this year. This is effectively full employment and herald's further labour shortages and upward pressure on wages. The problem will be compounded by the lack of weapons in the Government's arsenal with which to fight inflation, believes Mr McCoy.
The next administration will not be able to to trade tax cuts for moderate wage increases and industrial peace, he predicts. The pressure under which the public finances find themselves, following five years of tax cuts and double-digit annual expenditure increases, has ruled out another national wage agreement based on these principles.
"The public finances are forecast to deteriorate this year and next on the basis of expenditure commitments and revenue projections despite the improving economic growth conditions," according to the ESRI.
The Exchequer will be in deficit by around €727 million this year and €1.9 billion next year, according to the ESRI. This represents 0.7 and 1.7 per cent of GNP respectively.
The general government balance - which is used to measure our performance under the EU stability and growth pact - will move into deficit in 2003. The deficit is expected to to be 0.2 per cent of GNP. Although this is well short of the 3 per cent limit imposed by the pact, Governments are expected to run the general government budgets close to balance or in surplus.
There is also meant to be a sufficient safety margin so that a sudden shock does not push the balance through the 3 per cent barrier.
According to the ESRI, the public finances are so tight that there are virtually no tools available to the Government with which to fight inflation.
Failure to stop domestic cost pressure from feeding into higher prices and in turn eroding the purchasing power of wage incomes will quickly lead to a wage-prices spiral.
This in turn will led to the loss of export sales and the discouragement of foreign direct investment.
The problem will be exacerbated by any significant appreciation of the euro which will push up the price of Irish goods and services in export markets.
The limited scope for the Government to engineer another national wage agreement puts the responsibility on employers and unions to agree moderate increases.
