A Martian, with a background in economics, on arriving in Ireland would probably share the international concerns about the strength of the economy which have been expressed with growing frequency in recent times.
A quick perusal of the facts would show him: the economy is enjoying high single-digit growth; car sales are booming; property prices have gone through the ceiling; many employers are reporting difficulties in recruiting and holding on to staff; and not surprisingly wage pressures are becoming evident.
His economic training would probably lead him to conclude that a bubble was in evidence and that careful economic management would be needed to prevent it going the way of previous bubbles seen in areas such as Japan and south-east Asia.
The Irish authorities would respond that Ireland is a little bit different because it has unique characteristics which render the application of standard economic theory meaningless. For example, the demographic structure supports the level of growth which the economy has experienced and a wage system is in place which will ensure that wage demands won't spill over. In support of these arguments simple facts can be produced to show that since 1991 real growth in the economy has averaged 7.1 per cent per annum, while inflation has averaged just 2.2 per cent. Q.E.D.
It is important, however, to recognise that the situation may be changing. If Ireland's demographic structure is so unique and so supportive, why are acute labour shortages becoming increasingly evident? Inflation is also edging up, soaring house prices are taxing many great minds and pockets, and but for a small percentage of the private sector workforce, the wage elements of Partnership 2000 have faded into distant memory.
It can perhaps be justifiably argued that those who are flogging the overheating story simply don't understand how the economy operates or are seeking to scaremonger to command media attention. But just in case they are partly right, it might be prudent to address the issue. Tighter interest-rate policy is obviously not an option and in fact rates are set to become more accommodative to the tune of about 2.5 per cent over the coming months. This places the burden of adjustment on other areas.
Fiscal policy is the obvious candidate. However, successive governments have found it impossible to curb public spending over the past decade and in the environment we have at the moment, cutting public expenditure would prove impossible to sell.
Postponing the promised tax cuts or even increasing the tax burden will also be very difficult to sell from a political perspective. Personal tax payers already face an onerous tax burden and now believe they should be benefiting from the current economic phenomenon.
In any event, those who are tied into Partnership 2000 are now waking up to the reality of real wage cuts this year. Why should the already burdened PAYE sector bear the brunt of any fiscal adjustment?
One of the key reasons inflation is ticking up is because the Irish pound has fallen by almost 10 per cent in trade-weighted terms since the beginning of 1996 and this is now resulting in higher import prices. One way of addressing this would be to lock the pound into the euro at a significantly higher rate than DM2.4833 next January. Granted, such a move would make the Irish look a little silly following our assertion in the aftermath of the 3 per cent revaluation in March that the new central parity was appropriate for the economy.
Furthermore, the European Council stated at the beginning of May that current ERM central parities would be applied next January. So perhaps the situation is irreversible, but in reality nothing is irreversible until next January.
The risk in joining at a higher rate would be a sharp fall in the value of sterling ahead of its eventual EMU entry, but we have all been promising that for months and we have all been wrong. It might just be worth taking the risk.
Irish exporters would obviously react very negatively to a revaluation suggestion, but perhaps it would be a slightly less painful option than an overheating of the economy which would ultimately destroy competitiveness and result in much more serious economic dislocation.
If the currency option is ruled out as it most likely will, other alternatives might be considered. The ESRI recently made a very compelling argument that the Government should examine its policy on immigration to help alleviate both skilled and unskilled labour shortages and the longer term problem of falling fertility rates.
Migratory flows have always acted as a safety valve for the economy, but generally in the opposite direction. This raises the issue of the infrastructural shortfalls in areas such as housing. With a debate now starting on what to do with the fiscal riches, a strong argument can be made for increased investment in housing-related infrastructure in order to accommodate inward migration. If we want to attract workers in, we will have to provide housing and a proper transport system, and of course a tax package which is not penal.
Jim Power is chief economist at Bank of Ireland Group Treasury.
