Remarks by Tánaiste and Minister for Finance Brian Cowen at the Towards 2016 Plenary Meeting in Dublin Castle today.
Like many other economies, the Irish economy is currently facing its most difficult environment for some time, with both domestic and external headwinds likely to restrain the pace of economic expansion in the short term.
Domestically, new housing output this year will be lower than last year. Given the relative importance of this sector, the lower level of completions will exert a negative drag - possibly of the order 2½ percentage points - on the aggregate growth rate this year.
The external environment is also more challenging and this could potentially compound the moderation in domestic demand. The outlook for the US has clearly deteriorated in recent months with growing evidence that difficulties in the housing market are spilling over into the rest of that economy, and in its recent assessment, the IMF has revised downwards its forecast for growth to 1.5 per cent this year. From our perspective, the US is a key export market, being the destination for about one-fifth of our merchandise exports. Perhaps more importantly, it is our main source of inward foreign direct investment and the recent deprecation of the dollar is unhelpful in this regard.
In terms of our other main trading partners, the outlook for the UK economy also appears less favourable, while economic forecasts for the euro area are being revised downwards. The prospect of slower growth in the UK has been associated with an appreciation of the euro-sterling bilateral exchange rate, which remains close to its highest level since the beginning of monetary union in 1999.
Notwithstanding some improvement in recent weeks, uncertainty remains a key feature of international financial markets. Volatility in global equity markets would appear to be symptomatic of this uncertainty. At the same time, prices for a wide range of commodities, including agricultural commodities, remain close to historically high levels.
Reflecting these developments, I projected a GNP growth rate of 2.8 per cent this year in the December Budget, a growth rate which is lower than in recent years. However, it is fair to say that once the housing shock is absorbed - in other words when output returns to more sustainable levels - growth is expected to pick up in 2009 and 2010.
The most important basis for this assessment is the fact that the fundamentals of the Irish economy remain sound. By this I mean that:
the Irish workforce is dynamic, well educated and responsive to changing circumstances.
our markets for goods, services, capital and labour are very flexible by international standards.
we have an effectively regulated, pro-enterprise society where hard work and entrepreneurship are rewarded.
the burden of taxation is low, and is conducive to productivity growth and to attracting inward investment.
Recent Budgetary changes again sought to protect this situation, particularly so for those on low incomes. In general terms, our public finances are sound, with surpluses recorded in ten of the last eleven years, and we have one of the lowest levels of public debt in the EU. All of these factors mean that our medium-term growth prospects remain favourable and I think it's fair to say that most economic commentators would subscribe to this view.
I wish to highlight the key role that fiscal policy is playing in terms of providing support for the economy. Current spending will rise by around 8 per cent this year while revenues will grow by just 3½ per cent. Even still, only a modest deficit is in prospect and this is a prudent, sensible approach at this stage of the economic cycle. Moreover, capital spending will rise by around 12 per cent this year as full implementation of the National Development Plan has been prioritised by the Government. This will help to boost the productive capacity of the economy and lay the foundations for future growth. In relation to short-term economic prospects, it is fair to say that domestic demand, and in particular new house building could not sustain overall GDP growth in the longer term and we are now seeing a re-balancing towards more sustainable, export-led growth. In this regard, a renewed emphasis on improving competitiveness is required to ensure that the re-balancing towards export-led growth is achieved in a smooth manner.
While there are many aspects to this, labour costs are a key component. In this regard, a renewed emphasis on improving productivity is required so that wages can rise without jeopardising our ability to generate export-led growth. The Government continues to implement measures to enhance productivity - investment in human and physical capital under the National Development Plan is just one example. Nevertheless, it is crucial that wage expectations are kept in line with the rapidly changing economic environment in which we are operating. Over the last number of years, wage increases have exceeded productivity growth, with a resulting loss in competitiveness. Regaining market share will require an approach to wage determination which takes greater account of productivity developments as well as labour cost developments in our major trading partners.
Inflation developments are also crucial from a competitiveness perspective. Much of the increase in the consumer price index over the last number of years was due to factors beyond our control, namely the impact of rising mortgage interest rates and higher oil prices. In relation to mortgage interest rates increases that have occurred over the past year or so, my Budgetary changes to mortgage interest relief will help to offset the impact. Furthermore, it is now clear that the rate of inflation has peaked - the January CPI figure was the lowest since late-2006, and for this year as a whole, almost all economic commentators are forecasting a continued improvement. Pay negotiations should, of course, be cognisant of these prospective developments.
One of the core strengths of Social Partnership has been its strong foundation in realism regarding the nature of the competitive challenge for Ireland. I remain confident that Towards 2016 offers an important and strategic framework for meeting the economic and social challenges ahead.