ANALYSIS:Despite the slowdown, the OECD remains firm in its belief that the "economic fundamentals remain strong", writes Paul Tansey.
IN ITS latest survey of the Irish economy, the Organisation for Economic Co-Operation and Development (OECD) has grounded its analysis on two foundations.
First, after more than a dozen years of exceptional expansion in employment and output, the Irish economy is finally slowing down.
The slowdown is steep. Real economic growth averaged more than 4.5 per cent annually between 2000 and 2007. This year, there is general agreement among the
leading economic forecasters that the pace of expansion will fall below 2 per cent.
The first phase of the boom - broadly spanning the years 1994 to 2001 - was powered by exceptional export growth. The second phase, from 2003 to 2007, was fuelled by domestic demand. However, the slide in house building has sounded the death knell of the domestic boom. House completions peaked at 88,000 in 2006, when spending on housing soared to almost 16 per cent of national income. This year, house completions are forecast at 50,000 or fewer.
Second, despite the slowdown, the OECD remains firm in its belief that the "economic fundamentals remain strong". A skilled workforce, moderate taxation, a light regulatory touch and a still-sound budgetary position inform the OECD's view that the Irish economy possesses the capability to enjoy a bright future.
The essential question then resolves into how can the transition from the current slough of economic despond to the sunlit uplands of future prosperity be effected?
The answer is to switch economic resources from the domestic sector, where demand is flagging, to the export sector, where the world's your oyster.
The problem with oysters lies in the opening. So too, with foreign markets. Gaining access to export markets depends on selling foreigners goods and services that they want at prices that at least match those offered by competitors.
Ireland has been losing price competitiveness internationally since 2000. Three factors contributed to the erosion of Irish competitiveness. First, prices rose faster in Ireland than in trade rivals due to the strength of domestic demand. Increases in prices also pushed up the cost of doing business in Ireland. Second, the pace of annual productivity growth faltered, almost halving between 2001 and 2007 relative to the 1995-2001 period. Third, from 2002 onwards, first the dollar then sterling began to sink against the euro. During the domestic boom, Irish businesses did not worry too much about declining competitiveness. Their efforts were focused on reaping the rich harvest of domestic spending. Consumers with wads of cash were on their doorsteps.
Now, as businesses seek to escape from a weakening domestic marketplace into export markets, their ability to switch their sales is greatly impeded by the deterioration in Irish cost and price competitiveness. As the OECD survey puts it "the loss of competitiveness may be starting to become a serious problem".
To improve competitiveness in this period of economic adjustment, the OECD advocates wage restraint.
It says: "Unless wage and price inflation are reined in, the export sector will not be able to contribute either to short-term adjustment or the long-term improvement in living standards. Real wage growth needs to be limited to increase in line with productivity or by even less in the short term. Competitiveness problems are exacerbated by rapid increases in non-wage costs as diverse as electricity prices, insurance premiums, office rents and local authority charges".
Aside from the not inconsiderable difficulty of selling wage restraint to a trade union movement which claims that they have gained nothing from the current pay deal, there is an additional problem.
The scale of the deterioration in Irish price competitiveness has been very substantial. The real exchange rate is the ultimate arbiter of competitiveness. It measures the Irish exchange rate, weighted by trade, together with a component that includes Ireland's inflation rate relative to trade rivals.
Since Ireland joined the euro, the real exchange rate has appreciated - and price competitiveness has declined - by 24 per cent. It would take a lot of wage restraint to compensate for such a decline in competitiveness.
Much of the deterioration in the real exchange rate has been occasioned by the decline of the dollar and sterling against the euro, particularly over the past 12 months. During this period, the currencies of our two major trading partners have both declined by 18 per cent against the euro. Again, it is virtually impossible to compensate for currency changes on such a scale through changing the level of wages.
A moderation in rates of pay growth has a role to play in seeking to engineer the economy's escape from slow growth. But rates of pay cannot bear the burden of adjustment alone. While wage restraint may buy time on the competitiveness front, the time it buys needs to be used effectively to activate a range of other interventions that will improve long-run competitiveness.
Chief among these, as the taoiseach-elect, Brian Cowen identified in his Indecon Public Policy lecture last November, is the fostering of faster productivity growth.
For unless there is a sustained and successful effort to raise the pace of productivity growth - output per unit of labour input - the Irish economy may remain becalmed for some time to come.
