In this blog, NERI Co-director, Dr. Tom McDonnell comments on the newly released Department of Finance 'Stability Programme Update'.
The Department of Finance released their Stability Programme Update last Wednesday though it unsurprisingly flew somewhat under the radar given the other news that day. It’s an important document and well worth a read. Some notes and comments below:
The Department thinks the economy will avoid the volatility of recent years and that upside and downside risks are relatively balanced. They (Table 9) forecast GNI* growth of close to 2% this year and growth averaging around 2.15% over the next seven years. For context, IMF forecasts for the next four years from the recent World Economic Outlook are for average growth of 2.2% in the US, 1.35% in the UK, and just 1.25% in the Euro area.
Growth in Ireland is expected to slow dramatically as we look further ahead. While potential GDP growth is still as high as 3.3% in 2023, it nosedives to 1.7% in 2040 and to 1.2% in 2050. An important reason for the decline is the collapse in the growth of ‘labour input’ (employment and hours worked), which the Department estimates, based on population projections, will turn negative sometime in the 2040s. Of course policymakers can delay and/or ameliorate this decline, for example policies that remove barriers to labour force participation (e.g. affordable and available childcare, more flexible hours) and/or that encourage inward migration, would both increase labour supply.
The second reason for the decline in growth is the projected fall in the annual rate of improvement in ‘total factor productivity’ (the efficiency or productivity of labour and capital). TFP growth is projected at 1.9% in 2030 but just 1% in 2040 and 0.9% in 2050. While these latter TFP projections seem reasonable if somewhat speculative it should be noted that, again, policy can ameliorate the decline, for example through more and better targeted spending on education, through greater investment in R&D and development of a stronger system of innovation, and through policies that facilitate a gradual shift in employment towards higher value added sectors.
Turning back to the present – the Department, like all other forecasters, is projecting growth in the domestic economy in 2024. This will stem in the main from the increase in real disposable incomes as real wages turn positive. The Department is projecting inflation (HICP) to fall close to the 2% target this year (2.1%) and that wages per head will increase by 4.5%. Strong real wage growth is projected to arise from a still tight labour market (+50,000 net employment) combining with the falling inflation rate. A somewhat higher unemployment rate is explained by a fast growing labour force. Upside risks include a loosening of monetary policy in the second half of the year and a normalisation of household savings from their current very high levels. Downside risks are mainly external in nature although the Department does note the potential for supply-side bottlenecks (e.g. housing) to restrain growth.
Finally, the fiscal outlook remains ostensibly benign, albeit with an enormous caveat around the sustainability of growth in corporation tax receipts. Corporation tax receipts at around 8% of GNI* are over double the norm for the rest of the EU (3% to 3.5% of GDP) and highly concentrated. Nevertheless, a general government surplus of 2.8% of GNI* is expected. However, the longer-term picture looks much less rosy. Table 23 shows that demographic changes between now and 2050 will lead to a 6% of GNI* increase in age-related expenditure. This arises from a combination of higher pension expenditure (4pp) and the rising cost of health care and long-term care (3pp) partially offset by lower spending on education (-1pp). Hard choices about tax policy are coming.
Crucially, Ireland and the rest of the EU are now going to move to a ‘reformed’ set of fiscal rules (Box 6). Governments will be required to set out binding fiscal-structural plans over a multi-annual horizon (5 years for Ireland) with the first of Ireland’s plans published in the autumn. The new fiscal rules will be centred on a single indicator called ‘net expenditure growth’. In practice, this will set a ceiling on the amount by which government spending (excluding certain types of spending such as interest payments and the cyclical portions of unemployment payments) can increase each year. Governments will be able to increase their total spending beyond the amount allowed by the expenditure ceiling by structurally increasing taxes or other sources of government revenue. On the other hand, tax cuts will mean less scope for dealing with Ireland’s wicked problems in housing, health and a range of other areas. Presumably a country’s allowable net expenditure growth will be related to the multi-annual potential growth rate of the economy adjusted for the starting fiscal position. This suggests close to 5% per annum for Ireland of which 2% will be eaten up by price increases.
There was much else of interest. Perhaps the most notable is Box 5 which provides estimates that females are, in general, at much greater risk of downside exposure to AI than are males. The policy implications are still unclear but there ramifications for education and training policies are certain. Jobs in agriculture, construction and the caring professions may be relatively unscathed, whereas jobs in administration and in accountancy made be in trouble.