Quarterly Economic Observer - Autumn 2015 - "Policies for Long-run Growth"

This edition of the NERI’s Quarterly Economic Observer (QEO) outlines our latest expectations for the economic outlook in the Republic of Ireland and Northern Ireland (Section 3) and discusses a strategic approach to fiscal policy in the Republic of Ireland (Section 4).

Outlook for the Republic

The Republic was the fastest growing economy in the EU in the first half of 2015 and the main survey indicators of economic performance are suggestive of strong growth for the rest of the year. Based on existing data and our medium-term forecasts we now project that real GDP will grow by close to 6 per cent in 2015. Growth will remain strong in 2016 (circa 4.1 per cent), albeit moderating somewhat from the 2015 rate. The economy is benefiting from a number of tailwinds including the depreciation of the Euro against the US dollar and UK Sterling, the boost to private consumption and investment from the fall in oil prices, loose monetary policy, the mild stimulus announced in Budget 2015, pent up demand and improving confidence translating into consumption and investment after years of weak domestic demand and, finally, the closing of the output gap as employment continues to fall. The weaker Euro is particularly important for a small open economy like the Republic, while lower energy prices are boosting real disposable income. Total employment will exceed 2,000,000 sometime around the middle of 2016. We forecast the unemployment rate averaging 9.5 per cent in 2015, 8.6 per cent in 2016 and 8.3 per cent in 2017. Unemployment should fall below 200,000 sometime in early 2016 or perhaps very late in 2015. The scarring effect of the recession and the high-rate of long-term unemployment suggest the structural rate of unemployment is higher now than it was before the recession. This implies a need for innovative labour market policies in the years ahead. In light of our projections for economic output and the labour market, we are projecting that the government’s general budget deficit will fall to 1.7 per cent of GDP in 2015 and 1.1 per cent in 2016. We project that the gross debt to GDP ratio will fall to 91.3 per cent of GDP in 2017. This is still a high level and the Republic will remain vulnerable to an adverse interest rate shock.

Outlook for Northern Ireland

There are tentative signs of economic recovery in Northern Ireland but the outlook has weakened as a consequence of the Conservative’s victory in the General Election and the implications for public spending and aggregate demand in Northern Ireland. The potential collapse of the Stormont executive and the upcoming referendum on EU membership are generating instability and undermining the attractiveness of Northern Ireland as a location for foreign direct investment.

Policies for long-run growth

Section 4 discusses policies for long-run economic growth in the Republic of Ireland:

• • — The economy’s potential to grow depends on its ability to generate productivity gains year-on-year. The Republic’s productivity growth has been falling since the 1980s.
  • — The best way to sustain growth in productivity over the long-term is to invest in education and skills, in productivity enhancing infrastructure, and in the production and diffusion of new technologies.
  • — We propose a set of policies designed to increase the economy’s future potential output. For example, we propose the establishment of an infrastructure bank, increased funding for research and development and early years learning, increased support to prevent child poverty, and a phasing out of most though not all government subsidies and tax breaks.
  • — Growth in per capita output also depends on growth in employment and the number of hours worked across the economy. We propose a number of reforms to reduce barriers to labour market entry. Examples include subsidies for childcare and the gradual tapering of family supports along with income.
  • — Budgetary projections suggest the primary government expenditure share of economic output will, by the end of the decade, be at a very low level by modern historical standards. While acknowledging the need for reform of the tax system, we urge the government to reconsider its plans to cut the overall level of taxes in Budget 2016 and to take a more strategic and long-term approach to growing the economy.

Selected Policy Reforms to increase Potential Output