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Is there a robust recovery in sight?
By Professor Alan Ahearne
2015 will have been another year of very strong growth for the Irish economy. The consensus among forecasters is that the economic activity will expand by more than 5% this year, following a similar rate of expansion in 2014. Growth at this pace is expected to generate some 50,000 new jobs, as businesses hire new workers and expand productive capacity to meet growing demand for their goods and services. The unemployment rate remains elevated at around 9 per cent, but is projected to decline by ½-1 percentage point per year over the next few years, with full employment pencilled in by many forecasters by the early 2020s. With low interest rates for many borrowers and wages beginning to rise, the burden of high household debt – another legacy of the housing boom and bust – should continue to ease gradually.
Both external and domestic factors are driving the economy forward. The external influences largely relate to the marked easing of financial conditions in Europe and elsewhere.
For starters, the steep drop in the value of the euro against other major currencies has boosted the international competitiveness of Ireland’s export sectors. As a result, businesses here are gaining market share in global markets. The abundance of American and British tourists in parts of Ireland and elsewhere in the euro area this summer is testimony to the powerful effects on economic activity of movements in exchange rates. The downside of a weak euro is that it tends to push up the prices of imported products, though overall inflation remains very low.
Second, the European Central Bank has driven both short-term and longterm interest rates to historically low levels by buying large quantities of government bonds. The State has taken the opportunity to refinance some government debt at low cost, with resulting savings for the Exchequer. Moreover, low global interest rates have encouraged investors in search of reasonable returns to invest money in Ireland. These financial inflows have spurred activity in the commercial property market and helped parts of the property market to start functioning again.
Third, some of our major trading partners are enjoying solid growth, boosting demand for Irish exports. Growth in the UK and US remains robust, driven by improvements in labour market conditions, lower energy prices and a strengthening in the housing market.
Even the troubled euro area economy is showing tentative signs of life. The ECB now expects GDP growth of 1.5 per cent in the euro area this year, and is pencilling in growth of about 2 per cent for both next year and 2017. Indicators of business and consumer confidence are pointing towards moderate recovery, with notable improvements in Spain. Retail sales and industrial production have also nudged up in recent months. Bank lending to households has ticked up over the past year, while lending to the business sector is no longer declining.
For a small open economy like Ireland, these positive developments have created opportunities for robust recovery. Globally competitive sectors of the economy have taken full advantage of the improved external environment, including sectors such as agriculture and agri-food, information and communications technology, medical technologies, pharmaceutical and chemical, and tourism.
Data on industrial production for the second quarter of 2015 show an eyepopping 50% jump in the production of computer, electronic and optical products compared with the same period last year, while food and beverages production has surged more than 10 %. The number of overseas tourists visiting Ireland soared 12% in the first half 2015.
Ireland’s structural strengths in these industries reflect competitive advantages gained through decades of investment in knowledge, technology and physical capital. High levels of human capital and talent are key drivers of the economy’s competitiveness.
The medical technologies (MedTech) cluster in the Galway region serves as a good illustration. The flow of skilled graduates produced by NUI Galway and other higher education institutions is critical for the sector’s success. On the research front, close cooperation between MedTech firms and higher education institutions is driving innovation and growth.
None of this is to suggest that there are no risks to the near-term outlook. Nor does it mean that there can be room for complacency among policymakers. The recent crisis in Greece has taken a toll on confidence in the euro area and underscores the fragility of the recovery in the region. Recent volatility in Chinese financial markets raises the spectre of an unexpectedly sharp slowdown in economic activity in that part of the world. In addition, markets may react badly to increases in interest rates by the Federal Reserve, as the era of ultra-cheap money on the other side of the Atlantic comes to an end. Closer to home, a potential Brexit (that is, the UK leaving the EU) would have implications for the Irish economy.
Policymakers in Ireland can best guard against downside risks to Ireland’s recovery by keeping the country’s debt to GDP ratio on a firm downward trajectory and by continuing to focus on competitiveness. In the current favourable environment, prudent economic policies and a long-term focus by policymakers are crucial to sustainable growth.Professor Alan Ahearne is Head of Economics at NUI Galway. He is Chairman of the steering committee governing the newly launched Economic and Social Research Institute (ESRI) and Department of Finance Joint Research Programme on the Macro-economy and Taxation.