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Quarterly Economic Commentary, Winter 2008

19/12/2008

Dr. Alan Barrett, Dr. Ide Kearney, and Jean Goggin (ESRI)

Some of the main findings of the analysis include:

• The forecasts in this Commentary illustrate how the Irish economy is in the midst of a contraction that is large by both historic and international comparisons. For 2009, we expect GNP to fall by 4.6 per cent in volume terms. Coming after an anticipated contraction of 2.6 per cent in 2008, the accumulated fall in output is dramatic.
• The volume of consumption is expected to fall by 3.6 per cent in 2009. The fall in investment is expected to be larger still. We are forecasting a fall of 19.3 per cent in investment volume in 2009.
• We now expect that average employment will fall by 117,000 in 2009. A fall in employment of that size will be consistent with net outward migration of 50,000, the unemployment rate averaging 9.4 per cent and participation falling by 1.3 per centage points.
• On the public finances, we expect the General Government Deficit to be 6.9 per cent of GDP in 2008 and 10.2 per cent in 2009. We expect that the general government debt will reach 47.5 per cent of GDP in 2009, up from 24.8 per cent in 2007.
• We expect HICP inflation to average 0.5 per cent in 2009. With interest rates falling rapidly, we expect CPI inflation to be negative, at -2 per cent. For the economy as a whole, we expect zero wage growth in 2009. As wages in the public sector will show an increase during 2009 as a result of an increase granted in September 2008, implicit in our forecasts is a wage fall in the private sector in 2009.
• In our General Assessment, we argue that the focus of policy should be on ensuring that Ireland is as well placed as possible to participate in the global upturn. As part of this strategy, we need to ensure that the public finances do not become a constraint on growth, as they did in the 1980s. With this in mind, we would stress yet again the importance of ensuring quality in all public spending, whether current or capital. We would also re-iterate a point that was made in the last Commentary, namely, the likelihood in the medium-term of a need for tax increases as a result of the erosion in the tax base in recent years.
• We also argue that the deterioration in the public finances will make it difficult for the government to pay the 3.5 per cent increase in September due under the pay agreement. We argue that the social partners need to come together and to reassess the most recent pay deals in the light of rapidly changing circumstances. The possibility of pay cuts in the public sector should at least be considered in this context as pay cuts may well be considered preferable to cuts in services. As well as protecting services levels, the pay adjustment approach could well yield expenditure savings more rapidly than an approach based solely on job cuts through natural wastage, early retirements and redundancy schemes.
• New research reported on in the Commentary on the public/private wage differential suggests that there is a significant pay advantage for those working in the public sector and that this may have increased in recent years. Taking account of factors such as the education and experience of employees in both sectors, the public sector wage advantage appears to be over 20 per cent. Given this, it seems highly unlikely that any wage reductions in the public sector would, in general, lead to any significant challenges in terms of retaining or recruiting staff.

Notes for Editors:

1. The Quarterly Economic Commentary, Winter 2008, by Dr. Alan Barrett, Dr. Ide Kearney, and Jean Goggin (ESRI), will be published online on Friday 19th December. Please note that the embargo will be until 00:01 a.m. Friday 19th.

2. Members of the media are invited to attend a media briefing at 1.00 p.m. on Thursday 18th Dec., in the ESRI (Whitaker Square, Sir John Rogerson's Quay, Dublin 2).

3. There are two Special Article in this quarter's Commentary.

"An Analysis of the Potential of the European Commission Business and Consumer Surveys for Macroeconomic Forecasting ", by Jean Goggin (ESRI).

"An Empirical Analysis of Development Cycles in the Dublin Office Market 1976-2007", by John McCartney (formerly Head of Research, Lisney estate agents.

Please see media releases below on these papers.

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Media Release

Embargo: 00:01 a.m. Friday 19th December 2008

An Analysis of the Potential of the European Commission Business and Consumer Surveys for Macroeconomic Forecasting

by Jean Goggin (ESRI)

Special Article in the Quarterly Economic Commentary, Winter 2008

• Survey-based confidence indicators are widely believed to provide a reasonably accurate picture of the economic climate. The timeliness of their release ensures that they have a significant information lead advantage over other data sources, which typically have lengthier publication lags. While sentiment data are frequently used as informal indicators of economic conditions, little use has been made of such data for the purpose of formal macroeconomic forecasting, and there has not been extensive analysis of their predictive power.
• This paper provides a preliminary assessment of the potential usefulness of business and consumer sentiment data for short-term macroeconomic forecasting within Ireland. It uses data from the four monthly business surveys (industry, construction, retail and services) and the consumer survey, conducted in Ireland for the European Commission, and examines the extent to which they can track official data.
• The findings in this analysis indicate that the data from the consumer survey may possess some forecasting potential. In particular, consumer sentiment data regarding the recent and future economic situation and regarding their own personal finances are highly correlated with the official data on personal expenditure on consumer goods and services. This relationship could perhaps be exploited for the purposes of forecasting, and at the very least merits further investigation.
• Only a very small number of positive relationships between the business survey data and the official statistics were found, and the results suggest that the forecasting potential of these survey data is limited.

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Media Release

Embargo: 00:01 a.m. Friday 19th December 2008

An Empirical Analysis of Development Cycles
in the Dublin Office Market 1976-2007

by John McCartney (formerly Head of Research, Lisney estate agents)

Special Article in the Quarterly Economic Commentary, Winter 2008

(Members of the Media should note that John McCartney is not a staff member of The ESRI. Whilst this Article has been accepted for publication by the ESRI, the views expressed are not necessarily the views of the ESRI)

• DUBLIN OFFICE MARKET IS OVER SUPPLIED
• NEW BUILDING WILL HALVE BY 2010
• THIS WILL DEDUCT 0.6% FROM GNP AND WILL COST 7,500 JOBS

A new study by economist Dr. John McCartney indicates that excessive development has left Dublin oversupplied with office space.As a result, values are falling and office construction will decline by 55% over the next two years. This will subtract 0.6% from GNP and will lead to the loss of 7,500 building jobs. If second round effects are taken into account the economic consequences will be even more severe.

"An Empirical Analysis of Development Cycles in the Dublin Office Market 1976 - 2007", which is published in the latest Quarterly Economic Commentary, shows that office construction has been highly cyclical since the 1970s with supply overshooting demand at the peak of every cycle. This pattern of oversupply followed by building retrenchment results from long lead-times in commercial building, combined with developers' over-reliance on two simple barometers of market conditions - rental growth and letting activity.McCartney argues that, on their own, these indicators are not a sufficient basis for making construction decisions;

"In principle, rents should be a good indicator of whether or not the market needs more office space. But developers must distinguish between sustainable and transitory rental growth.Rents sometimes 'spike' temporarily pending the completion of large quantities of space that are already under construction.Invariably, some developers misread this as sustainable rental growth and undertake new office projects which only serve to flood the market."

Regarding letting activity, McCartney says that strong 'take-up' makes office building seem attractive when schemes are commenced. But demand shocks which occur during the 18 month construction phase can leave developers with a glut of unwanted space;

"This happened in 2001 when developers were left with unoccupied space after the dot.com bubble, foot and mouth disease and September 11th undermined demand.The credit crunch is having a similar effect now.Letting reached a record high in 2007 and this stimulated lots of new office building. But demand has evaporated before this space is even completed."

McCartney's analysis indicates that we have now reached the fourth crest in office construction since 1976 and, as at previous peaks, supply has overshot demand.History suggests that this will cause a sharp slowdown in building – in the year immediately after previous office building peaks completions fell by an average of 53%. Consistent with this, McCartney forecasts that completions will decline by 48% in 2009 and a further 14% in 2010. This will subtract between 0.5-0.6% from GNP and will result in around 7,500 job losses.

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