Dr. Tom McDonnell:

I thank the Chairman for giving me this opportunity to appear before the committee. Following the recent upward revision in Ireland's GDP, the Nevin Economic Research Institute's next set of macroeconomic projections is likely to forecast a 2016 general government deficit of close to 0.8% of GDP and a gross debt ratio of close to 75%. Our autumn forecast has not yet been completed but our summer forecast was for real GDP growth of 4.6% this year and 3.7% next year.

Our summer forecast was for real GDP growth of 4.6% this year and 3.7% next year.

While it is true that the headline GDP figures give a misleading picture of economic activity in Ireland, there is much evidence that the real economy grew strongly in 2015 and continues to grow strongly, although growth may have been softening in recent months. Personal consumption increased 4.5% in volume terms in 2015 and 5% in the first quarter of 2016 compared to last year. The growth in spending is being driven by the strong growth in employment. Other factors boosting consumption include the reversal of fiscal austerity, the ongoing decline in household debt, pent-up demand, loose monetary policy, the fall in energy prices and Ireland’s position within the economic cycle.

Employment increased by 2.6% in 2015 and is up 2.7% in the first half of 2016 compared to the previous year. Total employment is now in excess of 2 million for the first time since the fourth quarter of 2008, although this is still more than 130,000 below peak employment levels. All regions remain below their pre-crisis employment totals, with recovery relatively strongest in Dublin, at 97% of second quarter 2008 employment, and relatively weakest in the west, namely, counties Galway, Mayo and Roscommon, at 89%.

The unemployment rate was 8.6% in the second quarter of 2016. Unemployment rates are lowest in the mid east - the area around Dublin - and highest in the south east. Long-term unemployment has fallen below 100,000 for the first time since the third quarter of 2009 and now stands at 4.4%. However, it is three times as large as it was in the first quarter of 2008.

Average weekly earnings were up 0.5% in the second quarter compared to the previous year while average hourly earnings increased by 0.2%. Average hourly earnings are essentially unchanged over the past five years.

Consumer prices in July were up 0.5% over the previous year and 1.3% when energy products are excluded. The consumer price index is now broadly at 2008 levels and is up almost 3% since 2011.

In considering the fiscal context, the parameters for budget 2017 are set by the requirements of the preventive arm of the Stability and Growth Pact. Adherence to the fiscal rules limits the net fiscal space, as we estimate it, for new commitments to between €900 million and €1 billion in 2017. The recent upward revision to GDP will have a minimal impact, if any, on the 2017 fiscal space. The Government estimates the net fiscal space available over the next five years at €11.3 billion. However, this estimate is based on an assumption that the economy is running a structural deficit of 2% of potential output in 2016 and that the economy is overheating. However, a strong case can be made that the economy is not overheating. This analysis is based on the economy’s still high unemployment rate; the evident lack of domestic price and wage pressure in the economy; the current account surplus even after correcting for multinational restructurings; the low underlying investment ratio, excluding intangibles and aircraft purchases; and lack of housing supply. If this analysis is correct, it implies scope for increasing the fiscal space in 2018 as structural deficit targets will have been achieved.

The fiscal space is sensitive to the potential growth rate of the economy. The Nevin Economic Research Institute's baseline estimate is for real GDP growth of close to 3% extending out to 2030. Potential GDP growth could well be higher than this in the short to medium term given the potential for above trend employment growth over the next five years. However, a structural shock to the economy, a secular productivity decline, sustained underinvestment or an underperformance of employment growth would damage the economy’s growth potential. An average reference rate of real potential growth of 3% over the next five years, as opposed to 3.5%, would reduce the cumulative net fiscal space by around €1.8 billion over the next five years.

Not all fiscal measures have the same impact on potential output. In the long run, sustainable growth can only come from productivity gains. Given Ireland’s relatively low levels of spending by advanced economy standards on education, research and development and capital expenditure, there appears to be scope to use fiscal policy to enhance future productivity by increasing per capitainvestment in education and skills; increasing per capitainvestment in research and development, the production, diffusion and use of new knowledge and ideas, and the development of a strong innovation system; and increasing investment in productive infrastructure. Long-run investments in these three areas could increase the fiscal space available to government in the long term because these types of investment increase the productive capacity of the economy.

The future of the universal social charge, USC, has come under question in recent years. The USC has a simple and highly progressive structure. Average rates of combined income tax and employee social security contributions in Ireland are significantly below OECD averages for both low and middle income earners. Dismantling of the USC would be regressive and extremely costly. While there would be a short-term boost to demand and, therefore, real GDP growth, there would be no increase in the economy's long-term productive capacity. Ireland is not a high tax or a high public spending economy. Given our ageing population, it is likely we will have to increase taxes in the future. Cutting taxes now is not a prudent long-term budgetary strategy. I will be pleased to answer Deputies' questions.