Dr. Conor O'Toole:

I thank the Acting Chair for the invitation to appear before the committee to provide our views on the economic outlook ahead of budget 2025. I am Dr. Conor O’Toole and I am joined by my colleague Dr. Karina Doorley. We will be publishing our next quarterly economic commentary on 26 September, but we will aim to give some insight into the recent trends that will underpin those forecasts.

To frame the discussion around the appropriate Government budgetary policy, it is critical to understand the current macroeconomic context. The last number of years have seen the Irish economy perform particularly strongly even after experiencing repeated external shocks. This economic strength has come through growth in the multinational sector but also a robust performance domestically. It is typically difficult to get an accurate picture of the domestic economy due to the distortion of key indicators by those multinationals but nonetheless, most domestic indicators are performing relatively well.

In our latest published commentary, we expected GDP to rebound this year following the multinational led decline in 2023. It would be our expectation that that was going to continue, but the recent quarterly national accounts again displayed considerable volatility from those multinational transactions and that provides more uncertainty around the indicator for this year. In contrast to the volatility in these trends, the indicators for the domestic economy continue to point to a robust performance and an economy operating at or close to capacity. Modified domestic demand, which captures underlying investment and consumption levels, is set to increase by over 2% in 2024 and potentially increase further next year.

One of the main reasons for the expected continued growth in the domestic Irish economy is the strong performance of the labour market and a quicker than expected decline in consumer price inflation. Employment levels are forecast to continue to grow this year and next with the unemployment rate remaining near to 4% over the forecast horizon. This is despite the strong increase in population levels that have occurred recently. Exchequer receipts, another accurate indication of the Irish economy, are also continuing to register strong increases. The buoyant labour market and moderating inflation rate are likely to lead to increases in real incomes. This will boost household spending power on aggregate for this year and next. All of these indicators point towards a domestic economy that is growing strongly and operating with little slack.

While the current economic outlook is positive, there are a number of long-term challenges that will impact the potential growth rate and likely require significant State resources. These include infrastructure bottlenecks in housing, the requirement to invest in climate-related actions and population ageing. Over the past number of years, it is clear that Ireland has been producing insufficient levels of housing for a growing population. While previous estimates suggested that around 35,000 units per annum had been required to deal with the demographic demand, new estimates by the ESRI and others, based on updated population data, clearly point towards housing requirements being revised upwards notably. Many of these new units will be needed for low-income households and affordable housing thus requiring significant policy interventions and substantial State investment levels. A policy focus on supply side reforms and planning efficiencies is likely to yield positive impacts in the medium to long term. Alongside the housing requirements are the very acute investment needs to transition the economy away from fossil fuels and towards renewables as discussed in the ESRI’s review of the NDP in 2024.

The present budget occurs at a time when the domestic economy is performing very close to capacity. The recent substantial improvement in the public finances does present a certain opportunity for policymakers. In areas such as housing, healthcare and climate change, it is clear that significant investment by the State is required if infrastructural bottlenecks are to be addressed. However, addressing these bottlenecks at full employment with capacity constraints poses a risk to inflation. As was noted by Barrett and Curtis in the ESRI review of the NDP priorities, adding additional demand to a capacity constrained economy will increase construction inflation through wage and other channels. However, if investments can take place that do deal with infrastructure bottlenecks, both the long-term productivity and potential output of the economy can be raised. To create space in the economy for such investments, the targeting of investment priorities, be they in housing, health or climate-action, should be shifted towards those with low domestic labour intensity or high import content in the investment phase. Given that infrastructure bottlenecks need to be addressed, restraint is needed in other areas of fiscal policy to create the space for the investment that is necessary. In particular, taxation policy must be particularly prudent if the risk of increasing inflation is to be avoided. The ongoing risk of relying on increasing corporation taxes, if directed for current expenditure, continues to rise as their share of overall tax receipts continues to increase. It is imperative that these receipts are increasingly targeted towards the longer-term investment funds to ensure buffers are available to deal with long-term economic challenges, support infrastructural development and have funds available if the windfall elements decline.

To re-emphasise, the use of the windfall element to cover current expenditure is not advisable.

Regarding household incomes, the ESRI’s distributional impact analysis of budget 2024 last year revealed that it would result in average real income gains across the income distribution. However, most of these gains came from temporary changes to the tax and welfare system, including the provision of energy credits and once-off top-up payments to recipients of social welfare. Considering only the permanent changes to the tax-benefit system, we estimated that the purchasing power of low-income households has been eroded over the last four years as a result of successive below-inflation increases to social welfare.

More recent ESRI research, carried out for the fourth annual report of the poverty, income inequality and living standards research programme, highlights that material deprivation, or the inability of households to afford essentials, increased markedly between 2022 and 2023, especially for children. Permanent above-inflation changes to welfare will be needed if policymakers wish to maintain the real incomes of low-income households when temporary measures expire. Targeted measures, such as a second tier of child benefit, as suggested by Roantree and Doorley, may also be needed to achieve the reductions in child poverty envisaged by the child poverty and well-being programme office of the Department of the Taoiseach.

In conclusion, while the public finances appear in a robust position, there are notable risks, and careful use of the budget surpluses over the coming years will be needed to deal with bottlenecks while not overheating the economy. We thank members for their time and look forward to any questions they may have.