EEAG warns Irish economy “vulnerable to a global downturn.”

UTV picks up on the particular risks facing the Irish economy from a global economic downturn, as detailed by the European Economic Advisory Group which is holding a series of press conferences across Europe to launch their 2007 Report on the European Economy, press release here – the full report can be downloaded here. The report includes a chapter which focusses on the risks to the economies of Ireland and Italy [pdf file].. one an example of expansionary shock, the other contractionary shock.From the EEAG press release

Ireland is a typical example of an expansionary shock. This has led to a strong appreciation of the real exchange rate, which makes the country vulnerable to a global downturn. The Irish experiences point to two previously underestimated problems.

• The first is the interaction between a general upswing and housing price dynamics: large housing price increases and a strong expansion in the construction sector imply large risks of a substantial reversal once a downturn starts. [added emphasis]

• The second problem is that large immigration in a boom contributes to rises in aggregate expenditures and may thus reinforce, rather than dampen, the boom.

While in the Chapter referred to [pdf file]

Already in our 2002 EEAG report, we discussed adjustment problems with specific reference to the Irish case (see Chapter 4). In that report, we emphasised macroeconomic risks due to asymmetries in the adjustment process via factor prices and the real exchange rate. Adjustment to demand shocks via this channel tends to work effectively in response to expansionary shocks. It tends to be sluggish in response to negative shocks. In the case of Ireland, the risk is that recent high growth rates would translate into sustained expectations of growth in labour compensation, which may become incompatible with macroeconomic stability, especially once the process of income convergence comes to an end. There is thus a risk that the real exchange rate will overshoot. An important issue raised by the Irish case is the extent to which overvaluation in the goods market can interact with property prices and developments in the construction sector. The demand boom phase has been reinforced and arguably prolonged by the increases in property prices and a construction boom. The issue is whether and to what extent a possible output downturn can be exacerbated by a fall in property prices reducing consumption demand, but also generating a crisis in the construction sector. [added emphasis]

It should be pointed out that the report predicts – “There will only be a mild slowdown in the world economy. In Europe there will be a slower – but continued – recovery.”

And on preferred economic models..

As to the issue of what economic model Europe should opt for, the main conclusions are:

• Although not as successful as often perceived, recent macroeconomic performance in the Scandinavian countries is good. The lesson for Europe is not that one can do without market-liberal reforms, as is often claimed. It is instead that such measured reforms in both product and labour markets can produce very substantial results.

• Tax competition from the new member states has brought down corporation taxes in the EU. This raises equity concerns. To tax capital in an efficient way, the report proposes a simultaneous increase in the VAT and a reduction in labour taxes.

• Economic nationalism in the form of opposition to cross-border mergers, promotion of national champions and bailing out of domestic firms is a serious danger for economic efficiency. A key factor behind economic nationalism is public ownership, which should be severely restricted. The report proposes an EU rule to this effect.