LAST week's figures from the Central Statistics Office painted a bleak picture of inflationary pressures in the Irish economy. Reaching 4.9% in December 2006 for the first time since 2002, the rate of growth in prices is more than alarming.
According to the CSO, the most notable price increases in 2006 were in housing, water, electricity, gas & other fuels (+21.5%), alcoholic beverages & tobacco (+5.1%), education (+4.9%) and health (+4.4%). Although some of these prices - notably the cost of mortgages - were driven by factors outside our control, the majority can be attributed to poor regulation and lack of competition in domestic sectors of our economy.
The forecasts for 2007 are less than encouraging.
According to most analysts, inflation is expected to be around 3.7-4% in 2007 as measured by the consumer price index (CPI) - close to the 4% in 2006, but well above the 2.5% in 2005.
Growth in the Harmonised Index of Consumer Prices - the measure of inflation at the retail end - is likely to remain flat at 2.7% in both 2006 and 2007 - once again, above the 2005 figure of 2.2%. Both measures are expected to be exceeded by the wage increases which are expected to run at 4.5% in 2007.
The latest figures from the CSO and the forecasts reveal serious underlying weaknesses in the broader economy that, if left unchecked, will cost us dearly in terms of long-term growth. These include: the rate of government spending outpacing the rate of economic growth; lack of productivity growth in statecontrolled sectors; failure of our regulatory environment;
and the tightening labour markets trying to play catchup with the runaway train of state-sanctioned cost of living increases.
First, consider the issue of government spending. The overall share of government spending as a percentage of GNP has increased by some 5% between 1999 and 2006 to reach well above 30% of GNP. The state's current spending is growing 50% faster than domestic economy.
According to the Department of Finance estimates, in 2007, the government will burn through 120% more in discretionary spending than in 2000, an increase that is over four times greater than cumulative inflation.
Factoring in the usual errors in budget projections, this figure is likely to be even higher.
This does not account for the ambitious Euro180bn National Development Plan (NDP). Many of the NDP programmes are desperately needed to prop up declining productivity growth in our economy. However, a large section of the NDP is likely to fall under the umbrella of the notoriously wasteful National Spatial Strategy, directly fuelling inflation by rising government spending in the economically declining regions without any offsetting gains in competitiveness.
Looking at the sectoral decomposition of price increases over the 2001-2006 period, the competitive sectors of the economy are experiencing deflationary pressures due to increasing competition and productivity growth. For example, ordinary goods prices declined by 0.3% in the period 2001-2006, while prices in competitively supplied services fell by 6.3% over the same period. In contrast, prices of goods and services in governmentcontrolled and regulated sectors have increased by 40.9% and 24.1% respectively. In fact, regulated sectors and consumption taxation changes accounted for 85% of overall inflation in Ireland, since 2001.
Second, despite repeated promises to reform the public sector, the government has failed to deliver real improvements in the transparency, accountability and efficiency of its spending programmes.
The latest CSO figures show that the average public sector worker is paid 46% more than an industrial sector employee. As public sector output plunged, public pay more than doubled since 2000 and the state's employment swelled by 67,000.
The announcement in the last budget's of a vague 'value-for-money' framework initiative will cover only 3% of public spending and will not touch a gargantuan state pay and pensions bill that accounts for 38% of current expenditure. The largest spender in the budget, the Department of Health, is not expected to produce a review for at least two years, by which time it will have swallowed over Euro84bn.
This lack of efficiency and accountability in the public sector plays an important role in contributing to overall inflationary pressures in our economy. All of this directly translates into long-term wage pressures. Over the past two years, wage inflation in Ireland has been running at a cumulative 10.8%. By the end of 2007 this figure is expected to rise to 15.8%.
To a great extent, rising wages reflect the need to attract talent into Ireland.
From universities to the financial sector, from IT to pharmaceuticals, Irish and multinational companies are finding it increasingly difficult to source worldclass talents for one simple reason - the cost of living that undermines the quality of life available to skilled employees.
A recent survey of global business executives identified the shortage of skilled labour as the main drag on economic growth in developed countries. Given this, it is only a matter of time before our ever-rising cost of living translates into real declines in productivity.
Constantin Gurdgiev is an economist and editor of 'Business & Finance'
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