Looking ahead, given the extreme openness of the Irish economy and its labour market, it is likely that further changes in structure will occur. Whether these changes will affect the potential of the economy to generate stable and sustainable growth will depend on how adaptable the economy is. The external competitiveness of the economy will be affected by new factors and a failure to adjust to these could see the sustainability of growth called into question.
The changes in demographics and the labour supply will continue to have a number of important implications for the Irish economy over the next decade. While the growth in the labour supply will be much less than it was in the 1990s, it will, nonetheless, remain quite strong well into the next decade.
The rising educational attainment of the population should increase the potential employability of the labour market participants, reducing the risk that future shocks could lead to a return to high levels of long-term unemployment. Past experience suggests that well educated labour market entrants will not remain unemployed in Ireland; they will either obtain employment in Ireland or in other parts of the EU. The increasing investment and participation in education will result in further improvements in the educational attainment of the labour force, which should positively affect productivity.
Migration has played a crucial role in labour supply growth in recent years and is likely to continue to be one of the most important factors in determining changes in labour supply in years to come. This calls into question the choice of GNP growth as a policy objective. In the context of immigration,
26 MEDIUM-TERM REVIEW 2005-2012
an increase in the size of the economy (GNP) does not necessarily imply an increase in average living standards for existing residents (GNP per head). In the rest of this Review we pay particular attention to changes in GNP per head. For this reason, attention needs to be paid to the question of what precisely is the policy objective for immigration.
While GNP per head is a better measure of welfare than GNP alone, there are other factors that affect the welfare of the population. One of these is the endowment of infrastructure, especially of housing. The limited endowment of infrastructure that Ireland currently possesses is affecting the standard of living in a manner that is not captured by GNP. For example, the poor endowment of public transport infrastructure leads to enhanced commuting times that impact negatively on welfare. To the extent that a higher population puts increasing pressure on the existing infrastructure this will reduce the welfare of the population in a manner not captured by the traditional measure of GNP. This additional “externality” from rapid growth must be considered in formulating policy for the future. Just because GNP rises, or even because GNP per head rises does not guarantee a welfare improvement of a similar magnitude.
Arguably the Irish economy had too big an endowment of infrastructure in 1960, reflecting a misallocation of resources over the previous decade.15
However, today the economy shows all the signs of having “outgrown its clothes”. Both private infrastructure in the form of housing, and public infrastructure in the form of public transport, roads, sewerage and water supply, and electricity transmission are all constraining growth. This constraint is reflected in very high prices for housing and high indirect costs for individuals reflected in rising commuting times. In turn, these costs are passed on to the business sector through the labour market. Indirectly, through the adverse effect on competitiveness of the cost of maintaining an acceptable life style in Ireland, an infrastructure constraint is operating to reduce Ireland’s potential growth over the coming decade.
However, at some point in the future the current very high rate of investment in infrastructure will see the endowment of infrastructure catch up with the economy’s needs. When this happens it will both free up major public and private resources for alternative uses, and it will also see a major shift in production within the economy, with a move away from the building sector to other sectors, especially services. Accomplishing such a transition in a limited time frame will require huge flexibility in the economy if the costs to individuals and to society generally are to be minimised.
15 The over investment in railways over the previous century meant that Ireland had an excessive endowment of this form of infrastructure, the maintenance and operation of which was a major economic burden. This shows that merely providing such infrastructure is not necessarily an aide to future economic development.
A
PPENDIX
2.1:
T
HE
M
ULTIPLIER
T
he changes that have occurred in the structure of the Irish economy, as outlined in this chapter, have a number of important implications. Here we consider the issues discussed in terms of a very simplistic model of the economy, and the multiplier effects.16The traditional basic economics formulation of a macro-economy can be characterised in a series of simple equations:
here: = GNP tment) t f dome ic demand profit
quation (1) is the traditional national income identity. Equation (2)
Y = C + I + G + X – M (1) C = bY (2) M=m(C+I+G)+nX (3) Y = bY + I + G + X – mbY - mI - mG – nX (4) Y(1-b+mb) = (I + G) (1-m) + X (1-n) (5) ) 1 ( 1 1 m b n dX dY − − − = (6) W Y
C = Consumption (here taken to include housing inves I = Investment (here taken to exclude housing investment)
G = Government consumption
X = Exports
M = Imports
b = propensity to consume
m = propensity to import ou o st
n = propensity to import out of exports (including repatriations)
E
determines consumption as a function of income. Equation (3) determines imports as a function of domestic demand and exports. Equations (4) and (5) substitute Equations (2) and (3) into Equation (1). Finally, Equation (6) determines the impact of a marginal change in exports on GNP (Y). That response is referred to as the multiplier.