Chapter 3 - Structural Reform Initiatives

Summary

This Chapter sets out the key structural challenges facing the  economy and discusses the Government's responses to them. 

 Policies designed to increase labour supply such as active labour measures, upskilling and migration are outlined, as are policies to boost competition in product and capital markets.

 Measures to 'cool' the housing market and address the economy's infrastructural deficit - through the National Development Plan 2000-2006 - are also described.

 Finally the Government's long term policy for addressing the public finance implications of population ageing by means of a National Pensions Reserve Fund is discussed.  

3.1 Introduction

As the current phase of rapid economic convergence towards the living standards of the more prosperous EU Member States continues, Ireland is facing a new set of challenges many of which might best be termed 'the problems of success'.  These challenges include :

In the short term…

  • Supporting further gains in labour force participation and in skill levels as the economy approaches full employment;
  • Bringing supply and demand into equilibrium in a housing market which has a rapidly increasing population in the home owning' age cohorts;

 In the short to medium term...

  • Tackling the economy's infrastructural deficit;
  • Strengthening competition in product and capital markets;

 In the medium to longer term…

  • Responding to the public finance implications of an ageing population over the next fifty years.

A summary of the Government's policy responses to each of the challenges listed is set out below.

3.2 Boosting Labour Supply and Skills Levels

Ireland's 2000 National Employment Action Plan (EAP) focuses on measures to alleviate labour shortages, as they now constitute one of the major challenges facing the economy.  Policies are set out in detail in the EAP but summaries of some of the key measures are outlined below.

Passive to Active Labour Market Measures for the Unemployed

The preventive strategy implemented under Ireland's Employment Action Plan (EAP) represents a new dimension in the delivery of labour market supports. This strategy is aimed at engaging with both young and adult unemployed at an early stage of unemployment with a view to supporting their return to employment and preventing their drift into long-term unemployment. This on-going preventive approach commenced for young unemployed (under 25) in 1998, and adult unemployed in the age range 25 to 34, in 1999.  It was extended during 2000 to include adults aged 35-54.  In addition to this phased roll-out of the preventive strategy, the trigger point for early intervention with adult unemployed was brought forward, from 12 months to 9 months, during 2000.

This EAP-type approach was also extended to the long-term unemployed, on a pilot basis, initially in one urban and one rural location. It is being extended over time to further areas of the country.  

This approach is complemented with a substantial range and scale of active labour market programmes to assist the long-term unemployed and other disadvantaged groups re-integrate into the labour market.  The FAS (National Training Agency) Action Plan for the Long-Term Unemployed aims at increasing the proportion of long-term unemployed participating in FAS skills training programmes to 25% during the year 2000, compared to last year's target of 20%.

Improvement in Educational and Skills Level of Labour Force

Under the National Development Plan, almost IR£10 billion (€12.7 billion) will be invested in policies to increase employability, adaptability, encourage entrepreneurship and promote equal opportunity (the four pillars of the EAP).   

Based on recommendations of an Expert Group on Future Skills Needs, the Government in 1999 approved funding to support 5,400 extra third level places for the electronics and software sectors; 1,500 extra places on ICT postgraduate conversion courses and 730 new places in information technology skills courses.  A new National Training Fund to provide increased resources for upskilling is also being established. 

The second report of the Expert Group, published in March 2000, recommended 1150 additional third level places for the pharmaceutical, chemical, food and biotechnology sectors, to be introduced on a phased basis, and recommended initiatives to improve the availability of skills for research and for the construction sector    

Migration

Under Ireland's long-standing work permits system over 15,000 permits were issued in the first 11 months of this year, some 140% ahead of the number of permits issued over the same period in 1999.  A new work visa system to facilitate the recruitment of suitably qualified people for designated sectors (such as IT, nursing and skilled construction) where skill shortages are particularly acute was introduced this year.  The new visa scheme applies in respect of non EEA countries and will allow the prospective employee to apply to the Irish Embassy or Consulate in their home country and to have the work authorisation placed on their passport.

 Female Participation

 While Ireland's female labour force participation has risen considerably over recent years – and participation rates among single women are as high as elsewhere – there is still some scope for further growth.  Ireland's EAP and the PPF reaffirm the strong commitment set out in the National Development Plan and the Community Support Framework to equal opportunities between women and men.  Accordingly, as well as steps to enhance incentives, recent Budgets contained measures to encourage an expanded supply of child care places to meet the growing need for such facilities.  The NDP has allocated £250m (€317 million) towards childcare.  Budget 2001 includes additional measures to support childcare provision and significant increases in child benefit.

3.3 Bringing Supply and Demand into Equilibrium in the Housing Market  

Recent house price increases have shown moderating trends compared with previous years.  Inflation in the new house market peaked at 26% countrywide and 38% in Dublin in 1998.  The latest year on year figures are slowing at 12% and 10% respectively.  The main factors underpinning housing demand include demographic trends, such as growth in key household formation population age-groups (25-34 years), a decrease in average household size, reversal of earlier emigration trends and sustained economic growth.  

The Government recognises that continued house price inflation can pose a threat to the wider economy and has introduced a number of measures in recent years to respond to the demand/supply imbalance.

 The key objectives of the latest Government package launched in June 2000 are to:

  •   maximise housing output to meet the continuing strong demand for housing,

  • curb short-term speculative demand,

  • strengthen the position of first-time purchasers in the market,

  • increase the supply of social and affordable housing, and

  • improve the institutional arrangements to facilitate the delivery of housing related infrastructure and thereby increase overall housing supply.

 These objectives were implemented through a comprehensive package of measures including:  

  • exemption from stamp duty for first-time buyers for second-hand houses up to £150,000 (€190,000) and reduced rates up to £300,000 (€381,000), combined with a higher stamp duty rate of 9% for all housing transactions for non-owner occupiers;  
  • introduction for three years of an anti-speculative tax of 2% per annum on investors purchasing residential properties for non-owner occupation – but exemptions will apply in certain cases;  
  • the use of Strategic Development Zones to ensure the early development of large-scale residential developments, with a levy of £3,000 (€3,800) per housing unit for land owners who do not develop the land in accordance with the planning scheme for the zone and within specified time frames;
  • measures to increase the capacity of the construction industry, in particular to address shortages of professional and skilled workers;
  • an additional 1,000 local authority housing units per annum from 2001 to 2006;

The National Development Plan has also included significant investment in housing and housing-related infrastructure and in water and sewerage services, roads and public transport. 

3.4 Tackling the Economy's Infrastructural Deficit  

The 2000 Broad Economic Policy Guidelines recommended that Government should "ensure that the objectives of the National Development Plan are accorded high priority, given the necessity of meeting the infrastructural needs of a strongly growing economy, while at the same time achieving the stability objectives of fiscal policy".  

The National Development Plan (NDP) with investment of £40.588 billion (€51.5 billion) in 1999 prices is a key policy commitment to the achievement of continuing sustainable economic growth, a more inclusive society and better regional balance in economic growth.  

Just under £21 billion (€26.6 billion) will be spent in the main priority area of Economic and Social Infrastructure. The cost-effective and timely delivery of the Plan, and in particular the infrastructural investment, will be of key importance.  

Solid progress was made this year in advancing implementation of the Plan. Agreement on the Community Support Framework for Ireland was reached with the European Commission in July.  The Commission subsequently approved the Employment and Human Resources Development Operational Programme, the Economic and Social Infrastructure Operational Programme, the Productive Sector Operational Programme, the Borders, Midlands and West and the South and East Regional Operational Programmes.  

Monitoring committees and a Cabinet Committee will ensure on an ongoing basis that any possible obstacles to the successful delivery of the Plan are fully addressed. There will be flexibility in the monitoring arrangements to switch resources if necessary.  Indications are that Plan implementation will generally come close to target by year end.  

 3.5 Strengthening Competition in Product and Capital Markets

The Irish Government regards structural reform of product and capital markets as vital in ensuring efficient resource allocation, innovation and economic dynamism, all of which are key factors determining national competitiveness and standards of living.

 A detailed review of progress made during the year 2000 is set out in the Progress Report on Reforming Product and Capital Markets published by the Department of Finance in November. The key reforms undertaken include:

 Continued liberalisation of the utilities' markets …  

  • 30% of the electricity market was opened up to competition in February 2000.  
  • The Government launched a consultation paper on public transport in September 2000 in line with recommendations in the 2000 Broad Economic Policy Guidelines. It sets out a number of reforms including the phased introduction of a fully franchised Dublin bus market.
  • In late 1999, the Government decided to proceed with the privatisation of Aer Lingus, the state airline, and work to that effect has been ongoing in 2000.  

Investment in R&D and in measures to support the transition to a knowledge economy …  

  • The National Development Plan 2000-2006 provides for spending of £1.95 billion (€2.47 billion) to support R&D. As part of this strategy, the Government established the independent Science Foundation Ireland in June 2000 to administer a Technology Foresight Fund of £560 million (€711 million).  

Measures to promote competition and improve regulation in Irish capital markets…    

  • The Government has announced that it will introduce new legislation reforming competition and mergers rules, giving a greater role to the Competition Authority; and that the Authority will also enforce Articles 81 and 82 of the Treaty when this power is devolved to member states.
  • The Government is in the process of disposing of the state-owned banks.  

 3.6 Responding to the Public Finance Implications of an Ageing Population 

In common with other industrialised countries, Ireland is set to experience a significant ageing of its population over the coming decades.  The resulting increased dependency ratio will give rise to serious budgetary issues. In particular, it will put severe strain on the capacity of future Governments to continue to fund social welfare and public service pension liabilities on the present  “pay-as-you-go” basis.  

Ireland's demographics[1] are slightly more favourable than other European countries but the longer-term trend towards an older population is similar to that in other countries.  Almost uniquely in the industrialised world, Ireland's elderly dependency ratio will actually decline a little over the next few years. At present Ireland has - and will continue to have for most of this decade - about five people of working age for each person over 65.  However the position will begin to change at the end of the decade. By 2016 it is projected that there will be about four persons of working age to support each pensioner.  By mid-century it is projected that there will be only two people of working age for every pensioner.  In other words, Ireland's elderly dependency ratio is set to rise from about 20% today to about 25% by 2016 and to about 50% by 2050.  

It is projected that ageing of the population will affect pension costs as follows:  

  • the current Exchequer cost of public service and social welfare pensions is 4.7% of GNP;  
  • by 2026 the Exchequer cost of broadly maintaining the real level of this pension provision will rise to 8.1% of GNP;
  • by 2056 this cost will have risen to 12.4% of GNP.

In order to address this situation the Government has decided to move from the traditional reliance on 'pay-as-you-go' in the public sector and to introduce partial pre-funding of our future pension liabilities.  This will involve the establishment of a National Pensions Reserve Fund early in 2001.  Once the Reserve Fund is established, a statutory minimum of 1% of GNP will be set aside and invested each year to part-fund the cost of future pensions. The assets of the Fund will be drawn down by future Ministers of Finance commencing in 2025.  The size of these drawdowns will increase in line with the growth in the percentage of over 65s in the population.  In this way the Fund - over a very long time period - will help to smooth the Exchequer burden arising from our additional pension commitments.  

The legislation establishing the Fund will also allow the Government to make additional contributions to the Fund.  For example, the Government has already set aside the net proceeds of the sale of the former Telecom Eireann for pension prefunding.  

Appendix I - Sensitivity Analysis

The economic forecasts included in this updated Stability Programme represent the Department of Finance's assessment of Ireland's future growth prospects.  These are based on the following assumptions:  

unchanged interest and exchange rates      

unchanged commodity prices      

the continuation of reasonable growth in the world economy as forecast by the European Commission's Autumn 2000 Assessment       

a gradual loss in Ireland's competitiveness as growth in earnings continues to exceed those of our main trading partners  

It is assumed that the Irish economy achieves a “soft-landing” from the current period of rapid growth.  Of course, unexpected domestic or international developments could alter the expected growth path.  The purpose of this Appendix is to briefly outline the impact on the underlying budget balance of different possible economic scenarios.  

A number of points should be borne in mind when examining these results.  Firstly, the estimates should be seen as indicative and are subject to considerable uncertainty.  Secondly, it is assumed that there is no fiscal policy response to the changed budgetary position.  In reality such a response would occur, if required, having regard to the terms of the Stability and Growth Pact.   

Alternative Scenarios  

- Impact of 1% change in growth compared with central projection

 In line with estimates for previous years, it is estimated that a 1% impact on the growth rate would change the General Government Balance by about a ½% of GDP.  The budgetary impact of a 1% change in the growth rate per annum compared with the central projection is given in the Table below.  

Table 13 - Impact on the Budget Balance of 1% Change in the Rate of Growth Per Annum  

 

2001

2002

2003

Baseline GDP Growth

GGSurplus (% GDP)

(including contingency)

8.8

4.3

6.3

3.8

5.7

4.6

Cumulative impact of 1% change in growth per annum on GGSurplus

GGSurplus Range (%GDP)

up to 0.5%

3.8 to 4.8

up to 1.0%

2.8 to 4.8

up to 1.5%

3.1 to 6.1

- Impact of changes in Interest Rates compared with central projection

Interest rate changes would impact on economic activity and revenue receipts.   

The impact on economic growth is highly uncertain. The size of the impact clearly depends on future expectations.  If a given interest rate change is considered to be temporary it will have less of an impact than changes that are considered  to be longer-lasting. 

  The level of indebtedness in the economy is also important.  Clearly, a more indebted economy would suffer a greater impact from higher interest rates.   According to ESRI estimates personal debt as a % of personal disposable income has increased from 43 % in 1990 to 64 % in the first half of 2000.  However, the Government debt burden has fallen even more over this period, reducing the economy's overall exposure to higher borrowing costs.

 Previous estimates by the Economic and Social Research Institute suggest that a one per cent change in interest rates could affect growth by as much as a half a per cent in the short-run.  These estimates seem reasonable.  Accordingly a one per cent change in interest rates could affect the General Government Balance by as little as one quarter of a per cent.  It would also directly affect debt servicing costs but these are marginal when compared with the greater impact on growth and Government revenues.   

Appendix II - Output Gap and Cyclically-Adjusted Budget

By subtracting the estimated cyclically induced variation in the Budget from the observed budget balance, the Cyclically-Adjusted Budget Balance (CABB) can be estimated.  Comparing Cyclically-Adjusted Balances from year to year can give an indication of the discretionary changes in the Government's fiscal position.

It is however questionable whether attempts to measure the structural budget balance are useful in an economy changing as quickly as Ireland has done in the 1990s.  The extent to which Ireland's economy is above or below its trend growth position (i.e. the estimated output gap), and the magnitude of the related Cyclically-Adjusted Budget Balance, are very difficult to estimate for Ireland for the reasons set out below :  

First, with large structural changes having taken place, it is difficult to establish that there is currently an identifiable Irish economic 'cycle'.  

Second, it is currently difficult to reliably establish what is the sustainable trend rate of economic growth in Ireland, because of shifts in productivity, labour force participation and migration patterns.   

Third, there is a large degree of uncertainty regarding trend growth estimates generally.

Fourth, there is a weak correlation between measures of the output gap and inflation in Ireland given the importance of external factors in determining price developments.  

Fifth, the CABB indicator is a backward looking rather than a forward looking indicator of the budgetary position.  The key issue in terms of the sustainability of fiscal policy is where a country is expected to be over, say, three years ahead, not some notional trend estimate.

 Sixth, the CABB does not take into account the impact of changes in EU funding on national budgets.  

Estimations of the 'structural budget balance' and other such measures of the appropriateness of budgetary stance accordingly require to be treated with caution. Much more important in terms of evaluating the appropriateness of policy are the 'real' measures of the general government surplus and the general government debt level.  

Estimates of Cyclically-Adjusted Budget Balances and Output Gaps  

Notwithstanding these reservations, estimates of the cyclically-adjusted balance have been prepared and are presented overleaf.   These estimates are based on the projections described in this updated Stability Programme, and use a methodology similar to that of the European Commission.  

As indicated in the table, calculated on this basis, the cyclically-adjusted balance has risen by more than 3% of GDP since 1997, suggesting that fiscal policy has been contractionary over the past three years.   The methodology points also to a tightening over the period of this Stability Programme update as a whole - with the cyclically-adjusted balance estimated to rise from 3½% of GDP this year to 4% in 2003.  

Indeed, given the methodology employed, this estimated fiscal tightening understates the full impact of budgetary policy on economic activity in Ireland, as it does not take account of the effective withdrawal of 0.6% of GDP via a reduction in net EU transfers to Ireland over the period.   [The Y2000 GGSurplus assumes that Ireland receives net EU transfers - Structural, Cohesion and similar receipts, less contributions to the EU Budget - of 0.3% of GDP this year:   the Y2003 GGSurplus is based upon a net outflow equivalent to 0.3% of GDP as, by then, it is anticipated that the Irish Exchequer's contribution to the EU Budget will considerably exceed its receipts therefrom]  

Table 14 - Cyclically Adjusted Budget Balance [2]

 

Actual Growth rate

 %

Trend Growth rate

 %

Output Gap (% trend GDP)

Actual GGB (% of GDP)

Cyclically adjusted GGB (% trend GDP)

 GGB Change     [+=tightening]  %

1997

10.7

7.8

-0.1

0.3

0.3

0.3

1998

8.6

8.0

0.4

1.7

1.6

1.3

1999

9.8

8.1

2.0

3.9

3.4

1.8

2000

10.7

8.1

4.5

4.7

3.6

0.1

2001

8.8

7.9

5.4

4.3

2.9

-0.7

2002

6.3

7.7

4.0

3.8

2.7

-0.2

2003

5.7

7.4

2.4

4.6

4.0

1.3

ESA 95 basis

Appendix III - Policy Responses to Broad Economic Policy Guidelines (BEPGs) 2000

Each of the country specific recommendations concerning Ireland, contained in the 2000 Broad Economic Policy Guidelines, is set out below alongside relevant policy responses from Government.

Budgetary Policy

 BEPG 2000 Recommendation

Government Policy Responses

Budgetary policy should aim to be ready, already in 2000, to use budgetary policy to ensure economic stability given the extent of overheating in the economy; gear the budget for 2001 to this objective.

The Government remains committed to running substantial Budget surpluses for each year of the updated Stability Programme.

Restrain the growth in real public consumption from the 4.3% estimated in 1999 to 2.7% in 2002 as shown in the [1999] updated stability programme.

The Government recognises the need not to exacerbate inflationary pressures, and in this context fully agrees with the recommendation that public expenditure growth should be restrained.  The increases in public expenditure in this Programme underpin adherence to the new agreement with the Social Partners and in this way contribute to constraining inflation.

Ensure that the objectives of the National Development Plan are accorded high priority, given the necessity of meeting the infrastructural needs of a strongly growing economy, while at the same time achieving the stability objectives of fiscal policy.

Solid progress was made in 2000 in advancing the Plan. Agreement on the Community Support Framework was reached with the EU Commission in July.  The Committees to monitor implementation of the NDP held their first meetings. Expenditure on Roads was one area ahead of the financial provision proposed as the year proceeded.

Product and Capital Marke ts

BEPG 2000 Recommendation

Government Policy Responses

Give the Competition Authority the power to enforce Articles 81 and 82 of the EC Treaty; permit a real strengthening of competition policy in the reform of competition law to be drawn up this year and do not restrict it to procedural matters.

The Government has announced that it will introduce new legislation reforming competition and mergers rules, giving a greater role to the Competition Authority and that the Authority will also enforce Articles 81 and 82 of the Treaty when this power is devolved to member states.

Take measures to liberalise further the transport sector; in particular introduce competition into urban bus transport and into the railways, e.g. by franchising.

The Government launched a consultation paper on public transport in September 2000 in line with recommendations in the 2000 BEPGs. It sets out a number of suggested reforms including the phased introduction of a fully franchised Dublin bus market and the break up of the state rail company into independent infrastructure and operating companies - with the option that the operating company be privatised.

Make further efforts in particular to develop start-up and early-stage venture capital.

The Irish Venture Capital Market has made considerable progress during the past few years. Ireland is ranked fifth among seventeen OECD countries in terms of the overall amount spent on venture capital as a % of GDP, with cumulative venture capital raised totalling 1.09% of GDP in 1997. Overall performance by Government and EU supported funds to 31 December 1999 since 1996 has been 121 investments in 72 companies totalling £37.9 million (€48.1m).

Labour Markets

BEPG 2000 Recommendation

Government Policy Responses

Monitor wage developments so as to ensure that they are at most consistent with the recently concluded national pay and partnership agreement, the Programme for Prosperity and Fairness, as the minimum necessary basis for the maintenance of employment growth.

Against the background both of the current social partnership agreement, the Programme for Prosperity and Fairness and the need for vigilance in relation to inflationary pressures, the Government favours  wage developments consistent with maintaining competitiveness and economic growth.

Adopt a comprehensive strategy to increase the participation of women in the labour market, including the removal of tax-benefit disincentives, and put in place measures which facilitate the reconciliation of work and family life; pursue, in particular, flexible leave schemes and a sustained effort to increase the supply of care for children and other dependants.

Budget 2000 contained measures to enhance incentives to work especially for married women, and to encourage an expanded supply of childcare places to meet the growing need for such facilities.  Y2001 expenditure plans contain provision aimed at further expanding child-care supply.  Budget 2001 includes additional measures to support childcare provision and significant increases in child benefit.