It may come as a surprise to many but according to the Department of Finance the Irish economy is operating well above capacity. The economy’s potential output is determined by the available labour force and the productivity of that labour but output in the economy can be below that potential (a negative output gap, which can be large in a recession) or above it ( a positive output gap, which will lead to inflationary pressures ). The output gap is not observable and estimates can vary widely, particularly for Ireland given that migration has such a significant impact on the labour force, but the official view , from Finance, is that the gap turned positive in 2014 and rose to 2.3% in 2015 with a further increase forecast in 2016, to 2.5%.
The corollary is that unemployment is now deemed to be below the rate consistent with stable inflation, again not a view one often hears articulated from official circles; that unemployment rate ,of 10.3%, compares with the latest actual reading of 8.9%. Consumer prices are flat and Ireland’s Balance of Payments position is not deteriorating, neither of which is consistent with a large positive output gap, but the tightening of the labour market is beginning to have an impact on pay pressures in the economy.
The CSO had just published data on average weekly earnings, showing an annual increase of 2.7% in the third quarter and a more rapid increase of 3.6% for the private sector. The quarterly figures can be volatile but the average rise year to date is also strongly positive, supporting the view that labour is in higher demand , with a resultant upward pressure on earnings as the pool of unemployed workers shrinks.
That demand/ supply balance differs across industries of course and as a result there is a wide variation in earnings growth across sectors. Pay is rising very strongly in some industries, including Transport (5.6%), Information and Communication (4.6%), Administration (7.6%) and Finance (4.0%), while in others the increase is modest , such as Hotels and restaurants (1.9%) and Manufacturing (0.6%). A few are still experiencing falling pay, including Construction (-1.2%) although that sector did experience strong earnings growth in the early years of the recovery.
Price inflation is around zero so the pick up in earnings equates to a strong rise in real incomes, which in turn is likely to support household spending. The consensus forecast envisages further strong employment growth over the next few years and a concomitant fall in unemployment. It will be interesting to see the kind of pay growth that results as a feature of labour markets elsewhere , such as the UK and the US, is that falling unemployment rates have been associated with unusually weak wage growth in this recovery.