The Irish economy has performed remarkably well over the past decade, propelling per capita income to above the EU average. Though the period of rapid catch-up has ended and productivity growth has slowed in recent years, the economic fundamentals remain strong.

Economic activity has been fuelled by strong domestic demand but is now easing. In the short run, wage restraint and labour market flexibility will be important to continue to attract foreign direct investment and to crowd in foreign demand to offset slowing domestic activity. In the longer run, stronger productivity growth and continued increases in participation rates will be needed to sustain a fast pace of real income growth. The easing of activity has led to a slowdown in government revenues and a sharp drop in the fiscal surplus. At the same time, the government is committed to a large infrastructure investment programme, and there is strong demand for better public services. Over the long term, the public finances face serious pressures from the ageing of the population.

Maintaining strong growth. Productivity has faltered, partly due to the buoyancy of the lower-productivity construction sector in recent years. Better performance will hinge on boosting competition in sheltered sectors and the network industries, on improving the innovation framework and raising education standards further. Moreover female participation, while rising quickly, could be assisted by further increasing the supply of childcare places. The design of child benefits does little to encourage women to join the workforce.

Reforming the taxation of housing. Much of the past large rise in house prices was justified by economic fundamentals and rates of home ownership are high. But the unusually favourable tax treatment increases the role of housing in the economy and adds to volatility in the housing market. There should be a gradual move towards a more neutral system of housing taxation.

Containing risks to the financial system. The risks associated with the sharp run-up in domestic indebtedness have so far been contained. Irish banks are well-capitalised and profitable, so they should have considerable shock-absorption capacity. However, turmoil in the international markets continues to impact on the Irish financial system. Transparency in financial markets worldwide needs to be improved to restore confidence. It is important to prepare for downside risks and, in conjunction with international efforts, Ireland should consider its own arrangements.

Public spending needs to slow. Fiscal performance has been strong in recent years but revenue growth has moderated as the economy, particularly the housing market, has weakened. Public expenditure is set to slow but it is important to avoid locking-in expensive commitments, particularly on public sector pay. As spending rises more slowly, improving public services will have to rely more on undertaking further reforms to public sector management and getting better value for money.

Ageing will put pressure on government spending in the long term. Ireland faces the same, although more distant, pressures from ageing as other countries. A long-term framework needs to be put in place now to ensure decent incomes in retirement and fiscal sustainability. The recent Green Paper on Pensions sets out a comprehensive range of options for reform. A future package of measures should include linking the standard retirement age to longevity and ensuring that private pension savings are adequate. The current system of tax incentives for pension saving is very generous but needs to be better targeted.