THE GOVERNMENT should resist demands for wage increases in national pay talks as higher labour costs would erode competitiveness and discourage foreign direct investment (FDI) into Ireland, Friends First chief economist Jim Power has warned.

In his latest quarterly economic outlook, Mr Power said the increased pressure on FDI into Ireland was a cause of concern because of the heavy reliance on the construction and public sectors for employment growth. He said 53.2 per cent of jobs created in the last two years were in the construction and public sectors.

He said there was increased competition for FDI from emerging economies, and that a further loss of competitiveness would put Ireland's FDI model at risk. He said a new model was needed to attract "higher value-added employment". He cited a recent report which said the number of jobs created by FDI in Ireland in 2007 was 40 per cent lower than a year earlier.

Mr Power said a harmonised EU corporate tax base was also a "big threat" to FDI in Ireland.

"We have seen very little debate about it but it is starting to get on to the radar in a very aggressive way. Tax competition is heating up at a pretty dramatic pace," he said, referring to low corporate taxes offered by lower-cost eastern European countries.

"I'm not painting a dark picture on the FDI front but the strains are emerging and we have to address them before they become serious problems. Without a strong FDI model, alongside a strong indigenous model, this country will struggle."

Mr Power said the economy would grow by 2.3 per cent this year, the lowest growth rate since 1991. He expects the Exchequer deficit to be around €4-5 billion by the end of the year.

He said the European Central Bank (ECB) was "dragging its heels" on rate cuts because of high inflation. However, downside risks to growth in the second half of the year meant that two quarter percentage point interest rate cuts were likely before the end of 2008.

Mr Power said the average US recession lasted nine to 10 months, but the current downturn would last longer than the decline following the 2001 dotcom collapse as it involved housing rather than equities and more sectors were affected.

He said subprime losses could exceed $500 billion.

The US Federal Reserve was in "nightmare times", he claimed, and was pursuing "the least worst option" by cutting interest rates aggressively.