Sunday, 22 February 2009

Pay cuts are neither a panacea nor even a help for Ireland's economic problems

Paul Sweeney: The remarkable barrage of calls for pay cuts, from both orthodox economists and the "pop economists", as the the solution to (most of) our economic problems, in the mainstream media, without any alternative views, demonstrates that real solutions to our immense economic problems are further away than we thought. It demonstrates a very limited view of the complexity of competitiveness and the focus on one element of cost competitiveness is misguided.

Competitiveness is very complex covering costs, quality of infrastructure, services, public services, credit etc (see for example, NCC report contents which gives an overview of some issues around the subject on page 7). The list of "12 pillars of competitiveness" in the World Economic Forum’s World Competitiveness Report (page 3 of Chapter 1) can be found here. Some economists have even posted charts with rising costs and labour costs as THE indicator of overall competitiveness!

Unit labour costs are a better indicator, and Ireland's overall productivity is very high. We do have a problem because productivity has not risen in recent years in the era of the Domestically Induced Boom since 2001, but neither has it fallen. And of course, we know that some sectors are more productive than others. But the key issue, never addressed, is why wage and salary earners, who make up 80% of the workforce, should be the only ones who have to contribute to the cost reductions?

Orthodox economists assume society is classless and seldom address cutting professional fees, the profits of wholesalers and other owners of capital, except to vaguely murmur of the need for "more competition." Has this something to do with ideology?

But on cost competition, they say as we cannot devalue, we must do so with wages and this will automatically turn into overall costs!

The transmission mechanism is never detailed, perhaps because it does not work. Further, in the past 5/6 weeks, sterling has appreciated against the Euro by over 9% and the dollar by 13% (UK & US each take around 16% of our exports) and we have heard little of the impact of this devaluation, which has been an undoubted help. Furthermore, while the total cost of an employer hiring a worker in Ireland has been rising, as we have been catching up with Europe, it is still lower than in most of the other 15 member states.And I could go on on costs.

But the biggest issue around Ireland's competitiveness is that we do not have a functioning banking system. Credit is not flowing to businesses; there is a lack of confidence and we do not know how much the blanket banks guarantee will ultimately cost Irish taxpayers. This is the issue everyone is talking about, and it is the real competitiveness issue. Wages costs are nothing compared to getting over this enormous economic hump! And then there is the impact of damage to our international reputation on Foreign Direct Investment caused by our business leaders who have ru(i)n our banks, ably assisted by the sycophantic pro-business attitude dominant in the Financial Regulator's office, in Government and in the economic Departments. Regrettably, some top public servants came to believe that being pro-business meant that what is good for business, as determined by its leaders, is synonymous with the public interest!

The next biggest issue around competitiveness is falling demand. If you cut wages, domestic demand will fall further. It is falling already, as people save and some lose their jobs. But international demand is also falling with the recession, and so exporting is getting more difficult. Germany, the world's great exporting nation, is now facing serious export problems.
The answer is a major international stimulus. So far, this is not being tried at the level required in Europe. But to cut just wages in Ireland in an effort to stimulate exports will not succeed. It will exacerbate our economic problems. It will also impose serious hardship on the working poor and many middle income people. For in Ireland, consumer prices are far above the average in the EU27, being a staggering 33% for services (guess who is making serious money?). On the other hand, the huge gap in revenue and public spending does mean that total labour costs, the main component of current public spending, will have to be addressed - but innovatively, fairly and rapidly.

Where firms are facing serious problems, the existing agreement allows for assessment of finances and if inability to pay is proven, there is not an issue. For some firms, labour costs are so insignificant that pay freezes or cuts mean nothing.

Keynes may have been out of fashion for a long time, but it is remarkable that he is so rejected here and that the old classical economics is still dominant in so many heads in this little economically troubled country of ours.

Paul Sweeney is Economic Advisor to ICTU

1 comment:

Michael Taft said...

Another aspect ignored by those calling for wage cuts, or real devaluation, is the impact it will have on the fiscal deficit. Cutting wages will obviously reduce income tax revenue, social insurance contributions, Health Contribution Levy, Income Levy, etc. And that's not even counting the cost of reduced consumption and its impact on domestic demand with all the implications that has for job retention. Of course, I suppose our orthodox friends would counter with even more public expenditure cuts and tax increases on low-average incomes. And, so, the downward spiral continues.