Monday, 11 January 2010

Reduced costs are not the route to export competitiveness

Proinnsias Breathnach: I sent the following to the Irish Times in early December but it wasn't published:

The ability to penetrate export markets is the crucial ingredient upon which Ireland’s recent economic success was built. Today, exports of goods and services are the equivalent of over 80% of gross domestic product compared with less than 30% in 1960. However, the basis of Ireland’s exporting success is very poorly understood by most Irish economic commentators and by the politicians who come under their influence.

There is an extraordinary unanimity among economists that Ireland has been losing international competitiveness and that this is attributable to rising wage levels relative to our main trading partners. This view of Ireland’s competitive position is not only simplistic and erroneous but could be profoundly damaging to this country’s economic future.

In the modern global economy the recipe for competitiveness is a complex mixture of a wide range of ingredients. Up to now Ireland has managed to produce a good blend of these ingredients and, while the unsustainable boom conditions of the 1990s are now well behind us, the export sector has, for the most part, continued to perform quite solidly. Contrary to what appears to be a common view, Ireland’s exports grew in real terms (i.e. allowing for price changes) in each year between 2000-2007. Export volumes did fall by one per cent in 2008, and have fallen further in the first six months of 2009. However, the rate of export decline has been much lower than for the EU and OECD countries at large, which means that Ireland’s share of export volumes in both these regions has actually been growing.
Between 2000-2008 Irish exports grew by a total of 47% in real terms. While Ireland’s share of total world exports (in current value terms) did fall slightly in this period, this was due mainly to contraction in the electronics sector arising from growing competition from Asia, and particularly China. By contrast, Ireland has increased its share of global exports in six key sectors which, between them, now account for one half of our total exports: computer services (mainly software), insurance, financial services, other business services, odourifous mixtures (mainly drink concentrates) and heterocyclic compounds. Ireland’s share of global exports in some of these sectors is extraordinarily high, ranging from 18% (insurance services) through 21% (computer services/software) and 28% (heterocylic compounds) to 40% (odouriferous mixtures).

Strong growth in these sectors clearly has not been inhibited by rising labour costs. It could be that, unlike elsewhere in the economy, productivity is rising more quickly than wage costs in these particular sectors. However, in order to properly understand why Ireland might have a competitive advantage in sectors such as these requires a somewhat more sophisticated analysis of the nature of competitiveness than has generally been offered to the Irish public by our politicians and economic commentators.

The National Competitiveness Council (NCC) was established in precisely to provide such analysis, which it does in its annual Competitiveness Report. Unfortunately, the fruits of the NCC’s labours appear to have never troubled the gaze of those who seek to influence or formulate Irish economic policy. In its Competitiveness Reports, the NCC uses 18 different indicators (just one of which relates to productivity and labour costs) to assess Ireland’s competiveness. These include, inter alia, business environment and performance, physical and knowledge infrastructure, prices and costs, productivity and innovation. However, the NCC does not quantify these indicators in a way which would allow them to be compared with each other, or combined together to create a composite competitiveness index which would allow Ireland’s overall competitiveness to be monitored over time.
However, such an index is produced in the Global Competitiveness Report published annually by the World Economic Forum (WEF), the Swiss-based independent think-tank organisation. The WEF’s Global Competitiveness Index (GCI) was devised by, and is compiled under the supervision of, Michael Porter of Harvard University, one of the world’s foremost authorities on international competitiveness and author of the path-breaking book The competitive advantage of nations (1990).

The GCI is compiled from no less than 113 different indicators, divided into twelve “pillars” of competitiveness (education, efficiency of labour and product markets, business sophistication, innovation, etc.).. The relative weights given to these indicators vary depending on each country’s level of development. In the WEF’s view, competition based on cost is only appropriate for countries at a low level of development, for whom cheap labour or resources are frequently their only source of competitive advantage.

For countries at an intermediate level of development, the keys to competitiveness are production efficiency and product quality, while for countries at the highest development levels, the key factor is the ability to produce new and different products employing cutting-edge production processes. In the system of weightings applied to this group of countries (in which the WEF places Ireland), labour cost factors account for just 1.7% of the total value of the competitiveness index.
What is more, while Irish economists have been decrying Ireland’s declining competitiveness, the WEF have been moving Ireland up its competitiveness league table, from 30th position in 2002 to 22nd in 2009. From their point of view, Ireland’s key competitiveness weakness lies in infrastructure, along with small market size and the country’s current macroeconomic stability problems. Labour costs are not mentioned.

Evidence from other sources vindicates the WEF’s relatively sanguine view of the direction in which the Irish economy is moving. According to the IDA, the rate of return on US investment in Ireland rose from 19% to 22.5% between 2000-2007. This is over twice the EU15 average and is only surpassed by China, India and Singapore. In 2008 Ireland was the most successful country in the world in attracting foreign investment, up from tenth place the previous year. These are hardly the signs of a country in competitive decline.

Ireland’s economic future lies in maintaining and enhancing the country’s attractions for high-end inward investment. Inward investors repeatedly highlight the skillsets of Irish workers in this context. Spokespersons for the foreign sector have regularly emphasised the importance of continued and expanded investment in education – at all levels – and technological know-how. This was the key message in an article by Jim O’Hara, General Manager of Intel, published in the Irish Times on November 13 last.

Yet the Government appears to have swallowed, hook, line and sinker, the argument that reduced costs are the key to enhanced export competitiveness. This argument is being routinely used to help justify the current programme of spending cutbacks. While there is an obvious need to contain costs, it would be misguided to do so on the basis of false premises. The way to strengthen Ireland’s competitiveness is through expanded spending in education. Spending cuts in this area in order to balance the books in the short term could have very negative long-term consequences.


Joseph said...

This should be required reading for all TD's.


Proposition Joe said...


The problem with almost any number quoted on the quantum of exports from Ireland, is the distorting effect of transfer pricing schemes designed to take advantage of our low corporation tax rate.

For example, if a certain leading software company charges its Irish subsidiary a pittance for almost-finished product (just needing some low-value localization and packaging), then the notional amount of profits made by that subsidiary tells us almost nothing about the productivity of the Irish workers. They may be super-competitive, or they may not. The point is the actual value they provide is completely dwarfed by the money-laundering operation going on around them.

Spokespersons for the foreign sector have regularly emphasised the importance of continued and expanded investment in education – at all levels – and technological know-how.

Your phrasing here implies what's needed is simply the same approach to education, only more so. In fact if you really listen to what MNCs are saying, its more in the line of the current system of science/tech education not being fit for purpose and needing a complete reinvention in order to be effective.

Michael Burke said...


This is an excellent piece, not only highlighting the twin fallacies that Ireland is suffering a dire decline in competitiveness but also that the remedy is lower wages.

There is also a great value in highlighting the genuine areas of concern, notably infrastructure and education.

This is what Jim O'Hara said in that article, echoing a long sries of comments from represeantitives of MNCs in Ireland, "We must have a world-class, digitally connected education system and a clear government strategy across all four levels of education and on into lifelong learning. We need the best teachers in the subjects vital to the country’s economic interests: science, technology, engineering and maths.

Research is equally important. Ireland has significantly raised its investment in research over the last 10 years. The commitment is now 1.7 per cent of GDP – just below the European average..."

Not once did he mention the requirement for lower pay.

Paul Hunt said...

All this is fine, but it might be worth while seeing if the data in the following table could be rationalised in the same way:

It shows comparative price levels of final consumption by private households (incl. indirect taxes) with EU27 =100. Irish prices are nearly 23% above the Eurozone average. It takes purchasing power parity into account - which makes some adjustment for differences in per capita GDP. If this weren't taken into account the gap would be greater. Of course Irish prices have fallen more in 2009 than those in other countries, but this will close the gap by less than 2.5%.

A whole host of reasons can be trotted out to justify this gap - extra costs of getting goods to the periphery of Europe, small scale of the irish market, etc. - but there can be no doubt that inefficiencies, monopoly profits and price-gouging go a long way to explain this gap.

I have no interest in seeing, or desire for, falling Irish wage levels, but stripping out these unjustified costs would increase real earnings, reduce the costs of doing business, boost consumption and investment and contribute to internal and external competitiveness.

However, there is an eloquent silence on this blog when it comes to discussing these unjustified costs and how they might be stripped out.

Michael Taft said...

Paul - the charge of silence in the face of prices is not quite justified. For instance, the Forfas report on retail enterprises has been consistently referred to which shows that while wages are low by comparison with the Netherlands, one of the main cost problems is rent. There are any number of solutions to this problem (compulsory renegotiation of rents, commercial rent control, rational planning and zoning, etc.) but clearly cutting wages isn't. For electricity prices, let the market set the rate with any subsidies to private companies to be provided in a transparent manner (rather than through high, state-set tarrifs). Greater transparency in profit-reporting under a new corporate governance regime - out gross operating surplus is much higher in many areas than the EU norms. And, of course, greater control over land pricing, including stripping out distorting tax expenditures, which was a fundamental driver in rising house costs. These may not be solutions you'd favour, but they are analysis and prescriptions that have been advanced on these and other blogs.

Paul Hunt said...


Fair comment. I think you might understand why, and perhaps accept that, I was being a tad provocative. With the possible exception of electricity (and the other semi-states) I fully agree with the broad thrust of the reforms you outline. (Re the former I am hoping for further engagement with Michael Burke on investment and infrastructure issues. I'm not as close-minded in this area as you might think!) To your list I would add an effective re-establishment and empowerment of economic regulation and the expansion and empowerment of the Competition Authority to tackle citizen-harming, anti-competitive practices throughout the economy.

However, we both know that while the current Government remains in power none of these issues will be tackled in the way they should - and they seem more comfortably ensconced than they have been for some time. Ironically, but perhaps not surprisingly, the Minister for Finance's illness is strengthening its position as it touches the basic humanity and decency of the Irish people.

The most likely alternative of a FG/Labour might not be entirely to the liking of progressives, but it is what is on offer and has the potential to transform the political and economic landscape.

Many trades unions, quite understandably, are gearing up to take action against the public secor pay cuts. However, it is unlikely to be effective. A more effective approach (which I have suggested elsewhere) is for the unions to organise a mass petition to the President requesting that she convene the Council of State and advise the Taoiseach that a plurality of citizens demand that he seek her permission to dissolve the Dail. I realise there is no constitutional provision to "recall" a government, but it would prove impossible for any government to face down such a mass mobilisation. It would also strengthen the progressive voice in the formation of any subsequent government.

The alternative is remain wittering ineffectually through the ether on this and other blogs. The time for action is now.

Michael Taft said...

Paul - thanks for that and I hope to be posting on the subject of finding resources for the badly needed investment this economy needs. I know on that point we are also in agreement. Agreement on ends helps agreement on means.

Yes, FG/Labour look like the alternative and, yes, progressives should be wary and, no, I doubt that it will be 'transforming'; but it will probably be better in most areas. In any event, dialogue with this Government is next to impossible.

But the idea of a mass petition - now that is something that is worthy of further discussion.

Paul Hunt said...


Many thanks for the positive response. Dialogue is valuable. I look forward to your take on the financing of investment. And I would be more sanguine about the prospects for the likely alternative government. Power flows ultimately from the people and it is for them to decide by whom and how they are governed. Engagement, debate and action from the bottom up will help to shape the political and economic discourse. There are very few in the purely political sphere who generate ideas on governance and policy.

And I am greatly heartened by your reaction to my proposal of a mass petition. I fear that any direct action by the unions opposing the public sector pay cuts will be divisive, economically-damaging and will play into the hands of the Government. It will certainly be portrayed in this manner. Drawing on the "power of numbers" and the widespread disaffection with this government (and its predecessors of similar ilk) is perfectly legitimate both tactically and strategically. This Government is pursuing and compelling the enactment of policies for which it has no democratic mandate but that attempt to repair, in a highly inequitable manner, the damage it and its predecessors have done to society and the economy.

Slí Eile said...

@Michael @Paul
At last we are all in agreement (on somethings!)

@Paul the mass petition idea is very interesting and innovative. Lets agree that talk is not enough. We need positive and constructive action that has some chance of leading to good outcomes.

Paul Hunt said...

Sli Eile,

Yes, indeed. But how to get some traction for this idea? Some unions are already serving notice on the Government of limited industrial action later this month. Having made its decision on public sector pay cuts, and with the legislation enacted, the Government will not - repeat not - back down. In fact these tactics have every possibility of strengthening the Government's position and hardening its resolve. They are likely to be self-defeating and to weaken the progressive voice.

There is no guarantee that an alternative government would be more open to progressive policies, but it would be difficult to conceive of one being less so than this. Nor is there any guarantee that a mass petition would be successful.

However, a mechanism is required to allow the people of Ireland to convey a simple message to this Government, quietly, but firmly: "You and your predecessors have pursued policies that have contributed to the severity of this economic and financial debacle. Your attempted cure is as bad as, if not worse than, the disease. We have had enough. Go, and go now."

The question now is: can the unions retreat from the tactics they are planning to pursue and, with progressives, give the people of Ireland their voice?