Tuesday, 16 November 2010

Anthony Leddin on Ireland's export competitiveness

Proinnsias Breathnach: Last Friday’s Irish Times (November 12) contained an article by Dr Anthony Leddin, Head of the Department of Economics at the University of Limerick, which raises further serious questions about the quality of advice on economic policy emanating from Irish academic economists.

The basic thrust of the article was that Ireland’s international competitiveness declined seriously for most of the 2000s due mainly to rising costs, but that a fall in costs and wage restraint since 2007 helped reverse this trend. Leddin concludes that a deflationary budget, through further containing wage and other costs, will work to Ireland’s long-term advantage by enhancing competitiveness.
Leddin cites trends in what he terms net exports (i.e. exports minus imports) in support of his argument. He states that net exports fell from a surplus of €226 millions in 1999 to a deficit of €10.124 billions in 2007 (reflecting falling competitiveness) but then recovered to a deficit of €4.85 billions in 2009 (indicating improving competitiveness).

Even if these data were accurate, they would indicate a highly unlikely speed of response on the part of trade volumes to changes in costs. However, much more seriously, not only are the data inaccurate, but the trends derived from the data are the opposite of actual trends in net exports. In 1999, according to CSO Balance of International Payments data, total exports of goods and services exceeded imports by €12 billions, not the €226 millions claimed by Leddin. Between 1999 and 2007, the excess of exports over imports increased by €6.7 billions (to €18.7 billions), directly contrary to the fall of €10.3 billions postulated by Leddin.
Over the next two years Ireland’s trade surplus grew by a further €9 billions to €27.7 billions (according to Leddin there was a deficit of €4.85 billions in 2009).
The data cited by Leddin refer, not to net exports, but the so-called “balance on current account” which includes not only net flows of export revenues but also net flows in factor income and transfer payments. By far the biggest component of the latter elements is net direct investment income i.e. income earned by transnational firms from overseas operations.

In 1999, the net outflow of direct investment income came to €13.5 millions, which exceeded the trade surplus. However, a surplus in other investment income gave a small surplus in the overall current account of €226 millions which is the figure given by Leddin for the trade surplus. By 2007 the net outflow in direct investment income had doubled to €26.3 billions, €7.7 billions greater than the trade surplus. Deficits in transfer payments and other income flows produced the overall current account deficit of €10.1 billions which Leddin presented as the trade deficit.

Over the next two years the net outlow of direct investment income rose by €2.6 billions but a much sharper rise in the trade surplus (of €9 billions) produced the substantial fall in the current account deficit which Leddin presented as a fall in the trade deficit.

Overall, therefore, where Leddin claimed that Ireland’s net exports fell by €10.4 billions between 1999-2007, they actually rose by €6.7 billions. This, of itself, undermines Leddin’s argument that Ireland’s competitiveness deteriorated in this period. Indeed, the key factor in the difference between Leddin’s purported net export data and the true position, i.e. rapid growth in the net outflow direct investment income, is itself an indicator of rising rather than falling competitiveness, to the extent that it reflects rising profitability among foreign firms based in Ireland.

It is shocking that a senior academic economist would make such a glaring mistake in the presentation of basic macroeconomic data. What is more disturbing is that this is just the latest instance of misinterpretation (or non-interpretation) of data by a wide range of economists in support of an erroneous view that Ireland’s competitiveness was undermined in the first decade of the current century. I have already refuted this view in some detail in a series of articles on the Ireland After Nama website (May 2010).

Almost unanimously, these economists further attribute this postulated loss of competitiveness for the most part to rising labour costs (itself not true, at least insofar as it applies to Ireland’s main export sectors). The idea that international competitiveness is primarily dictated by labour costs is extraordinarily simplistic (and of course untrue, at least for the markets in which Ireland participates).

What is even more extraordinary is how widely held this idea is among Irish economists. It is a view very firmly held, for example, by Alan Aherne, Brian Lenihan’s economic advisor who wrote in the Sunday Tribune (January 11, 2009) that “if we are to regain competitiveness, we have to do it the difficult way – through wage cuts” and followed this up on RTE’s Morning Ireland programme (January 19, 2009) with the view that “the only way to improve export competitiveness is through wage cuts in the export sector”.

This immediately rules out enhanced productivity, design and performance improvement, technological upgrading, marketing and branding, to mention just a few of the standard approaches used by firms to improve market share in the real world. If the Irish government’s economic policy is based on views and analyses of the level of accuracy and sophistication indicated here, then there really is little hope for us at all.


Rory O'Farrell said...

I think he neglects the whole point of exports, they lead to wages.

Cutting wages might lead to some increase in exports. However, holding exports constant, a fall in wages -> more profits for multinationals -> more repatriated profits -> a worse Current Account.

I don't know which effect is dominant, but this negative effect has been totally ignored.

Anonymous said...

And Rory, you miss the whole point of regaining competitiveness, it leads to fresh investment.

More FDI -> more exports -> better current account.

Also more FDI -> more wages -> higher tax yield -> better fiscal position.

Rory O'Farrell said...

@ Anonymous

You should have read the second sentence in my post.

Also, as I pointed out more exports need not always lead to a better Current Account or more wages if it is achieved through cutting wages.

Michael Burke said...

Between 1997 and 2006 compensation of employees in this economy grew 36% faster than in the Euro Area (EU Commission Area Report), and and real compensation grew by 17% more, due to higher inflation.

Yet real unit labour costs fell by a cumulative 15% relative to the Euro Area over the same period, and exports grew 52% faster.

This is because investment grew by 74% more than the Euro Area.

Productivity is a function of investment and the quality of labour. Cutting wages is irrelevant to the main drivers of productivity. It simply reduces investment further in those sectors dependent on domestic demand.

Anonymous said...

Cutting wages is irrelevant to the main drivers of productivity.

Your views are oh so old economy.

The importance of labour costs in invertment decisions are totally dependent on the industry involved.

Highly capital-intensive, say for example an Intel fab plant, and yes labour costs only form a small component.

Similarly for very high added-value, say for example a Big Pharma plant cranking out patent-protected drugs.

Not so however for people-heavy endeavours with relatively low barriers to entry, such as software development. Just look at how much work is being off-shored to Belarus, Ukraine, Bulgaria, India and China. All completely wage-driven.

An Moltóir said...

It may interest - but not perhaps surprise - readers of this post that a letter which I sent to the Editor of the Irish Times on Sunday November 14 pointing out the basic errors in Anthony Leddin's article has not been published. It does not help public discussion of Ireland's current economic problems when the newspaper which likes to regard itself as Ireland's newspaper of record publishes an article, whose simplistic and ideologically-driven argumentation is based on profoundly inaccurate statistical data, refuses to publish a communication pointing out these inaccuracies (especially when the correct data directly contradict the findings based on the incorrect data).

Proinnsias Breathnach