Wednesday, 16 February 2011

Economists on Ireland's export performance - more sad stories

Proinnsias Breathnach: One thing that has always struck me about Irish economists is that, despite the importance of foreign direct investment and international trade to Ireland’s economy, they actually know very little about the activities of the transnational firms in question, or the structure of Ireland’s foreign trade and, above all, about the factors which attract foreign firms to Ireland and allow them to use Ireland as a base for serving external markets.

Rather than conducting real research in these areas, most economists who write on these topics appear to draw on undergraduate textbook models of how markets operate – models which in turn were originally devised to explain the kinds of competitive markets for commodity-type products (clothing, food, furniture) which were fairly typical of the British and US economies in the 19th century. Subsequent developments, such as industrial concentration, globalisation, rising living and educational standards, advertising and marketing and technological change, appear to have bypassed many of these people entirely.

Thus, a few weeks ago, we had Anthony Leddin of the University of Limerick (writing in The Irish Times) postulating trends in Ireland’s foreign trade which anyone with knowledge of this area would have realised right away were completely wrong. More recently (January 28), and again writing in The Irish Times, former Central Bank Chief Economist Michael Casey wrote: “At present the only bright spot in the economy is the output and exportation of pharmaceutical products”. This is an extraordinarily uninformed statement for a person of this status to make. Of the nine broad product categories into which the CSO divides Ireland’s merchandise exports, eight experienced growth in nominal export value in the first ten months of 2010 compared with the same period in 2009. Of the total growth in these eight categories, pharmaceutical products accounted for less than half (46.5%).

The growth in total merchandise exports, in turn, accounted for only one half of the overall growth in exports (including services) in the first three quarters of 2010. The growth in exports of computer services in this period exceeded that in pharmaceutical products by 24 per cent. Many economists have been unable to internalise the fact that services exports exist at all, never mind that they have been the main growth sector in Irish exports for many years and, in 2009, accounted for 46.5% of total exports. In the five years to 2009, exports of both computer services and business services grew much more strongly than exports of pharmaceuticals. In 2009, exports of both computer services and business services exceeded exports of pharmaceutical products in value terms.

In that year, these three sectors, along with organic chemicals, accounted for over half of Ireland’s total exports. If we throw in insurance & financial services, food & beverages and office & data processing machinery, the proportion rises to almost three quarters. If one were seeking the key to Ireland’s international competitiveness, one should be looking at why these seven very disparate sectors are able to use Ireland as a successful base for serving external markets.

But this would require some real research. Instead, our economists reach for simplistic and largely irrelevant statistics which are both readily available and tend to confirm deeply-entrenched prejudices. We got a good example of this in an article on Ireland’s competitiveness by The Irish Times’s chief economics journalist, Dan O’Brien, in the issue of February 4 last. While acknowledging that there are many ways of measuring competitiveness and that the National Competitiveness Council employs more than 100 competitiveness indicators in its annual reports,O’Brien then devotes most of the rest of his article to the old diehards – prices and labour costs.

Irish economists have an extraordinary tendency to rely on the EU’s harmonised index of consumer prices (HICP) as a measure of competitiveness, even though its relevance to Ireland’s export competitiveness is not immediately obvious – it is hard to see what bearing the price of a meal or a CD player has on the competitiveness of the organic chemicals or software sectors. Nevertheless, O’Brien regards the fact that Ireland’s HICP fell relative to the rest of the EU between late 2008 and early 2010 as evidence of Ireland “regaining” competitiveness.

O’Brien then suggests that trends in economy-wide unit labour costs (the ratio of wages to net output) are a better indication of Ireland’s improved competitiveness. However, the fact is that the vast majority of the Irish workforce are not engaged in export activity and, again, it is hard to see how the unit labour costs of a waitress or CD player salesperson have a bearing on the competitiveness of the main export sectors identified above. While Ireland’s economy-wide unit labour costs have tended to rise relative to the rest of the EU over the last ten years, the opposite has been the case in unit labour costs in manufacturing, the great bulk of whose output is exported. Yet, while the latter are to be found in the same page in the OECD website as the former, they are rarely, if ever, quoted by Irish economists.

There are no comparable data for export services, but the Forfás Economic Impact surveys indicate that payroll costs as a proportion of value added in foreign-owned export services (which account for 95% of the total) fell from 19% in 2000 to 9% in 2008 – a fall of over 50% in unit labour costs.

This is not to say that labour costs are important (never mind crucial) in the competitiveness of Ireland’s main export sectors. If general labour costs were a key determinant of competitiveness, then one should expect exports in all sectors to be influenced by labour cost trends. However, Ireland’s main export sectors have been very variable in their export performance, and there is no evidence that this variability has been influenced in any way by labour cost trends. Between 2000-2006 (the last year for which the relevant data are available), the chemicals & pharmaceuticals sector experienced volume output growth of 50%, despite a rise of 50% in the share of costs accounted for by pay (up from 12.6% to 18%). In the electronic components sector, there was a more modest rise in the labour share of costs from a lower base (up from 13.1% to 16.4%) yet production volume fell by 7%. In the office machines and computers sector, a fall in labour’s already very low share of total costs (down from 4.1% to 3.5%) produced volume growth of 22% - much more modest than that experienced by chemicals & pharmaceuticals.

The key point is that the idea of Ireland Inc. gaining or losing competitiveness is meaningless. Ireland’s exports are dominated by a small number of sectors whose characteristics are extremely varied and whose export performances are equally varied. Adding up these performances and then concluding from the total that Ireland is becoming more or less competitive is pointless. Over the last ten years Ireland has experienced strong export growth in a range of export services, and in pharmaceuticals and medical devices, modest growth in chemicals, and, overall, a sharp fall in exports of electronics hardware. A wide range of factors account for this export variability, of which labour costs play, at most, a minor role. In compiling its Global Competitiveness Index, the World Economic Forum employes no less than 113 quantitative criteria; in Ireland’s case labour cost factors account for less than two per cent of the total value of the competitiveness index.

The economists’ disconnect from the real world is nicely demonstrated from a passage towards the end of Dan O’Brien’s article. Referring to evidence that average productivity in Ireland has been raised by the collapse of the low-productivity construction sector, he suggested as an example that “a bricklayer produces less than the average assembly-line worker or office drone (sic)”. Productivity in the construction industry is indeed low when compared with manufacturing or business services, but O’Brien’s choice of bricklayers for his example was surely unfortunate. Assuming that earnings bear some relationship to productivity, in 2006, when industrial production workers were earning €601 per week, clerical and secretarial workers €540 and administrative civil servants €819, the average weekly earnings of all skilled construction workers came to €877 and there was one report of bricklayers at that stage earning over €3000 per week! The company making these payments was also reportedly paying its Turkish labourers €2.50 per hour. They might have been a better choice for O’Brien’s example.


juggernaut said...

I think Proinnsias is pot on except for the last paragrpah - the idea that wages are linked to productivity in the short run is highly questionable. A bricklayer layign 1500 block a week is as productive now as at the height of the celtic tiger - how much he gets for laying saad blocks will be very different.

Paul Hunt said...

It is reassuring to see some evidence that the deadweight costs being imposed by the non-tradable and sheltered sectors seem to have such little detrimental impact on Ireland's export performance.

It should, however, be a cause for concern that Ireland's exports come from so few sectors and should raise serious questions about the ability of these sectors - largely dominated by mobile MNCs - to expand and increase employment (and about the ability of other sectors to replicate their performance) in the current global environment.

Steve Daley said...

I agree wholeheartedly with Proinnsas' key accusation against economists. Namely, our learned economics lecturers can not peel themselves away from the popular rhetoric of business owners that excessive wage demands are harming international competitiveness.

I am sure many Irish businesses experience their business woes superficially as the burden of payroll costs. But as far as foreign firms are concerned, the capacity to operate profitably in Ireland is shaped by the general productivity of their operations not simply the cost base of salaries. This focus on productivity in a general sense is ignored by many economists because it does not suit the need for simplistic business friendly answers. Especially as this may expose the key problem of Irish-owned businesses, their unproductive management and models.

One question I do have, though, is why does Proinnsas ignore the key distorting factor of transfer pricing prevalent in FDI decisions. This 'creative accounting' process swells the export value of foreign firms by overstating the value added of Irish-based activity to optimise the benefits of Ireland's low corporate tax rate. This begs the question: what is the true share of export value created in Ireland? The fictional share of value in the celebrated export figures of foreign firms includes much value created elsewhere by foreign employees of such MNCs. So is the competitiveness of these dynamic foreign firms the outcome of parasitic tax arbitrage?

Paul Hunt said...

@Steve Daley,

I think we all know, but some are reluctant to sdmit it, that the answer to your final question is 'yes'. It also provides the pretext - under the rubric 'fiscal dumping' - for some low politics conducted by some core EZ politicians seeking to extract further concessions from Ireland before they agree to present their voters with the bill to share some of the debt burden being carried by the peripherals.

Some serious reform of political governance and meaningful structural economic reforms of the non-tradable, sheltered sectors will be required to deflect their focus on the CT rate. We have to defend this until we have a viable alternative strategy.

Proinnsias Breathnach said...

There is an important difference between physical productivity (how many blocks you can lay in a week) and economic productivity (how much you get paid for laying the blocks). Economic productivity, more formally, is the real value added by a worker per work-time period. The reason bricklayers were paid so much during the boom was because the value of what they were producing (houses) was skyrocketing and the builders could afford to pay these wages (in the context of a relative scarcity of brickies). Because the value of houses rose much more rapidly than prices generally, this was real value added, with the brickies getting their share. With house prices falling, so has brickies’ pay. Physical productivity may have fallen (e.g. fewer hours worked per week) but not as much as economic productivity.

Proinnsias Breathnach said...

@Paul Hunt
Having a narrow range of export sectors is not in itself necessarily a problem – this is normally the case with small advanced countries. The potential problem for Ireland is that these sectors are mainly branch operations of TNCs whose main bases are located elsewhere. To be fair to the chemicals and pharmaceuticals sectors, their Irish operations have been very stable over the years, and recent addition of process development functions hopefully will add to this stability. And luckily for Ireland, the pharmaceuticals sector tends not to be much affected by general downswings in the global economy (reflecting the priority given to spending on health by middle-class consumers). In 2009, when global merchandise exports fell by a whopping 22.5%, pharmaceutical exports actually rose by 2.8%. Ireland did much better than this, with pharmaceuticals exports growing by 9.7% in 2009. In similar vein (pardon the pun), global exports of medical devices grew by 2.4%, with Ireland again doing much better at 10.3%.

Ireland’s rapidly growing services exports are mainly built around (1) IFSC-related activities which so far appear to be quite stable; (2) software which, although dominated by Microsoft, is now a quite diversified sector; and (3) a rapidly-growing sector involving Irish administrative centres providing business services to overseas clients and affiliates. A perhaps reassuring development has been the number of TNCs which, while scaling down their manufacturing activities in Ireland, have been replacing them with service functions (Ericsson, Apple and IBM immediately come to mind), indicating a commitment to maintaining an operational presence in Ireland (in their own interests, of course).

While a vibrant export-oriented indigenous software sector has emerged over the last 20 years, I’m afraid the prospects for the development of other indigenous export sectors are not great – and this has little to do with the current global downturn. Irish capital is too inclined to target investment in property and sheltered sectors, while there is a very poorly developed entrepreneurial culture here. There are historical reasons for this, but I think the development agencies have also lacked imagination in their approach to indigenous enterprise development, which needs to be built up through networks and clusters in order to achieve the scale economies required to compete in global markets.

Proinnsias Breathnach said...

@Steve Daley
I didn’t really go into the reasons why TNCs come to Ireland in my piece, which is mainly devoted to demonstrating that labour costs are not among these reasons. The ability to exploit Ireland’s low corporate tax regime via transfer price manipulation is obviously a major factor here. Most pharmaceuticals firms operating here, as well as other firms such as Microsoft and Google, are extremely profitable (via monopolistic positions in segmented markets) which makes Ireland a very attractive location from this point of view. Electronics hardware is much more competitive – especially since China entered the market – so Ireland’s tax regime is less significant as a locational factor, especially at the more routine end of the sector which has largely disappeared in recent years.

It is very difficult to calculate the extent to which TNC output is exaggerated through transfer pricing (not least because of the monopolistic positions of the main actors involved which means that open market prices do not apply), but the scale of the annual profit outflow indicates that it is very large. At the same time, to the extent that the scale of imported profits is proportional to the level of real production in Ireland, then the trend over time in declared output levels should parallel trends in real output in the Irish operations. In other words, say the pharmaceutical sector was routinely boosting its declared output level by 30 per cent through transfer price manipulation, then a year-on-year growth of ten per cent in declared output would involve a ten per cent growth in production in the sector’s Irish plants and a ten per cent growth in the volume of imported profit which is added to the latter to give the total declared output growth. What I am saying here is that the strong reported growth in TNC exports is not just a function of transfer pricing, but represents real growth in TNC operations in Ireland.

This, incidentally, does not apply to the worrying recent growth in foreign firms setting up brass-plate “virtual” headquarters in Ireland which, to my view, is bringing Ireland into disrepute among the global business community and among governments elsewhere.

Paul Hunt said...


Many thanks for your thoughtful and considered response. The issue I have been banging on about, here and elsewhere, for some time is that we have been successful at leveraging our position at the intersection of the trans-Atlantic economic space defined by the US and UK and that defined by the EU single market, but there have to be doubts about our ability to leverage this any further - or, indeed, to sustain it.

Despite having a Democratic Party president the Neocons still rule the roost in the US. The US's ability to project military power is running into the ground in Afghanistan; its ability to project political power died in Tahrir Square in Cairo. The persistence of domestic unemployment will forge an inward-looking and isolationist US. It has gone through these bouts during its history.

This does not augur well for further US FDI in Ireland - or for increased rational economic engagement with the EU in general. The slow, but building, political pressure in the EU to rein in the forces of global financial capitalism will discourage US engagement in this area - which might not be a bad thing - but it will have knock-on effects in other sectors where more economic engagement would be beneficial.

Britain is in terminal decline and disengaging ever more from the EU. Core EZ politicians, in dread of thier voters, are playing low politics attacking Ireland's low CT rate. However, in addition to its attempt to impose fiscal discipline on the EZ, Germany has a strategic vision for the EU as an exporter of high value, high knowledge-content goods and services to the energing economies in the G20. It is pursuing this strategy successfully and its neighbours are happy to be - or see no voable alternative to being - economically alligned to this strategy. Ireland is not engaged with this - and by virtue of distance and previous policy has decided not to be engaged.

The key question is: should we? And in considering this question calmly and rationally we should eschew the German-bashing by some in politcial circles and the media.