Bad news from Germany

So far in 2009, Ireland’s manufacturing output and exports volume are spectacularly outperforming Germany’s, a fact which appears to have escaped the attention of most economists here. In Germany both are down about 25% in the first few months of 2009 as compared with the same months in 2008. In Ireland both are more or less at the same level, possibly down 1% or 2%, in the first few months of 2009 as compared with the same months in 2008.

Why the difference?

Well, Finfacts this morning reports the following for Germany:

http://www.finfacts.ie/irishfinancenews/article_1016872.shtml

“The fall in the number of hours worked was particularly striking in industry where it amounted to – 10.6%. The decline in production led to a reduction of overtime hours in working time accounts, to a decrease in the number of weekly working hours and to short-time work. All these factors made the price of labour as a production factor rise in relation to the number of hours actually worked and to what was produced. Consequently, labour costs per hour went up 11.2% in industry and unit labour costs rose 24.9% against the same quarter one year earlier.”

These statistics highlight the German problem. In its tightly regulated economy it is very difficult to sack people. When production slumps (by 25% y-o-y in this case), relatively few employees are laid off. Instead working hours are reduced, with the employees often receiving hourly increases in pay to maintain their incomes. The result: labour costs go through the roof. As the Finfacts figures show, unit labour costs in German industrt rose 24.9% y-o-y. A truly disastrous outcome.

In Ireland, as CSO figures also out today show (link below), the response would be different. More employees would be laid off, but working hours for those reamining would fall relatively little and unit labour costs would not rise, even when output was falling. Obviously, this is not good for unemployment in the short run. But, in the long run it helps expalin why over the past two decades the Irish economy has completely outperformed the German economy. Although industrial unit labour cost figures for 2009 Q1 have not yet been published for Ireland, based on the firues for industrial output and employment, I’d say its very likely that, when they are published, we’ll see that industrial unit labour costs in Ireland were lower in 2009 Q1 than in 2008 Q1, in contrast to the 24.9% rise seen in Germany.

http://www.cso.ie/releasespublications/documents/earnings/current/earnlabcosts.pdf

If I were Angela Merkel, I’d be more worried about the fact that one quarter of Geman industrial output and exports have gone up in smoke in the past year than whether or not Ireland’s goverment debt as a percentage of GDP does or does not reach 80% of the German level in the next few years.

So far in 2009, Ireland’s manufacturing output and exports volume are spectacularly outperforming Germany’s, a fact which appears to have escaped the attention of most economists here. In Germany both are down about 25% in the first few months of 2009 as compared with the same months in 2008. In Ireland both are more or less at the same level, possibly down 1% or 2%, in the first few months of 2009 as compared with the same months in 2008.

Why the difference?

Well, Finfacts this morning reports the following for Germany:

http://www.finfacts.ie/irishfinancenews/article_1016872.shtml

“The fall in the number of hours worked was particularly striking in industry where it amounted to – 10.6%. The decline in production led to a reduction of overtime hours in working time accounts, to a decrease in the number of weekly working hours and to short-time work. All these factors made the price of labour as a production factor rise in relation to the number of hours actually worked and to what was produced. Consequently, labour costs per hour went up 11.2% in industry and unit labour costs rose 24.9% against the same quarter one year earlier.”

In other words, the highly regulated German system is producing a massive increase in industrial unit labour costs because its extremely difficult to lay off people there even when output slumps. I’ll wager that, when industrial unit labour costs in 2009 Q1 are published for Ireland, they’ll show a fall compared with one year earlier, in contrast to the 24.9% rise in Germany.

@Ahura,

Lucky industry positioning in the main. Pharmaceuticals is non-cyclical, unlike heavy machinery or motor. It doesn’t matter how competitive you are or aren’t, if you are producing cars today you are in trouble.

We are also well positioned to be so heavily in services. Figures from the US and UK (and elsewhere) show that as expected, services exports fall is not nearly as big as goods at around 6% qoq, and much of that because of transport and similar services which are complementary inputs to manufacturing, not commercial services (our thing). Finally, IFSC employment levels virtually unchanged at year end, with 0.4% reduction. Sub-sectors like insurance actually showing decent employment growth. When services figures come out, they are likely to be pretty ok.

We are, generally, well positioned in the export front, with a very good ‘portfolio’ spread of export sectors, each big enough to ensure we have sufficient scale, but none so big that we are particularly reliant on them. Our entire economy is not reliant on a Nokia.

Finally, the fact that our economy and policymakers had the vision to put in place the conditions for transformation away from textiles, electronics etc, was not an accident, and credit should be given where its due.

@Eamonn,

It is undoubted that there is a strong element of exaggeration in our trade numbers, though the GDP/GNP gap also reflects the ‘honest’ flow of the return of foreign owned capital abroad. However to conclude that our exports are ‘paper exports’ is a nonsense (except of course our exports under SITC 64).

There are 150,000 direct employees of MNCs in Ireland (including only firms under the IDA banner, so the true figure is higher). However this doesn’t begin to capture the contribution to the economy, and I suggest you spend some time going through the ABSEI report published by Forfas, http://www.forfas.ie/media/forfas081024_absei_2007.pdf.

It shows, for example, payroll costs of €7.7bn, materials purchased in Ireland of €3.5bn, services purchased in Ireland €7.2bn. This is before any benefit to the taxman. While not a fan personally of industrial tourism, you should take the chance to visit some plants in Ireland, as the operations of many firms here is very impressive.

Finally, can I point out that our current account deficit at the peak of the property boom was around 5%, half the Spanish level at peak, and a fraction of those seen in Eastern economies. Given our domestic imbalance was very large relative to most other economies, this suggests that the net contribution of the exporting sector (after income repatriation and imported inputs) was very strong in Ireland in htis period, and that we have a very strong competitiveness base.

Ronnie,

I fully agree. Great credit is due to those who laid the foundations to establish these comparative advantages. But that was then and this is now. Karl Whelan in his May 20th presentation (http://www.irisheconomy.ie/May20th/WhelanMay20thSLIDES.pdf) shows that total factor productivity has been in almost continuous decline for most of the last decade. The bursting of the property bubble and the global credit crunch merely removed the froth that was concealing the underlying reality.

Surprising little research seems to have been done into the internal investment and operational decisions of the MNCs that use Ireland as an export platform to the EU. Rapid increases in the costs of doing business in Ireland cannot but be damaging to Ireland’s international competitiveness. It appears we have only anecdotal evidence of the extent of reductions in the cost of labour in the private sector – and crucially in the tradable sectors – but, despite the favourable tax regime and the other advantages Enterprise Ireland used to to sell Ireland as an investment destination, I would be surprised if their patience isn’t wearing thin.

We seem to have a wonderful ability to wait until the wheels come off and then apply all our intellectual resources to develop comprehensive and erudite analysis explaining why the wheels came off, rather than applying ourselves to identify what needs to be done not only to prevent the wheels coming off, but to ensure they turn more efficiently.

I remain convinced that there is an urgent public policy requirement to bear down on the cost of doing business in Ireland and to promote efficient investment in transport, energy and communications infrastructure. This is vitally necessary to retain the existing MNCs, to attract more and to develop the key linkages with home-grown firms.

This leads us into the areas of competition policy, comsumer protection policy, regulation and the efficient financing of infrastructure investment. It is not surprising that the banks, the fiscal situation and the recent elections are dominating the public discourse, but we ignore these areas at our peril.

Ronnie,

I fully agree. We need to recognise the positives and build on those. A combination of luck and good policy has meant that we have not made the mistake of picking “winners” as other countries have tried to do – and failed conspicuously. From the late ’80s we created the conditions to attract “winners” and to facilitate the emergence of local “winners”.

My principal concern is that we are not doing enough to maintain and improve these conditions. I’m not denying that there is policy activism in some key areas, but we have all the trappings of “international best practice” in terms of “better regulation”, “promotion of competition”, “protecting the interests of consumers”, etc., and the application is not only dysfunctional, but actually damaging to the interests of businesses and consumers.

The property bubble (and its crazy financing) and the inevitable fiscal deficit exploded in its face, but this is the can of worms that the Government (and the permanent government) is determined to keep a lid on. This can will have to be tackled with the same intensity as the banks and the fiscal deficit. The lid can’t be kept on indefinitely.

Thanks Ronnie,

This is an area outside my experience, so it’s good to get an informed response on Irish exports. I’m assuming that the CSO external trade report is the source data. From this it appears that Chemicals and Related Products account for c.55% of exports. Although I don’t have a clue what Organic Chemicals relates to, this category sounds as though it should weather the downturn quite well. I’m not certain how service exports are quantified, but what is the ratio between services and trade exports?

There are a couple of items I’d like to dismiss. Would companies like Shire be excluded from these figures (i.e. are all exports manufactured here)? I’m reluctant to use Irish GDP (even GNP) ratios to benchmark to other countries. I think our tax system skews the numbers (I’m confident that serious crime has reduced dramatically as a percentage of GDP). If Ireland were to lose its corporation tax, how sticky are these operations?

@Ahura,

Sorry, missed the last question on corp tax. For a genuinely informed comment on this issue, read:

http://www.irisheconomy.ie/index.php/2009/05/12/us-fdi-in-ireland/

or other posts by Ron Davies.

My personal feeling is that corporation tax is important, though not critical, for a few reasons:

> Ireland had a hugely competitive corporation tax rate in 1980, though the quality of FDI was very weak. Since then the tax advantage has halved, yet the scale and quality of FDI has surged. Productivity capability of the country seems far more important than the tax rate;
> A huge amount of annual investment in Ireland is re-investment by firms already here. How much of this re-investment/transformation is necessary for a pure tax play?
> The sheer amount of genuine productive/employment activity in Ireland is impressive. As with the figures above, spending €18 billion on local jobs and services is an expensive way to run a tax scam.

Of course, we will never really know. Of course every survey asks firms if tax is important and, unsurprisingly, they say yes. Slightly changing the Karl Marx mental game: If we assume that corporation tax rate was utterly irrelevant in location decisions, firms would still say it is crucial, as it in their interests to say it is important. As such, this survey evidence is of little value.