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Competitiveness

Pages 9-13 of the report contain an impressive array of data showing indications of Ireland’s falling competitiveness. They also indicate that the IMF team and the Irish authorities disagreed about the extent of the competitiveness problem, with the Irish being more optimistic (due to our falling wages). We all agree, I presume, (and the IMF agrees) that to the extent that our nominal wages fall, we will become more competitive. But, it would be nice to have more data on the extent to which this is happening, in Ireland and elsewhere. As the IMF points out, you can’t just assume that wages are not falling in any of our competitors (and that is even leaving aside the issue of nominal exchange rate changes). Good comparative quantitative evidence (as opposed to anecdotes) would be nice: does anyone know of any?

17 replies on “Competitiveness”

Kevin, it would be a mistake to assume universal support for the proposition that a fall in nominal wages will increase our competitiveness. The argument that wages, in general, are somehow uncompetitive, is rarely supported by hard data. Data necessarily lags but the German Statistical Board shows Ireland at the bottom half of EU-15 table – in both the private and manufacturing sectors (compared to the top 10 EU economies, Irish private sector wages trail the average by over 12% – http://www.destatis.de/jetspeed/portal). In our modern manufacturing sector, wages make up, as a rule of thumb, 4% to 7% of costs. Even to cut wages by 10% would have only a fractional effect on the cost structure. Indeed, the Industrial Relations News reports that almost all chem/pharm companies have paid the first tranche of the wage agreement, indicating that wage increases in this sector, at least, are not a factor in competitiveness.

It’s worth noting that the few sectoral reviews, again, do not indicate wage uncompetitiveness. Forfas’s survey of costs in the retail sector show that Eurozone competitors (at least the only one they surveyed – Maastricht) pay higher wages than in Ireland but still manage lower overal running costs. That’s because our cost structure suffers from non-wage uncompetitiveness (rents, IT and telecom costs, etc.). As well, IBEC’s recent review of the Food/Drink sector didn’t refer to wages but did point out the high cost of energy (a result of Government liberalisation policy), waste costs, low levels of R&D and the high concentration in the grocery retail sector which can lead to abuse of market power.

There is no doubt that some wages in some sectors are being re-adjusted – whether out of economic necessity or opportunistic management initiatives. However, to actively pursue a policy of wage reduction will exacerbate the fiscal deficit, place further pressure on private consumption, increase debt – and at the end of the day we will still have a cmpetitiveness problem.

Michael,

Fully agreed. AMECO data also suggest that as of 2008, manufacturing wages were 16% below the average Northern European economy. Services wages were slightly higher than average, but this is beacuse of relatively high public sector wages in Ireland (and these are clearly very high).

More generally, the size of the CA deficit at its worst (5%) was half that of Mediterranean countries (e.g. Spain 10%, Greece 14%) and was not an outlier compared to other wealthy Western economies (e.g. US 6%, New Zealand 9% and Australia 6%). Given the size of the domestic imbalance, would a CA deficit at least in double figures as a % GDP not be needed to convincingly prove that we have an external competiveness problem?

Thats is not to say that – competitiveness wise – we don’t have some problems as well as some assets. I think turning to Philip’s post on structural reforms, it is a pity a far greater emphasis isn’t placed on non-tradable costs outside of wages, namely reform of payment systems, legal sector, water, public transport …. the usual list. Of all the hard decisions that will be made in the next 12 months, I would have thought that these would be relatively easy.

@Ronnie: the current account really can’t tell you anything about competitiveness. Collapsing economies tend to see their current accounts improve. On the other hand, the IMF report gives an impressive array of graphs indicating worsening competitiveness. You would need to show why those specific indicators are irrelevant/wrong to make your argument.

@Michael: I stand corrected. We don’t all agree.
Where do we agree? Let’s start with the real exchange rate, EP*/P. I am defining E the American way, so an increase in E is a nominal depreciation. The problem is that our price/cost level is too high relative to those of other countries. And we can’t change E either. So, we need to reduce P, the Irish price level, or increase P*, the foreign price level.

I guess we agree on two things.
1. It would be much much better for us if P* were to increase. This would be a much easier adjustment than a decline in P, avoiding the debt issues that you correctly point to as constituting a major problem. Unfortunately the Germans are obsessed with inflation, to the point of worrying about it in a deflationary environment. And while the British and Americans are more focussed on the real problems facing the world economy, this will probably just lead to E moving in the wrong direction. So, I don’t see a deus ex machina helping us out here (but would love to be proved wrong).
2. It would be good if we could reduce non-wage components of P. (Ronnie agrees with that also.)

I am less clear on where we disagree. Do you disagree with the proposition that lowering wages will contribute to lowering P? Or do you go so far as to disagree with the proposition that the labour demand curve is downward sloping?

Kevin:

I didn’t mention anything about the improvement of the CA since 2007. I focussed purely on the pre-collapse deficit of 5.5%. My point is that it wasn’t huge compared to other countries. The case that it was because of an excess of imports, rather than an absence of exports, can’t be lightly dismissed, though many commentators interpret the external balance solely through the lens of exports.

In terms of the data, I have to say I just don’t understand the discrepancy between the wage data quoted by the IMF (high wages), and the AMECO & Forfas (middling wages). Anyone who has any insight into this please help.

Finally, in terms of the FDI data, UNCTAD data on jobs created suggests that as recently as 2007 Ireland attracted a far higher portion of Greenfield FDI per capita than virtually any other major economy, second only to Singapore, and 5 times the OECD average (Page 45 http://www.forfas.ie/media/ncc090108_acr_2008.pdf). Greenfield is the ‘good stuff’ and strips out all the M&A and privatisation projects which tend to skew the data. In any case, the IMF themselves have in the past drawn attention to the weaknesses of measuring FDI flows through NA data.

Where the IMF are right is that consumer prices are high. Hence the need for a comprehensive programme of non-pay costs, and to get away from the sole focus on wage slashing.

Ronnie, OK, your comment was about pre-crash. I accept that and apologise. Presumably you agree that an improving current account now tells us little about competitiveness. But I would tend to view the pre-crash current account deficits as reflecting savings/investment/borrowing decisions, rather than reflecting competitiveness. Indeed the causation goes the other way round, not from competitiveness to deficits, but from borrowing to a bubble to spiralling costs and worsening competitiveness. The broader point that you can’t infer a whole lot about competitiveness from the current account still holds IMO.

Thanks Kevin

Excuse me for being a little thick, I just want to be clear: If you are saying that the causation is from deficits to competitiveness, then presumably the only ‘excess’ costs in the economy are the ones generated since 2005, when the CA deficit first emerged. Given the time it takes for these excesses to feed through the labour market, local services etc, presumably this can only have started seeping through to the traded sector in (say) 2006? Is that a fair reading of your view?

If it is, then I just don’t see the salary increases since 2006 being of a sufficient scale to knock our compeititveness for six. Further, relative HICP in Ireland/Euro-area is back to February 2003 levels based on the May flash estimate.

Finally, given the direction of causation from deficits to competitiveness, is it not reasonable to believe that along the way we chalked up a serious level of excess imports?

… while taking Kevin’s point that the CA surplus will be flattering this year, as clearly households and business have excessive savings. Still, Ireland’s merchandise surplus Jan – Apr (just released) suggests a total in excess of €40bn for the year, against typical forecasts of €30bn. So much for the OECD prediction of a 10% fall in Irish exports ….

The merchandise trade figures for April have just come out. These show that in April, Ireland’s merchandise exports were 12% higher than in April 2008. In the same month, Germany’s were down 28% year-on-year, while most EU countries recorded year-on-year falls in the range 20% to 25%. I haven’t checked all figures yet, but its very likely Ireland was the only country in the developed world to record a year-on-year increase in April. The first 3 months of 2008 showed a similar, although not quite as good, pattern. Perhaps someone can explain why its necessary to cut wages in Ireland and not elsewhere?

@John: the reason is simple: unemployment heading for what..15%? 17%?

I think rather than focussing on competitiveness (and thus mea culpa as regards the title of this post, but that is how the issue is typically discussed), it is more helpful to ask: what is the real exchange rate consistent with internal and external balance? What is the real wage consistent with same? Of course answering those questions requires an economic model. The IMF says we are about 15% overvalued in real terms.

@Kevin

How exactly does the unemployment rate in Ireland affect the fact that exports are up 12% y-o-y, while down by 25% in every other country? It may affect imports, but not exports.

The scale of our economic collapse is simply staggering and denial is not much help. As I said, the important question is: what is the real wage consistent with internal balance (full employment) and external balance (a sustainable current account, however that is defined). We are heading for enormous levels of unemployment. Hence the real wage is too high/real exchange rate is overvalued.

@Ronnie: capital inflows causing real wage increases and real appreciations will damage competitiveness. That’s not to say that you couldn’t have internal things like benchmarking or domestically generated bubbles also doing damage, so I don’t think that 2005 is the starting point.

@Kevin

Thanks for that, we’re at agree to disagree stage I think.

On the point that denial of our internal imbalance is not much help, neither is making up problems that we don’t have. There is very little basis for the contention that Ireland has an external competitiveness problem on a number of metrics, yet it is held as a virtual unanimous article of faith amongst economists. The economists that spend the most time thinking about exports (Barry, Grimes, Van Egeeraat etc) are actually very impressed by the transformation of Ireland’s MNC base over the last decades, while noting increasing cost pressures as a distinct problem (though these guys can talk for themselves, and I am happy to be corrected).

If you are now saying (if I get you right) that, ok, we don’t have an external balance, but the size of the internal imbalance requires we be super-competitive for a few years, then well and good.

However even at that I find it surprising that the policy prescription (pay cuts) seems to be the same regardless of what the source of the problem is. If the problem is an excess of private level saving currently, not external comptitiveness, then is there not a benefit from at some point signalling that pay cuts are over, and tax rises will stop?

@Ronnie: the Salter Swan model is the one I carry around in my head at times like this, and teach my students. If you have an overvalued real exchange rate, then you can hit external balance, but at the expense of unemployment; or you can hit full employment, but at the expense of external imbalance. We have gone from the latter to the former. The only way we can hit both targets simultaneously is to have a real depreciation. In all these models there is a strong link between the real exchange rate and the real wage, hence the need for wage cuts. (But, to repeat, Eurozone inflation would be a much better option from our point of view, for this and other reasons.)

Kevin, it may well be that reducing wages will reduce prices but that is contestable and requires a more detailed analysis of how different employers/owners respond in different sectors. For instance, a reduction in wages may be used to assist cash flow – a not unreasonable development in light of difficulties in accessing credit for SMEs. Further, Eurostat shows that the gross operating surplus (or rate) is higher in Ireland than in most other EU countries – nearly 2.5 times higher – which suggests that some businesses have pocketed the difference in wage levels rather than passing it on to consumers. There are too many factors to automatically assume a decline in wages will either impact significantly on prices or competitiveness – especially as our wage levels are already relatively low compared to most of our EU-15 partners. The debate would be assisted by more sectoral-specific evidence.

Ronnie – the discrepency you identify arises from the IMF’s use of a particular piece of Eurostat data which can be found in one of their Statitstics in Focus publications. However, other data publications (e.g. datasets, business reports) from Eurostat show different results. Legitimate differences arise per the methodology used. But I have noted that many commentators use the Statistics in Focus data (I assume the IMF did as well) without referring to other data from Eurostat – never mind the OECD, AMECO, US Bureau of Labor Statatistics, German Statistical Board, etc.

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