Category: Economic Performance

There is a fascinating press release from SIPTU (the largest union) today: you can read it here.  The key segments of the press release are:

“Speaking after the meeting, the Union’s General President Jack O’Connor said, “The assault under way is about correcting the problem in the public finances without the wealthy contributing a single cent. It is equally about achieving the adjustment, which would normally be brought about through a currency devaluation, by driving down wages across the private sector as well.”

and

“While a devaluation would affect all sectors of society, cutting pay achieves the same results exclusively at the expense of workers.”

For a member of a monetary union, the analogue of currency devaluation is to engineer a reduction in the general price level relative to the price levels of trading partners (measured in the same currency). This indeed involves a reduction in the inflation-adjusted level of wages across the economy. In relation to the owners of firms, the impact on margins is ambiguous and depends on the structure of each industry. Firms that are exporters and are price takers on world should see an improvement in profitability, as should firms that produce goods and services that are close substitutes with imports. In contrast, firms in ‘nontraded’ sectors may well experience a decline in profitability, especially if these firms use imported inputs.

These considerations are basically similar whether the real devaluation takes the form of a currency devaluation or a decline in the general level of domestic wages and (domestically-influenced) prices.

The major problems with the current situation are:

(i) the national pay agreement is not supporting the attainment of real devaluation. Since the pay increases are still being implemented by ESB, Bank of Ireland and others, the goal of a ‘uniform’ movement in wages across the economy is being inhibited.  It would be better to cancel the existing agreement (the macroeconomic conditions now are far worse than when the deal was reached in September 2008).

(ii)  Wage adjustment is best accompanied by policies to promote competition among firms and, in regulated sectors, to ensure monopoly power is not abused.

(ii) while it is obvious that the overall fiscal adjustment package will require substantial tax increases (including a higher tax take from high income groups), the delay in announcing this component of the deal raises perceptions of unfairness, in addition to increasing uncertainty about the expected level of post-tax incomes for all groups in society. The government could do more in terms of explaining the likely nature of tax increases over the coming years (at least in broad terms). While the Commission on Taxation may have ideas in terms of expanding the tax base, much of the adjustment will be in terms of income taxes and (possibly) VAT.  The general strategy regarding these components could be communicated more quickly.

David McWilliams has expressed concern about the risk of deflation in Ireland and recommends that we “engineer inflation by pumping money into society”: you can read his article here.

For a member of a currency union,  there is a natural limit to national-level deflation.  Ireland may well face a sustained period of inflation below the euro area average (such that it may be negative in absolute terms for a while), this is self-correcting since it implies an improvement in competitiveness, which will in turn generate a boost in economic activity and a return to an inflation rate at around the euro area average. In contrast, no such self-correcting mechanism operates for a country with an independent currency. So long as the ECB avoids deflation at the euro area level, a true deflationary spiral for Ireland is not possible.

Of course, even if deflation (or low positive inflation) is just a temporary phase for Ireland, it can last for several years. It certainly amplifies the extent of the downturn, since it implies the real interest rate (the nominal rate minus the expected rate of inflation)  will be high. This is the mirror image of amplification of the boom period that was generated by the low real interest rate during our prolonged period of relatively high inflation.

One lesson is that it is much better to have a sharp fall in the price level now (generated by wage cuts and efforts to cut markups through more aggressive competition policies), rather than a gradual decline in the price level over several years.

It is worth remarking that the structure of the national pay deal does not provide the appropriate kind of ”incomes policy” that can help this process. In particular, deviation from the national pay deal is only permitted if a firm is in very serious financial distress. Rather, we need cost reductions even in sectors that are still profitable, since prices of all goods and services matter for the level of competitiveness.

A good example is the ESB.  It would be very useful to see wage correction in this sector, which will help to reduce input costs for many businesses.

Another way to express this point is that the national pay deal can accomodate firm-specific shocks but not macro-level shocks. To respond to macro-level shocks, the national pay deal should be re-negotiated to allow a generalised reduction in costs across the economy. (As a complement, competition policies could be reinforced and ‘administered’ prices could be forced down.)

Predictably, if sadly, Sarkozy’s idea of a Berlin summit to discuss what should be done if a Eurozone member were to get into trouble has been dismissed by Berlin. Discussing such things ex ante, on a purely theoretical basis of course, will turn out to be preferable to discussing them ex post, if ex post ever arrives. The German reasoning is that some things just shouldn’t be talked about in public:

A Berlin, un porte-parole du gouvernement, Thomas Steg, a estimé qu’une telle rencontre n’est “pas nécessaire dans l’immédiat. L’expérience nous a appris qu’il y a certains sujets relevant de l’Eurogroupe dont il vaut mieux ne pas discuter en public”.

Whether saying publicly that there are certain things that you shouldn’t talk about publicly is in fact reassuring, is probably something that one could debate.